Complexity Hides Reality - Arrest Of Alleged Flash Crash Trader Doesn't Solve Broader Issue

According to the CFTC Nav Sarao Futures Limited PLC used various manipulative tactics to game the price of the S&P 500 e-mini futures in Chicago. Specifically Sarao targeted the “intra-day price of the lead month of theE-mini S&P” according to the complaint.

There were various efforts to manipulate prices on multiple days

• April 27, 2010
• May 4, 2010
• May 5, 2010
• May 6, 2010
• May 10, 2010
• Jan 28 2011
• Feb 22, 2011
• Mar 4, 2011
• May 2, 2011
• July 29, 2011
• August 4, 2011
• Mar 10, 2014

Navinder Sarao used layering to mislead participants by stacking the order books with orders designed to be seen as aggressive in size but far enough from the last price to be executed against. Those order would move up and down the ladder as spot prices changed. Those orders “ constituted as much as 40% of all active sell-side orders.” That’s unreal! How could one trader exert that kind of influence over the market?

The complaint alleges Sarao used Layering Algorithms along with Flash Spoofing to manipulate prices. Very similar to what Hold Brothers was fined for doing to its own traders.

One problem in this never-ending drama is the inability of the under-funded and under-equipped SEC to regulate the markets or as Michael Lewis called them the “rigged markets”. Recall when the head of Direct Edge William O'Brien couldn’t remember what data feed his exchange used to match trades inside of its matching engine.

At the time of the flash crash all eyes turned to the SEC. Gregg Berman who at the time was the Director of the Division of Trading and Markets made clear that SEC was using all its resources to analyze how US markets lost 10 percent in a manner of minutes. In a documentary with VPRO Berman said “We developed and deployed a multi-divisional, cross-functional team, a big team…basically consisting of every division at the SEC.”

In the final report of what happened the SEC pinpointed what they thought was the reality of the situation:

This account was challenged by Nanex, a data outlet that decided on a whim to analyze the data it had collected during the Flash Crash. Nanex was handed the trades that Waddel & Reed made, the alleged mutual fund seller the SEC identified in its report. Nanex plotted those trades against its data and learned that Waddel & Reed could not have been the culprit.

The impact of this large seller is now very clear nearly 5 years after the Flash Crash as the Justice Department document highlights:

What is so clearly disturbing here is not only the question of how safe our markets are from rogue participants (DOD already looked into this Irregular Warfare) and how he knew what orders to use. Remember, many in the anti-HFT have shown that the special order types created to allow strategies like Sarao’s to operate were not disclosed in public filings.

The core of this entire discussion rests on the evidence of undisclosed order-types being used by inner-circles (as exposed by whistle-blower Haim Bodek in Dark Pools and subsequently in The Problem of HFT) and whether this should have been known to exist by all market participants in the years following the 2007 Reg-NMS ruling.

Surely there will still many more months if not years to pass before this situation is settled and by that time who's actually going to care anymore?