Where Were The Regulators?


“On average, on the Example Price-Impact Days, Defendants used the Layering Algorithm to place hundreds of orders for tens of thousands of contracts that were modified thousands of times and eventually canceled over 99% without ever resulting in a trade.” – CFTC Complaint Against Navinder Singh Sarao, 4/21/15

The numbers in the above statement are astonishing  especially since they were done by a single trader.  But more astonishing is the fact that Navinder Singh Sarao perpetrated this alleged fraud for years before finally being arrested yesterday in the UK.  While the folks at Nanex have spotted and documented these spoofing events numerous times over the past few years (see above picture), regulators let Sarao continue his manipulative behavior.  There are at least three levels of surveillance which should have spotted Sarao’s spoofing activities: his FCM (futures commission merchant), the CME and the CFTC.


We know from the CFTC case against Sarao that he switched FCM’s often : “Defendants traded the E-mini S&P at four futures commission merchants (FCMs) during the Relevant Period: FCM A (April 2010 to October 2011), FCM B (November 2011 to January 2012), FCM C (July 2012 to August 2012), and FCM D (August 2012 to June 2014). “​

We also now that the MF Global, which went bankrupt in 2011,  was his FCM at the time of the Flash Crash which may explain a few things.

But we don’t know why these FCM’s didn’t aggressively investigate Sarao.  Anybody that has ever sat through a Series 7 or Series 24 Continuing Education exam knows that suspicious activity must be reported to the brokers compliance department.


The CME should have easily been able to spot these spoofing orders and they did.  They approached Sarao in 2010 but for some unknown reason decided not to pursue him.  Yesterday, the CME issued a statement on the Sarao case:

Following the Flash Crash on May 6, 2010, together with other regulators, we did a thorough analysis of all activity in our markets during the Flash Crash, and concluded – along with regulators – that the Flash Crash was not caused by the futures market.  If new information has come to light, we look forward to reviewing it with the Commission.”

We know the CME has always been a staunch defender of their exchange but this statement is bordering on laughable.  The CME has long claimed there vertical silo market is superior to the fragmented equity market but they allowed this level of spoofing to continue for years. We would think that spoofers are much easier to spot in vertical silos as opposed to the fragmented equity markets.  We think the CME has some explaining to do.


Yesterday, Bloomberg published an article on the Sarao case which included some damning statements about the original CFTC/SEC Flash Crash investigation:

It turns out regulators may have missed Sarao’s activity because they weren’t looking at complete data, according to former CFTC Chief Economist Andrei Kirilenko, who co-authored the report. He said in an interview that the CFTC and SEC based their study of the sorts of futures Sarao traded primarily on completed transactions, which wouldn’t spotlight the thousands of allegedly deceitful orders that Sarao submitted and immediately canceled.

Spoofing wasn’t even part of the CFTC’s analysis of the crash, said James Moser, a finance professor at American University who was the agency’s acting chief economist in May 2010. The flash-crash review marked the first time that the agency worked through the CME’s massive order book. CFTC officials often needed to call the exchange for help interpreting the data, he said in an interview.  “We didn’t look for any sort of spoofing activity,” said Moser, who added that he doubts that Sarao’s activity was the main cause of the crash. “At that point in 2010, that wasn’t high on the radar, at least in our minds.”

The CFTC examined trades and not orders when analyzing the Flash Crash.  And it took them five months to do this? This explains why they originally blamed a Kansas City mutual fund for the Flash Crash.  The mutual fund was actually the victim and not the culprit.

The CFTC and SEC are funded differently (the SEC is self-funded and the CFTC is funded by the government)  and have different oversight committees in Congress (the SEC is overseen by the Financial Services Committee and the CFTC is overseen by the Agricultural Committee) but they share a common goal of protecting investors.  In order to carry out this investor protection goal, we believe it is time for the CFTC and SEC to merge their surveillance methods.  Last week ex-Fed Chair Paul Volcker also called for the merging of the CFTC and SEC and said:

“The system for regulating financial institutions in the United States is highly fragmented, outdated, and ineffective.  A multitude of federal agencies, self-regulatory organizations (SROs), and state authorities share oversight of the financial system under a framework riddled with regulatory gaps, loopholes, and inefficiencies.”

The real issue here is that markets have dramatically changed over the past two decades but regulators have not kept up.  While technology has increased efficiency and brought down trading costs, it has also changed the way traders access the markets.  Many trading strategies can reach across asset classes instantaneously but regulators continue to see the markets as separate asset silos.  If the E-mini S&P futures contract price is being manipulated, then maybe other markets around the globe are also being manipulated because of the high correlations that technology has brought to the market. Regulators need to take a more unified view of the markets.