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Peek ahead - To Catch a Spoofer

Published in Automated Trader Magazine Issue 37 Summer 2015

The first response to Peek Ahead's inquiries after the flash crash trader arrest was: "What a load of bollocks." As it turned out, that pretty much summed up the industry's viewpoint.

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It just seems so unlikely that some guy in some house in a London suburb, Hounslow, was such a nuisance that he could be a major factor in the flash crash of 2010.

Soon enough, the mainstream press started calling the man in question, Navinder Sarao, "Hound of Hounslow", a moniker Peek Ahead thinks is terrible hackery of the lowest order. Among our own conversations, the term "scapegoat" came up more than once.

Extradition proceedings are ongoing.

For those keen to form an independent opinion, there are dozens of pages of evidence released by the CFTC, including emails. One expert told Peek Ahead that Sarao's 2014 correspondence with UK regulator, the FCA, is "comic". In that email, Sarao claimed he is an "old school point and click prop trader" and that HFT should be banned.

Maybe it's for this reason that conspiracy theories abound that it was HFT firms pulling strings behind the scenes. But our favourite example of big picture thinking is: "Once again the US seeks to corner the market for themselves. They did the same with porn, betting and now exchanges."

Meanwhile, there is a chorus of critics wondering how there could be such a major oversight in the SEC-CFTC flash crash joint investigation. Not a whisper of Sarao or reference to his activities anywhere. Is this incompetence on a grand scale?

Regulators are a great target for ridicule, but it should be noted that high profile CFTC commissioners have put out a call for more sophisticated tools. Before taking the helm as CEO of ISDA, then commissioner Scott O'Malia made waves by dissenting from a budget request in 2014 because technology was underfunded.

More recently, commissioner Mark Wetjen said that there was no point in waiting for US legislators to get it together, and that partnering with exchanges for access to order book and message data might well be the way forward.

Also, many of the same people who scoff at the idea of some kind of flash crash causation think that there's a strong case for spoofing, in which large amounts of orders are sent with no intention of execution. The CME had warned Sarao about his activities as far back as 2009.

There's lots of questions about what the CFTC knew and when, but to gain any clarity Peek Ahead would simply have to see the evidence from the whistleblower who sparked the investigation.

That's unlikely to happen since the whistleblower has for now chosen to remain anonymous, but it should be noted that his or her legal counsel is the same as that of Haim Bodek, whose order type allegations led to a $14 million fine against BATS Global Markets for legacy Direct Edge practices.

If Haim Bodek had not been put in a position where he felt it necessary to reveal detailed evidence to a wider public, it's likely his allegations would have been scoffed at as well.

And then of course, there's self-interest.

In the US, a whistleblower is eligible for a payout of between 10% and 30% of any money recovered over $1 million if information leads to a prosecution. Sarao has been accused of making $40 million, which translates to a potential pay day of between $4 and $12 million.

Maybe that's why Peek Ahead is starting to hear talk of "algo bounty hunters", who will track down evidence against evildoers manipulating US markets and deliver it to regulators. And that could be a rewarding task for data gathering investigative types.

It could also be some food for thought for regulators in Europe, where whistleblowers are as likely to get thrown in jail as rewarded.

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