By Bradley Hope in New York, Chiara Albanese in London and Aruna Viswanatha in Washington
In his first comments since being arrested for allegedly
manipulating the U.S. futures markets and contributing to the 2010
"flash crash," the London day trader Navinder Singh Sarao said he
had "not done anything wrong apart from being good at my job."
A judge ruled against granting Mr. Sarao, 36 years old, a lower
bail. He was unable to post the GBP5 million ($7.6 million) bail
because his assets in the U.S. and in offshore banking
jurisdictions had been frozen, according to his lawyer, James
Lewis. Describing Mr. Sarao as "a man of good character," he vowed
to appeal to the High Court.
The U.S. Department of Justice has charged Mr. Sarao with
criminally manipulating the U.S. futures market. The Commodity
Futures Trading Commission has also brought civil charges against
him for the same alleged acts. In court documents, the CFTC and DOJ
said Mr. Sarao's alleged trading contributed to the flash
crash.
Wednesday's hearing came as exchanges, regulators and
law-enforcement officials in the U.S. face rising pressure to crack
down on the market manipulation known as "spoofing."
Mr. Sarao's remarks in court Wednesday highlight a debate in the
trading community about what constitutes spoofing and how to
distinguish between illegal manipulation of markets and deft
trading.
The CFTC is pushing exchanges to monitor futures markets for
manipulative behavior and bring enforcement actions against rule
breakers. Stock-market regulators also are ramping up efforts to
identify and stop spoofers.
Meanwhile, a new civil case was brought against two traders,
Heet Khara and Nasim Salim , who allegedly used spoofing tactics to
manipulate the price of gold and silver on the CME Group Inc.-owned
exchange from the United Arab Emirates.
"I'm in touch with CME officials and cooperating with them in
the best of my capacity," said Mr. Salim. Mr. Khara couldn't be
reached for comment.
The 2010 Dodd-Frank financial-overhaul law outlawed spoofing,
but the practice has continued to plague the markets, traders
said.
The tactic is essentially bluffing, with a trader putting large
orders he or she doesn't intend to fulfill into the market to trick
others into moving the price in a way that is advantageous for the
spoofer. When successful, it allows the spoofer to continuously buy
low and sell high by pushing the price up and down by relatively
small amounts.
However, some traders have argued spoofing is ill-defined. They
say there are legitimate reasons to place and cancel orders, such
as market-moving news. Others have argued spoofing is an age-old
practice that only hurts other traders, not genuine investors or
companies.
In a letter to the U.K.'s Financial Conduct Authority, Mr. Sarao
described himself as an "old-school" trader who used "intuition,"
quick reflexes and a computer mouse, according to court
documents.
He said his trading was more legitimate than that of the
high-frequency trading firms who use high-speed telecommunications
lines, powerful computers and algorithms to buy and sell in the
markets.
Critics say spoofing distorts prices. It is particularly
bothersome to firms that make markets, a strategy where they
simultaneously offer to buy and sell securities or futures
contracts in the hope of capturing a tiny spread between those
prices.
Hudson River Trading, a high-frequency trading firm based in New
York that uses market-making strategies, developed a system to
identify suspicious trading that could be spoofing and might cause
the firm to lose money.
For instance, the system might send an alert when large orders
are placed to buy a stock, then are suddenly canceled and
apparently replaced by new orders to sell.
On an average day, the system finds 10 to 20 incidents that the
firm considers highly suspicious and several hundred that are
moderately suspicious, said Adam Nunes, Hudson River Trading's head
of business development. The firm regularly flags suspicious
activity to regulators and exchanges.
Hudson River's spoofing-detection system refers to potential
manipulators as Cylons, a reference to a race of robots that rise
up against humans in the TV show "Battlestar Galactica."
The Financial Industry Regulatory Authority, Wall Street's
self-funded watchdog, has developed alert systems for suspicious
trading in the stock markets, too.
Thomas Gira, Finra's head of market regulation, said many of the
flashes of volatility in stocks--where prices rapidly swing in the
blink of an eye--could be related to a predatory trader in the
markets.
"What we're doing is catching those flash points during the day
and running surveillance" on the apparent perpetrators, he said.
"In many instances, it might be a spoofing attempt."
Investigations can often be challenging because of their global
scope. Recent Finra cases have shown incidents in which groups from
countries such as China and Russia attempt to manipulate stock
prices. There have been cases where groups use multiple accounts to
carry out their strategies, making it harder for regulators and
exchanges to determine that one entity is behind the activity.
In the futures market, where Mr. Sarao was alleged to be
manipulating a key futures contract tied to the S&P 500
stock-market index, surveillance for spoofing incidents falls to
the exchanges and the CFTC.
The CFTC says it has been hamstrung by resource constraints,
with a 150-member enforcement staff that is smaller than what the
agency had before it obtained wide-ranging new authority under Dodd
Frank. With the reduced head count, the agency has encouraged
exchanges to pursue more suspicious activity and to refer more
cases to regulators.
Since Mr. Sarao's case was filed, CME Group has come under fire
for failing to bring his allegedly manipulative trading to a halt
despite having contacted him about tactics used on its exchanges as
early as 2009.
The CFTC has pushed the CME to do a better job in spotting
spoofing and taking action more quickly, and it conveyed that
message in a November review of the disciplinary programs of its
exchanges.
"Spoofing has always been prohibited in our markets," a
spokeswoman for the CME said in a statement last week, highlighting
a "strong record" and "numerous cases and associated
sanctions."
The CFTC also has pushed for the Justice Department to bring
more cases alleging trading violations, according to people
familiar with the matter, meeting with federal prosecutors in
Manhattan, Brooklyn, New Jersey, Chicago and the Eastern District
of Virginia.
CME has taken pains to show it is serious about spoofing. Last
week, it denied Messrs. Khara and Salim access to trading on its
platforms for 60 days for alleged spoofing. The CFTC followed on
Tuesday with its own charges against the two men.
The CME identified the alleged conduct in February and soon
after told Mr. Khara he was under investigation, according to the
CFTC complaint. After Mr. Khara's broker suspended his access as a
result of the suspicions, he opened another account with a
different broker and coordinated similar trades with Mr. Salim, the
complaint said.
A federal judge in Manhattan froze their assets Tuesday and
scheduled a hearing for later this month.
Write to Bradley Hope at bradley.hope@wsj.com and Chiara
Albanese at chiara.albanese@wsj.com
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