— This is the script of CNBC's news report for China's CCTV on April 23, Thursday.
A futures trader was charged by the CFTC on Tuesday with illegally manipulating the stock market during the May 2010 flash crash using E-mini S&P 500 futures contracts.
Sarao was arrested Tuesday in the U.K., and the U.S. is requesting his extradition, the DOJ said. The charges were filed in a federal complaint in February, but were unsealed Tuesday following the arrest.
The Commodity Futures Trading Commission also filed parallel civil charges against Sarao on Tuesday, calling him a "very significant player in the market."
The CFTC alleged in a conference call that Sarao was believed to have profited by about $40 million for his scheme. U.S. authorities have frozen nearly $7 million worth of his assets and accounts, Aitan Goelman, CFTC director of enforcement, said on the call.
[Kenny Polcari, NYSE Institutional Trader] "Once again we've allowed technology in this industry to control us versus us controlling the technology and I think that was made very clear by this arrest yesterday based on what this gentleman was able to do by using advanced technologies that was under the radar, certainly broke every law in the book by spoofing and layering and creating false interest either way."
On Wall Street, spoofing is defined as when a trader places a bid or offer on a stock with the intent to cancel before execution. Layering is a more specific form of spoofing. Layering is when a trader places multiple orders that he does not intend to execute. These fake orders allegedly trick other market participants by creating the false impression of heavy buying or selling pressure.
How is layering done in practice?
Layering is an advanced form of spoofing because it implies there are multiple orders and market participants on one side of the market. For example, if I wanted to buy S&P mini futures but at a lower price, I would "layer" five big sell orders above the current market price.
The complaint alleges that Sarao "used an automated trading program to manipulate the market for E-Mini S&P 500 futures contracts (E-Minis) on the Chicago Mercantile Exchange (CME)," according to the DOJ.
By manipulating these futures tied to the Standard & Poor's 500 Index, Sarao allegedly "earned him significant profits and contributed to a major drop in the U.S. stock market on May 6, 2010, that came to be known as the 'Flash Crash,' " the DOJ said in a release.
[Ben Lichtenstein, Tradersaudio.com] "I think that if one person can have that large impact on the market, considering the high frequency and electronic aspect of this market, I think we should be very concerned about closing pits down, and we should be very concerned about some sort of consorted efforts to make some manipulate and create some turbulence or some sort of uncertainty and major price movements."
However, some say spoofing should not be illegal, including Raj Malhotra, a former BOA trader.
Raj told CNBC, spoofing wasn't specifically made illegal until the 2010 Dodd-Frank bill. Sell-side traders would sometimes use some type of spoofing, especially in illiquid markets. In a security that was more illiquid, traders would put a big order above or below the market to see how the market reacts.
CNBC's Qian Chen, reporting from Singapore.