In arresting Navinder Sarao this week and charging him with manipulating markets, regulators indicated they'd gotten to the bottom of 2010's "flash crash." Many on Wall Street, though, believe the work is only starting.
That's probably a gentle way of stating the Street's reaction to Sarao's arrest Tuesday. Many pros openly scoffed at the notion that Sarao was the sole culprit of the spectacular plunge on May 6, 2010. On that day, the Dow industrials rapidly lost about 600 points, taking the average down nearly 1,000 points on the session, only to rebound within a matter of minutes.
According to separate indictments, Sarao masterminded a scheme in which he was able to send orders to the market that he had no intention of executing, a practice called "spoofing" that caused a market plunge on which Sarao capitalized. The practice happened within minutes of the crash and was a direct cause of it, according to regulators. Authorities allege he acted mostly alone rather than as part of a large, sophisticated operation.
However, many experts believe the explanation is at least an oversimplification and at most an intent to deflect attention away from more fundamental weaknesses in the financial markets.
"The real issue here is that markets have dramatically changed over the past two decades but regulators have not kept up," Joe Saluzzi and Sal Arnuk, who run Themis Trading and have been ardent supporters of changes to market structure, said in a blog post Thursday. "While technology has increased efficiency and brought down trading costs, it has also changed the way traders access the markets."
Sarao's arrest immediately rekindled the debate over market speed and high-frequency traders who are able to execute—and cancel—orders in fractions of a second.
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Saluzzi and Arnuk, though, said the HFT question is not central to the flash crash case. Instead, they said, the debate should be more about developing the right regulatory procedures and making sure the market's watchdogs have the proper information and are aggressive in pursuing wrongdoing.
"While some in our industry are already debating whether or not Sarao was a high-frequency trader, we don't think this is the important issue in this case," the Themis duo said. "This case is about manipulation and the lack of regulatory oversight which allowed it to continue for five years."
They believe responsibility rests in three areas for allowing Sarao's alleged spoofing practices to continue so long: His futures commission merchant—essentially the entity that cleared the trades, which at the time was the now-defunct MF Global—along with the Chicago Mercantile Exchange and the Commodity Futures Trading Commission.
The CME said it has concluded that futures contracts were not involved in the flash crash, while the CFTC said Sarao's arrest shows it is committed to protecting markets. Neither agency immediately responded to requests for additional comment.
However, some Wall Street veterans found the regulators' narrative that emerged from the arrest to be troubling, particularly in regard to Sarao acting alone in causing the crash.
"That's the most absurd thing I've ever heard. That's sort of pathetic, don't you think?" said Michael Cohn, chief investment strategist at Atlantis Asset Management. "Five years later and this is what they come up with?"
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To satisfy the Street's curiosity, regulators would have to answer several questions.
Among them is why Sarao's actions on this particular day caused so much damage, when the indictments state that he'd done the same thing hundreds of times over a four-year period, concluding in April 2014, without causing similar market earthquakes.
"I still have a lot of questions about his ability to actually implement his rogue trading and cause the flash crash," said Peter Costa, president of Empire Executions and a New York Stock Exchange governor. "The only thing I can say is that if I recall correctly, the market was in a selloff because of Greece and maybe that jittery market and the timing of his program just accelerated things."
There was no indication from regulatory agencies that changes would be implemented in light of the Sarao case, something else that market pros have found disturbing.
"They actually just basically swept it under the rug and said, 'OK, we're done. We caught the guy who caused the flash crash,'" said Cohn, the Atlantis strategist. "Doesn't that seem stupid?"