by Liam Vaughan
The S&P 500 jumped from a low of 1,056: ‘Preliminary Findings’, CFTC and SEC, 18 May 2010, www.sec.gov.
Proctor & Gamble, Hewlett-Packard, General Electric, and 3M: ‘Preliminary Findings’, CFTC and SEC, 18 May 2010, www.sec.gov.
‘kiss my ass’: DOJ complaint, 21 April 2015, www.justice.gov.
CHAPTER 11: THE AFTERMATH
Since 2005 and the introduction of a set of rules: the Regulation National Market System, or ‘Reg NMS’, rules were introduced by the SEC to try to foster competition in US stock markets and ensure investors received the best possible price for their orders. One consequence was a significant rise in the number of exchanges and alternative trading venues and, in response to that, an explosion in the number of HFT firms seeking to capitalize on the opportunities thrown up by the fragmented new market structure.
‘High-Speed Trading Glitch Costs Investors Billions’: Nelson D. Schwartz and Louise Story, New York Times, 6 May 2010.
‘A temporary $1 trillion drop in market value’: Mark R. Warner, senator from Virginia, ‘Investigating the Wall Street Freefall’, 7 May 2010, https://warner.senate.gov.
It was an illustrious group: the committee’s members were Brooksley Born, ex-CFTC chair; Jack Brennan, ex-CEO of investment company the Vanguard Group; NYU Stern professor Robert Engle; Richard Ketchum, former director of market regulation at the SEC; Cornell professor Maureen O’Hara; ex–Federal Reserve board member Susan Phillips; ex–SEC chair David Ruder; and Joseph Stiglitz from Columbia Business School. At fifty-five, Brennan was the youngest.
One article in the Wall Street Journal: Scott Patterson and Tom Lauricella, ‘Did a Big Bet Help Trigger “Black Swan” Stock Swoon?’, Wall Street Journal, 10 May 2010.
Another, on CNBC’s website, cited chatter: ‘Stock Selloff May Have Been Triggered by a Trader Error’, CNBC.com with Reuters, 6 May 2010.
Mike McCarthy, an unemployed father: Lauren LaCapra, ‘How P&G Plunge Derailed One Investor’, The Street, 17 May 2010.
a small hedge fund called NorCap: ‘Dallas Hedge Fund Suing over “Flash Crash” Losses’, Dallas Morning News, 22 December 2010.
‘We’d watched the S&P completely fall apart’: ‘Reliving the 2010 Flash Crash with a Veteran Floor Trader’, Stocktwits, 8 May 2015, available on www.medium.com.
discovered that one entity: the CFTC never actually named Waddell & Reed, referring to it only as a ‘mutual fund complex’. Its identity was first revealed in the 14 May 2010, Reuters article ‘Exclusive: Waddell Is Mystery Trader in Market Plunge’, by Herbert Lash and Jonathan Spicer.
Waddell & Reed’s flagship investment vehicle was: E. S. Browning and Jenny Strasburg, ‘The Mutual Fund in the “Flash Crash”’, Wall Street Journal, 6 October 2010.
Normally, the firm’s head trader: Jenny Strasburg and Jeanette Neumann, ‘As Markets Sank, Waddell Traders Were at an Event’, Wall Street Journal, 7 October 2010.
However, Waddell & Reed had failed to incorporate: ‘Findings Regarding’, CFTC and SEC, 30 September 2010, https://www.cftc.gov.
Under normal conditions: according to the CFTC/SEC joint report, the firm had recently carried out a number of similar orders, including one of about the same size that took five hours to complete (although on that occasion, the algo was programmed to factor in price and time as well as volume).
markets were severely out of whack: at 1.30 p.m., the Chicago Board of Options had stopped routing orders to a NYSE platform after identifying price anomalies. In the e-mini, resting bids far outweighed offers and the chasm was growing. All day, sellers had been willing to ‘cross the spread’, a warning sign for market makers to get out of the water.
The CFTC would later conclude: ‘Findings Regarding’, CFTC and SEC, 30 September 2010, https://www.cftc.gov.
‘auto pilot(ing) into a ravine’: Tom Lauricella, ‘Debate on “Crash” and Its Causes’, Wall Street Journal, 5 October 2010.
On 6 May, the researchers found: A. Kirilenko, A. Kyle, M. Samadi and T. Tuzun, ‘The Flash Crash: The Impact of High Frequency Trading on an Electronic Market’, Working Paper, 1 October 2010.
‘During the Flash Crash, the trading behaviour: these quotes are taken from an updated version of the Kirilenko, Kyle, Samadi and Tuzun paper published on 12 January 2011.
when the e-mini collapsed, it triggered stock traders: ‘Findings Regarding’, CFTC and SEC, 30 September 2010, https://www.cftc.gov.
exchange-traded funds: an exchange-traded fund, or ETF, is a publicly listed basket of securities that tracks an underlying index.
In a few minutes: ‘Preliminary Findings’, CFTC and SEC, 18 May 2010, www.sec.gov.
‘no evidence to suggest’: Carey Gillam, ‘Waddell & Reed Says Not Cause of May 6 Flash Crash’, Reuters, 17 May 2010.
‘Who puts in a $4.1bn order without a limit price?’: Courtney Comstock, ‘Read the Email an HFT Chairman Is Forwarding Around About Firm That Caused Flash Crash’, Business Insider, 4 October 2010.
CHAPTER 12: MILKING MARKETS
Nav signed up for a plan: the dividend scheme was later closed down by HMRC, which wrote to Nav demanding repayment of unpaid taxes.
the company was shut down and two thousand customers: Charles Walmsley, ‘HMRC Secures Victory in £200m in Double Taxation Loophole Scam Trial’, Citywire, 6 October 2015.
‘expected return over 5 years is 300%’: From an advertisement placed on the website of OTS Solicitors, https://www.otssolicitors.co.uk.
he’d reportedly brought the inhabitants of Ayrshire to tears: according to an anti–wind farm campaigner quoted in the Ayrshire Post on 16 November 2013, Davie had, during one consultation meeting, ‘belittled those with genuine concerns, laughed at some of the points raised, was extremely rude to others and reduced some local residents to tears’.
CHAPTER 13: THE DUST SETTLES
CBS’s 60 Minutes aired a segment: Steve Kroft, ‘How High Speed Traders Are Changing Wall Street’, CBS 60 Minutes, 7 October 2010.
stocks like Cisco Systems and the Washington Post Company: the Washington Post Company changed its name to the Graham Holdings Company in 2013 after it was acquired by Jeff Bezos.
‘Stock Market Flash Crash: Causes and Solutions’: a video of the hearing is available on https://c-span.org.
To remedy the issue: as of November 2019, the Consolidated Audit Trail was still not completed.
The SEC’s budget in 2010: it’s worth noting that the agencies usually bring in considerably more money for the government in the form of fines than they ever spend.
HFT giant Citadel’s founder Ken Griffin: ‘Hedge Funds Make Hay’, New York Times, 3 April 2010. Citing a survey by AR: Absolute Return + Alpha magazine.
senators asked the owner of an HFT firm named Manoj Narang what risks: at the time Narang was CEO and founder of Tradeworx Inc. Today he owns and runs a trading firm called MANA Partners LLC.
creaming more than $10 billion: there are no precise figures on HFT profits. TABB Group estimates HFT firms made $7.2 billion trading US equities alone in 2009, so $10 billion across all asset classes is a conservative estimate.
The CFTC launched a public consultation: in February 2012, the CFTC announced the creation of a new subcommittee of its long-standing Technology Advisory Committee to focus on HFT. In September of the following year it published a ‘Concept Release’ on how it viewed and planned to regulate automated markets, and requested comment from market participants and the wider public.
The SEC undertook its own review: the SEC had actually already begun an overarching review of the equity market structure in January 2010, before the Flash Crash.
funnelled donations to their political allies: ‘Emanuel’s Rare Political Reach Fuels Fundraising Machine,’ Chicago Tribune, 2 February 2015.
Within the CFTC itself: Bart Chilton, a much-loved figure in futures markets, passed away in 2019.
Their influential 2012 book: Sal Arnuk and Joseph Saluzzi, Broken Markets: How High Frequency Trading and Predatory
Practices on Wall Street Are Destroying Investor Confidence and Your Portfolio (New Jersey: FT Press, 2012).
A mysterious commentator writing: R. T. Leuchtkafer’s comments, from 16 April 2010, are published on the SEC’s website, www.sec.gov.
noticed that some exchanges were intermittently being bombarded: ‘Analysis of the “Flash Crash” … Part 4, Quote Stuffing’, 18 June 2010, www.nanex.net.
Intriguingly, one occurred as the e-mini collapsed: ‘Nanex Flash Crash Summary Report’, 27 September 2010, www.nanex.net.
In July 2010, Hunsader was invited to Washington: Herbert Lash, ‘ “Flash Crash” Report Ignores Research: Nanex’, Reuters, 4 October 2010.
‘Why would SEC regulators deny’: ‘Quote Stuffing Bombshell’, 14 December 2012, www.nanex.net.
no multimarket ‘Splash Crash’: The term ‘splash crash’ was coined by John Bates, a senior director at Progress Software and an adviser to the CFTC, to describe a situation whereby a Flash Crash-type event spills over into markets and asset classes around the world with potentially catastrophic effects.
The CME and other exchanges: the CME increased the penalties it levied on firms that breached its fill-ratio thresholds from $1,000 to $2,000 within a thirty-day period (after two warnings).
In the autumn of 2012: Adam Clark-Joseph, ‘Exploratory Trading’, Harvard University, 13 January 2013 (a version of this paper circulated in late 2012).
And in November: Matthew Baron, Jonathan Brogaard and Andrei Kirilenko, ‘The Trading Profits of High Frequency Traders’, University of Chicago Booth School of Business, November 2012 (first published October 2011), www.chicagobooth.edu.
On 3 December 2012: Nathaniel Popper and Christopher Leonard, ‘High-Speed Traders Profit at Expense of Ordinary Investors, a Study Says’, New York Times, 3 December 2012.
The Wall Street Journal published its own account: Scott Patterson, ‘High Frequency Trading Arms Race Has Plenty of Drawbacks’, Wall Street Journal, 3 December 2012.
Amid pressure from the HFT lobby: ‘Review of the Commodity Futures Trading Commission’s Response to Allegations Pertaining to the Office of the Chief Economist’, prepared by the Office of the Inspector General of the CFTC, 21 February 2014.
An inquiry into the CFTC’s handling: ‘Review of the CFTC’s Response’, Inspector General, 21 February 2014.
CHAPTER 14: THOUGHT CRIME
King Jack Sturges: Jerry Markham’s sweeping history of skullduggery in the futures markets, ‘Manipulation of Commodity Futures Prices: The Unprosecutable Crime’ (Yale Journal on Regulation, 1991), as well as interviews I conducted with him, were invaluable for this chapter.
In the late nineteenth century, it was gold: Jerry Markham, ‘Manipulation of Commodity Futures Prices: The Unprosecutable Crime’, Yale Journal on Regulation 8, no. 2 (1991).
when three brothers from Texas monopolised: Nelson, William and Lamar Hunt successfully cornered the silver market in 1979, pushing prices from $6 per troy ounce to $50. After the authorities intervened, however, the price collapsed and the brothers lost over a billion dollars.
one manipulation case at trial: 2008’s DiPlacido v. CFTC – and even then, the case was decided by a so-called administrative law judge rather than at a full trial in federal court.
After one particularly high-profile failure: letter to CFTC Chairman Timothy Massad dated 8 October 2014, by Senators Dianne Feinstein, Maria Cantwell, and Carl Levin after energy trader Brian Hunter was fined just $750,000 by the agency compared to the $30 million originally sought by the Federal Energy Regulatory Commission for alleged manipulation.
When Gensler was appointed: Gensler had held a number of senior positions at Goldman Sachs, as well as in the Clinton administration, and Democratic senators including Levin and Cantwell worried he would be too soft on Wall Street in the aftermath of the financial crisis.
These included what’s colloquially known: ‘Banging the Close’ is the practice of trading in such a way as to try to move the market during key moments. For example, imagine a bank has built a large oil derivatives position by buying up contracts whose value is determined by the oil price at 4 p.m. on the last Friday of the month. That bank may be inclined to trade as aggressively as it can in the buildup to and during the 4 p.m. window in an effort to move the so-called ‘cash’ market and maximise the profits on its derivatives trade.
with little fanfare an amendment was inserted: a legislative history of Dodd-Frank is available on the Law Librarians’ Society of Washington, DC’s website at www.llsdc.org.
The existing manipulation statutes in the Commodity Exchange Act were also tweaked: Daniel Waldman, ‘Has the Law of Manipulation Lost Its Moorings’, 7 April 2017, www.arnoldporter.com.
practices like placing stop-losses: a stop-loss is an order that a trader places hoping that it will never actually be hit. a trader who believes the e-mini will rise, for example, might place a stop-loss order to sell at 50 points below the current price to minimise his potential losses if he’s wrong. At the time he placed the trade, he intended to cancel it. One concern was that the use of stop-losses would inadvertently be caught by the broad language of the new rules.
‘make the market more liquid and more efficient’: Adam Nunes was speaking at the CFTC’s roundtable on Disruptive Trading Practices on 2 December 2010. A transcript is available on the CFTC’s website, www.cftc.gov.
‘This is not a moral issue’: Ronald H. Filler and Jerry Markham, amicus brief to the US Supreme Court on Michael Coscia v. United States, 8 March 2018.
three years later, the CFTC issued a document: Interpretive Guidance and Policy Statement on Disruptive Practices, CFTC, 20 May 2013, www.cftc.gov.
spoofing was like pornography: John Lothian, publisher of the John Lothian Newsletter, made the analogy during the CFTC’s 2 December 2010, roundtable on Disruptive Trading Practices.
several HFT employees and firms have been sanctioned: traders from leading HFT firms Jump Trading and Tower Research have been charged with spoofing, for example.
firms such as Citadel and HTG Capital Partners: Citadel and HTG both testified against Igor Oystacher, who was charged by the CFTC on 19 October 2015, with spoofing in multiple markets.
CHAPTER 15: PIMP MY ALGO
‘It was as if a manager of the New York Yankees’: Peter Lattman and Nelson D. Schwartz, ‘In Corzine Comeback, Big Risks and Steep Fall’, New York Times, 1 November 2011.
Convinced the authorities would never let that happen: Bryan Burrough and Bethany McLean, ‘John Corzine’s Riskiest Business’, Vanity Fair, 10 January 2012.
former high school quarterback: Burrough and McLean, ‘John Corzine’s Riskiest Business’.
In October 2011: Paul Peterson, Department of Agricultural and Consumer Economics, University of Illinois, ‘Behind the Collapse of MF Global’, 2 August 2013, www.farmdocdaily.illinois.edu.
In the frenzied final hours: the CFTC alleged in its 27 June 2013, complaint that MF Global’s assistant treasurer, Edith O’Brien, ‘directed, approved, and/or caused numerous illegal transfers’. On 5 January 2017, she agreed to pay $500,000 to settle the matter. Corzine, who was accused of either not acting in ‘good faith’ or ‘knowingly’ inducing the violations, was fined $5 million.
Secrets of the Millionaire Mind: T. Harv Eker, Secrets of the Millionaire Mind (New York: HarperCollins, 2005).
The Secret: Rhonda Byrne, The Secret (New York: Simon & Schuster, 2006).
‘I received your message regarding TT’: these messages are included in the appendix to the CFTC’s Motion for a Statutory Restraining Order, 17 April 2015.
Nav sent Thakkar an email: Nav sent an identical message to two other software providers. At least one of them expressed an interest in working on the project, but Nav opted to work with Edge.
Nav wanted Edge to make him a program: Sarao talked through a video of himself trading when he was giving testimony during the trial of Jitesh Thakkar in Chicago in March 2019. Sarao agreed to testify agains
t the software developer as part of a plea deal with the US government. The description of his strategy contained in this section is largely based on that testimony.
Thakkar took Nav’s plans and instructed his developers: DOJ Criminal Complaint against Jitesh Thakkar, 19 January 2018, www.justice.gov.
‘this is sort of below cost for us’: CFTC complaint against Jitesh Thakkar and Edge Financial Technologies, 28 January 2018, www.cftc.gov.
a modest sum: Thakkar would later tell investigators that the reason he charged so little was because he had no idea how big or profitable of a trader Nav was. Sarao was stingy from the outset, and it’s considered almost gauche among developers to ask your client about their trading size. The government would argue at trial that the entrepreneur knew how desirable the machine would be to other traders, which is why he structured the deal so that Edge retained ‘all rights to modify, use or sell any code, or derivative work’.
He didn’t feel comfortable having such a controversial system named after himself: the ‘MASTERCHIEF’ email was entered into evidence during the Thakkar trial. Sarao was asked why he made the request on the stand.
The subcommittee Thakkar was a part of: testimony of CFTC economist Richard Haynes during the Thakkar trial.
One day a few months later: evidence presented at Thakkar trial, 3 April 2019.
CHAPTER 16: JESUS ENTERS
an Aztec word apparently meaning: Helmuth Fuchs, ‘Interviews: Alejandro Garcia, CEO IXE (English)’, www.moneycab.com, 18 September 2013.
a supplier in China would accept: this activity is commonly known as ‘trade finance’.
IXE was already making big profits: details on the opportunity were laid out in a document titled ‘Frequently Asked Questions’ distributed to potential investors and introducers in late 2012. Further details were contained in a three-page brochure dated August 2012.
‘We are offering alternative investment vehicles’: the same pitch was laid out in a Q&A with Garcia on IXE’s website, www.ixe-group.com.
Asked about IXE’s pedigree: ‘Frequently Asked Questions’, IXE, 2012.
