flash crash program trading villain Sarao charged by USDoJ

imagehi all. on the topic of program/ high frequency trading 1st considered here ~1yr ago. recently the USDOJ (US dept justice) announced a charge against a daytrader for “illegal trading”. this is a very rare charge, am not even clear on the legality of it, it was not really explained in their press release. looking over the charges, they are for “fraud and manipulation of prices” and a charge called “spoofing”. this made international headlines.[a11][a12][a13][a15] there is some indication this may have played a key role in the so-called “flash crash” from years ago (May 2010)

“spoofing” appears to be the process of posting bids or asks that are not later committed as trades, esp for large amts of money. its funky, but is it really illegal? a trading exchange is an auction and the mechanism not to follow through on a bid or an ask is built into the system. seems these types of rules need to be handled with algorithm constraints/ limits built into the code, not nec legalities/ laws & trials.

however, has anything like this ever been prosecuted before?

the defendant apparently used program trading mechanisms, but this is quite disturbing from a CS pov. program trading is rampant in markets, and highly used by large multibilliondollar hedge funds, and admittedly its a gray area legally. what are the legalities of a program that makes/ effects trades but behaves erratically?

the consequences before now have always been that the market will take away money from defective trading system. but now is it the case one could also be charged as a criminal? was the program being run by a human or was it semiautomated? how does one prove malicious intent of a trader? was it not that he “uncommitted” trades (which is apparently a basic part of legitimate daily market activity), but that they were too large? as the old saying goes, markets (since the beginning of capitalism) are driven by two main factors: fear and greed.

these are some deep questions that a trial would possibly delve into; but the likelihood is that it will never go to trial. its an awfully risky proposition to put analyzing all these esoteric/ tricky financial moves in the hands of Joe Sixpack a supposedly impartial/ intelligent/ acute jury. economics is not seen as the middle class friend right now & seems a surly jury might quickly shoot down any near-related target put in front of them. down in flames.

given the long odds and deck stacked against him, it seems high-flying (in the Daedalus sense) multimillionaire sarao might be imminently due to a visit at the Big House / Club Fed / Graybar Hotel / Castle… & gives new meaning to the phrase in a class all by himself… o_O 😮 😳 😡 👿 😦 😥

and its a bit unnerving how long its been since the action and the charges: almost exactly ½ decade … is there a statute of limitations on stuff like this? and does it give one confidence that the USJustice system is running/ working like a well-oiled machine? and if so, do we really want it to? does this give one confidence that there is sufficient policing in the vast financial area/ field/ span of US market trading?

what are the implications for the (supposed!) overall stability/ resilience of the financial system if a single “small” entity can cause a major crash as the USDoJ seems to be asserting here? isnt this a form of highly asymmetric economic leverage? is this the only possibility for such a form of “attack” to take place, or are there other areas similar tactics could be employed to major effect? did Sarao expose/ exploit some sort of “achilles heel” of markets? did he intend to cause prices to drop? could he have foreseen the consequences? where is the demonstration of malicious intent? doesnt this whole case (apparently!) imply that some “fake” market actions have the potential to drive real prices?

so the USDoJ goes after a small business owner for what might be too “innovative” trading techniques. and do we know that similar such techniques are not being used by large corporations… as we speak? presumably far more nefarious stuff goes on every day in those mysterious multbilliondollar hedge fund black boxes….

was Saraos real crime that he was more a lone gunner and not on a corporate board of directors? that reminds me of all the so-called financial innovation (a dystopic buzzword/ oxymoron of our age/ times) made by massive multibilliondollar corporations during the 2008 crash. but was anyone prosecuted? corporations were prosecuted and according to mitt romney, thats as good as people, right? the corps just paid record multibilliondollar fines and then went on with Business As Usual.™

❗ so… “bottom line,” real villain, or scapegoat/ little/ fall guy? only one thing for sure is, we will all find out sooner or later! maybe his defense attorney will soon have something to say about all that! or maybe he will have to even silently “fold” with a plea bargain beneath the crushing hammer of US justice system! its a poker game with some of the highest stakes and most powerful players around…

another case in the news again (caveat deja vu) is that a software developer for goldman sachs has been charged again wrt intellectual property laws of stealing code. was it also for program trading? apparently something like that.[a14]

decades ago Terminator by Cameron was cutting edge science fiction, but maybe the real AI mayhem is already present and mixed/ baked into our current financial markets, with many Terminators alive and kicking as we speak, and the Flash Crash one real life manifestation of this phenomenon. or maybe on other hand Sarao now has an image of the US Justice system as something like a Terminator… at least wrt the “small guy”. and gives new meaning to that old market aphorism “big fish eat little fish.”

or maybe the reality is far more banal, and program trading is a state of the art system for liquidity supply in the markets (a service that requires capital/ risk and pays marginal profits based on supply/ demand, much like any/ every other service in capitalism). (aka in semifamous 9½ weeks movie the nefarious trader says mysteriously/ dramatically to the innocent young ingenue of his job, ie how he makes money, is to “buy and sell money”.)

(5/13) found some great articles/ coverage by the web site “Wall St on Parade” on the flash crash/ Sarao & (coincidentally) the commentary matches a lot of this essay. it speculates on “ulterior motives” (verging on conspiracy theories) against wall st firms, & notes an agreement between Sarao and Credit Suisse, and that Sarao has had $40M of assets frozen by the govt while he is held in jail. the case is even more significant/ complex than much media is reporting.[b]

(5/18) did some more googling; its all very fast paced/ breaking, scattered, multidimensional, and hard to follow right now. many links, Sarao is now something of a british tabloid celebrity but the US press is not paying too much attn although New Yorker did cover it. he is now fighting extradition to US. reports are somewhat conflicting on his detention eg that his assets are frozen and he cant post/ pay bail & unable to pay lawyers,[a10] that he complained numerous times about other traders violating guidelines/ rules, that he barely spends any money (doesnt own car, rides bike etc) and lives with his parents; neighbors didnt even know he lived at the house, more dynamics and technicalities of spoofing, why the research took so long, controversy of fund manager calling him a “hero” for challenging other program trading systems,[c16] the charges max sentence is 380 years, etc [c]

(5/19) [a19] by Levin is very helpful in describing detail background theory along with a specific spoofing example/ dynamic with numbers. and could this be related to recent law changes? “And now [Michael Coscia] gets to be “the first federal prosecution nationwide under the anti-spoofing provision that was added to the Commodity Exchange Act by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.””

[a14] tabloid article cites an apparently influential blog by Hempton [a16] that calls sarao a “hero” using some funky logic; the blog has many very illuminating comments by apparent insiders. dont know about the “hero” aspect but this anonymous comment (quoted below) struck out at me as describing some algorithmic tradeoffs where designs might require mechanisms that allow spoofing as helping minimize market spread, and that it also relates to tradeoffs wrt different market participants leverage (capital).

there is very sophisticated research into auctions now in (T)CS (eg at conferences like “WINE”, Web and Internet Economics) and it made me wonder if there were theoretical ways to study spoofing and whether better market systems could be designed that protect against it. but still regard it as an open question whether spoofing actually could trigger market crashes. while suspicious-looking could it have just been the first grain of sand that triggered an avalanche? and the real problem is the critical state of the avalanche? finance defn has that big aspect of “playing with fire”…. hope to see some scientific study in this area that looks at the complex tradeoffs (it also reminds me of Nash equilibrium theory in economics, or Arrow-Debreu voting theory) and maybe even some auction design theory that helps to avoid crashes.

 Any market maker, whether computer or human, will respond to order book balance when making a market. If they didn’t they would be routinely run over by large orders and lose money. To make a tight market requires cancelling some orders, though those orders were real orders when placed. To not reprice (cancel some orders) when the book balance changes is tantamount to giving money to those placing larger orders. If you cannot cancel orders, then you cannot make a tight market.

While it is ludicrous to suggest this guy caused the crash, it appears as though he created algos whose purpose was to automatically cancel orders so that they could NOT be filled. Said orders were merely a diversion to other traders. In other words, they were never intended to be real and are thus fraudulent.

How is it good for the market to make it legal to post fake liquidity? Why do you assume that all HFT market makers are frontrunning computers? Human market makers are dead. If you allow spoofing, markets will trade wider and liquidity will be reduced–as will the usefulness of all information in an order book. Would wider spreads also be good for investors? Because that would be the result.

a. hft2

b. Wall St on Parade

c. hft3
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