We’ve previously reported on alleged spoofer Navinder Sarao’s extradition to the United States. On 9 November 2016, only two days after his extradition, Sarao pleaded guilty to one count of spoofing and one count of wire fraud and agreed to settle civil proceedings brought by the US Commodity Futures Trading Commission (CFTC). In his plea agreement, Sarao admitted that he had defrauded futures markets over a five year period, for which he earned US $12.8m in profits. Sarao is the second person to be convicted of spoofing in the United States, following the jury trial and conviction of Michael Coscia in November 2015.
The conduct at issue
Between 2010 and 2015, Sarao used both automated and manual strategies to trade futures contracts based on the S&P 500 index (E-mini S&P contracts) through the Chicago Mercantile Exchange (CME). According to his plea agreement, Sarao admitted that on thousands of occasions he placed “spoof” orders that he did not intend to trade. His “spoof” orders induced other market participants to trade, however, which had the purpose and effect of artificially depressing or inflating the price of E-mini S&P contracts. Sarao exploited these price movements by executing genuine orders for those contracts and generating significant trading profits over time.
The incriminating evidence
Sarao’s decision to plead guilty will likely have been influenced by:
- the emails he sent in 2009 to computer programmers employed to develop his algorithms. Sarao’s emails included references to “moving the market like we discussed”, “spoof[ing] [the market] down” and “getting hit on my spoofs all the time.” Irwin LJ, who considered Sarao’s extradition case earlier this year, described these emails as “direct evidence of dishonesty”.
- the functionality of his algorithms, which featured many potential hallmarks of “spoofing”, including “cancel if close” functions, the capacity to “enter multiple orders at different prices”, and the ability to cancel immediately if even one contract of a much larger order was executed. Similar functions were integral to the algorithms used by Coscia and highlighted by federal prosecutors at his 2015 trial.
- the very low execution rates of large orders placed by Sarao - including orders layered at multiple price levels, “flashed” orders, and orders automated to move to the back of the queue.
- the market analysis that E-mini S&P contract prices moved during the time period when Sarao’s automated trading programs were active.
Unlike Coscia, Sarao also manipulated the market through manual as well as automated trading strategies. While EU regulators are increasingly focused on algorithms, Sarao’s plea is a timely reminder that orders placed manually can also “spoof” markets - even markets trading at volume and high frequency.
Sarao is likely to receive a substantial prison sentence, much higher than the 3 year term received by Coscia. While Coscia defended the charges of spoofing at trial, he was found guilty of manipulating futures markets over a much shorter timeframe - less than three months - for US $1.4m in profit. Sarao’s sentencing will occur after the status conference set down for 09 February 2017.
Financially, Sarao is required to disgorge the US $12.8m in profit he earned illegally. He has also agreed to pay a civil monetary penalty of US $25.7m to settle parallel civil proceedings with the CFTC. That settlement, which is subject to approval in US federal court, also permanently restrains Sarao from trading on commodities markets.
Sarao’s plea follows the in principle civil settlement reached by Oystacher and 3Red Trading LLC with the CFTC in October 2016 regarding alleged spoofing on at least 51 trading days from 2011 to 2014. We expect that Sarao’s conviction - marking the second successful prosecution of “spoofing” - will only increase regulators’ enthusiasm to pursue cases of market manipulation in both civil and criminal forums.
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