On November 17, 2016, a federal court entered a consent order that will settle the civil case the Commodity Futures Trading Commission (“CFTC”) brought against Navinder Singh Sarao and his company, Nav Sarao Futures Limited PLC, for engaging in a “spoofing” scheme and manipulating the price of the Chicago Mercantile Exchange’s E-mini S&P 500 futures near month contract (“E-mini S&P”). On November 9, 2016, in a related criminal action, Sarao pled guilty to charges brought by the Department of Justice arising from the same conduct. Sarao’s conduct, infamously, contributed to the “flash crash” of May 6, 2010, in which various stock market indexes plunged and then rebounded suddenly.
In the consent order and plea agreement, Sarao admits to a massive multi-year spoofing scheme involving the E-mini S&P. Spoofing is defined by the Commodity Exchange Act (“CEA”) as “bidding or offering with the intent to cancel the bid or offer before execution.” Spoofers can profit by entering buy or sell orders that they intend to cancel, thereby creating the false appearance of market depth in a contract and artificially moving the price of that contract, and then entering into genuine trades that take advantage of the artificial price movement. Spoofing is explicitly prohibited by the CEA, and spoofing will also typically violate the CFTC’s rules prohibiting market manipulation.
Sarao’s spoofing scheme involved the use of various automated and manual methods to place large buy and sell orders for the E-mini S&P in ways designed to ensure the orders would not get executed before they were canceled. For example, Sarao used an automated program called the “Dynamic Layering Program” to place several large sell orders for the E-mini S&P at just a few price points higher than the then-prevailing market price. Placing these orders falsely signaled to the market a large supply of the E-mini S&P, driving the price downwards. As the price fell, the Dynamic Layering Program modified the spoofing orders in unison so that their offering price continued to remain at just a few price points above the new market price. Sarao typically ran this program for several minutes, and then canceled the orders created by the Dynamic Layering Program. Sarao would then execute genuine trades at the artificially low price. According to the consent order, it was the Dynamic Layering Program that helped spark the flash crash; on May 6, 2010, Sarao left the program running for more than 2 hours, precipitating a massive price drop in the E-mini S&P that rippled across the markets and contributed to the sudden large drop in various stock market indexes.
In the consent order, which covers 5 years of conduct, Sarao admits to spoofing, use of a manipulative device, attempted price manipulation and, on certain days, completed price manipulation. The order requires that Sarao disgorge the approximately $12 million profit he accumulated as a result of the scheme, and imposes a civil money penalty of more than $25 million and permanent trading and registration bans. The related criminal charges to which Sarao pled guilty carry a potential sentence of up to 30 years, although, based on recent criminal sentences imposed by courts for financial crimes, it seems likely that Sarao’s actual sentence will be much shorter.
As we noted in our 2016 Derivatives Enforcement Outlook, since bringing its first spoofing enforcement action in 2013, the CFTC has been very active in this area. As we also noted, the government’s victory in its first-ever spoofing criminal case against trader Michael Coscia, which resulted in a three-year prison sentence, would embolden the government in bringing criminal charges against alleged spoofers, a development that significantly raises the stakes for derivatives traders.