May 6, 2015, marks the five-year anniversary of the so-called ‘flash crash’ on the New York Stock Exchange. That day, the Dow Jones Industrial Average plummeted more than 1,000 points, before regaining much of its ground by the end of the day.
The causes of the flash crash are still debated, but certainly included a combination of civil unrest and market volatility sparked by the European debt crisis, plus high-frequency trading. Another key factor is now thought to be market manipulation by a single rogue trader in London, who was allegedly “spoofing” S&P futures (in particular, the S&P 500 E-mini contract). That trader, Navinder Sarao, 36, was charged last month in the U.K.
Similar cases have followed.
On May 5, 2015, in Manhattan federal court, the Commodities Futures Trading Commission, working with the Chicago Mercantile Exchange, filed civil charges against two traders in the United Arab Emirates. They allegedly spoofed the gold and silver markets from February to April 2015.
University of Maryland law professor Michael Greenberger, a former director at the CFTC, says “embarrassment” over the 2010 flash crash revelations seem to be galvanizing securities regulators to identify and track down alleged market manipulators. But he says the Obama Administration’s prosecutorial approach isn’t helping, as it has favored civil over criminal charges in most securities-fraud cases since the financial crisis.
“The cleanest and clearest way to stop people from doing these things is the real possibility of ending up in jail,” says Greenberger. When traders and their firms face only civil charges, Greenberger continues, “they pay penalties. Penalties are a cost of doing business. Spending time in prison is the most effective deterrent to the fraudsters.”
Greenberger also believes part of the blame for lax enforcement against spoofing and other attempts to manipulate market prices lies with the equity and futures exchanges themselves. He charges that the Chicago Mercantile Exchange, for instance, has dueling incentives—to ensure market integrity, but also to generate profits from higher trading volume, which high-frequency trading provides. Greenberger also says members of Congress, acting to help financial firms that are also big campaign contributors, have not adequately funded federal securities regulators like the CFTC and SEC.
Karen Petrou, a banking analyst at Federal Financial Analytics in Washington, D.C., believes that since the flash crash in 2010, the problem of market manipulation by participants with sophisticated technology for super-fast online trading has only gotten worse—in U.S. markets and overseas. She cites recent examples in the past year, including flash crashes on the German and Swiss markets and in the U.S. bond market. Petrou attributes much of the problem to under-regulated high-frequency traders.
“In its algorithm, in a nanosecond, a liquidity or temporary market phenomenon will give the high-frequency trader a teeny-tiny advantage,” says Petrou. “And if you do that a lot, very, very fast, you can make a lot of money.”
All of that rapid-fire computer-driven and -executed trading increases volatility and systemic financial risk, she says—not just for investors, but also for big banks.
“We are seeing flash crashes in the equity, treasury, foreign exchange and bond markets,” says Petrou. “We should be very scared. I know regulators are. But they’re not acting.”
A multi-agency plan conceived after the 2010 flash crash to monitor and prevent attempts to manipulate the markets has so far been mired in technological complexity, corporate rivalry and regulatory delays.
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