Flash Crash

by Liam Vaughan

  By now, exasperated investors had started heckling: ‘Where’s our money!’ IXE was in the midst of a ‘cash liquidity constrain’, Garcia went on. The company had assets all over the world, he said, including thirty million square metres of land in Bolivia worth as much as $192 million. It had also recently entered into a contract to supply quinoa to a ‘major agricultural Company in the Republic of China’, which, combined with its assorted other agricultural interests, would culminate in ‘potential consolidated income of about $86m’ a year. To help illustrate these prospects, he pulled up a slide containing a selection of photographs of verdant landscapes, and another with images of a tractor, a smiling Garcia in a field and some packets of quinoa with labels in Mandarin. In terms of actual investments, the presentation indicated that IXE had transferred 65 million Swiss francs ($66 million) into four privately owned entities in Florida, Singapore, Switzerland and Bolivia, none of which produced audited accounts. The takeaway, Garcia explained, was that there would be more than enough cash to repay the $75 million invested by those in the room and Sarao, as well as the $10.5 million in commissions owed to introducers like Adamson, Sawicki, MacKinnon and Dupont. The only problem, he said, was that liquidating the assets would take months, maybe even years, so if investors wanted their money back, they would have to be patient. In the interests of transparency, he offered to take a delegation to South America to see how their funds were being used.

  When Garcia finished talking, the room erupted. A lawyer representing one of the investors stood up and asked what evidence there was that the money was where Garcia said it was. Another individual asked why his funds had been moved from Arner Bank to these other entities when he’d signed a contract stating it would be used for ‘trades executed solely by way of non-speculative transactions with real end purchasers already in place’. One member of the audience said that he’d never authorised for his money to be taken out of Morgan Stanley. As the questions rained down, Garcia stayed quiet, allowing Dr Fischer to respond on his behalf. Meanwhile, his wife, Ekaterina, dressed in designer clothes, passed from table to table handing out vol-au-vents nobody wanted. Eventually, a frustrated creditor asked why they shouldn’t simply walk out of the hotel and into the nearest police station. On this point, IXE’s response was crystalline: if anyone took any legal action, the company would fold and they would never see their money again. Better, Garcia said earnestly, to trust him.

  The investors discussed the matter among themselves for a while before reluctantly agreeing to give IXE more time. When all was said and done, what choice did they really have? Garcia thanked them for their patience and, flanked by bodyguards, made his way to a side entrance where a blacked-out Mercedes was waiting to whisk him away.

  THEY CALLED it ‘Home Videos with Nav’. In the first week of February 2017, Rob Zink and Mike O’Neill from the Fraud Section, two agents from the FBI and Jeff Le Riche from the CFTC flew to London to spend a week squeezing as much information out of Sarao as they could. The setting was Kobre & Kim’s offices in Tower 42, a six-hundred-foot skyscraper in the heart of the financial district – exactly the kind of place Nav had spent his career avoiding. After the tension and high drama of the plea hearing a few weeks earlier, the mood in the conference room was relaxed and convivial. Now that he was working for the government, Nav asked, would he be allowed to draw the Justice Department seal on his notebooks?

  ‘Stop, go back a bit!’ Nav cried out as a video of his trading was played on a large TV. Every once in a while, when they got to something that sparked his memory, he jumped up from his seat and his eyes lit up like an old sportsman reminiscing about his career highlights. ‘So, what are you looking for here, Nav?’ one of the Americans asked, struggling to keep up with what was happening on the ladder. Bids and offers came and went, and prices hopped around so rapidly it was hard for mere mortals to keep up. ‘Come on, mate,’ replied Nav with a smile, and took them through it one more time.

  Over several days, Sarao gave the US government a crash course on scalping, the intricacies of market structure and how to identify when somebody was spoofing. His knowledge base was narrow but incredibly deep, and he spoke with a jargon-free, unvarnished clarity that was easy to comprehend. The interviewers took notes and asked questions while he talked about strategies and the footprints market participants leave behind. When they were done with the videos, they asked Nav how much his brokers knew and what role they played in his exploits. They had ‘no clue’, Nav replied. ‘They just wanted the money.’ When it came to software developers like Jitesh Thakkar, the answer was less clear-cut. If you make a bespoke weapon for somebody, how much responsibility do you have for how they go on to use it?

  One day, towards the end of the week, the group went for lunch in one of the building’s upscale restaurants. There were no burgers on the menu, so Nav ordered a steak, swearing he’d never heard of Béarnaise sauce. They chatted about London tourist spots, and the food they’d order if they were on death row. Nav made the table roar with laughter recounting how his mum would call upstairs, ‘Navinder, what are you doing?’ as he pulled off another million-dollar trade. And, for those few minutes, it was easy to forget why they were there.

  EPILOGUE

  Nav returned to Chicago to be sentenced on 28 January 2020. More than three years had passed since he’d pleaded guilty to fraud and spoofing in the same courthouse the day after the presidential election. As part of the plea deal, he’d agreed to help the authorities build other cases, and he’d been working hard to earn their favour and minimise any jail time ever since.

  The weeklong debriefing Nav gave members of the DOJ, the CFTC and the FBI in London in 2017 transformed their understanding of spoofing and market microstructure. He was only the second individual to be criminally charged with spoofing, and the government was still relatively naïve about the dark arts of electronic markets. Nav’s insights into identifying cheating in the order book were incorporated into the agencies’ detection software, helping lead to the convictions of more than two dozen traders from banks, hedge funds and even the HFT firms he so despised. Nav’s ‘home videos’ are still shown to investigators and prosecutors in training programmes across the United States. The CME and other exchanges have reported a sharp decline in spoofing and other forms of manipulation (although sceptics suggest market participants have just got better at hiding it).

  As useful as Nav’s intelligence proved to be, defendants are supposed to provide information on specific crimes if they want to gain any real credit for cooperation. That opportunity arose in January 2018, when the DOJ arrested Jitesh Thakkar, the software developer whose firm, Edge Financial Technologies, had built the NAVTrader program. Despite having never met Sarao in person, Thakkar was charged with conspiring with the trader to spoof the market as well as two related counts of aiding and abetting, offences that each carry ten-year maximum sentences. Thakkar wasn’t a trader himself, and the case raised important questions about the extent to which developers can be held responsible for how clients use their software.

  Nobody disputed that Sarao had utilised the NAVTrader program to make millions of dollars by misleading other market participants about supply and demand. The issue was whether Thakkar had any culpability, given that he was never present when Nav was trading and didn’t receive a share of the proceeds (Edge was paid a flat fee of $24,000 for the project). At trial in April 2019, prosecutor Mike O’Neill argued that, while Sarao didn’t explicitly talk about how he planned to use the system, his intentions were clear from the blueprints and would have been glaringly obvious to a seasoned professional like Thakkar. O’Neill took the jurors through emails between the pair, and highlighted a contract that seemed to spell out Sarao’s desire to cancel some orders before they were hit. Thakkar was represented by Renato Mariotti, the theatrical local attorney who, as a government prosecutor in 2014, had secured the first-ever spoofing conviction, against ex-pit trader Michael Coscia. ‘Ladies and gentlemen, can you imagine a wor
ld in which ordinary people were charged with a crime just for doing their jobs?’ Mariotti asked the jurors, before going on to compare Thakkar to a phone retailer who sells a handset to a drug dealer, or a car salesman who inadvertently supplies a getaway car.

  Much rested on Sarao’s shoulders when he lolloped through the courtroom in a red sweater to take the stand as a witness for the prosecution. Over several hours, he answered questions about his trading activities and interactions with Edge calmly and without prevarication, his eyes rarely lifting to make eye contact or take in his surroundings. Yes, he was a convicted fraudster, he said; no, he didn’t discuss spoofing with Thakkar; yes, he was there to try to reduce his sentence. On the critical question of his relationship with Thakkar, Sarao conceded: ‘At the time, I didn’t consider that we were colluding to commit crimes.’

  A few days later, after Sarao had flown back to Hounslow, the judge took the unusual step of throwing out the conspiracy charge against Thakkar on the grounds there was no evidence that the trader and his developer had ever struck up a nefarious pact. It was an embarrassing blow for the government, and a few days later the case collapsed when the jury failed to reach an agreement on the remaining counts. Ten of the twelve jurors reportedly favoured an acquittal, and, seeing an uphill battle ahead, the DOJ dropped the charges rather than pursue a retrial. It wasn’t the outcome they were looking for, but Sarao had done what was asked of him. (At the time of writing, Thakkar was still in settlement talks with the CFTC about the civil charges against him.)

  The clampdown on spoofing that followed Sarao’s arrest was largely good for the big HFT shops, but beyond that life had grown harder. Increased competition, low trading volumes and rising data and technology costs had squeezed profits, while a prolonged volatility drought, brought on by the intervention of central banks in global markets, was undermining a strategy that relied on big market moves. HFT continued to be involved in two-thirds of all futures trades, but the industry life cycle had spun and firms were increasingly looking at other strategies to make money. Artificial intelligence and machine learning, whereby robots continuously modify their tactics with little human interaction, were supplanting earlier forms of HFT, which relied more heavily on engineers to write and rewrite the algorithms. The result was even faster markets: trade speeds were now measured in nanoseconds, one billionth of a second.

  At the time of Nav’s sentencing, the hunt for his missing fortune was still ongoing. Hamstrung by a lack of jurisdiction outside the United States, the government had retrieved just $8 million of the $38 million it was owed. Mr X, who stood to receive between 10 per cent and 30 per cent of whatever was collected, waited patiently for his reward. The biggest recipient of Nav’s money, Jesus Alejandro Garcia Alvarez, still hadn’t returned any of it and was said to be pursuing new business opportunities in Zurich. Meanwhile, Lynn Adamson and Chris Sawicki, the couple who introduced Nav to IXE, put their company into liquidation in December 2017. Iconic Worldwide Gaming, Damien O’Brien’s online gaming venture, also folded. (O’Brien is now involved in crypto currencies.)

  Miles MacKinnon and John Dupont, Nav’s closest advisers, struggled to rebuild their business after his arrest. They said in a statement: ‘From 2010 to the time Nav was arrested, we had a great working relationship with Nav. He was making substantial amounts of money trading and asked us to alert him to any potential opportunities that gave large returns with minimum risk, which usually meant speculative investments in early stage businesses. Nav knew and appreciated this. Our role was to act as an introducer and at no time have we ever had any management or control over his assets or where his funds were invested. MD Capital Partners suffered substantial losses in the aftermath of Nav’s arrest.’ The pair asked that it be made clear that they had no involvement in Nav’s trading activities and that they had always urged him to cooperate with the authorities.

  In the days leading up to Sarao’s sentencing, the Justice Department, the probation office and Nav’s lawyer, Roger Burlingame, each filed memos to the court on what they considered to be a fair punishment. Burlingame painted his client as a kind of idiot savant who was barely able to function in the world without his parents. In a sprawling forty-one-page report, he recounted stories of Sarao leaving the house in his pyjamas and keeping spiders as pets, and he quoted family members, including Nav’s brother, Jasvinder, who wrote: ‘We all start life as innocent and inquisitive beings. As time goes on, due to numerous factors, we lose this quality, but Nav hasn’t.’ Simon Baron-Cohen, an autism expert, said Sarao’s condition made it impossible for him to distinguish between what was and wasn’t allowed in a nuanced way and warned that sending him back to jail would be highly damaging because he was so sensitive to light and noise.

  In a remarkable development, the Justice Department agreed, asking the judge in its memo to show leniency and let Sarao go home – a huge departure from the sentencing guidelines, which suggested he serve a minimum of six and a half years. O’Neill and Rob Zink cited Sarao’s ‘extraordinary cooperation’, and wrote that he had ‘substantially assisted and informed the government’s nationwide efforts to detect, investigate and prosecute these crimes’. The prosecutors had got to know Sarao since his arrest and maintained there was nothing to be gained by putting him behind bars, a conclusion shared by the probation officer.

  With all sides pushing for a release, it was now just down to the judge to acquiesce. Back in Chicago, O’Neill and Burlingame took turns laying out their reasoning at a bench at the front of the court, while Nav waited alongside them grasping a sheet of paper with both hands. When it was his turn to talk, he spoke quietly and slowly: ‘I spent 36 years trying to find happiness on a path built on a lie,’ he told the judge. ‘I made more money than I could have imagined. I did the things society says will give you happiness, and when they didn’t I didn’t know where to look.’ Sarao had been addicted to trading, he said, but during his time in prison he came to realise that trading wasn’t bringing him ‘deeper meaning’. After his release, his brother gave him a spiritual book that opened the door to a new way of living. ‘Money doesn’t buy you happiness,’ Sarao said. ‘And I’m glad I know that now.’

  Summing up the case, Judge Kendall said that when she first heard the facts she assumed she was dealing with some kind of criminal mastermind. ‘Now, here I am looking at this report of someone with autism who lives with his parents in a bedroom that looks like it hasn’t been changed since he was 13 years old.’ Sarao may have treated markets like a computer game, she said, but ‘that does not impact the seriousness of what happened’ on the day of the Flash Crash. ‘Your actions contributed to abusing the integrity of the market, something that’s essential to maintaining a healthy economy.’ Kendall was adamant that Sarao face some kind of punishment beyond the four months he’d already served, and, in recognition of his medical situation, ordered him to serve a year of incarceration at his parents’ house. If Nav wanted to leave – for a funeral, say, or a religious service – he would need to seek permission from the court first.

  It wasn’t exactly what they were seeking, but both the DOJ and Nav’s lawyer appreciated it was an incredible result under the circumstances. That night Sarao arrived back at Heathrow airport and prepared to hole up in the same bedroom where he had committed his crimes. The following month the entire world was on lock down. As ever, The Hound of Hounslow’s timing was impeccable.

  AUTHOR’S NOTE

  This book started with a twist of fate. In April 2015, I was working as a reporter at Bloomberg in London when Navinder Sarao was arrested. Calling around, I was amazed to find out that an old friend of mine had rented a desk at Futex at the same time as Nav. He told me some now-legendary anecdotes, and I started working up a profile. Everyone I interviewed remembered Nav vividly thanks to his outlandish abilities and his death-or-glory attitude. It was one of those rare finance stories that cross into the mainstream – the genius kid from the wrong side of the tracks who finds himself in the crossha
irs of the US government – and I watched with fascination as the Hound of Hounslow butted up against the UK and US legal systems. Then his lawyer revealed in court that, despite making tens of millions of pounds, the master manipulator of the S&P 500 couldn’t pay his fine because he himself had been the victim of a Ponzi scheme, and I knew someone had to write a book.

  This is a work of nonfiction. All the characters and events I describe are real, and no details have been changed or exaggerated for effect. The narrative was built using both public and private documents, which I detail extensively in the notes, as well as interviews with over 150 people from every facet of the story, many numerous times. Owing to the sensitivity of the subject matter, the majority of interviews were carried out anonymously. Where there is dialogue, it is based on the recollections of one or more people who participated in or witnessed the conversation and has been run by all participants for accuracy. Everyone who is referenced in the book was contacted and asked about the veracity of the material pertaining to them as part of the fact-checking process. Outside of my own reporting, I relied extensively on the work of academics, authors, lawyers, finance professionals and fellow journalists, particularly in the sections on HFT and the Flash Crash. They are cited in the notes. Before I wrote a word I read Michael Lewis’s Flash Boys, Scott Patterson’s Dark Pools and The Quants, John Sussex’s Day One Trader, and Edwin Lefevre’s Reminiscences of a Stock Operator, which all proved invaluable.