Accused UK trader likely not a factor in 'flash crash' - paper

By John McCrank

NEW YORK (Reuters) - A British trader facing extradition to the United States in a trial next week for allegedly helping trigger the 2010 "flash crash" likely had little, if anything, to do with the event, according to a draft of a new academic research paper.

Navinder Singh Sarao was arrested by British police on a U.S. extradition warrant in April after being charged with wire fraud, commodities fraud and market manipulation by the U.S. Justice Department.

The U.S. authorities accuse him of playing a part in the Wall Street flash crash on May 6, 2010, in which the Dow Jones Industrial Average briefly plunge more than 1,000 points, temporarily wiping out nearly $1 trillion in market value.

But three academics who poured through all of the trades and orders placed on the day of the flash crash said it was "highly unlikely" Sarao's actions, which may have been illegal, could have caused the dramatic market plunge, according to a Jan. 25 draft of a paper titled "The Flash Crash: A New Deconstruction."

Indeed, this paper suggests that the Flash Crash could have occurred even without Sarao's presence in the market," it said.

The paper was authored by Eric Aldrich and Gregory Laughlin from the Departments of Economics, and Astronomy and Astrophysics, respectively, at the University of California, Santa Cruz, along with Joseph Grundfest, at Stanford University's School of Law. Grundfest is also a former U.S. Securities and Exchange Commission official.

Sarao is accused of using an automated trading programme to "spoof" markets by generating large sell orders that pushed down prices. He then cancelled those trades and bought contracts at lower prices, prosecutors said.

But the paper found that unsettled market conditions early in the day, combined with a massive, aggressive sell order for the popular E-mini S&P 500 futures security by a mutual fund manager Waddell & Reed, helped trigger the sell-off.

The results of the paper echoed the findings of a 2010 report by the SEC and the Commodity Futures Trading Commission.

The new research paper warned of the danger that regulators will perceive the enforcement of spoofing activities as an effective substitute for more fundamental restructuring of the markets.

Sarao, who has said he did nothing wrong and was simply good at his job, is due to appear in a UK court on Feb. 4.

(Reporting by John McCrank; Editing by Lisa Shumaker)