The Evil Diaries: Layering and Spoofing

7 mins. to read
The Evil Diaries: Layering and Spoofing

As regular readers know I tend to regard securities industry regulators as bordering upon or in fact mad. As an example, about ten years ago a highly experienced and of course regulated stockbroker described to me how he had been warned that he was guilty of market abuse by getting into work early and putting up various bids and offers on SETS stocks which were way wide of the probable opening price of the relevant stocks. The idea, which he assured me worked, is that lazy investors put in orders at market which picked up these ridiculous prices since they were market. I do not imagine the harvest was huge but I expect he thought it worthwhile since he had to get in early. But how anyone could imagine that this practice was illegal was and remains completely beyond me. After all, did the regulator consider that only bids and offers within a moderated percentage could be entered? And, if so, what was that percentage? And why?

This tale is in my mind since a Crime Correspondent on the staff of the Daily Mail (be it noted that this correspondent is not on the City staff of the Daily Mail) reported on Navinder Singh Sarao, dubbed the Hound of Hounslow, who faces extradition proceedings at the hands of US prosecutors since he is accused by them of causing a £500bn Flash Crash in 2010. The idea is completely mad – regulators in  the USA are, hard though it may seem, even more stupid than the ones we have over here.

I imagine that Mr Sarao’s computer managed to put in bids and offers which were withdrawn a tiny fraction of a split second before investors could avail themselves of them. However, the emergence of a pattern of bids and offers caused investors to behave irrationally such that a trend of trading emerged that suited Mr Sarao. I can only congratulate Mr Sarao. He certainly has much more brain than I. But the idea of his having committed a criminal offence is completely beyond my grasp.

Where I suspect he does face difficulties is that he seems to have stashed the cash abroad in favour of a holding company. One would reasonably ask where the mind of management of this company was located. Of course, such a tax enquiry has nothing whatsoever to do with markets.

As it happens and since I had the time and opportunity to enquire further I asked people known to me to comment. This produced an interesting interchange:

First up, was a lawyer who offers:

“You asked for my view so I feel compelled to say, with the greatest respect, that you are a little out of touch with the zeitgeist. Spoofing and layering were always practices of dubious legality and contrary to the rules of the exchange. It is obvious that you believe that market manipulation and insider dealing are perfectly legitimate practices and that it was quite wrong of the government to legislate against this sort of behaviour, targeting “spivs” just trying to make a living. Why not just come out and say so?!”

And so I replied:

Well, strictly speaking, I was after your views concerning the Hound of Hounslow. But you draw me to defend myself on a broader basis. (However, I am pleased to see that you feel obliged to extend respect to me – even if it is qualified.)

The practices of “spoofing” and “layering” mean nothing to me. I can imagine that an exchange might devise some hidden rules for its members to cover these important activities – even if they are undefined. That is up to them. But the idea that normal people are subject to such rules is absurd.

As regards “market manipulation” the drawback is that nobody I have ever met has any idea as to what it is. I might share your lawyerly view that it is a dreadful practice if I were indeed a lawyer. But, and as I have remarked, it is difficult so to share if one has not been let into the secret code.

You may be right about my ignorance of the “zeitgeist”. But, then, I am a sensible fellow and decline to seek to know what cannot be known. By zeitgeist you may mean the idea that one should be ruled by grossly overpaid lunatics. I just do not know.”

Fortunately, an experienced practitioner in securities markets also offered:

“A few quick thoughts…

It wasn’t as if this Mr Sarao pitched up one day, decided to get spoofing (S), do a spot of layering (L) and the flash crash duly followed. As I understand matters, he’d been hard at it (in the S&L sense) day in – day out for some period of time. His winnings were by all accounts sizeable and accumulated over months if not years. I note that the market did not experience a flash crash on each of those days. And I doubt that he is the only spoofer ever to have spoofed nor that the spoofing ended there. 


Mr Sarao did not force any individual investor to lift any offers or hit any bids. Whilst simultaneously on the bid, he may well have been sitting pretty on the offer in say, FTSE futures, at 6,666.6 pts (a clear sign of satanic dealings afoot). Yet if I, as an individual, were looking to sell FTSE futures, there is nothing to stop me from matching Mr Sarao’s offer, offering higher or hitting the bid lower. 

Alternatively, let’s suppose that Mr Sarao is my neighbour and he has an identical three bed semi-detached house to mine. Mr Sarao’s house is on offer at £245,000 and I decide to sell up also. Does this compel me to offer my property at less than £245,000? Probably not. Otherwise where would the price war stop? But should I offer my property at say £240,000 and it is then snapped up by Mr Sarao, who simultaneously pulls his offer from the market, has a crime occurred? 

Further still…

The big losers from S&L would appear to be the algorithms. These are automated trading programmes that have access to a wide range of exchanges and can see bids and offers faster than the average punter. They have a unique advantage against the individual investor. 

For example, suppose an order arrives at the NYSE to sell 1,000 Dow future contracts at say 17,500. And let’s assume that a bunch of smaller orders are then lined up marginally above the offer at 17,500.

What will happen is the algo will believe those small offers to be genuine and believing there to be that genuine backstop will offer a tic or so lower, or possibly hit the bid. The algo takes the view that once the bid has dropped, those genuine offers will offer lower still and the algo can buy back at a relatively low risk gain. 

It is the algos that are the principal market manipulators as they are making riskless gains at the cost of true market participants. 

I would also ask…

Why would a speculator not be permitted to take a view on either side of the pricing? Surely I am permitted to be a buyer at X and a seller at X+i? I assume that I always face the risk that my X+i offer gets lifted. 

And finally, this is what market makers do all the time. If an exogenous event occurs, say an incidence of terrorism, the market maker does not hang around on the bid. He immediately pulls it.”

And yet, Mr Sarao has been held in detention for four months when, seemingly, he cannot have been guilty of any offence under British law. Should American law opine that he is guilty, one has to wonder why we are party to an extradition treaty in this regard.


I owe readers of my short note on milk prices last week an apology. I wondered as to whether the security of milk supplies could be endangered by the de facto switching of supply to elsewhere in the EU. But I have been corrected. The problem with many UK producers is that they are just hopelessly inefficient and should go bust. Apparently, it is possible to produce milk at a profit. For instance, there are specialists offering organic milk which American consumers are increasingly preferring since the American offering is thought to have deeply undesirable chemical additives. This milk achieves a 15p a litre premium. Further, some while ago, planning permission for a 7,000 cow unit was denied as a result of NIMBYs doing their magical work. Put another way, the milk business is complex and, as it happens, not assisted by the NFU who misrepresent the state of play.

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