This week's arrest of a British financier accused of crashing the Dow in 2010 is now raising questions about whether terrorists could wreck havoc on the global financial system using computerized, high-speed trading.
At the behest of American officials, British police on Tuesday arrested Navinder Singh Sarao, 36, on 22 charges of fraud, market manipulation, and other crimes related to using algorithms and automated trading to trigger the 2010 "flash crash" — a bizarre event where the Dow suddenly plunged 600 points in five minutes without explanation, wiping out $1 trillion in shareholder value before markets rebounded on the same day.
After the crash, the then-chairman of the Commodities Futures Trading Commission (CFTC) likened the daylong crisis to driving one's car on "autopilot into a ravine." Since then, high-speed trading has resulted in other smaller crashes for individual stocks, including Apple's.
Sarao allegedly employed strategies later documented by financial journalist Michael Lewis in his 2014 bestseller Flash Boys. Lewis wrote that high frequency trading now dominates Wall Street, where major financial institutions use high-powered computers to execute trades in milliseconds. As a result, they can capitalize on market trends before the vast majority of investors even know what's happening.
In his book, Lewis argues that high frequency trading is rigging the markets. Meanwhile, security experts wondered if terrorists could take high frequency trading one step further, and cause a full-blown financial panic.
"It's extremely easy to cause that type of damage to a financial system, especially with technology nowadays," Alex Van Ness, a cyber terrorism analyst at the Center for Security Policy, told VICE News. "We are not really prepared for this. It doesn't take anything more than a home computer to be able to launch these type of threats."
Sarao allegedly upset the global economy from his parents' duplex in the west London neighborhood of Hounslow. He's accused of amassing $40 million from "spoofing," or illegally canceling trades before they were executed, with the intent to suppress prices so he could buy assets for a song.
Sarao is now fighting extradition in London, and his bail was set at £5 million. If convicted, he faces a possible 380-year jail sentence. A full extradition heading is set for August.
The news of his arrest is arguably a huge embarrassment for US regulators. Five months after the flash crash, the CFTC said that a Kansas investment firm sparked the crisis with a single $4.1 billion high-speed trade. The CFTC said the trade was legal, but faster and larger than the financial system had handled in the past.
Now the authorities blame Sarao — which is leading many to wonder if regulators are missing anything else.
"This is now five years ago," investment consultant Kevin Freeman told VICE News. "You could get away with it and do it every few months, and it would be five years before anyone tracked you down."
Freeman has argued that foreign powers tried to worsen the 2008 financial crisis — a notion former treasury secretary Hank Paulson corroborated recently with the BBC, revealing that Russia contacted China to conspire to tank the US market by selling Fannie Mae and Freddie Mac securities as they destabilized.
Freeman noted that Sarao probably wasn't seeking to spark a crash, and didn't have the deep pockets to make the magnitude of trades necessary to force a financial catastrophe.
Instead, Freeman said the British trader likely screwed up while thinking he was making lots of money legally. Sarao reportedly created a new company on the Caribbean island of Nevis called "Nav Sarao Milking Markets" and told regulators to "kiss my ass" — small time behavior that doesn't smack of shadowy conspiracy.
Though countries like China and Russia have the money and technological know-how to produce a financial panic, they have little to gain from doing so, Freeman added. He worried about other rich and tech-saavy enemies taking a cue from Sarao.
"A terrorist with nation-state capabilities could absolutely crash our stock markets," Freeman said. "They would force multiply what the one trader did. If a 36-year-old in his basement can do it, what can ISIS do with the $ 1 billion war chest they've amassed?"
Follow John Dyer on Twitter: @johnjdyerjr