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Virginia Law Review

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liability, algorithmic trading, negligence, securities markets


Antitrust and Trade Regulation | Law | Securities Law


In April 2015, the Department of Justice charged Navinder Sarao for his role in causing the Flash Crash-the near-1,000-point drop-and- rebound in the Dow Jones Index that roiled markets in May 2010. Sarao, a small-time British trader operating out of his parents' suburban basement, stood accused of putting together a string of illusory, fake orders that fooled markets enough to spark the largest single-day drop in the index's history. Commentators rightly contest whether a bit-player like Sarao could have unleashed a near-catastrophe on U.S. securities markets single-handedly. Yet, the complaint-and its causal account- point to a troubling dilemma facing scholars and policy makers today. This Article shows that the longstanding liability framework undergirding securities regulation looks increasingly fragile in the face of modern market design. With trading growing ever more automated- characterized by complex algorithms, a proliferation of specialist traders, and interconnections between markets--single weak links can create outsize costs. This evolution in market design poses a profound challenge for well-established liability regimes governing fraud, negligence, and mistakes. Trading firms are easily capable of creating far larger risks than they can either provision for ex ante or pay for ex post. In decoupling the riskiness of trading firms from their capacity to realistically bear the cost of their conduct, market structure casts doubt on the law's ability to credibly constrain as well as punish mistakes and misbehavior in trading.

While scholars have vigorously debated the design of liability regimes in securities regulation, few dispute the underlying need for a guiding framework in this context. Securities amount to little more than simple claims on the future value of a company's cash flows. Without credible, trustworthy information to substantiate these claims, investors face deep uncertainties in valuing them and in determining how much of their capital to invest. The risk of fraud, mistakes, or manipulation in presenting information can dissuade investors from bringing their money to markets or force them to rationally discount for the risks and the costs of verification. A regulatory framework that punishes misinformation constrains those whose expressive conduct and communication matter to investors. Given this importance, scholars have devoted extensive attention to the regime underlying fraud and misrepresentation in securities regulation, generating a vast literature studying its effectiveness.



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