Market Manipulation
Market manipulation involves artificially influencing the price, supply, or demand of securities through deceptive or misleading practices. These activities undermine market integrity and harm investors who make decisions based on manipulated prices.
Why Market Manipulation Is Prohibited
Fair and efficient securities markets depend on prices that reflect genuine supply and demand. Market manipulation:
- Distorts true market prices
- Harms innocent investors
- Undermines confidence in the markets
- Creates unfair advantages for manipulators
Key Point: All market manipulation schemes are prohibited under both state and federal securities laws, regardless of whether they technically "succeed" in moving prices.
Types of Market Manipulation
Wash Trading
Wash trading (also called "wash sales") involves buying and selling the same security to create the appearance of trading activity without any actual change in ownership.
| Element | Description |
|---|---|
| What happens | Same person buys and sells, or colluding parties trade between themselves |
| Purpose | Create false impression of market activity or interest |
| Why it's illegal | No genuine change in ownership; misleads other investors |
Example: An investor sells 1,000 shares of XYZ stock and simultaneously buys them back through a different account, creating the appearance of trading volume.
Matched Orders
Matched orders occur when two or more parties collude to enter buy and sell orders at the same time to create the appearance of active trading.
Example: Party A agrees to buy 5,000 shares from Party B at a specific price at a specific time, creating artificial volume.
Pump and Dump
Pump and dump is a scheme where manipulators:
- Pump: Artificially inflate a stock's price through false or misleading statements, aggressive promotion, or manipulative trading
- Dump: Sell their shares at the inflated price before the price collapses
| Phase | Activity |
|---|---|
| Accumulation | Manipulators quietly buy shares at low prices |
| Promotion | Spread false positive information (newsletters, social media, etc.) |
| Dump | Sell shares as price rises from promotion |
| Collapse | Price falls, leaving other investors with losses |
Exam Alert: Pump and dump schemes frequently target low-priced "penny stocks" because they are easier to manipulate due to lower trading volumes.
Marking the Close
Marking the close involves executing trades at or near the end of the trading day to artificially affect the closing price.
Why it matters:
- Closing prices are used to calculate NAV for mutual funds
- Performance measurements often use closing prices
- Margin requirements may be based on closing prices
Spoofing and Layering
Spoofing involves placing orders with the intent to cancel them before execution, creating a false impression of supply or demand.
Layering is a form of spoofing where multiple orders are placed at different price levels to create the illusion of market depth.
| Technique | Description |
|---|---|
| Spoofing | Place large order → Others react → Cancel order → Profit from the reaction |
| Layering | Place multiple orders at different prices → Create false depth → Cancel before execution |
Front-Running
While often discussed with insider trading, front-running is also a form of manipulation:
- Trading ahead of a known large customer order
- Exploiting advance knowledge that a large order will move the price
- Profits from the price movement caused by the customer's order
Manipulative Trading Patterns
| Pattern | Description | Red Flag |
|---|---|---|
| Domination | Controlling the available supply | Acquiring large position to control market |
| Parking | Hiding true ownership | Placing securities with others temporarily |
| Painting the tape | Creating misleading trade reports | Series of trades to create false impression |
| Bear raids | Driving down prices | Coordinated short selling with false rumors |
Penalties for Market Manipulation
Market manipulation can result in:
Civil Penalties
- Fines and disgorgement of profits
- Injunctions prohibiting future violations
- Payment of restitution to harmed investors
Criminal Penalties
- Imprisonment
- Criminal fines
- Probation
Administrative Actions
- Revocation or suspension of registration
- Bars from the industry
- Cease and desist orders
Detecting Manipulation
Regulators look for patterns that may indicate manipulation:
- Unusual trading volume
- Price movements inconsistent with news or fundamentals
- Trading concentrated among few accounts
- Orders placed and quickly canceled
- Coordinated trading activity
Key Takeaways
- Market manipulation artificially affects security prices through deceptive practices
- Wash trading creates false appearance of activity without genuine ownership change
- Pump and dump involves inflating prices through false promotion, then selling
- Spoofing places orders with intent to cancel before execution
- Marking the close manipulates end-of-day prices
- All manipulation schemes are prohibited regardless of whether they succeed
- Penalties include civil fines, criminal prosecution, and industry bars
An investor simultaneously buys and sells the same security through two different brokerage accounts to create the appearance of trading activity. This practice is known as:
A group of investors buys shares of a penny stock, then spreads false positive information on social media to drive up the price, and finally sells their shares at the inflated price. This scheme is called:
A trader places a large buy order to make it appear there is strong demand for a security, then cancels the order before it executes. This practice is known as:
4.6 Insider Trading and Front-Running
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