7.1 Prohibited Acts and Market Manipulation

7.1 Prohibited Acts and Market Manipulation

In an orderly capital market, prices must reflect genuine supply and demand founded on complete, truthful public disclosures. When unscrupulous participants distort price discovery or fabricate artificial volume, public confidence erodes, liquidity dries up, and capital allocation fails. To preserve market integrity, Section 24 of the Securities Regulation Code (SRC / Republic Act No. 8799) and the SRC Implementing Rules and Regulations (SRC-IRR) establish an exhaustive statutory prohibition against market manipulation, deceptive trading practices, and fraudulent devices.

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Statutory Foundation: Section 24 of the Securities Regulation Code

Section 24.1 of the SRC broadly declares it unlawful for any person, directly or indirectly, to use or employ any manipulative or deceptive device in connection with the purchase or sale of any registered security. The statute delineates prohibited conduct into several distinct statutory categories:

1. Creating a False Appearance of Active Trading: Transactions designed to mislead the investing public regarding the true market liquidity or trading interest in a listed security.
2. Inducing Trading Activity Through Artificial Price Movements: Raising, depressing, or pegging prices through concerted buying or selling to lure unsuspecting market participants into transactions.
3. Disseminating False or Misleading Information: Circulating market rumors, unverified tips, or fabricated corporate announcements to manipulate security valuations.
4. Employing Deceptive, Manipulative, or Fraudulent Devices: Any scheme or artifice intended to defraud counterparties or the market as a whole.

Under Philippine law, proof of successful financial enrichment is not required to establish a violation of Section 24. The mere execution of manipulative orders with the intent to deceive or fabricate artificial trading conditions constitutes a completed statutory offense.

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Artificial Volume Schemes: Wash Sales and Matched Orders

The two most fundamental volume-fabrication mechanisms prohibited under Section 24.1(a) are wash sales and matched orders:

1. Wash Sales (Section 24.1(a)(i))

A wash sale is defined as any transaction in a security which involves no change in the beneficial ownership thereof.

• Mechanism: Investor A sells 100,000 shares of a listed company from Brokerage Account 1, while simultaneously purchasing 100,000 shares of the identical security through Brokerage Account 2 at another brokerage firm, where Investor A is the ultimate beneficial owner of both accounts. Alternatively, an entity executes trades between two corporate subsidiaries under common control.
• Deceptive Purpose: The transaction appears on the Philippine Stock Exchange (PSE) trading tape as genuine market volume, creating an illusion of high investor demand or institutional accumulation. However, because economic ownership never changes hands, the trader incurs no market exposure or price risk aside from transaction fees and taxes.
• Statutory Element: The critical legal test for a wash sale is the absence of a change in beneficial ownership.

2. Matched Orders (Section 24.1(a)(ii))

A matched order occurs when an order or orders for the purchase or sale of a security are entered with the prior knowledge that a substantially similar order or orders—matching in size, time, and price—for the sale or purchase of such security will be entered by or for the same or different colluding parties.

• Mechanism: Participant A agrees with Participant B (or a syndicate of colluding traders) to enter pre-arranged orders. At precisely 10:15 AM, Participant A enters a limit sell order for 50,000 shares at ₱12.50, and Participant B enters an identical limit buy order for 50,000 shares at ₱12.50. The exchange trading engine matches the orders instantly.
• Deceptive Purpose: While two distinct legal persons are involved, the trade is not executed at arm's length. The participants collude to simulate market activity, establish benchmark price levels, or bypass order-book queues without bearing genuine competitive execution risk.
• Distinction: In a wash sale, beneficial ownership remains with a single party. In a matched order, colluding counterparties coordinate execution details to manufacture artificial volume and price points.

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Price Distortion and Advanced Deceptive Trading Schemes

Beyond basic volume fabrication, Section 24 prohibits sophisticated order-routing and execution strategies engineered to distort prevailing market valuations:

1. Painting the Tape

Painting the tape involves executing a rapid succession of buy and sell transactions—often via wash sales, matched orders, or nominal odd-lot trades—at progressively higher or lower prices. The objective is to print artificial transactions onto the public exchange ticker (the "tape"). Retail investors and momentum algorithms tracking volume breakouts are misled into believing that an authentic institutional trend is unfolding, prompting them to enter orders in the manipulated direction.

2. Marking the Close

Marking the close is the illegal practice of entering manipulative purchase or sale orders at or near the close of the trading session (including the run-off or closing auction period) to artificially inflate or depress the official closing price of a security.

• Motivations for Marking the Close:
  • Collateral Protection: Inflating closing prices allows borrowers to avoid margin calls on stock-pledged loans.
  • Performance Inflation: Fund managers or proprietary trading desks inflate portfolio valuations and Net Asset Value Per Share (NAVPS) at the end of financial reporting periods.
  • Benchmark Manipulation: Influencing closing prices affects index rebalancing weights and settlement prices for derivative contracts.

3. Hype and Dump / Pump and Dump Operations

A pump-and-dump (or hype-and-dump) scheme combines false publicity with coordinated market manipulation across four distinct operational phases:

1. Accumulation Phase: The perpetrators quietly purchase shares of an illiquid, small-capitalization company at depressed price levels.
2. Hype / Pumping Phase: The syndicate launches an aggressive promotional campaign, disseminating fabricated corporate disclosures, exaggerated revenue forecasts, rumors of impending foreign acquisitions, or bullish social media recommendations to generate retail buying frenzy.
3. Artificial Price Surge: As retail buyers flood the market with buy orders, the share price escalates rapidly on fabricated enthusiasm.
4. Dumping Phase: At the peak of the surge, the syndicate secretly sells off its accumulated inventory into the retail buying frenzy. Once the syndicate ceases buying support, the stock collapses, leaving retail investors with catastrophic losses.

4. Churning

Churning is the unlawful practice whereby a broker-dealer or registered salesman executes an excessive volume of purchases and sales in a customer's discretionary or managed account primarily to generate brokerage commissions and execution fees, without regard for the customer's financial profile, resources, or investment objectives.

• Legal Elements: To prove churning, regulatory authorities examine: (1) broker control over the account (either formal discretionary authority or de facto control through unsophisticated clients), and (2) excessive trading volume relative to the account's conservative investment mandate. The client does not need to show an overall net capital loss; the wrongful generation of excessive commissions at the client's expense constitutes the violation.

5. Spreading False Rumors and Misleading Disclosures

Under Section 24.1(c) and (d) of the SRC, it is strictly unlawful to induce the purchase or sale of any listed security by circulating or disseminating rumors or statements to the effect that the price will rise or fall due to manipulative market operations. Similarly, making statements that are false or misleading regarding any material fact, which the speaker knew or had reasonable grounds to believe was false, constitutes actionable fraud.

6. Pegging, Fixing, and Stabilizing Market Prices

Pegging or fixing involves entering orders to establish an artificial price ceiling, floor, or fixed trading range for a security, preventing normal market forces from adjusting valuations.

• The Green-Shoe Exception: Price stabilization is strictly illegal under Section 24.1(e) unless conducted in accordance with rules prescribed by the SEC. Under SRC Rule 24.1(e)-1, the only lawful form of market stabilization is stabilizing action conducted by an appointed stabilizing agent during an Initial Public Offering (IPO). This overallotment (green-shoe) option must be fully disclosed in the registered prospectus, limited to the IPO offering price, and terminated within a prescribed window (typically thirty calendar days).

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Short Selling Regulation: SRC Rule 24.2 and PSE Guidelines

Short selling is the sale of a security that the seller does not own, executed in the expectation that the price will decline, allowing the seller to repurchase the shares later at a lower price. While lawful short selling provides liquidity and aids price discovery, unregulated shorting creates severe risks of manipulative "bear raids."

Lawful Short Sale Architecture (SRC Rule 24.2)
  ├── 1. Prior Borrowing: SBL Agreement Executed (Naked Shorting Banned)
  ├── 2. Eligible Equity: PSEi Component / Designated Liquid Stock
  ├── 3. Price Execution: Must Comply with Uptick / Price Test Rule
  └── 4. Mandatory Marking: Order Flagged as "Short Sale" on PSE Trading Engine

1. Absolute Prohibition of Naked Short Selling

Under SRC Rule 24.2-2 and PSE Short Selling Rules, naked short selling is strictly prohibited in the Philippines. A naked short sale occurs when a trader enters a short sale order without having borrowed the shares, without an enforceable agreement to borrow the shares, or without confirming that the shares are available for borrowing prior to order entry.

Before entering any short sale order on the exchange:

• The seller must have secured a valid Securities Borrowing and Lending (SBL) contract.
• The lending agent must confirm that the underlying shares are held in custody and ready for settlement on the standard clearing cycle.

2. The Uptick Rule (Price Test)

To prevent short sellers from driving an already declining stock into a free-fall spiral, Philippine regulations impose a strict Uptick Rule:

• A short sale order can only be executed at a price higher than the last traded price (an uptick), or
• At the last traded price if that price was higher than the preceding different traded price (a zero-plus tick).
• Short sales are prohibited on a "downtick" (a price lower than the last traded price) or a "zero-minus tick" (the same price as the last trade when the preceding move was downward).

3. Eligible Securities Framework

Short selling is not permitted across all listed stocks. The PSE restricts short selling eligibility to designated securities meeting strict market capitalization, liquidity turnover, and public float criteria (predominantly constituent members of the PSE Index / PSEi).

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Civil Liabilities and Penalties: Sections 59, 63 and 73

The Securities Regulation Code imposes severe dual-track penalties for market manipulation:

1. Civil Liabilities Under Section 59

Under Section 59 of the SRC, any person who willfully participates in any act or transaction in violation of Section 24 is liable to any person who purchased or sold a security at a price affected by that act or transaction, and the injured person may sue to recover the damages sustained. (Section 57 is a different provision: it covers liability connected with prospectuses, communications, and reports.)

• Court and Damages: Under Section 63.1, these suits are brought before the Regional Trial Court, which has exclusive jurisdiction. The court may award damages not exceeding triple the amount of the transaction plus actual damages, exemplary damages in cases of bad faith or fraud, and attorney's fees not exceeding 30% of the award.
• Joint and Several Liability: Under Section 63.2, persons liable under Section 59 are jointly and severally liable, subject to rights of contribution.
• Prescription of Action: Under Section 62.2, an action to enforce Section 59 liability must be brought within two (2) years after discovery of the facts constituting the cause of action and within five (5) years after the cause of action accrued.

2. Criminal Sanctions Under Section 73

Under Section 73 of the SRC, any willful violation of Section 24 or its implementing rules constitutes a criminal offense punishable by:

• A fine of not less than ₱50,000 nor more than ₱5,000,000, or
• Imprisonment of not less than seven (7) years nor more than twenty-one (21) years, or both, at the discretion of the court.

3. Administrative Sanctions

In addition to criminal prosecution and civil suits, the SEC exercises administrative authority under Section 54 to impose administrative fines, suspend or revoke broker-dealer licenses, disqualify individuals from serving as corporate officers, and issue Cease and Desist Orders (CDO).

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Summary Comparison Table: Manipulative Devices, Mechanics, and Legal Classifications

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Practical Exam Traps & Regulatory Pitfalls

• Trap 1: Beneficial Ownership in Wash Sales. Exam questions frequently describe a transaction where Company X sells shares to Company Y, noting that both companies are wholly owned subsidiaries of Holding Corporation Z. Candidates often mistakenly treat this as a legitimate transaction because two corporate entities are involved. In securities law, this is an illegal wash sale because beneficial ownership remains identical at the parent holding company level.
• Trap 2: Legal Stabilization vs. Illegal Pegging. Stabilizing stock prices during an IPO is lawful only if conducted by the registered stabilizing agent, strictly pursuant to an overallotment (green-shoe) provision disclosed in the SEC-registered prospectus, and executed at or below the offering price. Any other attempt by underwriters or issuers to peg, fix, or support stock prices in secondary trading constitutes illegal price pegging under Section 24.1(e).
• Trap 3: Churning Does Not Require Client Losses. A registered representative may argue that their high-frequency trading generated a modest net profit for the client and therefore cannot constitute churning. This defense fails. Churning is defined by the excessive volume and frequency of trades relative to the client's financial resources and investment objectives, undertaken to enrich the broker through commissions.
• Trap 4: Short Selling on a Downtick. An exam scenario might state that a trader borrowed shares under a valid SBL contract and entered a short sale at a price lower than the last traded price to ensure immediate execution. Despite having an SBL contract, the order is illegal because it violates the Uptick Rule, which forbids executing short sales at a price below the last sale.