Be on your Guard against Market Manipulation Schemes
This week, the TTSEC continues its series of articles designed to protect the investor. This article addresses the issue of Market Manipulation and the schemes used by investors to deceive or defraud investors.
One of the expressed functions of the TTSEC as enshrined in Part II-4 of the SIA 1995, (the Act) is to “maintain surveillance over the securities market and ensure orderly, fair and equitable dealings in securities”. This means that it should strive to eliminate from the Stock Exchange illegal manipulative practices of all kinds.
Definition of Market Manipulation
Manipulation connotes intentional or willful conduct designed to deceive or defraud investors by controlling or distorting market activity. Non-disclosure or false or misleading information is usually essential to the success of a manipulative scheme.
Market manipulation is deleterious conduct because it affects the integrity of the securities marketplace. Price (and volume) should be set by the unimpeded collective judgment of buyers and sellers. Manipulation alters the independent trading and pricing mechanism of the market place and turns it into a stage-managed performance. This can lead to tremendous losses to investors.
Types of Market Manipulation Cases
In general, there are two types of market manipulation, examples of which may not be mutually exclusive.
- Pump and dump schemes
- “Traditional” or “classical” trading.
Pump and Dump Schemes
In Pump and Dump schemes, a fraudster deliberately and artificially inflates the price of a stock and then dumps his holding of securities on the market at the artificially high price.
Pump and dump schemes work best where stocks are thinly traded, that is, only a small portion of the issued stocks are available for regular trading, and the perpetrator can control the float (the shares of a company that are freely available to investors). Small events in the market can cause relatively large price increases thereby making it easy to attract prospective buyers before eventually dumping the security.
In order to pump up the price of a stock, false or misleading information is supplied over the internet, bulletin boards, chat rooms, false e-mails, or false press releases. False or misleading information can also come from brokers, “boiler rooms”, faxes and answering machines. Additionally, the schemes may “manufacture” trading activity by ensuring that there are matched or coordinated sales, i.e. the perpetrator or affiliate operates on both sides of a transaction. All of these factors give an illusion of demand which can cause the price of a security to inflate. The perpetrator then sells at the inflated price in order to prevent other investors from capitalizing on the inflated price.
Market manipulation of the form described above normally takes place through “shell companies”. A shell company is one that has no operating business, but exists for the purpose of merging with an operating company. Shell companies enable perpetrators to control the float of an issuer’s stock because the price of the stock is initially low.
Recently, in certain international markets there has been a noted increase in the frequency of use, and sophistication of pump and dump schemes to defraud investors. Users of the Internet are most commonly the victims of these schemes. One such example is the case of Orex Gold Mines Corporation in Florida, a shell company whose directors created a website, and circulated promotional material that sought to portray Orex as a functioning company which possessed gold mines, employees and a new gold extraction process, the Haber Gold Process which was approved by the Environmental Protection Agency, none of which was true. Further, the directors advertised that investment in Orex required no serious decision-making and irresponsibly promised potential investors significant returns on their investment, which they deemed as safe and risk free and in which they claimed to be personally invested.
Manipulation based on Trading
In the case of traditional or classical trading, the market is manipulated through the concerted efforts of traders, brokers and others engaged in trading and/or the handling of quotations. Manipulative conduct through trading may harm investors although they may not necessarily move market prices significantly. Among the more frequently observed manipulative schemes are churning, mark-ups, scalping and touting.
Churning refers to excessive trading in a customer’s account, i.e. when a broker buys and sells the same stock several times in the same month without the authorization of the customer. The broker dishonestly earns a commission every time he buys or sells a stock and also puts the customer’s interests at risk.
A mark-up represents the difference between the higher price charged to a customer by a dealer and the lowest current offering price which is agreed upon among dealers. In this circumstance, dealers acting on behalf of their customers can abuse the arrangements in order to make abnormally high profits.
In the case of scalping, a market actor such as an investment adviser purchases a security for a client before recommending the security and then sells the security at a profit upon the rise in the market price following the recommendation. These transactions usually take place within the same day or can also take place over a few minutes. Scalping is also known as front-running when performed in advance of large buy orders even without a recommendation.
Finally touting refers to any person who is paid directly or indirectly, to recommend the sale of any security, without disclosing this fact and the amount of compensation to be received. Once someone is paid to recommend a security, this information should be provided to the market. Touting is also illegal practice in the securities market since it does not follow the principle of full disclosure to the market and gives an unfair advantage to some investors over others.
Market manipulative conduct is illegal and clearly not in the interest of investors. Part VII, of the Securities Industry Act, 1995 (“the Act”) which deals with market conduct and regulation, identifies several types of market manipulative schemes (sections 80 to 84), namely:
- Market Rigging Transactions
- Inducement to purchase or sell securities by dissemination of information
- Employment of Deceptive Devices
- Excessive Trading
The first three of these schemes constitute strategies that correlate with pump and dump schemes. The latter fits perfectly into the description of churning. Investors are encouraged to become familiar with these sections of the Securities Industry Act, 1995 (the Act) and to inform the TTSEC immediately if they believe that they have been unfairly affected by any of the behaviours alluded to above which may have occurred in the Securities Market.
Trinidad and Tobago Securities and Exchange Commission
© August 2005