Market Manipulation
Market manipulation involves artificially influencing security prices or trading volume. These practices are illegal under federal securities laws and FINRA rules.
What is Market Manipulation?
Market manipulation is any conduct designed to deceive investors by artificially affecting the price or volume of a security.
Why It's Prohibited
- Undermines market integrity
- Harms innocent investors
- Destroys confidence in fair markets
- Creates artificial prices that don't reflect true value
Types of Market Manipulation
Wash Trading
Wash trading involves buying and selling the same security to create the illusion of market activity.
| Element | Description |
|---|---|
| Definition | Simultaneously buying and selling the same security |
| Purpose | Create appearance of active trading |
| Result | No change in beneficial ownership |
| Violation | Securities Exchange Act, FINRA Rules |
Example: A trader sells 1,000 shares to a related account and immediately buys them back, creating artificial volume.
Matched Orders
Matched orders are prearranged trades between parties with no real change in ownership.
- Orders entered knowing a matching opposite order exists
- Creates misleading appearance of active trading
- Often used with wash trades
Painting the Tape
Painting the tape involves executing a series of transactions to create the impression of active trading.
| Element | Description |
|---|---|
| Definition | Transactions creating misleading activity appearance |
| Purpose | Attract other investors to trade |
| Name Origin | From ticker tape showing trade activity |
Note: Painting the tape and matched orders often work together to manipulate prices.
Pump and Dump
Pump and dump schemes artificially inflate a stock's price through false promotion, then sell at the inflated price.
| Phase | Action |
|---|---|
| Pump | Spread false positive information to inflate price |
| Dump | Sell shares at artificially high prices |
| Result | Innocent investors left holding devalued stock |
Spoofing and Layering
Spoofing involves placing orders with the intent to cancel before execution.
| Element | Description |
|---|---|
| Definition | Placing non-bona fide orders to move prices |
| Intent | Cancel before execution |
| Purpose | Manipulate other traders' behavior |
Layering is a form of spoofing where multiple orders are placed at different price levels:
- Place large orders on one side of the market
- Execute smaller order on opposite side at better price
- Cancel the large orders
Example: Place large sell orders to push price down, buy at lower price, cancel sell orders, price rises.
Front Running
Front running is trading ahead of a customer order to profit from the expected price movement.
| Element | Description |
|---|---|
| Definition | Trading ahead of known customer order |
| Who | Broker-dealer or representative |
| Purpose | Profit from price impact of customer order |
| Violation | Breach of fiduciary duty |
Example: A broker learns a client will buy 100,000 shares. Before executing the client's order, the broker buys shares for their own account, knowing the large order will push the price up.
Marking the Close/Open
Marking the close (or open) involves placing trades near market close (or open) to influence the closing (or opening) price.
| Type | Description |
|---|---|
| Marking the Close | Trades at end of day to affect closing price |
| Marking the Open | Trades at start of day to affect opening price |
Why it matters: Closing prices are used for:
- Portfolio valuations
- Index calculations
- Options settlement
- Performance benchmarks
Churning (Excessive Trading)
Churning is excessive trading in a customer's account to generate commissions.
| Element | Description |
|---|---|
| Definition | Excessive trading for commission generation |
| Control | Broker must have control over account |
| Intent | Generate commissions, not serve customer |
| Harm | Costs eat into customer's returns |
Backing Away
Backing away is a market maker's failure to honor a published quote.
| Element | Description |
|---|---|
| Definition | Refusing to trade at quoted price and size |
| Who | Market makers |
| Rule | Must honor firm quotes |
Exception: Quotes can be updated as market conditions change, but must honor quote when order is received at displayed price/size.
Spreading False Information
Market Rumors
Spreading false or misleading information to affect security prices is prohibited:
- False press releases
- Misleading social media posts
- Fabricated research reports
- Fake news about companies
Scalping
Scalping involves recommending a security while secretly selling it.
Example: An analyst publicly recommends buying a stock while simultaneously selling their own position.
Regulatory Framework
Key Laws and Rules
| Rule/Law | Focus |
|---|---|
| Securities Exchange Act Section 9(a) | Prohibits manipulation |
| SEC Rule 10b-5 | Fraud and manipulation |
| FINRA Rule 2020 | Manipulative and deceptive devices |
| FINRA Rule 2010 | Standards of commercial honor |
| FINRA Rule 5210 | Publication of transactions and quotations |
FINRA Surveillance
FINRA monitors for manipulation through:
- Trade surveillance systems
- Pattern detection algorithms
- Cross-market analysis
- Tips and complaints
Consequences of Market Manipulation
| Type | Potential Penalty |
|---|---|
| Civil | SEC fines, disgorgement of profits |
| Criminal | Imprisonment, criminal fines |
| Regulatory | FINRA suspension or bar |
| Private | Investor lawsuits |
Red Flags for Manipulation
| Category | Warning Signs |
|---|---|
| Trading Patterns | Unusual volume, price spikes |
| Order Flow | Large orders cancelled repeatedly |
| Timing | Activity concentrated at open/close |
| Communications | Promotional campaigns before price moves |
Key Takeaways
- Market manipulation is illegal and harms investors
- Wash trading creates false appearance of activity
- Pump and dump artificially inflates then crashes prices
- Spoofing/layering involves placing orders to cancel
- Front running profits from customer order knowledge
- Churning generates excessive commissions
- Penalties include fines, imprisonment, and industry bars
A trader places multiple large sell orders with no intention of executing them, then buys shares at a lower price and cancels the sell orders. This practice is known as:
A broker-dealer representative learns a large institutional client is about to place a major buy order. Before entering the clients order, the representative buys shares for their personal account. This is an example of:
Which of the following BEST describes a "pump and dump" scheme?
3.10 Insider Trading
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