Features
Market manipulation and insider dealing
This provision is outlined in Rule 12 of the SEC Rules, published in the Gazette Extraordinary No. 1215/2 dated 18th December 2001, titled ‘Acts Committed to Create a False or Misleading Appearance of an Active Share Market.’
Numerous criminal prosecutions are currently underway at Magistrate Courts in Colombo, as reported by the Securities Exchange Commission (SEC) on its website (https://www.sec.gov.lk/criminal-prosecution/). These cases primarily fall into two categories: insider dealings and market manipulation. Insider dealing (or insider trading) is generally considered a separate category of criminal offense from market manipulation, though both are related to unethical or illegal activities in financial markets. Here’s a clearer distinction:
Insider Dealing (Insider Trading): Insider dealing involves trading a public company’s stock or other securities, such as government bonds, by individuals with access to non-public, material information of such securities. This information could significantly impact the price of such securities once it becomes public. Examples: An executive buying or selling stock based on non-public information about the company’s upcoming earnings report, merger, or acquisition.
Market Manipulation: Market manipulation involves deliberate actions taken to deceive or mislead investors by artificially affecting the price or trading volume of a security. The goal is often to create a false market condition, benefiting the manipulator financially. Market manipulation includes various activities such as pump and dump, spoofing, wash trading, churning, and cornering the market.
Key Differences
Nature of the Offense: Insider trading is based on the misuse of non-public, material information. Market manipulation involves creating artificial or deceptive market conditions.
Mechanisms: Insider trading typically involves informed individuals acting on undisclosed information. Market manipulation uses a variety of tactics to distort market behavior and investor perceptions.
Relationship
While insider trading and market manipulation are distinct offenses, they both undermine market integrity and investor trust. In some cases, actions might overlap. For instance, an insider might manipulate the market by spreading false information to benefit from insider knowledge, blurring the lines between the two offenses. However, legally and conceptually, they are treated as separate categories with their own regulatory frameworks and penalties.
Types of stock market manipulations
Stock market manipulation can take various forms, typically aimed at creating artificial, false, or misleading appearances with respect to the price or market for a security. Common types of stock market manipulation include:
Pump and Dump (P & D): P&D is a form of securities fraud that involves artificially inflating the price of an owned stock through false and misleading positive statements (pump), in order to sell the cheaply purchased stock at a higher price (dump). Once the operators of the scheme “dump” (sell) their overvalued shares, the price falls and investors lose their money.
Churning: Churning is the illegal and unethical practice by a broker of excessively trading assets in a client’s account in order to generate commissions. While there is no quantitative measure for churning, frequent buying and selling of stocks or any assets that do little to meet the client’s investment objectives may be evidence of churning.
Spoofing: Spoofing in stock trading is a disruptive algorithmic trading strategy where traders place large orders with the intention of canceling them before execution. This tactic creates a false impression of market demand or supply. In order-driven markets, spoofers typically post numerous limit orders (orders set at a specific target price rather than the current market price, executed only if the market price matches the target price) on one side of the order book—either bid (to buy) or offer (to sell)—creating the illusion of market pressure. This deceptive practice can lead to price changes as the market interprets the imbalance in orders as shifts in investor sentiment, causing prices to rise (more buyers) or fall (more sellers).
Wash Trading: Wash trading is an illegal practice where a single trader buys and sells the same financial instruments simultaneously. This deceptive activity creates misleading market information and artificial trading activity. Wash trading is commonly used to inflate the trading volume of a security artificially.
Bear Raiding: Attempting to push the price of a stock down by heavy selling or spreading false negative rumors. A bear raid is an illegal tactic where traders collude to drive down a stock’s price through coordinated short selling (selling stocks they do not own, intending to buy them back later at a lower price to cover their short position) and spreading negative rumors about the company. This strategy is often employed by unethical short sellers aiming to profit quickly from their short positions, using platforms like social media and online forums to amplify their impact. While individual short selling is legal in certain markets (not at the CSE), market manipulation and spreading rumors can constitute fraudulent activities.
Front Running: Front running, also known as tailgating, is the practice of trading securities based on advance knowledge of pending large transactions that will affect their prices. This involves executing personal trades ahead of client orders in the same securities. It’s considered market manipulation and can involve brokers or firms trading through undisclosed accounts or using inside information. This unethical practice is prohibited because it allows the front runner to profit unfairly from nonpublic information, potentially at the expense of clients or the broader market integrity.
Cornering the Market: Cornering the market in stock trading involves gaining significant control over a specific stock or commodity to manipulate its market price. One way of doing this is purchasing a substantial portion of the available supply in the spot market and holding onto it (hoarding). Another approach is where the cornerer buys a large number of securities to drive up prices and then sells them for profit once the price is inflated.
Painting the tape: Painting the tape is a form of market manipulation where traders engage in coordinated buying and selling of a security among themselves to create the appearance of active trading and artificially inflate the trading volume or price of the stock.
Marking the close: Marking the close involves manipulating the closing price of a stock by executing trades at or near the market close. The goal is to influence the official closing price to benefit positions or portfolios held by the manipulator.
The following show cause notices issued by the SEC can be quoted as examples of market manipulation.
There have been numerous cases in Sri Lanka involving individuals in criminal activities (see SEC website). However, only minor offenders have been charged, while major players often escape justice by cleverly using various tricks and powerful connections.
Conclusion
Rule 12 of the SEC Rules, published in the Gazette Extraordinary No. 1215/2 dated 18th December 2001, prohibits actions intended to create, or reasonably expected to create a false or misleading appearance of active trading or market conditions regarding securities listed on a licensed stock exchange. This provision aims to safeguard market integrity and investor trust by preventing fraudulent activities that distort market behavior. Despite numerous cases of market manipulation and insider trading reported in Sri Lanka, prosecutions have predominantly targeted minor offenders, while major perpetrators often evade justice through sophisticated means and powerful connections, as documented on the SEC website.
Insider trading involves trading based on non-public, material information that could impact security prices, whereas market manipulation involves deliberate actions to deceive investors and artificially affect security prices or trading volumes. Common forms of market manipulation include pump and dump schemes, churning, spoofing, wash trading, bear raiding, front running, cornering the market, painting the tape, and marking the close. These activities undermine market fairness and transparency, necessitating robust regulatory enforcement as demonstrated by the SEC’s ongoing prosecutions and show cause notices.
By distinguishing between insider trading and market manipulation, the SEC’s regulations provide a comprehensive framework to address various unethical practices, ensuring a fair and orderly market environment. However, the challenge remains to hold all offenders accountable, regardless of their influence or resources.
(The writer, a senior Chartered Accountant and professional banker, is Professor at SLIIT University, Malabe. He is also the author of the “Doing Social Research and Publishing Results”, a Springer publication (Singapore), and “Samaja Gaveshakaya (in Sinhala). The views and opinions expressed in this article are solely those of the author and do not necessarily reflect the official policy or position of the institution he works for. He can be contacted at saliya.a@slit.lk and www.researcher.com)