Since the stock market's rise, many individuals have attempted to manipulate it for personal gain, potentially harming other investors in the process. Market manipulation involves intentionally distorting financial markets to achieve a personal advantage, a practice that can have severe consequences for the integrity of the market and the financial well-being of investors.
Generally, these manipulative tactics are designed to deceive investors by artificially inflating or deflating the value of a security. Such unethical practices not only harm individual investors but also undermine the integrity of financial markets, highlighting the need for vigilance.
Market manipulation, often illegal, aims to deceive investors by artificially influencing the prices of securities. Despite its illegality, it remains difficult to detect or prove, which underscores the seriousness of the offense and the need for constant vigilance in the financial markets.
Market manipulation can include false statements, but its main goal is to influence prices to deceive other traders. Essentially, stock market manipulation intends to mislead market participants. Detecting and proving such manipulation is challenging, and it becomes even more difficult in larger, more liquid markets.
Federal laws govern the stock market, aiming to promote fair trading and protect investor trust. If accused of illegal manipulation, you may face fines and jail time under these laws. Here are five common forms of stock market manipulation.
Pump and Dump
A common form of stock manipulation is the pump-and-dump scheme, in which traders artificially inflate the price of a microcap stock before selling it. Currency manipulation, on the other hand, is a separate political issue often raised in trade disputes between sovereign nations.
A "pump and dump" scheme involves artificially raising a stock's price through false or misleading statements (pumping) and then selling off the stock at its highest point before the deception is exposed (dumping). These schemes typically focus on small-cap or micro-cap stocks, as their lower trading volumes make them more susceptible to manipulation.
Someone could spread false or exaggerated news about a company on social media to inflate its stock price, then sell their shares for a significant profit before the truth is revealed and the price drops.
A less common approach is the inverse "poop-and-scoop" method, where false, derogatory claims are made about a stock to buy it cheaply. Another variation is the short-and-distort tactic, which is essentially a short-sell strategy used by short-sellers to generate a profit. Although these schemes primarily rely on misinformation or promotion, they are often combined with illicit trading practices designed to deceive investors.
Insider Trading
Insider trading is considered illegal when individuals make trades using material, non-public information. This practice threatens the fairness and integrity of the stock market.
An example of illegal insider trading involves an executive buying or selling their company's stock using confidential information about upcoming financial reports or merger and acquisition news that could greatly influence the stock price once made public.
In simple terms, insider trading occurs when someone with non-public, material information about a public company buys or sells its stock or other securities.
Insider transactions are lawful when the insider reports the trade to the Securities and Exchange Commission. However, trading based on material information that is not yet public remains illegal.
Spoofing
Spoofing involves traders submitting numerous orders and cancelling them before execution. This creates a misleading illusion of demand or supply, deceiving other market participants.
For example, a trader might submit large buy orders for a stock without actually intending to buy, in order to artificially raise the price. When other traders begin buying the stock at this higher price, the spoofer cancels their buy orders and sells their holdings at the inflated prices.
Order spoofing occurs when an individual places numerous buy or sell orders to manipulate the stock price, then cancels them after other traders have responded or adjusted their bids.
Order spoofing has tempted employees at major Wall Street firms and dubious day traders. It can happen in bonds, metals, and stock markets.
Wash Trading
Wash trading occurs when a trader repeatedly buys and sells the same financial instruments to generate false, artificial market activity. This creates an illusion of liquidity and trading interest that is not actually present.
For example, a trader may use two separate accounts to buy and sell a specific stock, creating activity that could lure other investors to the seemingly popular stock.
In simple terms, wash trading occurs when an investor simultaneously buys and sells the same or a similar security. The IRS refers to this as a wash sale, as buying the same security essentially nullifies the sale of that security.
It's also known as round-trip trading because you ultimately return to your starting point, retaining the same security in your portfolio.
Wash trades serve as a method of market manipulation, where investors execute repeated buying and selling of the same securities to sway prices or trading volumes. This tactic aims to boost buying interest to raise prices or to promote selling to lower them.
Front Running
Front-running occurs when a broker or another party with insider knowledge of a large transaction acts on that information before the deal is finalized, thereby affecting the price.
For example, if a broker is aware that their client intends to buy a large amount of a specific stock, they might buy shares of that stock in advance and then sell them for a profit once the client's purchase affects the market price.
In simple terms, front-running involves a broker trading stocks or other financial assets using insider knowledge of an upcoming transaction that will significantly impact the price.
A broker might also be front-run if they possess insider knowledge that their firm is about to issue a buy or sell recommendation to clients, which will likely impact the asset's price.
What Penalties Are There for Stock Market Manipulation?
Depending on the specific behavior suspected, stock market manipulation can be prosecuted under various federal laws. Many cases of such manipulation are prosecuted under the broader charge of intentionally falsely manipulating the price of a commodity, which carries the following penalties:
- Fines reaching up to $1 million and
- Up to 10 years of imprisonment (7 U.S.C. 13).
Stock market manipulation is generally regarded as a form of securities fraud, with more serious cases potentially prosecuted under 18 U.S.C. § 1348. Convictions under this law can lead to imprisonment for up to 25 years.
What are the Typical Defenses Used?
If you're accused of stock market manipulation, it's essential to consult a skilled federal criminal defense attorney promptly. Typical defenses an attorney might employ to challenge these charges include:
- Lack of Intent: You did not aim to manipulate the market or deceive investors. This is because stock market manipulation is only illegal if it involves an intent to deceive.
- Non-public Information: In insider trading allegations, a potential defense is to prove that the trading relied on information available to the public, rather than confidential or non-public data.
- No Control: If you can demonstrate that they lacked direct control over your account's trading decisions—perhaps because a broker or financial advisor was managing it—this may be a valid defense.
- Safe Harbor Rules: Some communications, such as forward-looking statements with clear cautionary language, are protected by "safe harbor" laws. This protection may apply if you can demonstrate that their actions meet these criteria.
If you are being investigated for stock market manipulation, contact our law firm for an initial consultation. Eisner Gorin LLP has offices in Los Angeles, California.
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