Since the rise of the stock market, individuals have tried to manipulate it for their benefit, often at the expense of other investors. Stock market manipulation refers to deliberately distorting the financial market to achieve personal advantage.
Usually, these manipulative strategies aim to deceive investors by artificially raising or lowering a security's price. Such dishonest practices not only damage individual investors but also compromise the integrity of the financial markets.
Market manipulation involves intentionally controlling or influencing securities prices to deceive investors, which is often difficult for regulators to detect and prove.
Market manipulation may include false statements, but its primary goal is to influence prices to mislead other market participants. In simple terms, stock market manipulation is about misleading others. It isn't easy to detect or prove, especially in larger, more liquid markets.
A common form of stock manipulation is the pump-and-dump, in which the price of a microcap stock is artificially inflated before it is sold. Currency manipulation, on the other hand, is a separate political issue usually raised in trade disputes between sovereign nations.
Federal laws govern the stock market, aiming to promote fair trading and protect investor confidence. Accusations of illegal stock manipulation can lead to charges, hefty fines, and jail sentences. Here are five common forms of stock market manipulation.
Insider Trading
Insider trading is illegal when transactions are conducted using material, non-public information. This practice compromises the fairness and integrity of the stock market.
For instance, an executive engaging in stock trades of their company based on confidential information about upcoming financial statements or merger and acquisition news that could greatly influence the stock price once announced, would be engaging in illegal insider trading.
In simple terms, insider trading occurs when someone with confidential, material information about a public company's stock or other securities trades.
Such transactions are legal if the insider reports the trade to the Securities and Exchange Commission. Conversely, insider trading is illegal when the material information remains non-public.
Wash Trading
Wash trading occurs when a trader buys and sells the same financial instruments to create the illusion of market activity. This creates a false appearance of liquidity and trading interest that isn't real.
For instance, a trader may use two separate accounts to buy and sell a specific stock, generating activity that might lure other investors into believing the stock is more popular than it actually is.
In simple terms, wash trading happens when an investor trades the same or a very similar security at the same time. The Internal Revenue Service (IRS) calls this a wash sale because buying the same security effectively cancels the sale of that security.
Round-trip trading, also known as wash trading, involves ending up with the same security in your portfolio after a series of buy and sell actions.
Such trades can serve as a form of market manipulation, in which investors buy and sell the same securities to sway prices or trading volumes. The intention might be to boost buying activity to push prices higher or to promote selling to lower prices.
Pump and Dump
A "pump and dump" scheme occurs when someone artificially raises the price of a stock they own by spreading false or misleading information (pumping). They then sell the stock at its highest point before the deception is revealed (dumping).
These schemes usually target small-cap or micro-cap stocks because their lower trading volumes make them easier to manipulate.
A person might disseminate false or exaggerated information about a company on social media to inflate its stock price, then sell their shares for a hefty profit before the truth is revealed and the stock price drops.
A less common approach is the inverse poop-and-scoop, in which false negative claims about a stock are used to buy it cheaply. Similarly, the short-and-distort strategy involves short-sellers spreading misinformation to profit.
Although these schemes mainly depend on promotion or false statements, they are often reinforced by illegal trading practices meant to mislead.
Front Running
Front running occurs when a broker or another party with prior knowledge of a large transaction exploits that information to profit before the trade is completed, thereby influencing the price.
For example, if a broker knows a client intends to buy a large amount of a specific stock, they might buy shares of that stock in advance and then sell them at a profit once the client's order affects the market price.
In simple terms, front-running involves a broker trading stocks or other financial assets using inside information about a future transaction that could significantly impact the asset's price.
A broker might also engage in front-running if they know their firm is about to give a buy or sell recommendation to clients, which will likely influence the asset's price.
Spoofing
Spoofing involves traders submitting numerous orders and canceling them before they are executed. This tactic gives a misleading impression of demand or supply, tricking other market participants.
For example, a trader might place large buy orders for a stock without intending to buy, artificially increasing the price. When other traders buy at this inflated price, the spoofer cancels their orders and sells their holdings at the higher prices.
Order spoofing is when someone places many buy or sell orders to influence the stock price, then cancels them once other traders adjust their bids or asks. This tactic has tempted employees at major Wall Street firms and unscrupulous day traders alike. It can happen across bonds, metals, and stock markets.
What are the Potential Penalties?
Depending on the details of the suspected behavior, stock market manipulation can be prosecuted under different federal laws. Many cases of such manipulation are charged as falsely manipulating the price of a commodity, which can result in the following penalties:
- Fines reaching up to $1 million and
- Maximum of 10 years in prison (7 U.S.C. 13).
In essence, stock market manipulation is considered securities fraud, which can result in sentences of up to [years], emphasizing the legal severity of such actions.
What are the Available Defenses?
If accused of stock market manipulation, consulting a qualified federal criminal defense attorney immediately is vital to protect your rights and build a strong defense.
- No Intent: You did not mean to manipulate the market or deceive investors. This relies on the understanding that market manipulation is only illegal if it involves intent.
- Non-public Information: In cases of suspected insider trading, one potential defense is to show that the trading relied on publicly accessible information rather than confidential or non-public data.
- No Control: If you can demonstrate that they did not have direct control over your trading decisions — for example, if a broker or financial advisor was managing the account - this could be used as a valid defense.
- Safe Harbor: Certain communications, such as forward-looking statements with significant cautionary notes, are shielded by "safe harbor" rules. This protection may apply if you demonstrate that their actions meet these criteria.
If you're under investigation for stock market manipulation, reach out to our law firm for a consultation. Cron, Israels & Stark has offices in Los Angeles, California.
