Ever since the stock market emerged, people have been attempting to manipulate the market to their advantage—often to the harm of other investors. Stock market manipulation involves intentionally distorting the financial market for personal gain.
Typically, these manipulative tactics are designed to mislead investors by artificially inflating or deflating the price of a security. These deceptive practices not only harm individual investors but also undermine the integrity of the financial markets.
Market manipulation is designed to deceive investors by controlling or artificially affecting the price of securities. Manipulation is illegal in most cases, but it is often difficult for regulators and other authorities to detect and prove.
Market manipulation might involve factually false statements, but it always seeks to influence prices to mislead other market participants.
Simply put, stock market manipulation aims to mislead other market participants. It's hard to detect and prove in larger and more liquid markets and harder to execute.
A common type of stock manipulation is the pump-and-dump, which artificially inflates the price of a microcap stock before selling it. Currency manipulation is a distinct political claim typically made in trade disputes between sovereign countries.
Federal laws regulate the stock market. They are designed to ensure fair trading practices and maintain investor confidence. If you are accused of illegal stock market manipulation, you could be charged under these laws and possibly face significant fines and prison time. Let's look at five of the most common types of stock market manipulation.
Pump and Dump
A "pump and dump" scheme involves artificially inflating the price of an owned stock through false or misleading statements (pumping) and then selling the stock at its peak before the deception is uncovered (dumping). Pump-and-dump schemes target small-cap or micro-cap stocks due to their lower trading volumes, making them easier to manipulate.
An individual might spread exaggerated news about a company on social media, driving up the stock price, then sell their shares for a significant profit before the truth emerges and the price plummets.
A less common method is the inverse poop-and-scoop scheme, in which false, derogatory statements are made about a stock to buy it on the cheap. There is also the short-and-distort, essentially a poop-and-scoop executed by short-sellers to profit.
While these schemes rely primarily on promotion or factual misstatements, they are often supplemented by illegal trading tactics designed to deceive.
Spoofing
Spoofing is a practice where traders submit a flurry of orders and cancel them before execution. This behavior creates a false impression of demand or supply, misleading other market participants.
For instance, a trader might place large buy orders for a stock without intending to purchase it, artificially driving up the price. Once other traders start buying the stock at the inflated price, the spoofer cancels their buy orders and sells their holdings at elevated prices.
Simply put, order spoofing involves placing numerous buy or sell orders designed to move the stock price and canceling them once other traders have moved their bids or asked accordingly. It has tempted staff at large Wall Street firms and shady day traders. Order spoofing can occur in bonds, metals, and stock markets.
Wash Trading
Wash trading involves a trader buying and selling the same financial instruments to create misleading, artificial market activity. This can give the impression of liquidity and trading interest that doesn't exist.
For example, a trader might use two different accounts to buy and sell a particular stock, generating activity that could attract other investors to the seemingly popular stock.
Simply put, wash trading occurs when an investor buys and sells the same or a similar security investment simultaneously. The Internal Revenue Service (IRS) also refers to this as a wash sale since purchasing the same security cancels out the sale of that security.
It's also called round-trip trading because you essentially end up where you began with shares of the same security in your portfolio.
Wash trades can be used as a form of market manipulation. Investors can buy and sell the same securities to influence pricing or trading activity. The goal may be to spur buying activity to increase prices or encourage selling to drive prices down.
Insider Trading
Insider trading becomes illegal when trades are made based on material, non-public information. This undermines the fairness and integrity of the stock market.
An example of illegal insider trading would be an executive buying or selling stock in their own company based on confidential information about upcoming financial reports or merger and acquisition news that could significantly impact the company's stock price once the news goes public.
Simply put, insider trading involves trading in a public company's stock or other securities by someone with non-public, material information about the company.
Insider transactions are legal if the insider makes a trade and reports it to the Securities and Exchange Commission. However, insider trading is illegal when the material information is still non-public.
Front Running
Front running occurs when a broker or other party with advanced knowledge of a significant transaction uses this information to their advantage before the transaction has been executed, thereby affecting the price.
For instance, if a broker knows their client plans to buy a large quantity of a particular stock, they might purchase shares of the same stock beforehand, then sell them at a profit once the client's purchase influences the market price.
Simply put, front-running is trading stocks or any other financial asset by a broker who has inside knowledge of a future transaction that is about to affect its price substantially.
A broker may also be front-run based on insider knowledge that their firm is about to issue a buy or sell recommendation to clients, which will almost certainly affect the price of an asset.
What are the Penalties for Stock Market Manipulation?
Based on the specifics of the suspected behavior, stock market manipulation can be charged under various federal statutes. Many instances of stock market manipulation are charged under the umbrella of falsely manipulating the price of a commodity, punishable by:
- Fines of up to $1 million and
- Up to 10 years in prison (7 U.S.C. 13).
At its heart, however, stock market manipulation is considered a form of securities fraud, and more severe instances may be charged as such under 18 U.S.C. 1348 securities and commodities fraud. A conviction under this statute can result in up to 25 years in prison.
What are the Common Defenses?
If you're facing stock market manipulation accusations, immediately seeking legal counsel from a skilled federal criminal defense attorney is crucial. Common defenses a good attorney might use to combat these charges include:
- Lack of Intent: You did not intend to manipulate the market or deceive investors. It's based on the premise that stock market manipulation requires intent for the action to be considered illegal.
- Absence of Material Non-public Information: In cases of alleged insider trading, a possible defense is to demonstrate that the trading was based on publicly available information, not confidential or non-public information.
- No Control over Trading Decisions: If you can prove they had no direct control over the trading decisions in your account – perhaps because a broker or financial advisor was managing it – this could serve as a valid defense.
- Safe Harbor Rules: Certain communications, like forward-looking statements accompanied by meaningful cautionary statements, are protected under "safe harbor" rules. This defense could apply if you show their actions fall within these provisions.
If you are under investigation 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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