Trading manipulation

II) Limiting trading manipulation

The prohibition of trade manipulation, along with the application of severe

punishments, constitutes an effective defense against illicit financial market
activity. Together, these procedures not only prohibit manipulation but also
protect the worldwide financial system's stability and equity. As a result, the
first section will focus on prevention (A), followed by sanctions (B).

A) Prevention

Several preventative measures have been implemented throughout the years to

safeguard the integrity and fairness of these marketplaces. These measures
include an extensive range of legal and technical solutions aimed at detecting
and discouraging manipulation in all of its manifestations. In this section, we
will look at some of the important preventative tactics and approaches used to
protect financial markets from trade manipulation, such as regulatory
monitoring, market surveillance, and investor education. These policies work
together to promote accountability, transparency, and the preservation of trust in
the global financial system.

Regulatory bodies

*U.S. Securities and Exchange Commission (SEC): The SEC is the federal
agency responsible for regulating the securities industry, including the
prevention and enforcement of trading manipulation in U.S. securities markets.
During the early 1930s, during the height of the Great Depression, two key
pieces of federal legislation were passed: the Securities Act of 1933 and the
Securities Exchange Act of 1934. The 33 Act has a somewhat narrow reach
because it primarily addresses the procedure by which firms can register, sell,
and issue new securities. However, it can prevent pump and dump schemes
because the requirement of full disclosure can make it difficult for promoters to
engage in this act. The 34 Act, on the other hand, was intended to
comprehensively control the acquisition or selling of securities on secondary
markets in the United States. In other words, the Act concentrates on what
happens after a security is issued for the first time. The 34 Act made it illegal for
anybody participating in the securities industry—investors, brokers, dealers, and
traders—to act dishonestly1. As stated in the 34 Act’s introductory section, the
law was intended to be a comprehensive legal framework for essentially all
securities transactions in the U.S. The Section 9(a) of this act makes it unlawful
to:

1) Create “a false or misleading appearance of active trading in any

security other than a government security, or a false or misleading
appearance with respect to the market for any such security” through
wash sales or matched orders;
2) Engage in a series of transactions that creates “actual or apparent active
trading” or raises or depresses prices “for the purpose of inducing the
purchase or sale” of a security by others; or

3) Knowingly spread false information about a security in order to raise or

depress its price and thereby induce the purchase or sale of a security by
another2.

Also, the same act addresses insider trading conduct, which is the illegal
practice of trading securities based on material, non-public information.
Section 10(b) and Rule 10b-5 of this act make it illegal to engage in insider
trading in the United States. Therefore, the security exchange act of 1934 is
the cornerstone of U.S. Securities Regulation that Prohibits Market
Manipulation and Fraudulent Activities in Securities Market3.

*Commodity Futures Trading Commission (CFTC): The CFTC is responsible

for regulating the U.S. futures and derivatives markets. It enforces rules and
regulations to prevent and address manipulation in commodities, futures, and
options trading by the commodity exchange act such as the prohibition of wash
trading4.

*Financial Industry Regulatory Authority (FINRA): Self-Regulatory

Organization Overseeing Brokerage Firms and Their Registered Representatives
1
https://www.financestrategists.com/financial-advisor/business-ethics/market-manipulation
(consulted on November 3rd 2023)
2
https://www.rahmanravelli.co.uk/expertise/market-manipulation-investigations (consulted
on November 3rd 2023)
3
https://www.law.cornell.edu/wex/insider_trading (consulted on November 3rd 2023)
4
https://www.financestrategists.com/financial-advisor/business-ethics/market-manipulation
(consulted on November 3rd 2023)
that Enforce Rules and Regulations for Market Integrity and Investor
Protection5.

*Other relevant law: various federal and state law such as The "Dodd-Frank
Wall Street Reform and Consumer Protection Act," commonly known as the
Dodd-Frank Act, is a significant piece of financial reform legislation passed in
the United States in response to the global financial crisis of 2007-2008. , it’s
aimed at Combating Market Manipulation and Maintaining Market Integrity.
Along with commodity exchange act, the Dodd-Frank covers spoofing and
layering in the context of commodity futures trading6.

Surveillance and monitoring techniques

Regulators and financial institutions use advanced surveillance and monitoring

techniques, including market surveillance systems, algorithms analysis and
artificial intelligence, to detect and analyze suspicious trading activity that may
indicate trading manipulation.

Exchanges and regulatory authorities use market surveillance systems to

continually monitor trading operations, looking for abnormalities such as odd
price fluctuations, order imbalances, or patterns indicative of manipulation.
Whereas, algorithmic analysis is the use of algorithms to detect imperfections in
trade data, assisting in the identification of suspected instances of manipulation.
Finally, Artificial intelligence and machine learning are increasingly being used
to filter through massive volumes of data, identifying patterns that human
experts may miss. These approaches are further strengthened by the awareness
of experienced traders and whistleblowers who may disclose questionable
activity. Overall, the mix of technology instruments and human control is
critical for preserving market integrity and discouraging trade manipulation. In
this context, we may emphasize the significance of reporting as a potent
deterrent to manipulation since it creates a clear audit trail that can be checked
for abnormalities. Furthermore, because regulatory authorities have access to a
multitude of data and information, openness and reporting enable them to
identify and examine suspected manipulative activities. As a result, a well-
regulated environment that prioritizes disclosure and reporting contributes to the

5
https://www.financestrategists.com/financial-advisor/business-ethics/market-manipulation
(consulted on November 3rd 2023)
6
https://www.financestrategists.com/financial-advisor/business-ethics/market-manipulation
(consulted on November 3rd 2023)
integrity and fairness of financial markets while discouraging those who may
attempt to participate in trade manipulation7.

Cybersecurity

While surveillance and monitoring tools are primarily concerned with detecting
abnormal trading patterns and attempts at manipulation, cybersecurity serves a
complementary function in safeguarding the underlying infrastructure and data.
Maintaining the security of these systems is critical in the present era of
electronic trading when a large share of trade occurs through digital platforms.
Cyber attacks can be used to affect trade, whether by breaking into trading
systems to perform unlawful transactions, publishing fake information to
manipulate prices, or interrupting trading platforms to generate chaos. To
prevent illegal access and manipulation efforts, sophisticated cybersecurity
solutions such as encryption, multi-factor authentication, intrusion detection
systems, and firewalls are required. Furthermore, cybersecurity contributes to
the confidentiality and integrity of financial data, lowering the danger of insider
trading based on stolen information8.

Whistleblower program

On the simplest level, a whistleblower is someone who reports waste, fraud,

abuse, corruption, or dangers to public health and safety to someone who is in
the position to rectify the wrongdoing. A whistleblower typically works inside
of the organization where the wrongdoing is taking place; however, being an
agency or company “insider” is not essential to serving as a whistleblower9.
What matters is that the individual discloses information about wrongdoing that
otherwise would not be known. In the context of trading manipulation, Under
the CFTC and SEC Whistleblower Programs, whistleblowers may be eligible for
monetary awards if they voluntarily provide the CFTC or SEC with original
information about violations of federal laws that leads either agency to bring
successful enforcement actions. Whistleblowers may receive awards of between
10-30 percent of the total sanctions imposed. The programs also protect the
confidentiality of whistleblowers and do not disclose information that might

7
https://eflowglobal.com/what-is-trade-surveillance-market-abuse-monitoring-explained
(consulted on November 3rd 2023)
8
https://istari-global.com/insights/spotlight/the-impact-of-security-events-stock-market
(consulted on November 3rd 2023)
9
https://www.whistleblowers.org/what-is-a-whistleblower (consulted on November 3rd 2023)
directly or indirectly reveal a whistleblower’s identity. Whistleblowers can even
submit tips anonymously if represented by counsel10.
Since the law went into effect, the SEC Whistleblower Office has awarded more
than $1.2 billion to 233 whistleblowers. As an example of an effective
whistleblowing, Harry Markopolos, a financial analyst and fraud investigator,
had long been skeptical of Bernie Madoff's investment business, Bernard L.
Madoff Investment Securities LLC. Even though several regulatory bodies
failed to identify any illegality, Markopolos remained persistent and kept on
scrutinizing the firm's actions. Finally,in 2005, Markopolos filed a thorough
report with the Securities and Exchange Commission (SEC) describing his
conviction that Madoff's activities constituted a vast Ponzi scheme. However, it
wasn't until December 2008 that Madoff's fraudulent actions were revealed
when he confessed to his sons, who subsequently denounced him to the
authorities11.
Media
By serving as a watchdog and sharing information to the public, the media may
help avoid trade manipulation. Journalists and financial news organizations can
examine and report on discrepancies. While the media's primary duty is to report
and investigate rather than directly prevent trade manipulation, there have been
occasions where media investigation and reporting have uncovered manipulative
activities, resulting in regulatory action and prevention. The issue of "flash
crashes" and high-frequency trading (HFT) techniques is one example. First of
all, flash trading involves the use of extremely advanced high-speed computer
technology to enable traders to see orders from other market participants
in fractions of a second before the rest of the sellers in the marketplace. This
provides flash traders a competitive advantage in recognizing changes in market
mood and judging supply and demand before other traders. So, the media
coverage of the Flash Crash encouraged regulatory authorities such as the
United States Securities and Exchange Commission (SEC) to draft a proposed
regulation that would remove the legality of flash trading from Regulation
NMS12.

10
https://www.zuckermanlaw.com/whistleblower-rewards-bounties-disclosures-market-
manipulation-schemes (consulted on November 3rd 2023)
11
https://www.zuckermanlaw.com/whistleblower-rewards-bounties-disclosures-market-
manipulation-schemes ‘consulted on November 3rd 2023)
12
https://carnegieendowment.org/2021/11/02/financial-markets-and-social-media-lessons-
from-information-security (consulted on November 3rd 2023)
B) Sanctions
Sanctions are required to minimize trading manipulation, making wrongdoers
accountable for their conduct, and discouraging future manipulators. The threat
of financial fines, legal consequences, and reputational harm blocks market
players from engaging in illegal operations. These severe actions convey a clear
message that trade manipulation will not be tolerated, reinforcing market
integrity.
Trading manipulation is illegal and initiates both criminal and civil penalties.
The law aims to create a stable and fair trade market for all participants but
manipulation can jeopardize this and destabilize financial markets. Section 104A
of the Corporations Act 2001 states that, a person must not take part in, or carry
out (whether directly or indirectly):
(a) A transaction that has or is likely to have; or
(b) 2 or more transactions that have or are likely to have;
The effect of:
(c) Creating an artificial price for trading
(d) Maintaining at an artificial level13

Under the Corporations Act, the criminal penalty for trading manipulation has a
maximum sentence of up to 15 years imprisonment. Insider trading, spoofing,
and pump-and-dump schemes are serious criminal activities that can result in
imprisonment14. Firstly, insider trading can lead to a range of imprisonment,
with severe cases involving significant profits and multiple violations resulting
in longer sentences as we can observe in Martha Stewart’ s case : In 2001,
Martha Stewart, a well-known American businesswoman and television
personality, was involved in a high-profile insider trading case. She sold her
shares of ImClone Systems based on non-public information about an FDA
decision that would negatively impact the company's stock price. Stewart was
sentenced to five months in prison and fined. While spoofing can result in up to
10 years in prison under U.S law : Navinder Singh Sarao, a British trader, was
accused of contributing to the 2010 Flash Crash by employing a manipulative

13
https://lylawyers.com.au/criminal-law/corporate-crime/market-manipulation ( consulted on
November 3rd 2023)
14
https://lylawyers.com.au/criminal-law/corporate-crime/market-manipulation ( consulted on
November 3rd 2023)
 trading technique known as spoofing. He used spoof orders to profit from quick
market swings. Sarao pleaded guilty and was sentenced to over one year in
prison. Another form of manipulation is pump-and-dump schemes can result in a
few years to over a decade of imprisonment such as in the notorious case of the
"Wolf of Wall Street" involved the brokerage firm Stratton Oakmont, whose
employees engaged in pump and dump schemes by artificially inflating the
prices of stocks they promoted, only to sell them at a profit. Key figures in the
case, including Jordan Belfort and Danny Porush, received various prison
sentences and fines for their involvement in the fraud.

Under the market manipulation civil penalty provisions, the civil penalty for
individuals has a maximum of either 5,000 penalty units (currently $1.11
million) or three times the benefit obtained and detriment avoided, whichever is
greater.
For companies, the maximum civil penalty they face is the greater of:
 50,000 penalty units (currently $11.1 million)
 three times the benefit obtained and detriment avoided, or
 10% of annual turnover, capped at 2.5 million penalty units (currently $555
million).
Therefore, the value of a penalty unit is prescribed by the Crimes Act 1914 and
is currently $222 for offences committed on or after 1 July 202015.

In addition to criminal and civil punishments, we must address the reputational

damage produced by manipulative techniques. The reputational impact of trade
manipulation can be just as substantial, if not more so, than the legal
consequences. In the financial business, reputation is an expensive commodity
that can have long-term ramifications if damaged. When people or businesses
are linked to trade manipulation, their reputation and credibility become
compromised, which frequently leads to the loss of commercial clients,
relationships, and deals. Market players and investors may feel hesitant to
interact with persons regarded to be dishonest, resulting in a loss in professional
connections and financial possibilities. Furthermore, regulatory organizations
and industry groups may take action against people and businesses implicated in
manipulation, harming their reputations even further. Essentially, the
reputational impact of trade manipulation serves as a long-term, non-monetary

15
https://lylawyers.com.au/criminal-law/corporate-crime/market-manipulation (consulted on
November 3rd 2023)
consequence16. For instance, Enron Corporation: Enron, once considered one of
the most innovative and successful companies in the United States, faced a
spectacular downfall due to accounting fraud and manipulation. The company's
leadership was found to have manipulated financial statements to hide debt,
leading to its bankruptcy in 2001. The scandal resulted in a lasting negative
impact on Enron's reputation as a trusted and ethical company.

To conclude, trading manipulation endangers the integrity and fairness of

financial markets. To limit this risk, an extensive strategy including preventative
actions and punishments is required. Prevention entails governmental control,
market monitoring, transparency, and reporting, as well as industry experts'
alertness. These techniques establish a solid foundation for early identification
and prevention. At the same time, sanctions act as a powerful deterrent,
imposing criminal and civil penalties, fines, and the loss of stolen profits.
However, the consequences go beyond the legal domain, with reputational harm
serving as a substantial non-monetary penalty. The combination of these
preventative and punitive actions demonstrates a dedication to market integrity,
openness, and accountability, emphasizing the need to sustain faith and fairness
in the worldwide.

16
MOAZENI(B),<<Manipulation of stock price and its consequences>>,
https://eujournal.org/index.php ,2013,Vol.2,No 3(S),pp. 430-433