Market manipulation, a form of market abuse, is the illegal act of artificially altering the supply and demand of a financial security to deceive other market participants. For example, placing fake orders to inflate the price of a particular security.
Methods of market manipulation
Common methods of market manipulation include:
Spoofing
Spoofing is the act of placing a large number of fake buy or sell orders to adjust the price of a security up or down respectively. The market reads this activity as evidence of a change in demand and the price will move in the direction that benefits the spoofer before they cancel the orders.
Churning
Churning is when brokers use a client’s account to excessively trade securities with the intention of racking up commissions and without regard for the client’s investment objectives. This is facilitated when a broker earns commissions on each trade rather than a flat fee, increasing income with every transaction.
Pump and dump
The pump-and-dump method involves the use of false or exaggerated information to make investment recommendations, inflating the hype around a stock or security. The perpetrator can then sell their holdings at a higher price.
Painting the tape
Painting the tape is a method of market manipulation where market participants engage in buying and selling among themselves to create an illusion of demand. This increases the volume of trades around a specific security. The manipulators earn profits by selling their holdings to newly attracted investors oblivious to the foul play.
Potential effects on the market
Market manipulation distorts the proper functioning of an effective market and can significantly impact the economy. It alters pricing mechanisms and weakens the foundations of efficient capital distribution. These effects significantly belittle general trust in the operation of financial markets and can lead to reduced participation.
EU regulations relating to market manipulation
The EU Market Abuse Regulation (MAR) highlights the improper practices of market manipulation, insider dealing and illegal disclosure of inside information. Under the regulation, these sanctions can occur if an entity is found in violation:
- A cease-and-desist order
- The repayment of profits earned due to the misconduct
- A public warning exposing the identity of the entity and the nature of the manipulation
- Suspension from investment management positions
- Fines of up to €5,000,000 for natural persons and up to €15,000,000 or 15% of annual revenue for legal persons
Enforcement
Market manipulation regulators incorporate different devices and techniques to identify and prevent unlawful trade. MAR requires firms to maintain insider lists and records of all transactions as evidence of any foul play.
Regulators may utilise surveillance systems, data analysis and internal investigations to identify perpetrators.