Manipulative practices

The Securities and Exchange Commission was reported to have already started monitoring social networks like Facebook and Twitter to crack down on stock market manipulations and Ponzi schemes.

It was also reported that the SEC had started collecting evidence against one company for insider trading.

Insider trading is “the illegal buying and selling of stocks on the basis of information that is generally unavailable to the public.”

One simple example is the purchase of company shares by an “insider” like a member of the board of the concerned company and making profits in the market on the “surprisingly good information” not yet made public.

Insiders can also be the firm’s “investment bankers, proxy printers, lawyers, company officers or large stockholders with holdings equivalent to 10 percent of the company.”

They can also be employees who have direct access to information not yet made public that can cause volatility in the price of the company’s price in the market.

Section 24 of the amended implementing rules and regulations of the Securities Regulation Code identifies the person and describes his manipulative practices as “any person who makes a bid or offer, or deal in securities, with the intention, or if that bid, offer or dealing, has the effect or is likely to have the effect of creating a false or misleading appearance of active trading in any or security or with respect to the market for, or the price of, any security.”

Mentioned in the code are the broker-dealers and their associates and salesmen.

The code also describes in detail the prohibited conduct and/or acts. The first is called “painting the tape.” This involves “engaging in a series of transactions in securities that are reported publicly to give the impression of activity or price movement in a security.”

Second is “marking the close.” This is committed by “buying or selling securities at the close of the market in an effort to alter the closing price of the security.”

Third is the so-called “improper matched orders.” This is prohibited if “both the buy and sell orders are entered at the same time with the same price and quantity by different colluding parties.”

Fourth is the practice of “hype and dump.” This is done by “buying at increasingly higher prices and selling in the market at the higher prices and vice versa” such as selling at lower prices and then buying at such lower prices.

Fifth is “wash sales.” This involves “transactions in which there is no genuine change in actual ownership.”

Sixth is “squeezing the float.” This is done by “taking advantage of a shortage of securities in the market by controlling the demand side and exploiting market congestion during such shortages in a way as to create artificial prices.”

Disseminating false or misleading market information through media, including the Internet, or any other means to move the price of a security in a direction that is favorable to a position or transaction held is as well specified as an unlawful—thus, certainly prohibited manipulative—conduct.

The SEC also covers in its “list of other types of prohibited conduct and/or manipulative practices the creation of temporary funds for the purpose of engaging in other manipulative practices.”

Arguments

“Profits realized through insider trading should be allowable as a reward for entrepreneurship.” While insider trading causes losses to those who bet against the “insider trades,” it benefits the broader community of investors because insider trading “keeps prices more closely aligned with the underlying determinants of share value.”

The example given is as follows: “A department of an investment bank may be in a possession of information concerning a client firm that is relevant for customers of another department of the bank. By law “the bank’s fiduciary responsibility to the client firm dictates that the information be kept secret, but the bank’s fiduciary responsibility to customers calls for disclosure.”

The practice followed to resolve such conflicts of interest involves the separation of the departments with a mechanism called the “Chinese wall.”

To complete the story, the proponents argue: “Assume the registered representatives at a brokerage house are promoting the stock of a manufacturing corporation at a time when the investment banking department of the securities firm knows that serious technological problems have emerged at one of the plants.”

“The manufacturing corporation is unwilling to allow the securities firm to divulge the situation, and a Chinese wall at the securities firm prevents the investment bankers from passing the information to the registered reps.”

“The brokerage firm, however, is not allowed to solicit customers without revealing all of the information that it has. They could, of course, stop trading in the client’s stock; however, this very act of not trading would signal the existence of new information to the market.”

Bottom line spin

Thus, as proponents claim in the example, restrictions in insider trading does not only result in conflict of interest, it attains nothing for “it appears that whichever way, the securities firm turns [in the story], it will not have fully satisfied the dictates of the law.”

(The writer is a licensed stockbroker of Eagle Equities Inc. You may reach Market Rider at [email protected] and [email protected])