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Market Manipulation & Trading Violations

Fraud in the trading and pricing of securities and financial products and other market manipulation schemes undermine the integrity of the markets and can cause substantial harm to investors.  Such fraud can be committed by broker-dealers, financial exchanges, transfer agents, and other market participants including traders in off-exchange markets such as dark pools. These schemes can violate securities laws of the Commodity Exchange Act, depending on the markets and securities at issue.

Market manipulation and trading schemes include:

Front-running

Also known as forward trading or trading ahead, front-running occurs when a broker or trader takes advantage of foreseeable market movements by trading on the broker’s account based on advanced knowledge of a pending order. In the traditional example, a broker learns of a large client order and makes a trade before the client order is executed. The broker, anticipating that the large client order will move market prices, structures the trade to ensure personal benefit before execution of the client’s order.  With the increased use of high-frequency trading (HFTs) strategies, front runners may seek to detect large competitor orders, and then trade ahead of them.

Although front-running is widely considered unethical, it is not on always illegal—but it can be if the front runner is using information that is not available to the public, and violates a duty of loyalty to a client.

Spoofing

Spoofing is a form of market manipulation that occurs when a trader places a bid or offer with the intent to cancel before execution, thereby creating an untrue picture of actual demand for or supply of the security.  HFT can be particularly effective method for spoofing trades and manipulating prices.

Naked short selling

Traditional short selling involves selling securities or other investment instruments the seller does not actually own, and then subsequently repurchasing them to cover the sale within the standard three-day settlement period (“T+3”). “Naked” short selling or “naked” shorting occurs when the seller does not actually borrow the security or ensure the security is even available to be borrowed.

If the seller or the seller’s broker-dealer fails to deliver the shares within the requisite T+3 settlement period, then a “failure to deliver” occurs.

While “naked” short selling does not necessarily violate SEC rules or federal securities laws, Regulation SHO outlines general requirements designed to curb abusive “naked” short selling. Rule 204 requires self-clearing broker-dealers to close out “failure to deliver” positions by purchasing or borrowing securities of like kind and quantity within one business day following the settlement date (“T+4”).

Additionally, Rule 201 requires trading centers to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent the execution or display of a short sale at an impermissible price once a stock has experienced a price decline of at least 10% in one day.

Pump and dump schemes

Perpetrators of a “pump and dump” scheme attempt to artificially boost the price of an owned stock through false, exaggerated, or misleading positive statements, then subsequently sell their positions after the puffery has led to a higher share price. Traditionally these schemes have been referred to as “boiler rooms,” which are essentially high-pressure call centers that solicit potential investors.  However, the internet has more recently provided additional channels to reach large numbers of potential investors. Such arrangements violate securities law and can result in significant losses to investors when stock prices fall after the process is complete.

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