Market Manipulation and “Noneconomical Trading”
Last week the SEC initiated action against a AutoChina International Limited and eleven “investors”, including a senior executive of the company and charged them with a market manipulation scheme designed to create the false appearance of a liquid and active market for the company’s stock. What I found interesting when I read this complaint was that it describe in great detail what it termed “noneconomical trading.” Additionally the complaint provides a very good definition of “matched orders” and “washed trades.” All of these activities are a form of market manipulation. I thought that this would be a good opportunity to look at what constitutes these activities, and the resulting SEC regulatory violations that result from this activity.
Matched Order: In this complaint, the SEC defines a “matched order” as when trades are coordinated for the purchase or sale of a security. Essentially an order is placed with the knowledge that another order (or orders) of substantially the same size, at substantially the same time, and at substantially the same price, has been or will be entered.
Washed Trade: In this complaint, the SEC defines a “washed trade” as trades where there is no change in beneficial ownership. Essentially when you sort through the accounts the same person either owns the accounts, or the companies behind the accounts, or provided the money to the front people whose names the accounts are in.
NonEconomical Trading: In this complaint, the SEC defines “noneconomical trading” as trading for which there is no economic rationale.
For their efforts the Defendants in this SEC action found themselves being charged with the following:
- Violation of Section 17(a) of the Securities Act of 1933: In layman’s terms Section 17(a) states that it is unlawful if you trade stock across state lines or utilize commercial forms of communication and engage in acts of fraud or deceit.
- Violation of Section 10(b) of the Exchange Act and Rule 10b-5 of the Exchange Act: In layman’s terms Section 10(b) states that it is unlawful to do anything in an attempt to avoid complying with the rules and regulations of SEC. For the uninitiated, this a very broad and general section of the Exchange Act of ’34 that the SEC can use against almost anyone it does not like.
- Violation of Section 9(a) of the Exchange Act: This is the anti-market manipulation section of the Exchange Act of ’34, and it was strengthened significantly by Dood-Frank. This is now a very big and significant portion of U.S. securities regulations. These washed traded, matched orders, and noneconomical trading all fall squarely in the list of prohibited activities.
- Aiding and Abetting the above violations: If the defendants had anything to do with the above they were charged with aiding and abetting the above violations.
I took a particular interest in this action because the SEC complaint so clearly spells out what these violations are and how it intends to prove them. Section 9(a)1 states that it is unlawful “For the purpose of creating a false or misleading appearance of active trading in any security other than a government security, or a false or misleading appearance with the respect to the market for any such security, (A) to effect any transaction in such security which involves no change in beneficial ownership thereof, or (B) to enter an order or orders for the purchase of such security with the knowledge that an order or orders of substantially the same price, for the sale of any such security, has been or will be entered by or for the same or different parties, or (C) to enter any order or orders for the sale of any such security with the knowledge that an order or orders of substantially the same size, at substantially the same time, and at substantially the same price, for the purchase of such security, has been or will be entered by or for the same or different parties.” I think that it is pretty clear that “matched orders” and “washed trades” fall squarely under Section 9(a)1. “Noneconomical trading” in order to create false volume falls pretty squarely under Section 9(a)1 as well, but in case there is any doubt there is always the remainder of Section 9(a) which includes 9(a)2-6. In particular, I think it would be worthwhile to be familiar with 9(a)6.
Section 9(a)(6) states that it is unlawful …”To effect either alone or with one or more other persons any series of transactions for the purchase and/or sale of any security other than a government security for the purpose of pegging, fixing, or stabilizing the price of such security in in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.” There you have it, non-economical trading when used for market stabilization activities by non broker/dealers.
These are very important issues and knowing how to spot this sort of activity is very key in any sort of investigation of improper activity in the market. In the small and micro cap end of the market stock manipulation is a very big issue. Many companies are hungry and desperate to raise additional capital in order to expand or to just be able to survive. There are an untold number of unlicensed individual promising to raise money for these companies; and some of them have gotten really good at convincing others to participate in their illicit activities. Many times that people that get involved do not even realize what they are actually participating in, or what laws they are breaking. I have seen many of so-called consultants and promoters who have managed to put together a group a/k/a syndicate of investors who go and buy up the float of a small cap stock; moving to higher prices in the process. Then they get a handful of these same investors to engage in price or bid supporting activities where they are the buyer or in effect the market when someone is a seller; in return these consultants/promoters usually promise to find new buyers to take or buy their stock at a profit, or cover their losses if they can’t. The investors usually find themselves going along with these illicit activities in order to protect their much larger holdings in the company, or because the company needs additional funding which won’t come in if the market isn’t a stable price. This sort of activity is rightly considered to be illegal, and justifiably so. It artificially inflates the market prices of the companies stock, it entices investors to invest at artificially high valuations, and when the price can no longer be supported everyone ends up loosing money and getting hurt.
I have seen a lot of people attempt these sort of activities, but after nearly 20 years I have never seen anything other than the eventual collapse of the stock price. In the end everyone pays a price from this sort of activity.
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The SEC Litigation Release can be found at: http://www.sec.gov/litigation/litreleases/2012/lr22326.htm
A copy of the SEC’s complaint can be found at: http://www.sec.gov/litigation/complaints/2012/comp-pr2012-59.pdf
We do applaud the SEC ‘s efforts to police this type of activities.