A Look at Recent SEC Action Concerning Market Manipulation, Broker Bribery, and Matched Trades
In our periodic review of enforcement actions by the Securities Exchange Commission (SEC), we saw one that caught our attention concerning market manipulation, broker bribery, and matched trades that caught our attention. Back in July the SEC charged a Company, its CEO, and Stock Promoter with Market Manipulation, and a Stock Broker Bribery scheme involving matched trades. This is a form of criminal activity that plagues illiquid securities in the market and strikes at the very heart of the integrity of how the market operates.
This is also a very simple form of a scheme where the criminals basically are able to find a broker they can bribe at a brokerage firm where they can ensure the trade execution is directed the firm where they are selling. Here is how these schemes basically work.
In the first part of these sort of schemes an unscrupulous group gains control of a micro or small cap company and are able to gain control of a very substantial portion of the free trading shares, and in the process they work to ensure that no else is able to get any of their shares unrestricted or deposited into their brokerage accounts. Once these individuals are confident that they control the the majority of the shares deposited in brokerage accounts they move onto the second phase of the scheme.
In the second phase of these schemes, the unscrupulous individuals then find a broker, or brokers, who they can bribe to buy shares in their company. The broker then gets paid a percentage of the value of the shares purchased. While this sounds relatively simple, it is slightly more complicated than it sounds. Finding the broker that can be bribed is probably the hardest part. As trade execution has turned into a commodity item, and commissions have shrunk as a result, there are a lot of struggling brokers out there who are desperate for cash; however what it really takes is a broker who is either extremely desperate for cash of who has no morals. It generally helps if the broker is both, desperate and without morals. In addition to finding a broker who meets this criteria, the broker needs to be at a brokerage firm that is a smaller firm where the broker can convince the trader at the firm to execute the trade with the firm where the unscrupulous individuals are selling their shares.
In the third phase of these schemes, the broker then recommends shares of the company controlled by the unscrupulous individuals to his or her clients. After the clients of the broker agree to purchase shares in the company being controlled by these unscrupulous individuals, the broker then gets the trader at the firm to buy the shares from the brokerage firm where the unscrupulous individuals are selling their shares. Basically the money of the clients of these brokers is transferred to these individuals who are selling shares.
Finally in the fourth phase of these schemes, after the trades settle, the seller of the shares then pays the broker an agreed upon percentage of the value of the trade. This is usually anywhere from 25-50%. In the old days, the seller would pay the broker in cash delivered in a brown paper bag; and as a result these would be known as “brown bag deals.” Now days there is a tendency for the sellers to pay the brokers with wire transfers; which is more than just a little stupid considering how easily wire transfers can be traced by the Feds.
These are horrible and rotten schemes of market manipulation that need to be aggressively pursued by not only the SEC, but the Department of Justice as well. Broker bribery strikes at the heart of the integrity of the market, and damages it to the core. If a client cannot trust his or her broker, then there will never be any faith in the market. Generally the companies involved are nothing more than shells or development stage companies with little or no revenues; and usually after the sellers have finished selling all of their shares the price of the stock collapses, inflicting huge losses on the clients of the brokers who participated in the scheme.
For their part, the participants in the scheme referenced below found themselves charged with violations of Section 9(a)(1) of the Exchange Act of 1934, and Section 17(a)(1) and (a)(3) of the Securities Act of 1933, as well Violations of Section lO(b) of the Exchange Act and Rule lOb-5(a) and (c).
Section 9 of the Exchange Act of 1934 concerns market manipulation, and Section 9(a)(1) deals with creating false and misleading appearances with respect to the market for any security. This is mainly through the prohibition of wash trades and matched trades. Wash trades are those where there is no change in the underlying ownership of a security. Matched trades are orders for the sale or purchase of any such security where a corresponding order of substantially the same size, at substantially the same time, and at substantially the same price, for the execution of the other side has been or will be entered by or for the same or different parties. In the scheme described above, the parties are engaging in matched traded in order to ensure that the only shares being bought are those of the unscrupulous sellers.
In reading the complaint, which I have provided a link to below, it looks the Defendants’ may have been dealing with a Federal Agent. In addition to their troubles with the SEC, I expect that they will face criminal prosecution and probable jail time.
A copy of the litigation release can be found at: http://www.sec.gov/litigation/litreleases/2012/lr22410.htm
A copy of the complaint can be found at: http://www.sec.gov/litigation/complaints/2012/comp22410.pdf
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We do applaud the SEC ‘s efforts to police this type of activities.