Market Abuse: Beware of These 6 Types of Scams

The alleged death of Napoleon is a prominent example of market abuse, but it’s neither the first nor the last one. Back in 600 BC, the philosopher Thales of Miletus cornered the market for olive presses, gaining a monopoly over it. And in 2022, the US Securities and Exchange Commission (SEC) filed 43 criminal complaints in court for the offense of insider trading alone (15 more than in 2021).

The SEC applies a very broad definition to do justice to the countless ways that exist to unfairly manipulate the market. “Market manipulation,” the SEC writes, “is when someone artificially affects the supply or demand for a security (for example, causing stock prices to rise or to fall dramatically).”

Despite this very generalized wording and although fraudsters are very inventive, an exhaustive “taxonomy of cheating” of sorts actually exists today. The Financial Markets Standards Board (FMSB), a nonprofit organization that develops new market standards, examined 400 cases of market abuse in 28 countries spanning over 200 years in a large-scale study and grouped almost two dozen different market manipulation techniques into six misconduct categories.

“History may not repeat itself, but it rhymes” is the motto of the study. Decide for yourself in which category you would classify the Great Stock Exchange Fraud of 1814.

The spectrum of behaviors that illicitly influence the price of securities or derivatives includes the following:

The term “spoofing” stems from the IT sector and means “deception,” “manipulation,” or even “disguisement,” and it refers to an attempt to conceal one’s identity. On the markets, spoofing means deceiving under false pretenses: the defrauding party feigns interest by placing a large purchase or sell order and afterwards immediately cancels the order.

In this specific form of spoofing, the defrauding party enters multiple orders in different places in an attempt to create the illusion of market liquidity.

Building (or ramping) a position in a security through the purchase of multiple small lots causes prices to constantly increase. This artificially inflates the market, and the defrauding party afterwards can sell a large lot of the security at an excessive price.

Dealing rings that collude to engage in prearranged transactions do that with the objective of driving up prices by creating a false impression of market activity. Manipulations by these pools usually take place over extended periods and can stretch over months.

“Cornering the market” is an attempt to achieve a dominant controlling position in order to influence the price of a commodity, a security, and/or a related derivative.

If a party does not seek a dominant controlling position in the market but only strives for a position large enough to influence prices, this is called a squeeze.

Disseminating false or misleading information about a security or its issuer can impact the price of the security. This type of manipulation is called a bull or bear raid depending on whether the aim is to cause the price to rise or fall.

Pump-and-dump is a prominent form of bull raid in which a security first gets hyped (“pumped”) and then when its price climbs high enough, the perpetrator sells (“dumps”) his position.

Circular trading typically involves entering into transactions that cancel each other out and therefore do not transfer any market risk or value. The spectrum of transactions with no legitimate commercial rationale includes:

The simultaneous purchase and sale of the same financial instrument for the same volume and price between two counterparties is called a wash trade. Neither party derives a benefit or affects its risk structure through the transaction.

Churning is executing wash trades solely for the purpose of generating commissions.

In this variant of wash trades, a securities transaction is used as a medium to disguise a payment. The primary objective of a compensation trade is not to manipulate a market, though market manipulation is often a collateral effect.

Securities can be sold to a buyer subject to an agreement that they will be repurchased by the seller shortly afterwards at a pre-agreed price. If the objective of this arrangement is to conceal the identity of the true owner of the securities, this is called parking.

Insider knowledge becomes a detriment to third parties in cases of:

Insider trading is when a buyer or seller obtains an unfair advantage from the use of inside information.

It is illegal to disseminate inside information.

Actions or attempts undertaken to influence reference prices that are used in the market to value other positions are illegal. The various ways of illicitly influencing reference prices include:

This has to do with transmitting false or inaccurate information used to calculate a closing price, reference price, or index.

This has to do with buying or selling a large volume of securities and/or derivative contracts with the intent of illicitly influencing a benchmark.

The objective of this type of price manipulation is to enhance the performance of a portfolio shortly before a reporting period deadline. It is also called window dressing.

This technique involves deliberately engaging in actions to trigger or to avert the triggering of barriers that act as reference levels for associated derivative contracts.

Customers or their data can be misused by:

Dissemination of client order information gives third parties an information advantage over the market at large.

The defrauding party enters into a transaction in advance of (i.e. front-runs) a known pending order with the intention of profiting from the anticipated impact of the pending order on the market.

If the allocation of a security to a client is withheld pending assessment as to whether the execution order is a winning or losing trade, this is called cherry picking. If the market moves adversely, the trade is allocated to the client. If the market moves positively, the trade is taken by the defrauding party.

By deliberately triggering or protecting stop-loss or other limit orders, the defrauding party gains an advantage, usually to the detriment of clients and other market participants.

A misleading impression can be created in the minds of clients or market participants by:

False information can concern bids, offers, or transactions that have never taken place or for which no actual orders exist.

Since regulatory authorities are always on the close lookout for market manipulations and don’t hesitate to punish infractions, it is imperative for financial institutions to monitor for market abuse and manipulation attempts and ideally to prevent them from happening.