Market manipulation of emerging or small-cap companies is pervasive on Wall Street and according to the SEC has increased significantly in the last decade. The nature and scope of market manipulation schemes is limited only by the creativity and audacity of their perpetrators. While the specific mechanics of each market manipulation scheme may differ, the objective is the same - to inject false information into the marketplace that interferes with share prices being determined by the natural interplay of the forces of supply and demand.
Spoofing is a predatory form of market manipulation that is artificially used to drive the share price of a security either upwards or downwards. The objective of a spoofing scheme is to distort the publicly available information concerning the actual supply and demand of the targeted company’s securities. This objective is accomplished by the spoofer placing in the Limit Order Book (“LOB”) or Inter-Dealer Quotation System (“IDQS”) hundreds or thousands of “Baiting Orders” that have no legitimate financial purpose and are never intended to be executed. The purpose of these Baiting Orders is to create a false illusion or artificial perception of market interest (either negative or positive) that will cause other market participants to follow either the selling or buying signal created by the Baiting Orders. This is commonly referred to as the “pile-on” effect. If the goal of the spoofing scheme is to drive the price of the targeted company’s securities downward, the spoofer will flood the market with Baiting Orders to Sell, which are intended to “trick” other market participants into entering their own sell orders to minimize or avoid suffering losses in a declining market.
Within a nano or millisecond after the Baiting Orders are placed, the spoofer will place, on the opposite side of the LOB or IDQS, Executing Orders to Buy. These orders are intended to be executed at the lower artificial price caused by the Baiting Orders to Sell. Immediately after placing the Executing Order to buy, the spoofer will cancel the Baiting Orders to Sell, which completes the spoofing cycle. If the spoofer’s goal is to drive the price of a security upward, the process is similar except that the spoofer places Baiting Orders to Buy and Executing Orders to Sell at the manipulated higher price.
Spoofing schemes to either buy or sell are used multiple times during a trading day and are repeated throughout a protracted trading period. To maximize the speed of their market access and execution of their trading strategies, spoofers typically utilize algorithmic trading programs through high-frequency trading computer systems which enable thousands of Baiting Orders to be placed and canceled in a matter of nano or milliseconds. Like naked short selling, spoofing is used to destroy companies and cause their shareholders to lose billions of dollars in investments. Recently the SEC imposed a fine and penalty on JP Morgan, which was caught spoofing, in the amount of $920 million. However, as industry experts have observed, regulatory fines have only a de minimis deterrent effect because they are treated by broker-dealers as the cost of doing business.
Brokerage firms are considered “gate-keepers” of our exchanges and are required to monitor and surveil the trading activities of their clients and their own traders. However, certain brokerage firms are facilitating the destruction of shareholder equity and emerging companies by turning a blind eye and deaf ear to the market manipulation schemes in order to realize billions of dollars in fees and commissions. When broker-dealers knowingly place orders that have no legitimate financial purpose and are not intended to be executed in order to trick unsuspecting investors to buy or sell securities, some observers have called this conduct--- “fraud on the market.”
Alan M. Pollack is a partner in the New York City law firm of Warshaw Burstein, LLP. Mr. Pollack specializes in representing individual investors and corporations who have been defrauded in market manipulation schemes. This article is not intended as legal advice. If a reader believes that they have been victimized by a market manipulation scheme, they should consult with their own attorney for advice and guidance.