Standard II(B) – Market Manipulation

Standard II(B) – Market Manipulation

Standard II(B) – Market Manipulation dictates that members refrain from any activity that will fraudulently manipulate volumes of trading and/or causes a distortion of securities pricing.

Compliance

Two key attributes of market manipulation are information-based and transaction-based.

Information-based manipulation involves the distribution of false or misleading information as a means of distorting volume trading and market price valuation. An example of the distribution of misleading information is the over-inflation of the projected value for a security, only to sell off the majority of holdings once the market price achieves an artificially high level. The common term for this practice is “pump and dump.”

Related to information-based manipulations, social media networks are a particularly viable target for such practices.  The anonymity of those providing misinformation and the availability of amateur traders make this channel type an often preferred medium for market manipulation. Logging on to chat rooms to share inflated information about a holding to generate excitement for that security can be construed as market manipulation.

Transaction-based manipulations include making trades that would trigger a falsification in price-setting mechanisms, thereby misleading market participants. In addition, any transaction that artificially gives the impression that there is a movement within a financial instrument beyond expected market activity is subject to review for manipulation.

A firm can bolster its compliance with Standard II(B) – Market Manipulation by taking added precautions before making recommendations.  Smaller firms, for example, are more easily manipulated based upon lighter trading and low liquidity.  Therefore, prudence in releasing public information is critical.  Additionally, healthy cynicism related to third-party research reports or press releases that make extreme marketing claims is advised. Finally, as a reminder, all research must include a disclaimer as required by the SEC.

Violation

The key to violation is the intent to deceive parties who depend upon accurate market information. For example, knowingly using inaccurate reporting under the guise of analysis would be an abuse of Standard II(B) – Market Manipulation.

Question

James Murrow, CFA, would like to make a large purchase of Smith Corporation.  He is concerned, though, that due to infrequent trading of Smith Corp., buying a large volume of the company would result in an immediate price jump of the stock.  To this end, Murrow wants to know if this is a violation of Standard II(B) – Market Manipulation.

You would indicate to James Murrow that:

  1. He would violate Standard II(B) – Market Manipulation via transaction-based manipulation.
  2. He would violate Standard II(B) – Market Manipulation through information-based manipulation.
  3. No violation would occur.

Solution

The correct answer is C.

Murrow would commit no violation by purchasing stock in Smith Corporation.  He would not intentionally distort prices through fraud or deceit.  The overall lack of trading on Smith Corporation is not within his control.  Therefore, a price jump based on Murrow’s purchase is a natural reaction of an otherwise ethically traded security.

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