Definition
Market manipulation refers to practices carried out with the intent of artificially inflating or deflating the price of a security or influencing the behavior of the market for personal gain. It involves strategies such as spreading false or misleading information, conducting transactions that mislead investors, or rigging quotes, prices, or trades to create a false or deceptive picture of the demand for a security. Such activities are illegal and punishable by law.
Key Takeaways
- Market Manipulation refers to artificial inflation or deflation of the price of a specific security, misleading investors using false, misleading or greatly exaggerated statements.
- It is an illegal practice and is subject to penalties and fines because it creates an unreal market. Regulatory authorities such as the Securities and Exchange Commission (SEC) often work to prevent such practices.
- Pump and dump, churning, and pools are some common strategies used in market manipulation. The technological advancement has even contributed to the ease of deploying these tactics.
Importance
Market Manipulation is an important finance term because it refers to the deliberate interference in the free operation of the market to create false, misleading, or artificial appearances of the trading activity, prices or volumes of a particular security.
This deceptive practice can give a distorted image of the actual supply and demand in the market, leading to prices that are skewed from their intrinsic values.
Investors may then make trading decisions based on these manipulated prices, resulting in financial losses when the truth emerges.
Therefore, recognizing and understanding market manipulation is crucial to maintain the integrity of the financial markets and to protect investors.
Explanation
Market manipulation refers to purposeful attempts to interfere with the free and fair operation of the financial markets. Its overall objective is to create artificial, false or misleading appearances concerning the price of, or market for, a security, commodity or currency.
Market manipulation can take many forms including, but not limited to, spreading false or misleading information about a company, improperly limiting the number of publicly-available shares, or rigging quotes, prices or trades to create a false or deceptive picture of the demand for a security. This deceptive strategy is exploited in order to gain unfair market advantages or profits.
In essence, the purpose of market manipulation is to distort the supply and demand for securities to benefit the manipulators at the expense of other market participants. Often, manipulators carry out actions that typically affect the price of the commodity, allowing them to profit from the consequent price move.
Such activities may lead to significant financial losses for other market participants who trade based on the manipulated information, undermining trust in the financial markets. Therefore, market manipulation is considered a fraudulent activity and is heavily monitored and penalized by financial regulators like the Securities and Exchange Commission in the United States.
Examples of Market Manipulation
Enron Scandal (2001): This is one of the most infamous cases of market manipulation. Enron was a U.S. energy-trading and utilities company that perpetrated one of the biggest accounting frauds in history. Enron’s executives employed accounting loopholes, special purpose entities, and poor financial reporting to hide billions of dollars in debt and inflate profits to manipulate the market.
Volkswagen Short Squeeze (2008): At one point, Volkswagen briefly became the most valuable company in the world due to a manipulation tactic known as a “short squeeze.” Porsche, which was in the process of trying to buy Volkswagen, secretly accumulated a controlling stake in VW. When they disclosed this, the hedge funds who had shorted VW stock (betting that the price would go down) were squeezed as they scrambled to buy shares to cover their positions, driving the price up drastically.
LIBOR Scandal (2012): Various banks were accused of rate manipulations from 2003 to
The London Interbank Offered Rate (LIBOR) is a benchmark interest rate used worldwide, and even small adjustments can impact investments worth trillions of dollars. Several high-profile banks were accused of colluding to manipulate LIBOR for their own gains. In all three examples, the manipulations not only resulted in significant market distortions, but also broke the trust between investors and the market, leading to calls for stronger regulations.
FAQs about Market Manipulation
1. What is Market Manipulation?
Market manipulation refers to artificial inflation or deflation of the price of a security or otherwise influencing the behavior of the market for personal gain. It is illegal under both securities and antitrust laws.
2. What are the Types of Market Manipulation?
Some common types of market manipulation include spread manipulation, pump and dump, spoofing, and wash trading. All of these activities involve creating an artificial price movement in a security or commodity.
3. What are the Legal Consequences of Market Manipulation?
Market manipulation is considered a serious financial crime. Penalties for market manipulation could include heavy fines, restitution to victims, dissolution of entities, imprisonment, and other civil and criminal penalties.
4. How Can I Report Market Manipulation?
If you suspect instances of market manipulation, they can be reported to regulatory authorities such as the Securities and Exchange Commission (SEC) in the United States, or the Financial Conduct Authority (FCA) in the United Kingdom.
5. How Can I Protect Myself from Market Manipulation?
Investors can protect themselves by being wary of hot tips and quick profits, being aware of high-pressure sales tactics, and investing only after thorough research. It’s also helpful to recognize the signs of market manipulation and report any suspicious activity to regulatory authorities.
Related Entrepreneurship Terms
- Wash Trading
- Pump and Dump
- Churning
- Corners
- Insider Trading
Sources for More Information
- U.S. Securities and Exchange Commission: This is the regulatory body for all finance and securities related matters in the United States. They have a wealth of information about market manipulation.
- Investopedia: A comprehensive online financial education resource with a vast array of articles, including on market manipulation.
- Federal Trade Commission: The FTC is responsible for enforcing federal consumer protection laws and combating deceptive and fraudulent practices in the marketplace, including market manipulation.
- Financial Industry Regulatory Authority: FINRA is a not-for-profit organization authorized by Congress to protect America’s investors. They have numerous resources on preventing market manipulation.
