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Market Manipulation

Market Manipulation is a deliberate attempt to interfere with the operation of the market and create artificial, false, or misleading prices. There are different ways to manipulate stock prices. What are they? What are the regulations governing market manipulation?

By: Melena Janet Jeen R, 4th Year, BBA LL.B (Finance and Business Hons.), Alliance University.

Introduction

A capital market is a place for the buying and selling of long term financial claims. It is the market where transactions are made in long term securities such as stocks and bonds.

The Indian Stock Market is one of the oldest stock markets in Asia. After a long journey, a formal stock exchange called the Bombay Stock Exchange (BSE) has evolved. In 1956, the Government of India recognized the Bombay Stock Exchange as the first stock exchange in the country under the Securities Contracts (Regulation) Act.

The most decisive period in the history of the BSE took place after 1992 after a major scandal with market manipulation involving a BSE member named Harshad Mehta.

This encouraged the creation of the National Stock Exchange (NSE), which created an electronic marketplace. NSE started trading on 4 November 1994.

Existing Legal Situation

Market manipulation is illegal in India as most of the countries. The regulating authority of market manipulation in India is the Securities and Exchange Board of India (Prohibition of fraudulent and unfair trade practices relating to securities market) Regulations, 1995.

Chapter 2 of the act provides the following prohibition against market manipulation.

4. No person shall –

(a) effect, take part in, or enter into, either directly or indirectly, transactions in securities, with the intention of artificially raising or depressing the prices of securities and thereby inducing the sale or purchase of securities by any person;

(b) indulge in any act, which is calculated to create a false or misleading appearance of trading on the securities market;

(c) indulge in any act which results in reflection of prices of securities based on transactions that are not genuine trade transactions;

(d) enter into a purchase or sale of any securities, not intended to effect transfer of beneficial ownership but intended to operate only as a device to inflate, depress, or cause fluctuations in the market price of securities;

(e) pay, offer or agree to pay or offer, directly or indirectly, to any person any money or money’s worth for inducing another person to purchase or sell any security with the sole object of inflating, depressing, or causing fluctuations in the market price of securities.

Types of Manipulative Conduct

Market manipulation comes in many shapes and sizes. The following are a few examples of different types of market manipulation.

Churning – An attempt by a stockbroker to increase activity in a client’s account to boost commissions by buying and selling orders at the same price. This activity is intended to drive up the price and attract other investors.

Ramping – Creating activity or rumors intended to raise the price of a stock.

Wash trading – Generating activity to push up the stock price by selling and repurchasing the same security.

Bear raiding – An attempt by a broker to short sell a security and drive the price down, allowing it to be bought back at a lower price and thus make a profit on the difference.

Cornering – When enough of a certain stock, commodity, or other asset is purchased to gain control and establish the price for it.

Insider trading – This is perhaps the most well-known type of market manipulation; it refers to when insiders with confidential information about a company use that information to their benefit.

Objectives of Manipulative Conduct

The objective of manipulative conduct will normally be to make money either directly to the transaction, or by other means. Some examples of how this motive is achieved include:

Influencing the price or value of a security or a derivative contract, so that the manipulated can buy at a lower cost, sell at a higher price, influence takeover bids, or other large transactions, or compact competitive transactions.

  • Influencing the price of a derivative contract or the underlying asset.
  • Influencing the price of a security underlying an index.
  • Influencing the subscription price in public or non-public offerings.
  • Influencing the price/conversion ratio in connection with the merger of companies.
  • Influencing the price of a security in connection with takeover offers.
  • Influencing someone to subscribe for, purchase, or sell assets or rights to assets, or to abstain from doing so.
  • Influencing the account balance sheet of institutional investors.
  • Influencing the limit for triggering the first sale by creditors.
  • Influencing the impression of financial advice or placements.

Parties Involved

Those in a position to effect a manipulation include:

  • Issuers of security
  • Participants in the securities market 
  • Market intermediaries
  • Any combination of the above acting in co-operation with another.

Harshad Mehta Scam

During the early 1990s, Harshad Mehta, a stockbroker, started facilitating transactions of ready forward deals among the Indian banks, acting as an intermediary. In this process, he used to raise funds from the banks and subsequently illegally invest the same in the stocks listed in the Bombay Stock Exchange to inflate the stock prices artificially.

Because of this malpractice, the Sensex moved upwards at a fast pace and reached 4,500 points in no time. The retail investors started feeling tempted to see the sudden rise of the market. A huge number of investors started investing their money in the stock market to make quick money.

During the period from April 1991 to May 1992, it is estimated that around five thousand crore rupees were diverted by Harshad Mehta from the Indian banking sector to the Bombay stock exchange. After the fraud was revealed, the Indian stock market crashed consequently. And as guessed, Harshad was not in a position to repay crores of money to the Indian banks.

Conclusively, Harshad Mehta was sentenced to jail for 9 years by the honorable court and was also banned to carry out any share trading activity in his lifetime.

Conclusion

Preventing the manipulation of securities has long preoccupied the popular and political imaginations. A regulator should focus on the extent of price pressure rather than on the size of stock price changes. Another recommendation is that a regulator ought to allow supported price pressure and ban unsupported price pressure. Supported price pressure has an adequate influence on the stock price, while unsupported price pressure creates market inefficiency. If a trader’s price pressure is larger than the justifiable price pressure, he produces unsupported price pressure. The exercised price pressure minus the justified price pressure is the extent of the unsupported price pressure. Otherwise, if a trader’s price pressure is equal to or less than the justifiable price pressure, he produces supported price pressure. In conclusion, we can say that unsupported price pressure results in welfare shifts and reduced liquidity, which has a negative impact on market operations.

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