Market manipulation schemes use social media, telemarketing, high-speed trading, and other tactics to intentionally drive a stock price dramatically up or down. The manipulators then profit from the price movement. Unsuspecting investors who were lured in are left with losses or worthless stock. However, market manipulation schemes have some common themes and warning signs. Learn what they are, and how you can avoid them.
Definition and Examples of Stock Market Manipulation
Market manipulation is an intentional effort to deceive and defraud investors by artificially affecting the supply or demand for a security and driving its price up or down. Those who orchestrate artificial price movements then profit from them at the expense of other investors.
Market manipulation isn't always clear-cut. In January 2021, retail investors got together to counter a hedge fund’s short position on the GameStop stock at the behest of Reddit page “wallstreetbets.” While that drove the price of GameStop stock up significantly, it soon came crashing down.
The U.S. Securities and Exchange Commission (SEC) has warned investors about short-term trading based on social media and online message boards, and it has committed to protecting retail investors from “abusive or manipulative trading activity."
In February, the law firm Hagens Berman announced a class action lawsuit against one of the main instigators on the Reddit page, alleging price manipulation.
The Securities Act of 1934, and the Commodities Exchange Act prohibit three types of market manipulation activities:
Fraudsters can circulate rumors intended to inflate a stock price or drive it down, depending on whether they are interested in selling or buying. Social media, chat rooms, email campaigns, and phony newsletters are all effective tools for spreading rumors and misinformation.
Fictitious trades are sham transactions intended to give the appearance of activity or price movement. These trades don't have any change in ownership and carry no financial risk to the trader. Entering a large number of buy or sell orders and then canceling them is one example of fictitious trading.
Price-manipulation schemes can use high volumes of trades to raise or depress prices. Fraudsters can also acquire inactive shell companies with registered shares. They then inflate the value of the shares through a series of phony transactions.
Financial markets are critical to the growth and efficiency of the economy. Manipulation not only defrauds investors but also harms the economy by eroding confidence in the financial markets as well as the institutions that support and regulate them.
How Stock Market Manipulation Works
While there are an infinite number of variations, there are a few common market-manipulation schemes:
Pump-and-dumps are the most common schemes to directly ensnare the average investor. They involve small companies, called "microcaps" or "penny stocks," with shares that are traded over the counter (OTC). Companies that are traded OTC don't have to meet the strict listing requirements of an exchange like the NYSE or Nasdaq. Fraudsters use microcaps for their schemes because there is usually very little public information available about the businesses, and it's easier for them to gain control of the stock.
When fraudsters have control of a company's stock, they begin a coordinated campaign to promote or "pump" it. The campaign uses social media, emails, fake analyst reports, phony trades, and telemarketing to spread misinformation and create demand. Once the stock price has been inflated, the fraudsters dump their shares. The campaign ends, the share price drops, and legitimate investors are left with worthless stock.
Pump-and-dump promoters often capitalize on pressure sales tactics or news-based recent events to reel in unsuspecting investors.
In 2020, the SEC charged a California-based trader who had made misleading claims on an online investment forum about biotechnology the microcap company Arrayit Corporation, including claims that the company had developed a blood test to detect COVID-19. The trader held a large number of shares in the company and planned to sell them as false claims encouraged other investors to buy the stock and drive its price up. The trader was able to make a gain of $137,000 in six weeks before the SEC suspended trading in the shares of the company.
Wash Trades and Matched Orders
Wash trades and matched orders are forms of fictitious trading. Wash trades are simultaneous buy and sell orders for the same number of shares and share price by the same party. There is no change in ownership, and there is little or no financial risk to the trader. Matched orders are prearranged trades between a buyer and a seller for a set number of shares at a set price.
Wash trades and matched orders are often used in the "pump" phase of a pump-and-dump scheme to create the appearance of a legitimate trading volume.
Spoofing is another form of fictitious trading. It involves placing large numbers of buy or sell orders and cancelling them before they're executed. In 2020, the Commodity Futures Trading Commission (CFTC) fined JP Morgan Chase $920 million for placing hundreds of thousands of commodity futures orders over eight years with the intent of canceling them before execution in order to influence prices.
Marking the Close
Marking the close is a high-volume trading scheme. Large numbers of trades are placed at the end of the day, artificially driving up the closing price of the stock. In 2014, the SEC fined trading firm Athena Capital $1 million for systematically placing high volumes of trades in thousands of Nasdaq stocks in the last two seconds of the session over a six-month period.
What It Means for Individual Investors
Unfortunately, investors are taken in by market-manipulation schemes every day and are often left with little recourse. The SEC Office of Market Intelligence, the U.S. Department of Justice, the CFTC, and other agencies are responsible for actively identifying and preventing market-manipulation fraud. If you believe you are the victim of fraud, or if you wish to report market manipulation confidentially, contact the SEC. The best protections, however, are simple steps you can take before you invest your money.
- Be skeptical of any unsolicited investment offerings and stock recommendations through email, social media, or the internet. Fraudsters also use telemarketing and the U.S. mail to promote their schemes.
- Investigate the source of any investment recommendation by using FINRA's brokercheck or SEC's Investment Adviser Public Disclosure tool. If they are not licensed, it is a red flag. Don't assume that a promoter who is recommended to you by someone you trust is legitimate. Celebrity endorsements are not reliable.
- Newsletters are often used to promote fraudulent schemes. Be wary of them. Search SEC.gov to see whether anyone associated with the newsletter has had actions taken against them.
- Microcap and OTC stocks are high-risk and more susceptible to fraud. If you want to invest, search the SEC Edgar database for regular SEC filings. Avoid stocks that have no regular filings. Check the SEC’s list of trading suspensions to see whether a particular company is on it.
- The promise of high returns and sales pressure to act now are red flags. Walk away.
- Market manipulation is deliberately and artificially affecting the supply or demand of a stock to move its price up or down.
- When other investors buy or sell the security that has changed in price, the market manipulators make a profit.
- Market manipulation can be done through rumors, sham transactions, or price manipulation, for example.
- There are several common schemes that can fool average investors, who are often left with no way to recover any money they lose.