Risk Consulting           Modeling & Analytics           About Us           Contact           Home

Market Manipulation  

Download PDF
share on Twitter Share on Facebook

It is likely that man tried to manipulate markets from the beginning of their existence.  The early kings would regularly debase their precious metal currencies by reducing the content of gold and silver to fund their wars and extravagance. 

The first public companies were largely controlled by insiders who profited handsomely at times from their non-public information.  The biggest case of market manipulation in terms of underlying market size (and the resulting fines) is undoubtedly the recent London Interbank Offered Rate (LIBOR) fixing scandal involving over twenty major banks and affecting $800 trillion worth of financial instruments.  It is worth noting that some veteran traders commented that LIBOR has been fixed since the 1980’s, so it appears to be a case of prosecutors finally acting, rather than the manipulation having recently occurred.  Regulation and more importantly, successful prosecution of market manipulation has been lacklustre, but the trend seems to have turned for the better.  The financial crisis of 2008 gave regulators a host of new laws and, given the record-breaking fines being levied in the U.S. and abroad, a willingness to prosecute some of the largest banks and hedge funds.  Lawmakers have taken Winston Churchill’s advice to heart, “never let a good crisis go to waste.” 

A general definition of market manipulation from Wikipedia “is a deliberate attempt to interfere with the free and fair operation of the market and create artificial, false or misleading appearances with respect to the price of, or market for, a security, commodity or currency.”  One of the pivotal market abuse cases in the U.S. was the successful prosecution of Standard Oil in 1911 which was found guilty of monopolizing the petroleum industry and using abusive and anticompetitive actions.  Over a hundred years later, the Supreme Court of Australia departed from the market power focus of market manipulation by finding that purchasing shares for the sole or dominant purpose of creating or maintaining a specific price is also market manipulation. 

While the anti-trust laws in the U.S. and Europe are available to prosecute companies abusing their dominant positions, the Securities and Exchange Commission (SEC) and Commodity Futures and Trading Commission (CFTC) both have their own acts specific to stocks and futures/swaps, respectively.  According to the SEC, market manipulation “is intentional conduct designed to deceive investors by controlling or artificially affecting the market for a security.”  The CFTC states that it is “unlawful for any person, directly or indirectly, to manipulate or attempt to manipulate the price of any swap, commodity, or futures contract.”  With the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, the CFTC has now expanded its powers including the use of “manipulative and deceptive devices” and not having to prove that an artificial price was created. 

In the past, the CFTC used a four-part test to determine if a violation had taken place including; 1) the accused had the ability to influence market prices; 2) the accused specifically intended to create or effect a price or price trend that does not reflect legitimate forces of supply and demand; 3) artificial prices existed and; 4) the accused caused the artificial prices.  JP Morgan Chase agreed to pay a $100 million fine (part of the “London whale” scandal) because of dumping $7 billion of credit swaps in one day.  It was found guilty of employing a deceptive device that disregarded the consequences to the broader market.  This case would have been very difficult for the CFTC to win without the new laws as the burden of proof was much higher in the past.

It is worthwhile distinguishing between market bubbles and mania versus outright manipulation.  While a market may seem irrationally exuberant (to quote Alan Greenspan), this does not mean that it is being manipulated.  In the case of the credit bubble, there certainly was mortgage fraud in various forms, but the dramatic rise in housing prices and the resulting proliferation of over-the-counter credit instruments and their misuse could not likely have occurred without the very low interest rates. 

There are many ways in which market manipulation can take place depending on whether it is a security, commodity or currency.  As the Australian Court of Appeals rightly noted in a case involving cornering of the futures market that “… the methods and techniques of manipulation are limited only by the ingenuity of man."  In the futures market, the concern has been with “cornering” and “squeezing”, in which a trader attempts to control a large portion of the deliverable supply of the futures contract and thereby create a shortage leading to a temporary and artificially high price.  Two notable squeezes were the Hunt brothers in silver in 1979/80 and Italian crusher Ferruzzi in July 1989 soybeans.  Both firms were ordered to liquidate their positions.  Regulators seem to be on top of potential squeezes and corners and the manipulators have moved onto less scrutinized activities and markets.      

Stocks are subject to many schemes to manipulate prices.  The pump and dump involves a firm luring its clients into buying a thinly traded stock (“the pump”) and when prices are sufficiently high the firm sells its own holdings (“the dump”) after which the stock collapses.  A good example of such a scheme at work can be seen in the movie Boiler Room (2000).  A similar scheme of manipulation is “painting the tape”, which refers to stock trades designed to make a particular stock look active and technically attractive to the broader market, thereby allowing the manipulator to unload the stock at a more favourable price.  Larry Livingston in Reminiscences of a Stock Operator was routinely hired to help insiders unload stocks that had become inactive.  The “tape” refers to the old ticker tape used to transmit market prices.  Another common practice is manipulating the closing price of a stock or futures to affect the value of derivatives or cash prices that are based on the closing price.  Optiver Holdings BV was found guilty by the CFTC of “banging the close” in energy futures to influence the settlement value of derivatives.  

Physical commodities have largely escaped market manipulation probes, especially if there is no associated futures contract in which to give the regulator legal authority to act.  There are notable exceptions, such as the U.S. Federal Energy Regulatory Commission victory over JP Morgan, which agreed to pay $410 million for allegations that it manipulated the California electricity market from 2010 to 2012.  Amaranth Advisors was also fined $7.5 million by the CFTC for manipulating the natural gas market, but it traded both physical natural gas and futures.  However, most cash commodities are not regulated directly and trade globally, giving the manipulator more room to maneuver.  The increased scrutiny on banks has led some to exit their commodity business such as Deutsche Bank.  Non-bank corporations such as Vitol, Glencore and Cargill that specialize in trading physical commodities stand to gain and can increase their dominance of these markets.  Manipulation for physical commodities may be tackled through anti-trust laws in which other corporations affected by the alleged manipulated price file lawsuits.  A recent example of this is the lawsuit filed by a Florida aluminum user against JP Morgan, Goldman Sachs, Glencore, and the London Metal Exchange for manipulating the aluminum market by deliberately restricting the flow from LME listed warehouses and also price fixing. 

Commodities that are produced in relatively small volumes and in isolated geographic areas are especially prone to market manipulation.  These include flax, durum wheat and even cocoa (which has seen concentrated ownership a number of times).  Interestingly though, there have also been a number of successful manipulation prosecutions in one of the largest markets in the world – crude oil, in part because it is such a visible and politically sensitive market.  While the physical market may be the most vulnerable at this time to manipulation going unprosecuted, the Dodd-Frank law also provides for data reporting for both cleared and uncleared swaps tied to 46 physical commodities.  This will make it easier for the CFTC to monitor speculation limits and assess potential market abuses. 

Manipulation is here to stay for the simple reason that it can be much more profitable than trying to trade honestly.  Traders and managers receive bonuses at least annually and their own personal capital is usually not at risk from fines.  Also, the chance of getting caught has been very small up until recently.  The CFTC, founded in 1975, won its first contested manipulation case in 2008 against Anthony DiPlacido, a NYMEX floor broker, for improperly executing trades to manipulate the closing price of electricity futures.  In 2012 alone, the CFTC fined Barclays PLC a record $200 million for LIBOR manipulation, fined high-frequency trading firm Optiver Holding BV $14 million for manipulating energy futures and filed market manipulation charges against a former MF Global trader and the Royal Bank of Canada. 

Attitudes about market manipulation will only change when upper management and directors start to seriously weigh the large fines being levied and the probability of being prosecuted against the potential profits.  Firms are now undoubtedly aware that the Dodd-Frank law lowering the burden of proof from “specific intent” to do harm to a “reckless conduct” standard gives the CFTC some real teeth.  This is good news for fair, healthy and competitive markets. 

Iebeling Kaastra, CFA FRM


Gibson Capital Inc.
Calgary, Alberta, Canada

Email: info@gibsoncapital.ca

Copyright © Gibson Capital Inc. Commodity Risk Management, Modeling & Analytics


Developing world class solutions for
commodity risk managers and traders since 1998.


Website by Media Eye Studios