Market Manipulation

Market manipulation is a federal-level offense under the Exchange Act and a B/D-level offense under the broker-dealer manipulative-practices prohibition and the FINRA prohibition on manipulative quotations and transactions. The exam tests both the substantive prohibitions and the issuer-repurchase safe harbor in detail.

The Market-Manipulation Prohibition

The Exchange Act's market-manipulation prohibition outlaws specific manipulative practices on national securities exchanges. The exam-tested practices:

• Wash trades: Transactions involving no change in beneficial ownership (for example, a person trading between two accounts they own; trades between accounts one person controls are a red flag to investigate). The trade reports to the tape but no economic transfer occurs
• Matched orders: A prearranged buy and sell with another party at the same price and time to create the false appearance of trading volume
• Bona fide cross trade (the permissible contrast): A real buy order from one unrelated party genuinely meets a real sell order from another, so beneficial ownership actually changes hands. That genuine, independent ownership change between unrelated parties is what a wash trade and a matched order both lack, and it is what makes the cross legitimate
• Pegging, fixing, or stabilizing the price of any security in violation of SEC rules (legitimate Reg M stabilizing in a public offering is exempted; unauthorized stabilization is manipulation)
• Disseminating false or misleading information about a security to induce a purchase or sale (rumor-based manipulation)
• Inducing transactions through deception by a broker, dealer, seller, or purchaser

Private Right of Action for Manipulation Damages

Any person who bought or sold a security at a price affected by a market-manipulation violation may sue for damages the person who willfully participated in the violation. The action is independent of SEC enforcement and gives affected buyers and sellers a federal-court damages remedy.

Exam Tip: Gotchas

• Wash trades and matched orders are different. A wash trade is one party trading with itself (no beneficial-ownership change). A matched order is two parties prearranging both sides of a trade. The exam tests this distinction.
• A bona fide cross trade is not a wash trade or a matched order, even though all three involve two matched sides. The difference is a real, independent ownership change between unrelated parties. Price alone does not make a trade bona fide, and market-maker status and SEC approval are not the test either.
• Stabilization is sometimes legal and sometimes manipulation. Stabilization conducted in a public offering under Reg M's stabilization safe harbor is exempt from the market-manipulation prohibition; unauthorized stabilization (no offering, no compliance with Reg M) is per-se manipulation.

Manipulative Devices and Exempted Securities

The market-manipulation prohibition does not apply to exempted securities. Exempted securities (such as U.S. government and Treasury securities) are excluded from many SEA registration provisions, and this exclusion carries over to the manipulative-device prohibition itself.

A person who manipulates a U.S. Treasury bond is not liable under the market-manipulation prohibition, but is still liable under the general antifraud rule (the SEC's broad antifraud rule under the Exchange Act), which reaches all securities, exempted or not.

The Broker-Dealer Manipulative-Practices Prohibition

The broker-dealer manipulative-practices prohibition specifically prevents brokers and dealers from using manipulative or deceptive devices in connection with the purchase or sale of any security (including exempted securities).

This rule is the B/D-focused complement to the general antifraud rule and gives the SEC a B/D-specific charge that does not require proving classical antifraud elements like materiality.

A B/D who participates in a wash trade can be charged under both the broker-dealer manipulative-practices prohibition and the market-manipulation prohibition (or, if the security was off-exchange, under the broker-dealer manipulative-practices prohibition alone).

The Corporate-Action Notification Requirement: Untimely Announcements of Record Dates

An issuer of a class of publicly-traded securities must give timely notice to FINRA (or the appropriate self-regulatory organization, SRO) of:

• Dividends or distributions in cash or in kind
• Stock splits or reverse stock splits
• Rights or other subscription offerings

The 10-Day Rule

Notice is required at least 10 days before the record date of the distribution.

The 10-day notice gives FINRA and the markets time to:

• Calculate and disseminate the ex-dividend date (under T+1 settlement, typically the same day as the record date)
• Update execution systems so trades after ex-date settle without the dividend
• Notify market participants of the changed pricing

A late or missing corporate-action notice can mislead the market about ex-date pricing and trigger trading-halt or unwinding consequences. Failure to file is itself a manipulation-style violation under the rule.

Exam Tip: Gotchas

• The 10-day notice runs to the RECORD date, not the EX-DATE. Under T+1 settlement, the ex-date is usually the same day as the record date, so a 10-day record-date notice also gives roughly 10 days before the ex-date. The exam tests the 10-day-before-record-date wording.
• The corporate-action notification requirement reaches issuers, not just B/Ds. The notice obligation runs from the issuer to FINRA. A broker-dealer that knows of an undisclosed distribution may have separate disclosure obligations under Reg BI or other anti-fraud rules.

The Issuer Buyback Safe Harbor

The issuer share repurchase safe harbor provides a non-exclusive safe harbor from manipulation liability under the Exchange Act's market-manipulation prohibition and the general antifraud rule when an issuer (or affiliated purchaser) repurchases its own common stock and complies with four daily conditions.

The Four Conditions

The Block Exception

Once each week, in place of the 25%-of-ADTV daily volume limit, the issuer may make one block purchase, provided no other safe-harbor purchases happen that day. A block is:

• A quantity of stock with a purchase price of $200,000 or more, OR
• At least 5,000 shares with a purchase price of at least $50,000

The block exception does not relieve the manner, timing, or price conditions; only the daily 25% ADTV volume cap is waived, and only for that one weekly block purchase.

How the Safe Harbor Works

• The safe harbor is not an obligation. An issuer that exceeds 25% of ADTV does not automatically violate the rules; it just loses the safe harbor for that day's repurchases and must defend against manipulation charges on the merits
• Failure to meet any of the four conditions on a given day removes all that day's repurchases from the safe harbor (the day's safe-harbor protection is all-or-nothing)
• The safe harbor is not available if the repurchases are otherwise fraudulent or manipulative under all the facts and circumstances. A repurchase made with manipulative intent loses the safe harbor regardless of literal compliance

Think of it this way: The issuer buyback safe harbor is a checkbox that says "if you stay in these four lanes today, you cannot be charged with classical price manipulation for the buyback." Step outside any lane on a given day and the day's protection is gone, but you have not necessarily violated the law; you have just lost the easy defense.

Exam Tip: Gotchas

• The issuer buyback safe harbor is a safe harbor, not an obligation. An issuer that exceeds 25% of ADTV on a given day does not automatically violate the rules; it just loses the safe harbor for that day's repurchases and must defend against manipulation charges on the merits.
• All four safe-harbor conditions must be met on each day. A miss on the price condition (paying above the highest independent bid for one trade) blows the safe harbor for the entire day's volume, not just that single trade.
• The block exception waives ONLY the volume condition. The manner, timing, and price conditions still apply to a safe-harbor block purchase.

FINRA Prohibition on Manipulative and Deceptive Quotations

The FINRA SRO-level analog of the federal manipulation rules:

• Inconsistent with the FINRA standards of commercial honor, the FINRA fraud prohibition, and the publication-of-transactions-and-quotations rule for a member to publish or circulate any report of a securities transaction unless the member knows or has reason to believe the transaction was bona fide
• Inconsistent with the same standards for a member to publish a quotation (bid, offer, "bid wanted," or "offer wanted") unless the member has reasonable cause to believe the quotation is bona fide, not fictitious, and not for any fraudulent, deceptive, or manipulative purpose

The FINRA quotation-prohibition reaches conduct that may not rise to a federal-court manipulation case but that nonetheless undermines market integrity. Examples include posting non-bona-fide quotes to mislead other market participants or reporting a non-bona-fide trade through ACT or TRACE.

What Should You Check on Exam Day?

• Can you distinguish a wash trade, where a person trades with itself, from a matched order, prearranged with another party at the same price and time?
• Do you know an issuer must give FINRA at least 10 days notice before the record date of a dividend, split, or rights offering?
• Can you name the four issuer buyback safe harbor conditions: manner, timing, price, and a daily volume cap of 25% of average daily trading volume?
• Can you state that the weekly block exception waives only the volume condition, not the manner, timing, or price conditions?