Manipulative, Deceptive, and Fraudulent Devices
With the antifraud provisions as the legal foundation, we now turn to specific market manipulation tactics that the NASAA Statement of Policy on Dishonest Practices prohibits.
The Catch-All Prohibition
It is a dishonest or unethical business practice for a broker-dealer to effect any transaction in, or induce the purchase or sale of, any security by means of any manipulative, deceptive, or fraudulent device, practice, plan, program, design, or contrivance.
This broad prohibition encompasses all forms of market manipulation and fraud. Three specific types are called out:
Wash Trades
- Definition: Effecting a transaction in a security that involves no change in beneficial ownership
- A wash trade occurs when a person simultaneously buys and sells the same security through different accounts they control
- Purpose: Create the false appearance of trading activity without any real change in economic position
Example: An agent places a buy order and a sell order for the same stock through two accounts they control. No actual transfer of ownership occurs; the same person owns the shares before and after.
Exam Tip: Gotchas
- "No change in beneficial ownership" is the test. If the same person ultimately owns the shares before and after the pair of trades, it is a wash trade, even if the accounts have different names (joint, trust, corporate entity the trader controls).
Matched Orders
- Definition: Entering an order to buy or sell a security with knowledge that an order of substantially the same size, at substantially the same time, and substantially the same price has been or will be entered on the opposite side
- Involves coordination between two or more parties who agree to trade with each other
- Purpose: Create a false or misleading appearance of active trading or a false appearance with respect to the market for the security
Exception: Bona fide agency cross transactions for customers are permitted; this is not a matched order. A legitimate agency cross occurs when a broker matches a real buyer with a real seller.
Painting the Tape
- Definition: Effecting, alone or with others, a series of transactions in a security to create actual or apparent active trading, or to raise or depress the price, for the purpose of inducing others to buy or sell
- Unlike a single wash trade, painting the tape involves a sustained pattern of manipulative transactions
- The key element is purpose: the transactions are designed to lure other investors into buying or selling based on artificial activity or price movement
Comparison of Manipulation Types
| Type | Who Is Involved | Key Feature | Purpose |
|---|---|---|---|
| Wash trade | One person, multiple accounts | No change in beneficial ownership | False appearance of activity |
| Matched orders | Two or more parties coordinating | Same size, time, and price on opposite sides | False appearance of active trading |
| Painting the tape | One or more persons | Series of transactions over time | Induce others to buy/sell based on artificial activity or price |
Exam Tip: Gotchas
The exam may describe two parties trading a thinly traded stock back and forth to make it appear actively traded. This is matched orders (if individual coordinated trades) and painting the tape (if a sustained series). Both are prohibited. But a legitimate agency cross transaction (where a broker matches a real buyer with a real seller) is not a matched order and is permitted.