Market manipulation can take many forms, and it’s always prohibited. A financial professional manipulates the market when they take actions designed to artificially influence the price of a security.
These are common prohibited activities:
Painting the tape is the practice of creating a false appearance of market activity. It’s often done in thinly traded stocks, because low trading volume can make it easier to create the illusion of heavy interest.
Assume a group of financial professionals targets a small penny stock. The group buys and sells the stock among themselves, creating a noticeable increase in trading volume. When a thinly traded stock suddenly shows more activity, it can attract attention and lead other investors to buy. As demand increases, the stock price rises. After the price increase, the group sells and takes a profit.
Painting the tape is sometimes referred to as matched orders or wash trades.
Marking the open or close means placing trades right before the market opens or closes for the purpose of influencing the stock’s price. The opening and closing prices are closely watched, so manipulating them can affect how other market participants view the security.
For example, if a group colludes to place a large number of buy orders just before the open, they may be able to push the opening price higher than it otherwise would be. A higher-than-expected opening price can increase demand, allowing the group to sell shortly afterward for a quick profit.
The same idea can be applied near the market close to influence the closing price. Either way, the intent is to distort the market price, and it’s prohibited.
Spreading false rumors about a security to manipulate its market value in any direction is explicitly prohibited. Even if a rumor contains some truth, intentionally spreading misleading information to move a security’s price and profit from that movement is prohibited.
Pump and dump schemes involve intentionally spreading information (sometimes by embellishing truthful information) to create additional demand for a security. Once that demand pushes the market price higher, the people who promoted the information sell the security to “cash in.”
This type of market manipulation is not rare. The Securities and Exchange Commission (SEC) routinely prosecutes individuals and organizations for engaging in these activities (here are three examples - 1 2 3). Even 50 Cent (the rapper) was once accused of participating in a pump and dump scheme.
Free riding is a prohibited trading practice that occurs when an investor buys a security and sells it before paying for the purchase with settled funds, which violates Regulation T. If the investor sells before paying, they are effectively using the broker’s funds to complete the trade without putting up their own capital.
As a penalty, the brokerage firm must freeze the investor’s account for 90 days. During the freeze, all purchases must be fully funded in advance.
Free riding is a violation in cash accounts. In a margin account, it may be avoided by using borrowed funds to cover purchases while waiting for sales to settle.
Sign up for free to take 13 quiz questions on this topic