The stock market plays a crucial role in the economy of a country and effects the growth of its commerce and industry. The industry, government and central banks will work together to keep an eye on the goings-on of the stock market. Investing on the stock market poses a greater risk than other investments. The question that arises is what happens if there is an attempt to interfere with the operation of the stock market?
Stock markets operate on the principle of a free market, according to which supply and demand regulate the price of securities so that the price of a security reflects its true value. Any interference with this operation of price determination amounts to market manipulation. Investors are misled into purchasing worthless shares or selling their otherwise valuable investments below their true market value. Market manipulation can harm the integrity of and undermine public confidence in stock markets.
Market manipulation is prohibited by both common and statutory law. The statutory law governing the prohibitions consists of the Stock Exchanges Control Act, 1985; the Financial Markets Control Act,1989; and the Securities Services Act, 2004 (“the Securities Act”). The object of the Securities Act is to:
i. increase confidence in the South African financial markets by –
ii. requiring that securities services be provided in a fair, efficient and transparent manner;
iii. contributing to the maintenance of a stable financial market environment;
iv. promote the protection of regulated persons and clients;
v. reduce systemic risk; and
vi. promote the international competitiveness of securities services in the Republic.
There are three types of market manipulative practices that are prohibited. A prohibited trading practice such as a trade-based market manipulation is the first prohibition. It involves methods intended to distort and interfere with the normal market mechanisms of supply and demand for securities. Section 75(1) of the Securities Act states that no person may:
- either for such person’s own account or on behalf of another person, directly or indirectly use or knowingly participate in the use of any manipulative, improper, false or deceptive practice of trading in a security listed on a regulated market, which practice creates or might create a false or deceptive appearance of the trading activity in connection with; or an artificial price for, that security;
- place an order to buy or sell listed securities which, to his or her knowledge will, if executed, have the effect contemplated in paragraph.
A deemed prohibited trading practice is governed by section 75(3) of the Securities Act. It states that certain trading practices are deemed to be manipulative, improper, false or deceptive and will be deemed to have contravened section 75(1) of the Securities Act. There are a number of deemed prohibited trading practices and only a few will be mentioned.
‘Wash sales’ involves approving or entering an order to buy or sell a security listed on that market which involves no change in the beneficial ownership of that security. This practice involves a person either directly or indirectly being both the seller and the purchaser of securities in the same transaction. It is clear that this practice creates a false and deceptive appearance of trading activity with a security.
The common law states that a manipulator involved in a ‘wash sale’ transaction trades in the security hoping that investors will be attracted to the increased turnover of the security. The law further states that the object of this practice is to gain financially by creating a lesser price gap between the buy and sell rates of the security in question.
A ‘matched order’ involves approving or entering on a regulated market an order to buy or sell a security listed on that market with the knowledge that an opposite order or orders of substantially the same size at substantially the same time and at substantially the same price, have been or will be entered by or for the same or different persons with the intention of creating a false or deceptive appearance of active public trading in connection with or an artificial market price for that security.
Courts have stated that the main objective of this practice is to create an appearance of renewed interest in the security in question in order to persuade others to purchase the security. The manipulator creates this impression hoping that a sufficient number of interested investors will cause the price of the security to rise.
Lastly section 76(1) prohibits disclosure-based market manipulation that entails a person (directly/indirectly) spreading incorrect, false, misleading, deceptive rumours relating to the demand, supply, price or value of a security. The ‘hype and dump’ or ‘pump and dump’ scheme is a common scheme involving disclosure-based market manipulation.
This abovementioned prohibition entails the advertising of a company’s shares through misleading statements with the object of deceiving unsuspecting investors to purchase shares in the company with the aim of increasing its price. Once the price has been ‘pumped up’ by all the hype and the demand for the shares increases, this causes the share price to increase.
Once the share price has increased, the manipulators then ‘dump’ their shares on the market and make a profit for themselves. The ‘pumping’ of the shares will then be stopped and the price will decrease causing the investors to lose their money.
Penalties for market manipulation are provided for in the Securities Act and include a fine, imprisonment and administrative penalties. A person can be liable on conviction to a fine not exceeding R50 million or to imprisonment for a period not exceeding 10 years, or to both such fine and imprisonment.
In recent news the Financial Services Board (“FSB”) has given strict warnings to market manipulators that it will continue to penalise offenders as it has been doing over the past few years. The FSB further mentioned that it will not only continue penalising manipulators but that such manipulators will lose any or all of their movable, non-movable and incorporeal assets, if these assets are attached and sold in execution.