Maxwell K. Multer, 01 September 2011
Regulators have addressed market manipulation with Rule 10b-5 since its promulgation under the Securities Exchange Act in 1942. While Section 9 of the Securities Exchange Act addresses manipulation of securities prices, it requires the specific intent “for the purpose of inducing the purchase or sale of such security by others”1 or “for the purpose of creating a false or misleading appearance [of market activity] . . ..”2 It is likely for that reason that prosecutors rarely use Section 9, choosing instead to bring manipulation proceedings under Rule 10b-5.3 But as the tools available for accomplishing market manipulation have evolved, the judicially narrowed contours of Rule 10b-5 may be such that certain new schemes escape liability. With modern advances in trade execution, market platforms and derivatives, it is now possible to accomplish a profitable market manipulation without engaging in any overtly fraudulent or illegal behavior.
Several courts have elected to distinguish between these alleged schemes and schemes which do include illegal behavior, employing a higher level of scrutiny and requiring proof of additional elements in the former situation. Manipulative schemes are referred to as “open market manipulations” when the alleged scheme is accomplished solely through the use of facially legitimate open market transactions. That is, where the manipulator has not engaged in any conduct that is inherently or otherwise illegal, such as fictitious transactions, wash sales or by disseminating false reporting. The transactions are seemingly legitimate, but for their manipulative intent and effect in combination.
Because these schemes are comprised of facially legitimate transactions, a number of courts have refused to impose liability, some categorically so. This refusal is inappropriate and operates to the detriment of honest market participants. Furthermore, refusal to impose liability on a categorical basis unnecessarily and improperly places conduct that intentionally distorts prices outside the scope of Section 10(b). In 2005, the Federal Energy Regulatory Commission’s anti-manipulation rules were modified to mirror the language of SEC Rule 10b-5, and the Commission considers existing Rule 10b-5 precedent when hearing manipulation cases.
In late 2010, the Commodity Futures Trading Commission proposed rules to implement its expanded and clarified anti-manipulation authority under Section 753 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.4 The CFTC’s analysis of alleged market manipulation claims has historically differed from the Securities and Exchange Commission’s under Rule 10b-5.5 The proposed language of the new rule mirrors that of Rule 10b-5 and FERC’s anti-manipulation rules, and the scope of prohibited behavior may be changed and expanded as a result.