Manipulation and false information

The securities market runs on prices being informative. Manipulation attacks that directly, which is why the prohibitions are drafted broadly and then illustrated at length.

Fraud, defined unusually widely

Before the prohibitions, the definition. "Fraud" includes any act, expression, omission or concealment, and the enumerated instances include:

• "a knowing misrepresentation of the truth or concealment of material fact"
• "a suggestion as to a fact which is not true by one who does not believe it to be true"
• "an active concealment of a fact by a person having knowledge or belief of the fact"
• "a promise made without any intention of performing it"
• "a representation made in a reckless and careless manner whether it be true or false"
• "deceptive behaviour by a person depriving another of informed consent or full participation"
• "a false statement made without reasonable ground for believing it to be true"
• the act of an issuer giving out misinformation that affects the market price

Two of these deserve attention. A representation made recklessly is fraud whether or not it turns out to be true — so "it happened to be right" is no answer. And a statement made without reasonable ground for believing it is fraud without any requirement that the speaker knew it was false. Honest conviction arrived at carelessly is caught.

The general prohibitions

Regulation 3: no person shall, directly or indirectly, deal in securities "in a fraudulent manner", employ any "manipulative or deceptive device or contrivance", employ any "device, scheme or artifice to defraud", or engage in any act or practice "which operates or would operate as fraud or deceit upon any person".

Regulation 4(1): no person shall indulge in a "manipulative, fraudulent or an unfair trade practice" in securities markets — with an Explanation confirming that siphoning off or diverting a listed company's assets or earnings, and manipulating its books of account or financial statements so as to affect its share price, are included; as are transactions through mule accounts.

The enumerated practices

Regulation 4(2) deems a list of dealings to be manipulative, fraudulent or unfair. It repays reading as a catalogue of what actually goes wrong.

Creating a false picture of activity

• "knowingly indulging in an act which creates false or misleading appearance of trading"
• dealing "not intended to effect transfer of beneficial ownership" but operating only as a device to inflate, depress or cause fluctuations in price — trading with yourself, in substance
• circular transactions between persons, including intermediaries, to give a false appearance of trading or to move the price
• entering a transaction without intention of performing it or without intending any change of ownership

Moving the price

• any act or omission amounting to manipulation of the price of a security, including influencing or manipulating a reference price or benchmark price
• inducing any person to deal in securities for artificially inflating, depressing, maintaining or causing fluctuation in price, "through any means including by paying, offering or agreeing to pay" money or money's worth
• inducing subscription to an issue to fraudulently secure the minimum subscription

Information offences

• "knowingly publishing" or reporting, by a person dealing in securities, information relating to securities — "including financial results, financial statements, mergers and acquisitions, regulatory approvals" — which is not true or which they do not believe to be true, before or in the course of dealing
• "disseminating information or advice through any media, whether physical or digital, which the disseminator knows to be false or misleading in a reckless or careless manner and which is designed to, or likely to influence the decision of investors"
• "knowingly planting false or misleading news which may induce sale or purchase of securities"

Against the client

• front-running: any order placed while "directly or indirectly in possession of information that is not publically available, regarding a substantial impending transaction" in that security, its underlying or its derivative
• "fraudulent inducement of any person by a market participant to deal in securities with the objective of enhancing his brokerage or commission or income" — the churning provision
• an intermediary predating or falsifying records, including contract notes, client instructions and account statements
• mis-selling of securities or services, which chapter 9 takes on its own

And two closing Explanations: the list "is not exhaustive", and an act is prohibited if it falls within regulation 3 even if it is not listed; and "market participant" includes any person registered under section 12 of the Act and its employees and agents.

The pump-and-dump, assembled

The classic abuse is built from several of these at once. Acquire a position in something thinly traded, where your own buying moves the price. Promote it — a target, a story, a claim of inside knowledge. Sell into the demand your promotion created.

The thin float is not incidental; it is the mechanism. In a liquid stock neither your buying nor your audience's would move the price enough to matter. The abuse requires an instrument where a modest amount of coordinated demand is a large fraction of normal volume.

This is also why the format of modern promotion has outrun its appearance. A channel reaching tens of thousands is a distribution network of the kind that once required a boiler room, and chapter 4's point applies: issuing targets makes you a research analyst in substance whatever you call yourself, with registration and disclosure obligations attached.

Working the problem

The operator buys a thin small-cap, posts a target to fifty thousand followers, sells into the buying.

Provisions likely engaged:

Dissemination of false or misleading information — if the target or the reasoning is one they do not believe, or was arrived at recklessly, the media-dissemination provision bites directly, and it is drafted to cover digital media and to require only that the material be likely to influence investors' decisions.

Manipulation of price — the act or omission amounting to manipulation, since the promotion was the instrument by which the price moved.

Inducing dealing to cause price fluctuation — inducing others to deal in order to inflate the price, which is what the promotion did.

Concealment amounting to fraud — the definition covers active concealment of a fact by a person having knowledge of it and depriving another of informed consent. Omitting that they hold the stock and intend to sell is the material fact, and its omission is what makes the recommendation work.

The research analyst regime — making a recommendation and giving a price target to a group of persons or the general public is a research service; doing it unregistered, without disclosing their holding, breaches chapter 6's disclosure obligations independently of any manipulation finding.

Possibly front-running, if the substantial impending transaction is read to include their own intended sale, though the provision is aimed principally at trading ahead of a client's or another party's order.

The hardest element to prove: intention at the time of buying. Everything else is documentable — the trades are on exchange records with timestamps, the posts exist, the holding is visible. What a regulator must establish is that the promotion was a device rather than a sincere opinion that the operator later changed. The operator's defence writes itself: I bought because I believed in it, I said so publicly, the price rose, I took profit like any investor.

Two things cut against that defence. The sequence and timing — buying immediately before posting and selling immediately into the resulting volume is a pattern, and a repeated pattern across several stocks defeats the single-instance explanation. And the recklessness limb: SEBI need not prove the operator knew the target was false, only that the representation was made without reasonable ground for believing it or in a reckless and careless manner, which is a far lower bar than dishonesty and is why the definition of fraud was drafted to include it.

The point

SEBI defines fraud to include not only knowing misrepresentation but reckless representation and statements made without reasonable ground for belief, so honest carelessness is caught and being accidentally right is no defence. The enumerated practices read as a catalogue of recurring abuse: trades that create a false appearance of activity, circular transactions, price manipulation including of benchmarks, publishing untrue information while dealing, planting news, front-running, churning for commission and falsifying client records. A pump-and-dump assembles several at once and depends on a thin float, and the element hardest to prove is the operator's intention when buying — which is why the recklessness standard, rather than dishonesty, usually does the work.