Transcript THE INSURANCE INDUSTRY - University of Pennsylvania

THE METHODS TO PREVENT MARKET
MANIPULATION ON SECURITIES
EXCHANGES
ASLI BASTURK
Capital Markets Board of Turkey
April 21, 2003
Introduction
The central economic function of markets is to
create LIQUIDTY.
Investors face lots of kinds of risks on the
process of trade.
Information is a valuable commodity in security
market.
However, information can be gained lawfully or
unlawfully.
Introduction (cont.)
The major objectives of securities
regulation are open, honest and fair
markets.
Most of the regulation of financial markets
seeks to prevent manipulation.
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Securities Act of 1933
Securities Exchange Act of 1934
Introduction (cont.)
The problem of manipulation was attacked by
Congress in a number of ways;
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By specific prohibitions,
By giving the SEC rulemaking authority in certain
areas,
By a general prohibition against any trading for a
manipulative purpose.
The statutory scheme is a blend of fraud
theories and open market concept developed in
the English and American cases.
What is manipulation?
No satisfactory definition of the term
exists.
No definition in the regulatory statutes.
Courts and commentators have suggested
various formulations.
Definition of manipulation
Manipulation means anything in particular; it
means conduct intended to induce people to
trade a security or force its price to an artificial
level.
Deliberate interference with the free play of
supply and demand in the security markets.
Any price change that results from trading
designed to produce such a price change is an
artificial price.
Definition of manipulation (cont.)
The only definition that makes sense is subjective – it
focuses entirely on the intent of the trader. Manipulative
trades could be defined as profitable trades with “bad
intent” – in other words, trades that meet the following
conditions:
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(1) the trading is intended to move prices in a certain direction;
(2) the trader has no belief that the prices would move in this
direction but for the trade; and
(3) the resulting profit comes solely from the trader’s ability to
move prices and not from his possession of valuable information.
Traders who trade with “good” intent – for the purpose of moving
prices in the direction they believe prices will move – are not
engaged in manipulation.
Manipulation as a white collar crime
The label “white collar crime” introduced by
Edwin Sutherland in 1940s.
Aimed to foster an integrated analysis of ‘crime
in the upper, or white collar class’.
Many white collar offences, like manipulation,
are complex and heterogeneous acts.
The very first case against
manipulation
Rex v. de Berenger, decided by the King’s
Bench in 1814.
In this case, as a matter of criminal law,
the concept of a free and open public
market established.
Manipulation before the SEC
The pre-cases in the US arose in three contexts:
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Criminal prosecution,
Litigation between manipulators,
Litigation between investors and manipulators.
The criminal attack on manipulation came under the mail
fraud statute and special state legislation, primarily in
New York.
In 1933 Judge Woolsey in the Southern District of NY
adopted the open market theory.
The provisions of SEC statutes
The purpose of the various statues and rules
prohibiting market manipulation is to prevent
activities that rig the market and thereby to
permit the operation of the ‘natural law’ of supply
and demand.
The function of the SEC statutes has been to
give a greater degree of definiteness to the
concept of manipulation and to supply an
enforcement and preventive mechanism .
Securities Act of 1933
According to the provision of section 17 (a), it shall be
unlawful for any person in the offer or sale of any
securities or any security-based swap agreement by the
use of any means or instruments of transportation or
communication in interstate commerce or by use of the
mails, directly or indirectlyto employ any device, scheme, or artifice to defraud, or
to obtain money or property by means of any untrue statement of a
material fact or any omission to state a material fact necessary in
order to make the statements made, in light of the circumstances
under which they were made, not misleading; or
to engage in any transaction, practice, or course of business which
operates or would operate as a fraud or deceit upon the purchaser.
Assets Held by Insurance Companies
Insurance industry has a dominant role in the capital markets
because off their role as the managers of pension funds and
mutual funds and the main demander of long term bonds.
Insurance companies held assets;
 Bonds
 Mortgages
 Stock
 Real Estate
 Other
Traditionally insurance companies heavily invested in fixedincome securities. Secondary preference for life/insurance
companies is mortgages and for property/casualty companies
is equities. But for the last years the boom in the stock market
cause a shift toward equity-based securities for life/insurance
companies.
The Regulation of Insurance Companies
Since the McCarran-Ferguson Act of 1945, insurance companies
have been regulated by the states.
State regulations include firm solvency and product specification.
While regulations vary from state to state, they share at least the
following goals:
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Prevent insurer investment in speculative assets
Ensure that assets are not vulnerable to dramatic shifts in the economy
Restrict insurers from control beyond the influence of regulatory
authorities
Achieve “social goals”
To promote a convergence of standards, the National Association of
Insurance Commissioners (NAIC) was formed in 1871. This
organization provides various services to the state commissioners
and has developed the standardized examination system known as
the “Insurance Regulatory Information System (IRIS)”.
Securities Exchange Act of 1934
Section 9
Section 10 (b)
Section 15(c)
Section 9 of 1934 Act
Outlaws manipulative practices in connection with the
trading of exchange-listed securities and also provides a
private remedy for investors injured by the prohibited
manipulative conduct. .
Unlike most other provisions of the 1934 Act, section 9 is
limited to securities traded on a national securities
exchange and does not apply to the securities of the
many registered reporting companies that are traded in
the over the counter markets.
Section 9 of 1934 Act (cont.)
Section 9(a) expressly prohibits ‘wash sales’, ‘matched sales’, or
any transactions entered into simultaneously where the purpose is
to create ‘a misleading appearance of active trading’. The section
also prohibits any exchange-based transactions that give the
artificial impression of active trading as well as transactions entered
into for the purpose of depressing or raising the price.
Section 9(e) of the Exchange Act contains an express remedy to
redress damages incurred by investors who have been injured by
illegal manipulative conduct with regard to those exchange-listed
securities. Liability under section 9(e) is expressly limited to persons
‘willfully’ participating in the manipulative conduct; willfulness would
seem to be an even stricter requirement than that of scienter which
is required generally in suits under Rule 10b-5.
Section 9(a)(6) of 1934 Act
Section 9(a)(6) acts as a limitation on Section 9(a)(2) in that it
excludes certain types manipulation _ “any series of transactions
for the purchase and/or sale of any security registered on a
national securities exchange for the purpose of pegging, fixing or
stabilizing the price of such security”- from the general prohibition
and subjects them to the Commission’s rulemaking authority.
Congress found the evidence as to the value of stabilizing
operations was “far from conclusive”. And so it authorized the
Commission “to prescribe such rules as may be necessary or
appropriate to protect investors and the public from the vicious
and unsocial aspects of these practices” .
Section 10 (b) of 1934 Act
Section 10 (b) of Securities Exchange Act empowers the SEC to
promulgate rules prohibiting manipulative and deceptive devices
and contrivances in connection with purchases and sales of
securities.
Section 10(b), which is the general antifraud provision of the 1934
Act provides that it is unlawful “to use or employ (utilizing any means
or instrumentality of interstate commerce), in connection with the
purchase or sale of any security… any manipulative or deceptive
device or contrivance in contravention of such rules and regulations
as the Commission may prescribe as necessary or appropriate in
the public interest or for the protection of investors.
Section 10 (b) of 1934 Act (cont.)
The Commission has utilized this rulemaking power in a
number of instances, with regard to a wide variety of
manipulative and deceptive acts and practices and in
Rule 10b-5 it fashioned its most encompassing antifraud
prohibition.
The rule prohibits:
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(1) Fraudulent devices and schemes,
(2) Misstatements and omission of material facts,
(3) Acts and practices which operate as a fraud or deceit .
Section 15 (c) of 1934 Act
The Commission is given the power to promulgate rules
prohibiting brokers and dealers from engaging in
‘manipulative, deceptive, or otherwise fraudulent’
devices and contrivances .
Fischel and Boss’s arguments on
manipulation
Fischel and Ross argue in their article that, the law’s
efforts to prevent manipulation are misguided. They
conclude that “the concept of manipulation should be
abandoned altogether … Actual trades should not be
prohibited as manipulative regardless of the intent of the
trader.”
Steve Thel’s arguments on manipulation
Thel concludes that, much of the regulation of financial
markets seeks to prevent manipulation. The law should
not lightly abandon this quest, Fischel and Ross’
arguments notwithstanding. Manipulators can sometimes
control prices with trades and by doing so they can reap
profits, whether by taking advantage of preexisting
contracts or by inducing other market participants to
trade at manipulated price.
It is often hard to tell what motivates a particular trade,
so rules that turn on intentions would be unlikely to
prevent intentional manipulation. Objective rules may
more accurately identify and prevent manipulative
trading .
Article 47/A-2 of the CML
According to the article: “Real entities, the authorized persons of
legal entities and those acting together with them all which trade
capital market instruments in order to artificially affect their demand
and supply, to give the impression of existence of active market, to
hold the prices at the same level, to increase or decrease the
prices.”
shall be punished with a prison sentence of from two to five years
and a heavy pecuniary fine of from 10 billion TL up to 25 billion TL. If
two or more of the cases specified in this sub paragraph are
combined in the committing of the crime, then the minimum limit of
the prison sentence is three years and the maximum limit is six
years”.
Article 46 (i) of the CML
Beside these criminal provisions, Article 46 (i) of the CML
authorizes the Board, “to take such measures needed to
ensure the prevention of real persons or legal entities
that are determined by the Board to have directly or
indirectly participated in acts enumerated in the provision
of subparagraph A of Article 47 of this Law from
engaging temporarily or permanently in transactions on
exchanges and other organized markets following the
supervision, examination and auditing made in
accordance with this Law”.
The CMB rule about prohibition to engage
transaction on the exchanges and other organized
markets.
This measure is applied to all the manipulators and
insiders, and is also applied to other crimes like
unauthorized broker-dealers.
With the authority given by the Law, the Board applies
two major methods to prevent manipulators from
engaging the same kind of exercises;
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prohibition to engage transaction on the exchanges and other
organized markets and
unlisted the securities that manipulators owned.
Conclusion
Much of the regulation of financial markets seeks to
prevent manipulation.
The difficulty to prove manipulation as a crime in the
courts is parallel to the most of the markets.
Since CML have the criminal and administrative
provisions against manipulation in the Law, the Law does
not have a similar rule like Rule 10(b)(5) of SEC.
To formulate classic manipulative conducts as fraud or to
regulate manipulation with objective rules can not be the
right solution for preventing manipulative conduct.