Manipulative trading practices: A guide for banks’ legal and compliance departments (2024)

How to recognise manipulative and deceptive trading practices

Types of market manipulation

Indicators

Red flags for potential misconduct will depend on, among other things, the type of asset class, the type of trading in question and the features of the particular market. However, previous enforcement action has highlighted the following potential indicators of market manipulation. These indicators do not, in themselves, constitute market manipulation, but may be taken into account when transactions or orders to trade are investigated by the FCA:

• Unusual size of orders.
• Orders placed on the order book for an unusually short time period.
• Consistent buying interest at increasing prices regardless of market conditions (Winterflood).
• Orders at prices above the prevailing market price (Goenka).
• Entering orders to “buy high and sell low”. That is, entering orders to buy shares on one exchange at a certain price, while offering to sell the same security on another exchange at a lower price (Da Vinci).
• Using different systems to place orders on each side of the trade.
• Different strategies or levels of visibility for buy and sell orders (Abbattista).
• Orders representing a very high proportion of the orders placed in the market in relation to the shares in question (Da Vinci).
• Very close correlation between the placing of the orders by traders and the price movement of the instrument in question (Da Vinci).
• Placing orders in the last few seconds of an auction effectively ensuring little or no time for potential sellers to enter orders in response to buy orders (Goenka).
• High volume and frequency of rollover trades (Winterflood).
• Where a market has a small number of participants, two or more participants acting in concert to manipulate the price have the potential to have a greater impact than might otherwise be the case (Kerr, 2010).

Other red flags for market abuse more generally include using codes in communications, using personal communication channels for business matters and the deletion of specific messages or emails. UK MAR also sets out in Annex I indicators of manipulative behaviour. Annex I confirms that these indicators are non-exhaustive and again do not, in themselves, constitute market manipulation, but they are taken into account when transactions or orders to trade are investigated by the FCA.

Indicators relating to false or misleading signals and to price securing

Where the orders to trade or transactions:

• Represent a significant proportion of the daily volume of transactions, especially when it leads to a significant price change.
• Are undertaken by persons with a significant buying or selling position, leading to significant changes in price.
• Lead to no change in beneficial ownership.
• Include position reversals in a short period, represent a significant proportion of the daily volume of transactions and might be associated with significant changes in the price.
• Are concentrated within a short time span in the trading session and lead to a price change which is subsequently reversed.
• Change the representation of the best bid or offer prices and are removed before they are executed.
• Are undertaken at or around a specific time when reference prices, settlement prices and valuations are calculated and lead to price changes which have an effect on such prices and valuations.

For more information, seePractice notes, UK Market Abuse Regulation (UK MAR)andUK MAR: market manipulation.

Indicators relating to the employment of a fictitious device or any other form of deception or contrivance

When the orders to trade or transactions are undertaken by persons:

• And are preceded or followed by dissemination of false or misleading information by the same persons or by persons linked to them.
• Before or after the same persons or persons linked to them produce or disseminate investment recommendations which are erroneous, biased or demonstrably influenced by material interest.

Manual and automated processes

Sanctions apply regardless of whether the trading practice was carried out manually or through automated means. Although the FCA recognises the benefits of automated processes (for example, that algorithmic trading may be beneficial for market integrity by providing an important source of liquidity), it is clear that abusive strategies, whether via automated trading or otherwise, will not be tolerated (seeFCA: Market Watch Issue 44 (August 2013)). In 2013, the FCA found an individual to have engaged in market abuse by deliberately manipulating commodities futures using an algorithmic “High Frequency” strategy, imposing on him a fine of nearly £600,000 .

Dealing with suspected market manipulation

Where possible market manipulation is suspected, firms should consider:

• Whether it is appropriate to conduct an initial fact-finding exercise internally to ascertain whether further investigation or regulatory notification may be required (taking into account whether any criminal activity may have occurred and considerations regarding preservation of evidence).
• If so, who is best placed to carry out this exercise (taking into account how the suspicion has arisen or been identified) and what steps should be taken.

The FCA may seek details of any fact-finding or internal investigation carried out by a firm and it is therefore important that these follow a clear and defensible methodology. Firms should consider taking legal advice including in relation to the creation of any written communications or other documents and the extent to which such materials may be privileged.

From a practical perspective, as part of any fact-finding exercise, it may be useful to:

• Ask open questions designed to obtain as much information as possible.
• Stress test explanations rather than accepting initial explanations at face value.
• Review emails, trading data and its patterns, and listen to tapes. Gathering all relevant pieces of evidence is crucial and can be challenging.
• Create a timeline of trading activity using the available data.
• Verify explanations against the available data and pose follow up questions where necessary in relation to any discrepancies.
• Where possible, seek assistance from those with first-hand experience and understanding of the relevant market (but who are not themselves potentially implicated).
• Seek to quantify any potential market impact (bearing in mind that practices can be manipulative even when trading in small volumes).
• Be mindful of any data privacy implications and other employment law considerations. For more information, seeData protection in employment under the UK GDPR and DPA 2018 toolkit.

In stress testing explanations, it may be useful to have regard to previous cases and the regulator’s view of explanations that were provided (while recognising that all cases must be assessed on their own particular facts).

Defences which have been raised, and rejected, in market manipulation cases include:

• Traders were simply making a market (Da Vinci). Market-making involves quoting on both sides (sell and buy) of the marketplace. The function of a market-maker is to provide liquidity to the market by standing ready to fulfil both buy and sell orders and as such they must maintain continuous two-sided quotes. In Da Vinci, the court held that the defendants did not maintain continuous two-sided quotes and their practice was to place orders predominantly on one side of the book, moving orders from one side to the other in a “saw-tooth” pattern consistent with trading conduct intended to influence demand and supply and therefore price. The court concluded that they were not acting as genuine market makers.
• Legitimate long-term investment strategy (Chaligné). In Chaligné, the argument that Mr Chaligné was combatting downward pressure in a difficult and volatile bear market by trying to support the prices, not to increase them to their maximum possible level, was unsuccessful. The Upper Tribunal’s view was that, even if Mr Chaligné genuinely thought the prices of the stocks needed to be “shored up”, his claimed strategy for doing so (whether or not it amounted to market abuse) made little sense because it was likely to be financially disadvantageous for him.
• Misunderstanding. For example, a misunderstanding that led to instructions that traders buy stocks more aggressively than intended (Chaligné). In Chaligné, the evidence did not support the argument that there had been a misunderstanding. This defence was rejected on the strength of, among other things, the transcripts of telephone conversations which showed that at no point did Mr Chaligné express any misgivings about the strategy of placing orders at increasingly higher prices and of doing so near to the close of the markets.
• Being unaware that what they were doing was wrong (Da Vinci). In Da Vinci, the court found that the individuals involved were experienced traders who had had previous association with Swift Trade (which was fined for layering in 2014). The court concluded that they must have been aware that spoofing and layering was improper.

While preserving confidentiality, it is important for the investigation team (which may include the compliance department; carefully selected and non-conflicted senior front office employees; senior management; and legal (including employment lawyers)) to work in a co-ordinated manner. It may be appropriate to consider:

1. filing a suspicious transaction and order report (STOR) in accordance with MAR requirements. For more information, seePractice note, UK MAR: suspicious transaction and order report (STOR) regime;or
2. making a Principle 11/ SUP 15 notification.

When conducting internal investigations into potential market manipulation, in addition to their regulatory position, firms should also be mindful of their employment law position vis-à-vis relevant traders and other employees, and take into account whether legal requirements in other jurisdictions may be relevant (for example, from an employment or data protection perspective). Firms have previously been faced with employment proceedings in connection with an internal investigation process.

Policies, procedures and controls

• Regular updates to policies and procedures to ensure that guidance is clear, including in relation to the escalation of any suspicious activity.
• A systematic approach to risk assessments, which are properly documented and repeated annually or when another trigger occurs. This may mean that firms need to invest in more sophisticated and automatic surveillance tools.
• Pre-trade controls to prevent the entry of orders that exceed credit limits or appropriate price or size parameters.
• Alerts generated through surveillance arrangements being evaluated by appropriate independent individuals in a timely manner and in conjunction with other relevant contextual data (for example, information regarding near-misses) and through discussions with traders and trading management where appropriate (providing no conflicts of interest).
• An appropriate written methodology for investigating alerts, as well as appropriate levels of sign off for the closure of alerts and proportionate sample testing of alerts and escalations.
• Supervisory controls and procedures that address the creation, modification, usage and testing of trading algorithms for manipulative, deceptive or suspect trading practices.
• Sufficient trader login and access procedures.
• Bespoke market conduct training provided on a risk-based approach with real life examples or case studies, which is annually assessed to ensure that it remains appropriate.
• Adoption of appropriate incentives and evaluation of employees’ commitment to compliance in promotion and compensation decisions.

• Failing to arrange suitable alternative surveillance where automated alerts had been disabled.
• Having identified the risk of market abuse in an affiliate or group entity, failing to map that risk across the business and adequately address it.
• Lack of formal senior management board and committee structure to facilitate compliance and conduct risks, including the risk of market manipulation, being properly considered.