Financial Ethics 101: Market Manipulation

By Kieran Dearden

Market manipulation, put simply, is the act of deliberately misinforming traders (typically by over- or under-selling a product or stock) to profit from the trader’s predicted actions. Broader definitions also include securing dominant positions within a market to fix prices and create unfair trading conditions, and conducting trades in ways that prevent others from reacting in a timely or reasonable manner [1,2]. Other definitions may include short selling and insider trading as forms of market manipulation [3,4], but the difference between manipulation and acceptable practice within the market becomes blurry in these instances [1,5]. Regardless of where the line is drawn, the common theme across all definitions is deception and unfairness. To manipulate a market, one needs to deceive participants or unfairly leverage a position to justify a price that otherwise would be unjustified under regular market forces. 

Examples of Market Manipulation

Procedures recognized as market manipulation are termed corners, squeezes, pump-and-dumps, and poop-and-scoops [5,6]. 

1. Corner or Squeeze

In a corner or squeeze, an agent obtains a dominant position within a market, and leverages that position, artificially raising prices to a point not normally attainable (or sustainable) within normal market conditions. The classic example of a corner causing abnormal price hikes is that of the Hunt brothers silver corner in 1979, in which Bunker and Herbert Hunt leveraged their own existing assets to buy the equivalent of 62 million troy ounces of silver in bullion and futures positions and contracted another major company to buy a further 50 million troy ounces in futures [6]. This dominant position within the silver market caused the price of silver to jump from approximately $6/oz t to about $50/oz t in the span of two weeks, before exchanges, refiners, and the Federal Reserve stepped in to break the corner.

This is manipulation not because of any deception or misinformation (though concealing the presence of a corner is useful in avoiding regulations and counterpressure), but due to the unfairness introduced into the market. Without such a dominant position within the silver market, the price of silver would likely not have jumped seven-fold across a two-week span. Had the 100 million troy ounces in futures positions and bullion been distributed across several traders (as they were before the Hunt brothers’ purchases) instead of only two, the market would not have suffered such pressures, and would have likely remained at around $6/oz t.

The inverse of this practice, known as a reverse corner or squeeze, is also a case of market manipulation, as it involves the same form of artificial price control, and thus a similar form of unfairness. In a reverse squeeze, the manipulator floods the market with product or collateral, causing prices to fall beyond normally attainable or sustainable rates. Unlike a standard corner, this does not require a necessarily dominant position within the market, only sufficient collateral. However, the stronger a position the manipulator holds, the tougher the recovery will be for the agents that suffer from the sudden price loss. Notably, this reverse squeeze is harder to pull off, at least with storable goods, as its main purpose is to drive competitors out of markets and make a profit in the long term. A regular squeeze or corner holds prices artificially high as long as possible to profit in the short term. For goods more difficult to store, like oil or electricity [7], a reverse squeeze is more plausible, and, like a regular corner, does not necessarily require deception or false information. 

2. Pump-and-Dump

Like a corner, a pump-and-dump scheme aims to artificially inflate the price of an asset within a market, but instead of holding, the manipulator aims to sell at the inflated price before the price collapses. However, the manipulator inflates prices not by maintaining a dominant position, but by convincing other agents the asset is performing far better than current circumstances. In the straightforward example of a (mostly) successful pump-and-dump scheme, Morrie Tobin and other collaborators in 2018, doubled the share price of Environmental Packaging using a stock promoter. To make the promotion of the stock convincing, Tobin concealed his involvement, instead pretending the promotion came from a neutral third party [8]. Ownership of the relevant companies and stocks were kept hidden using offshore entities, and the sale of the pumped stocks to a legitimate company “generated more than $165 million” [8]. Without the false information created by a stock promoter, Environmental Packaging shares would have likely remained at around $1.05, generating only a fraction of the $165m through natural market swings. Without Tobin hiding the ties between himself and the relevant companies, many traders would have likely seen this as unreliable self-promotion and would not have bought Tobin’s shares.

3. Poop-and-Scoop

Poop-and-scoop schemes are the inverse of pump-and-dump, though they employ much the same methodology. Manipulators convince others that an asset is overvalued, again through misinformation and similar leverage, then buy when the market value is low, making a large profit when the asset stabilizes to regular market values. However, pump-and-dump schemes usually target companies with a low initial market value [9] to quickly double or triple the price. A poop-and-scoop treatment needs to target a company with an already solid market value, crash it, buy low, and hold until the value returns to its stable position. This makes a poop-and-scoop harder to pull off. A company with a stable, high market value is likely to have a reliable and transparent performance history, thus requiring a convincing counter-narrative for other traders to have reason to believe the stock is overperforming. Pump-and-dump schemes, on the other hand, have comparatively little prior performance history to overcome, and in some cases require nothing more than coordinated effort [9,10]. 

James Craig demonstrated the difficulties of performing a poop-and-scoop scheme in 2015, when he imitated real securities firms on Twitter and made false claims regarding two companies, causing their share prices to drop by 28 and 16 percent respectively. After the drop, Craig bought shares in both companies, but was unsuccessful in turning a significant profit [11]. Without the deception involved in imitating real firms, traders would likely not have heeded Craig’s false Tweets, and would not have tried to offload their shares at such low prices. Without the resulting crash, Craig would have no way of making a large short-term profit off these companies and would have had to rely on standard market strategies instead.

Evaluations of Market Manipulation

Market manipulation behavior as described can, at times, be difficult to separate from optimal trading strategies [6,12]. Coordinated pump-and-dump and poop-and-scoop schemes are little more than groups of people acting on a common trading strategy of buying low and selling high, with the key difference being control and dissemination of information. An unwitting trader could very well buy stock about to be pumped at a low cost, see the stock spike, and sell high, benefiting just as much as any member of the coordinated pump, without violating market principles. Even the act of coordinating trades can be seen as an optimal trading strategy, not manipulation, as an individual who bought stock wants that stock to increase in value and may want others to legitimately benefit from that stock. They therefore, convince others to buy the stock, knowing the benefits to both parties. Presuming no deception from either party, this action is a legitimate, mutually beneficial arrangement, and, when taken to the extreme, mimics that of a pump-and-dump scheme. 

Corners and squeezes are harder to justify within legitimate trading strategies, as they require a dominant market position and the intent to leverage this situation to artificially raise prices. One may end up in a dominant position within a market through skillful trading, and may then set higher prices as a reaction or prediction of performance. However, to set higher prices for the purpose of squeezing others out of the market is to step beyond these accepted strategies. Similarly, an inverse corner artificially drives down prices for the same purpose of squeezing others out of the market, but the mere act of doing so also goes against these basic strategies, as one never normally wants one’s own stock price to dip, let alone for the time period required for others to suffer significant losses. An inverse corner is, however, beneficial when dealing in short positions, as the dip in stock price from flooding the market allows the trader to rebuy low after selling the same stock high. Short positions themselves are generally not considered market manipulation [5,13], so an inverse corner set up for the purpose of generating value from a short position may be considered an acceptable market practice. 

Kyle and Viswanathan attempt to clarify the difference between market manipulation and legitimate market practices by classifying (illegal) market manipulation as a trading strategy whose “intent is to pursue a scheme that undermines economic efficiency both by making prices less accurate as signals for efficient resource allocation and by making markets less liquid for risk transfer” [6]. This definition falls in line with EU regulations on market manipulation, which state a practice that would normally be considered market manipulation, but “has a positive impact on market liquidity and efficiency” is instead an accepted market practice, though is notably different in terms of intent [1]. EU regulations, due to the legal format and environment of operation, focus on actions, consequences, and expected knowledge, not intent. The trader who encourages others to buy stock simply because they bought the same stock and wish for the group to profit, may be guilty of reducing price accuracy and/or market liquidity through “misleading signals”, provided they “knew, or ought to have known, the information was false or misleading” [1]. Whereas, under Kyle and Viswanathan, the trader must intend for such actions or information to reduce accuracy and liquidity to be deemed guilty of market manipulation [6]. This difference may not matter to those who suffer losses from a pump-and-dump, or are forced to offload oil at negative values, or are driven out of their own market due to dominant trading companies, but matters greatly when considering the moral standpoints of these practices. 

Moral Assessment of Market Manipulation

These forms of market manipulation require deceit and unfairness to be performed with any degree of success and require specific intent and knowledge for such actions to be deemed manipulative. Without an unfair market position, a trader cannot initiate a corner or squeeze. Without the spreading of false or misleading information about a stock or company, or the conducting of trading without allowing for others to react properly and in a timely manner to the new market situation [1], one cannot conduct a pump-and-dump or poop-and-scoop operation. Without the knowledge and intent to form a corner or squeeze, a trader with a dominant market position is at best incidentally setting prices and will otherwise be following market trends. Without the knowledge and intent to perform a pump-and-dump, a trader will merely invest in a stock and hope it performs well, and likely sell if it does. On these necessities, we can consider these practices morally.

Utilitarianism 

From a utilitarian perspective, one ought to maximize utility by pursuing actions and outcomes that lead to the greatest amount of good for the greatest number of people. When applied to market manipulation, for such practices to be justified under Utilitarian principles, they must lead to more net good than harm. In some cases, this outcome may appear to be the case. In several instances of pump-and-dumps, the stabilized price of the goods involved after the dump can still be greater than the initial price before the pump [14]. Those who invested before the pump benefit from the increased price after the dump; those who sold during the dump gain far more than they would have by holding or not investing, and those who bought at any point during the pump below the new, stable price still benefit, whether they held or sold. However, in order to sell the dump, others must buy, necessitating some losses from all those who buy above the future stable price and fail to sell in time, and from those who buy during the dump, and are forced to sell at a loss or hold at the new price, higher than the previous stable price, but lower than the spike at which it was bought. 

Utilitarianism cares about net gains, however, not simply the presence of losses. As the new price of a pump-and-dumped good is still higher than the pre-pump, the net gains in potential or actualized profits must be higher than the losses. If we were measuring utility in terms of net profit as a good to be maximized, this would be an ethical outcome. This, however, is a small part of the picture, and, while making a profit can be viewed as an increase in utility via the resulting increase in pleasure, directly comparing profits and losses is not the same as comparing the resulting pleasure and harm. According to behavioral economics, people are generally “more averse to losses… than they are attracted to same-sized gains” [15]; and will act and suffer accordingly. The loss of $100 is significantly more painful than the gain of $100 is pleasurable. Thus, the Utilitarian calculus must, in these instances, weigh the losses of those who suffer from a pump-and-dump as greater than the equal gains made by those who profited. To what degree or proportion these losses are to be weighed is difficult to say, and may still allow some instances of market manipulation to be justified, provided the net gains are high enough. 

Even in the instances where market manipulation may be initially justified, there is little reason to believe these practices will result in the necessary gains. In every case in which this fails, harm is done not only to those involved, but to the market as a whole. As these practices necessarily involve misinformation, deception, and leveraging of unfair market positions, market manipulation lowers trust and price accuracy in the market, subsequently lowering liquidity, transparency, and efficiency [6,16]. Consequently, genuine benefits are harder to obtain and are more costly to deal in (due both to increased risk from lower transparency, and lower efficiency due to lower price accuracy), not just for those directly impacted by the form of market manipulation employed, but by all those participating in the market in which this occurs. If one product’s price steadily increases, only to crash a few days, hours, or minutes later, when another product’s price increases at a similar rate, similar concerns naturally arise regardless of whether this new product is being manipulated. Thus, for market manipulation to be justified under utilitarianism, the net gains must outweigh both the weighted losses and the short- and long-term damage done to the market environment. 

Deontology

From a Kantian Deontological perspective, market manipulation appears to be a straightforward issue, requiring a single hurdle to overcome before any weighing of values: can the practice be universalized? Can every member of a group meaningfully practice this pursuit without issue? While there is a great deal of literature regarding lying and deception within Kantian theory, it is still arguable that degrees or purposes for such deceptions can be universalized [17,18]. In this case, however, market manipulation does not seem to pass Kant’s test. If every individual involved in every (or any particular) market performed acts of market manipulation, regardless of the degree or purpose for such manipulation, price accuracy and trust within the market would not just decrease, they would become meaningless. If every individual within a market is relying on spreading misinformation to perform a pump-and-dump, then one cannot possibly trust any piece of information relating to the state of the market to be true, let alone accurate. This results in a blind, risk-filled market, where standard market forces cannot be trusted, and may not be present at all. Market manipulation require deceiving others into believing those market forces are at play. In an environment where markets are perceived as unreliable, such manipulations fail. In sum, were market manipulation to be a universalized practice, the knowledge a stock price is increasing or decreasing only informs a trader that someone is trying to manipulate that stock. They would steer clear. With nobody trading in a manipulated stock but those manipulating it, there is nobody to absorb the losses or pay for the gains, nobody to buy the dip or sell at the peak. Just as unconditional universal lying becomes self-defeating by necessity, so does universal market manipulation.

Virtue Ethics

From an Aristotelian virtue ethics perspective, what makes an action moral is whether the agent embodies or is motivated by a virtue (or virtues). These virtues are character traits held to be necessary and beneficial for eudaimonia, or the good life. The precise nature of these traits comprises a matter of great discussion [19,20]. As we are dealing with deception and unfairness as necessary traits for the performing of market manipulation, we need only consider whether these traits could be considered Aristotelian virtues. Notably, virtue ethics requires both the action and intention of an individual to be virtuous for the act to be moral. One who charges into a burning building with the intention of recovering a valuable lamp, but mistakenly grabs a child instead, is not as virtuous as one who charges into the same building with the intent to rescue the child, even if the outcomes are the same. This gives us some justification as to why we might want to treat the trader whose actions are similar to market manipulation, but who does so with reasonable intentions, as morally different to a traditional pump-and-dumper, even if both acts lead to similar results within the market. 

Aristotelian virtue is that which falls between two vices: that of excess, and that of deficiency [21]. A deficiency of courage is the vice of cowardice, an excess that of foolhardiness. In general, we condemn the vice and praise the virtue. Any time we condemn something like bravery, we actually mean to condemn the related vices (cowardice or foolhardiness) instead. When applied to market manipulation, we must consider deception and unfairness in terms of virtues and vices. Deception and misinformation are clear examples of a deficiency of truth. Truthfulness is, in general, a virtue (it is hard to live a good life without being truthful). Similarly, unfairness in market manipulation, seems to be a deficiency in the virtues of fairness or justice. Aristotle would say to live a good life one needs to be fair and just [21]. Thus, a trader who intends to enact some form of market manipulation, and takes actions towards doing so, cannot be motivated by the virtues of truthfulness and fairness, but by their corresponding vices, and likely do not count as virtuous individuals. 

Unethical But Not Unlawful

Market manipulation, necessitating some form of deception or unfairness, is unjustified under utilitarianism, due to the net harm done to the individuals and the market. Market manipulation is unethical from a deontological perspective, due to the lack of universalizability of the practice.  Market manipulators, according to principles of virtue ethics, cannot be virtuous individuals because deception and injustice are not virtues. While utilitarianism justifies market manipulation under some circumstances, neither deontology nor virtue ethics allow for such wiggle-room. 

Allowances for market manipulation by the European Union regulations and the New Zealand Financial Market Authority under certain circumstances goes against these moral theories, arguably making such allowances immoral. These allowances, (1) specify practices that increase transparency (and thus promote truthfulness), (2) consist of standard market procedures and necessary safeguards (thus increasing fairness), or (3) increase market liquidity and efficiency (thus increasing the respective ‘good’ of the market). It’s unclear whether these exceptions aim to address the moral issues of market manipulation, or just the practical issues. 

Both EU and New Zealand market manipulation laws do not, and cannot, condemn market manipulation if the act adheres to accepted market practices, even if such actions are unethical. Similarly, these regulations focus on knowledge and outcome, not intent, resulting in the potential harm to traders whose actions resemble market manipulation, regardless of their intent. 

Works Referenced

1. European Parliament, Council of the European Union. Council Regulation 2014/2021 of 16 April 2014 on market abuse (market abuse regulation) and repealing Directive 2003/6/EC of the European Parliament and of the Council and Commission Directives 2003/124/EC, 2003/125/EC and 2004/72/EC. Apr. 2014. http://data.europa.eu/eli/reg/2014/596/oj, Accessed 20 Dec. 2023.
2. Cumming, Douglas, Sofia Johan, et al. “Exchange Trading Rules and Stock Market Liquidity.” Journal of Financial Economics, vol. 99, no. 3, Mar. 2011, pp. 651–71. DOI.org (Crossref), https://doi.org/10.1016/j.jfineco.2010.10.001.
3. Goldstein, Itay, and Alexander Guembel. “Manipulation and the Allocational Role of Prices.” Review of Economic Studies, vol. 75, no. 1, Jan. 2008, pp. 133–64. DOI.org (Crossref), https://doi.org/10.1111/j.1467-937X.2007.00467.x.
4. Aitken, Michael, et al. “Exchange Trading Rules, Surveillance and Suspected Insider Trading.” Journal of Corporate Finance, vol. 34, Oct. 2015, pp. 311–30. DOI.org (Crossref), https://doi.org/10.1016/j.jcorpfin.2015.07.013.
5. New Zealand Parliamentary Council Office. Financial Markets Conduct Act 2013. Aug. 2013. https://www.legislation.govt.nz/act/public/2013/0069/latest/DLM4090578.html. Accessed 20 Dec. 2023
6. Williams, Jeffrey. Manipulation on Trial: Economic Analysis and the Hunt Silver Case. Cambridge University Press, 1995.
7. Kyle, Albert S., and S. Viswanathan. “How to Define Illegal Price Manipulation.” American Economic Review, vol. 98, no. 2, Apr. 2008, pp. 274–79. DOI.org (Crossref), https://doi.org/10.1257/aer.98.2.274.
8. United States District Court, District of Massachusetts. Securities and Exchange Commission v. Morrie Tobin et al. Nov. 27, 2018. United States Securities and Exchange Commission, https://www.sec.gov/litigation/litreleases/lr-24361. Accessed 10 Jan. 2024.
9. Xu, Jiahua, and Benjamin Livshits. “The Anatomy of a Cryptocurrency Pump-and-Dump Scheme.” USENIX Association, Aug. 2019, pp. 1609-25
10. La Morgia, Massimo, et al. “The Doge of Wall Street: Analysis and Detection of Pump and Dump Cryptocurrency Manipulations.” ACM Transactions on Internet Technology, vol. 23, no. 1, Feb. 2023, pp. 1–28. DOI.org (Crossref), https://doi.org/10.1145/3561300.
11. United States District Court, Northern District of California. Securities and Exchange Commission v. James Alan Craig. Nov. 6, 2015. United States Securities and Exchange Commission, https://www.sec.gov/litigation/litreleases/lr-23401. Accessed 10 Jan. 2024.
12. Van Bommel, Jos. “Rumors.” The Journal of Finance, vol. 58, no. 4, Aug. 2003, pp. 1499–520. DOI.org (Crossref), https://doi.org/10.1111/1540-6261.00575.
13. European Parliament, Council of the European Union. Council Regulation 2012/2022 of 14 March 2012 on short selling and certain aspects of credit default swaps. Mar. 2014. http://data.europa.eu/eli/reg/2012/236/2022-01-31. Accessed 20 Dec 2023.
14. Li, Tao, et al. “Cryptocurrency Pump-and-Dump Schemes.” SSRN Electronic Journal, 2018. DOI.org (Crossref), https://doi.org/10.2139/ssrn.3267041.
15. Hanson, D., and Douglas A. Kysar. “Taking Behavioralism Seriously: Some Evidence of Market Manipulation.” Harvard Law Review, vol. 112, no. 7, May. 1999, pp. 1420-1572.
16. Tomasic, Roman, and Folarin Akinbami. “The Role of Trust in Maintaining the Resilience of Financial Markets.” Journal of Corporate Law Studies, vol. 11, no. 2, Oct. 2011, pp. 369–94. DOI.org (Crossref), https://doi.org/10.5235/147359711798110628.
17. Macintyre, Alasdair. “Truthfulness, Lies, and Moral Philosophers: What Can We Learn from Mill and Kant?” in The Tanner Lectures on Human Values 16. University of Utah Press, 1995, pp. 307-61.
18. Korsgaard, Christine. “The Right to Lie: Kant on Dealing with Evil.” Philosophy & Public Affairs, Vol. 15, No. 4, Autumn, 1986, pp. 325-349.
19. Hursthouse, Rosalind. “Normative Virtue Ethics.” In Roger Crisp (ed.), How Should One Live?: Essays on the Virtues. 1996, pp. 19-33.
20. Russell, Daniel C. Practical Intelligence and the Virtues. Oxford University Press, 2009.
21. Aristotle. Nichomachean Ethics. Translated by W. D. Ross. Batoche Books, 1999. 

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