Manipulative Trading

Regulatory Obligations 

Several FINRA rules prohibit firms from engaging in impermissible trading practices, including manipulative trading—for example, FINRA Rules 2010 (Standards of Commercial Honor and Principles of Trade), 2020 (Use of Manipulative, Deceptive or Other Fraudulent Devices), 5210 (Publication of Transactions and Quotations), 5220 (Offers at Stated Prices), 5230 (Payments Involving Publications that Influence the Market Price of a Security), 5240 (Anti-Intimidation/Coordination), 5270 (Front Running of Block Transactions), 5290 (Order Entry and Execution Practices) and 6140 (Other Trading Practices). 

Under FINRA Rule 3110 (Supervision), firms are required to include in their supervisory procedures a process to review securities transactions that is reasonably designed to identify trades that may violate the provisions of the Exchange Act, the rules thereunder, or FINRA rules prohibiting insider trading and manipulative and deceptive devices that are effected for accounts of the firm and its associated persons. The firm must conduct promptly an internal investigation into any such trade to determine whether a violation of those laws or rules has occurred.

Among other obligations, FINRA Rule 5210 prohibits firms from publishing or circulating communications regarding transactions and quotations unless they believe the information is bona fide; FINRA Rule 5270 prohibits trading in a security or related financial instrument that is the subject of an imminent customer block transaction while in possession of material, nonpublic market information concerning that transaction; and FINRA Rule 6140 contains several requirements to ensure the promptness, accuracy, and completeness of last sale information for National Market System (NMS) stocks and to prevent that information from being publicly trade reported in a fraudulent or manipulative manner.

Findings and Effective Practices

Findings

  • Inadequate WSPs: 
    • Not having procedures reasonably designed—based on the types of business the firm engages in—to identify patterns of manipulative conduct; not identifying specific steps and individuals responsible for monitoring for manipulative conduct; and not outlining escalation processes for detected manipulative conduct. 
    • Not tailoring procedures to reasonably supervise differing sources of order flow (e.g., proprietary trades, retail customers, institutional customers, foreign financial institutions).
  • Non-Specific Surveillance Thresholds: 
    • Not reasonably designing and establishing surveillance controls to capture manipulative trading (e.g., thresholds not designed to capture the appropriate market class of securities or type of securities or include both customer and proprietary trading or thresholds set too low or too high to identify meaningful activity). 
    • Failing to periodically evaluate adequacy of firms’ controls and thresholds in light of changes in their business, customer base or the market.
  • Surveillance Deficiencies: 
    • Not establishing and maintaining a surveillance system reasonably designed to monitor for potentially manipulative trading (e.g., potential layering, spoofing, wash trades, prearranged trades, marking the close, odd-lot manipulation) with parameters that are reasonably designed and documented. 
    • Not adequately monitoring customer activity for patterns of potential manipulation, including potential prearranged trading across customers.
    • Not considering external sources for red flags (e.g., inquiries from regulators or service providers or publicly available information about known manipulators).
    • Not performing the timely review of surveillance alerts or exception reports.
    • Not dedicating sufficient resources and training to the review of surveillance alerts or exception reports. 
    • Not documenting alert review findings.

Manipulative Trading in Small Cap IPOs

Between 2022 and 2023, FINRA, Nasdaq and NYSE observed that initial public offerings (IPOs) for certain small cap, exchange-listed issuers were targets of potential market manipulation schemes, similar to so-called “ramp and dump” schemes.1

FINRA observed significant, unusual price increases on the day of or shortly after the IPOs, which mostly involved issuers with operations in foreign jurisdictions.2

In 2024, these schemes evolved:

  • FINRA has recently observed these unusual price increases occurring less frequently on the day of or shortly after certain small cap issuers' IPOs, but more frequently in the weeks or months after these IPOs.
  • These recent unusual price increases appear to be associated with manipulative trading of shares originating from apparent nominee accounts that invest in small cap IPOs.
  • These accounts then sell these shares shortly after the IPO, in a manner which appears to funnel them—through manipulative orders and trading activity—to foreign omnibus accounts that accumulate and later liquidate them for profit.

These market manipulation schemes may also involve defrauding investors:

  • FINRA has recently observed an increase in investor complaints regarding social media scams associated with encrypted chat investment clubs, in which bad actors utilize imposter and financial grooming scams to convince investors to purchase shares of small cap companies.3
  • The victims’ purchases occur in conjunction with—and likely cause—price increases in the targeted securities. Notably, these purchases often coincide with liquidations of shares by accounts presumed to be controlled by foreign bad actors.

For additional guidance FINRA recommends these Investor Insights articles:

Effective Practices

  • Manipulative Schemes: 
    • Maintaining a surveillance program that is reasonably designed to detect manipulative trading schemes (e.g., momentum ignition, layering, front running, trading ahead, spoofing, wash sales, prearranged trading, marking the close, mini-manipulation), including surveillance for cross-product manipulative trading schemes that involve correlated securities, such as stocks, exchange-traded products (ETPs) and options (e.g., manipulating the price of a stock to influence the price at which a market participant can either establish or close a related options position).
    • Tailoring supervisory systems and processes to differing types of manipulative order entry and trading activity based on product class, including listed and OTC equities, options and fixed income products (e.g., Treasuries).
    • Monitoring for red flags associated with customer accounts that may have a relationship with an issuer, such as:
      • customer accounts (foreign or domestic) referred by a microcap issuer to the underwriting broker-dealer (particularly when the same officer or CEO has been noted across multiple issuers); and
      • money movements between the issuer and customer accounts. 
    • Monitoring for red flags indicating:
      • conflicts of interest in private capital raises in advance of IPOs (particularly where a nominee controls shares); and
      • the involvement and participation in underwriting and selling activities by unregistered individuals in private and public offerings. 
    • Supervising for efforts by the firm or customers to artificially support or suppress the price, or prevent or reduce natural price falls, of securities.
  • Multiple Platform and Product Monitoring: Monitoring activity occurring across multiple platforms, including platforms that also may involve related financial instruments or multiple correlated products, as well as cross-border activity in the same or related products.
  • Algorithmic Trading: Using Regulatory Notice 15-09 (Guidance on Effective Supervision and Control Practices for Firms Engaging in Algorithmic Trading Strategies) to inform a firm’s surveillance program in areas such as general risk assessment and response, software/code development and implementation, software testing and system validation, trading systems, and compliance.
  • ETPs: Developing and maintaining a robust supervisory system to safeguard material, non-public information to prevent front running and trading ahead by:
    • establishing effective information barriers and controls to prevent information leakage and the misuse of material, non-public information;
    • reviewing for manipulative strategies that exploit the unique characteristics of ETPs (e.g., their creation and redemption processes) and strategies that exploit information leakage related to portfolio composition files; and
    • tailoring the firm’s compliance program to align with how the firm trades ETPs.
  • Wash and Prearranged Trading: Monitoring activity to identify firm customers engaging in wash trading (e.g., to collect liquidity rebates from exchanges) or prearranged trading (e.g., to create the appearance of active trading), by: 
    • monitoring accounts identified as related (or in concert) in the firm’s wash/prearranged trading surveillance reports; and 
    • reviewing trading activity that relates to information provided on account opening documents.

Additional Resources

  • Algorithmic Trading Key Topics Page 
  • Cross-Market Equities Supervision Manipulation Report Card
  • Regulatory Notices
    • Regulatory Notice 22-25 (Heightened Threat of Fraud: FINRA Alerts Firms to Recent Trend in Small Capitalization IPOs)
    • Regulatory Notice 21-03 (FINRA Urges Firms to Review Their Policies and Procedures Relating to Red Flags of Potential Securities Fraud Involving Low-Priced Securities)
    • Regulatory Notice 19-18 (FINRA Provides Guidance to Firms Regarding Suspicious Activity Monitoring and Reporting Obligations) 
    • Regulatory Notice 18-25 (FINRA Reminds Alternative Trading Systems of Their Obligations to Supervise Activity on Their Platforms)
    • Regulatory Notice 17-22 (FINRA Adopts Rules on Disruptive Quoting and Trading Activity and Expedited Proceedings)
Previous:
Anti-Money Laundering, Fraud and Sanctions
Up:
Manipulative Trading
Next:
Firm Operations

1 See the 2023 Report’s Anti-Money Laundering, Fraud and Sanctions topic.

2 See Regulatory Notice 22-25 (Heightened Threat of Fraud).

3 See the Report’s Anti-Money Laundering, Fraud and Sanctions topic’s Investment Fraud by Bad Actors Targeting Investors Directly “callout” box for additional examples of fraudulent schemes that target investors.