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Insider Dealing and Market Manipulations fines - what should we learn from it
20 min

Introduction

Following my previous lesson about market abuse regulation, today I would like to talk about the biggest insider dealing and market manipulation cases in the world.

It is always good to know the regulations and rules, but it is extremely important to understand the practice. And the best way to learn it is actually from real-life examples and to make sure that you can protect your organisation and increase your levels of control.

 

Stock exchange has always been a very attractive place for investors around the world. This is where the wealthy become even wealthier, where lucky people become even luckier, and the place where you can lose all your money in just one second. This is the temptation to get rich fast.

 

The history of market manipulations started from the beginning of the first stock exchanges. Unfortunately, this is something unavoidable. The regulators are trying to fight prohibited trading activities by imposing bigger fines and even imprisonment  sentences, but there is always someone, who will try to trick the system.

 

Biggest insider trading and market manipulation cases through the history

 

Ivan Boeski - 1987

 

The regulators around the world assume that if a market participant has committed a crime at least once, they will commit it again. This is how Ivan Boeski, one of the biggest speculators on Wall Street, was revealed in the 1980s. In 1987, he was sentenced to three years in prison. The reason was the illegal earning of $ 50 million as a result of obtaining confidential information from Denis Levine. He was known as a man called “Ivan the Terrible” for his success in trading stocks.

 

Mr. Boesky was a specialist in risk arbitrage, which is a term that describes when stock traders try to exploit market inefficiencies, such as when a trader believes one company’s stock has been undervalued. Arbitrage traders often buy up big chunks of stock in a company on the bet that the price will jump, especially if that company is on the verge of being acquired.

Risk Arbitrage key points:

  • Risk arbitrage is an investment strategy used during takeover deals that enables an investor to profit from the difference in the trading price of the target's stock and the acquirer's valuation of that stock.
  • After the acquiring company announces its intention to buy the target company, the acquirer's stock price typically declines, while the target company's stock price generally rises.
  • In an all-stock offer, a risk arbitrage investor would buy shares of the target company and simultaneously short sell the shares of the acquirer.
  • The risk to the investor in this strategy is that the takeover deal falls through, causing the investor to suffer losses.

 

Ivan Boesky decided to cooperate with federal authorities. He pleaded guilty to a single charge of making false statements to the government and agreed to pay a then-record $100 million fine.

 

Martha Stewart - 2001

In December 2001, media empire owner Martha Stewart sold her shares in pharmaceutical company ImClone Systems, the day before its price plunged. She used confidential information which was not public yet, which she received from her broker, Peter Bacanovic. Suspected of insider trading, Martha Stewart was found guilty in March 2003. However, in the absence of clear evidence, the authorities had to drop this allegation and accused her of obstructing the investigation of the transaction. A New York court sentenced her to five months in prison. In addition, the court sentenced her to five months of house arrest, two years of judicial supervision, and a fine of $ 30,000. In March 2004, Martha Stewart was acquitted of another charge: securities fraud for which she was punished by a 10-year prison sentence. The broker Peter Bacanovich was found guilty in March 2004 for the same crimes as his client and for perjury. The Stewart case was one of the numerous scandals in the US corporate world. Therefore, the US government has tightened the penalties for committing financial crimes. Martha Stewart Omnimedia's shares rose 11% after the court ruled.

 

Bernard Madoff - 2009

Bernard Madoff, an American financier and broker, at the age of  71 was sentenced to 150 years in prison. Following a famous Ponzi scheme, he made investors lose billions of dollars. He organized the largest financial scam pyramid in history.

Madoff was well-known and well-positioned on the financial market with many years of experience. In 1960 he started his own business and helped to launch Nasdaq stock exchange. He also was a member of the National Association of Securities Dealers and advised the Securities and Exchange Commission on trading securities. With such a great reputation on the market, it would be hard to believe that someone like Madoff will organise one of the biggest scam in history.

Madoff set up a strategy that prevented him from needing to pay too much to his existing investors. He did everything to remain under the radar by keeping the scheme low. Madoff targeted only a specific and elite group of investors. He always made sure that his paperwork is up to date and consistent, so the regulator will not have any concerns.

Madoff also did very little to arouse suspicion among his investors. He made them believe that they could withdraw their money almost immediately, so they had no reason to think anything was wrong.

 

 

Among insider traders and market manipulators there are some people that are called rogue traders.

A rogue trader is an employee of a financial firm who engages in unauthorized, often high-risk activities that result in large losses for the firm.

Source: Investopedia

 

Nick Leeson - 1995

One of the most famous rogue traders was Nick Lesson. In 1995, he led to the biggest scandal in world banking history, which caused the collapse of Barings Bank. It all began when Lesson, in addition to the usual transactions, started to speculate on Nikkei 225 contracts. In this way, he turned his activities without financial risk on the stock exchange into an aggressive investment portfolio. Unfortunately, Leeson was a very weak speculator - he was losing money from the start, his cost was covered by the bank, as his own funds were used to trade. Leeson hid all the deals in an unused account by Barings Securities, where the losses were increasing regularly. He tried to cover it, but it wasn’t very fortunate for him. At the end of 1992, the hidden account balance was negative at £ 2 million. At the end of 1993, Barings Bank's balance was minus £ 23 million and a year later £ 208 million. In February 1995, the bank lost £ 827 million. Leeson forged bills, accounts,signatures,  correspondence, manipulated accounting entries, while securing flows from bank branches as well as from private clients' accounts. Leeson was detained at the Frankfurt airport, from where he was deported to Singapore, charged and sentenced to 6.5 years in prison. However, he was released in 1999 after being diagnosed with cancer. Baring Bank filed for bankruptcy and was accepted by ING for a symbolic pound.

 

Kweku Adoboli - 2011

In 2011 Swiss Bank UBS lost US$2 billion, by the fault of only one person - Kweku Adoboli. He began his career at UBS as an intern in 2006, and was promoted to director in 2010 with an annual salary of £ 200,000. Adoboli became the greatest rogue trader in the history of Great Britain. He was convicted in 2012 for losing $2.3bn of the Swiss bank UBS’s money.

He was working as a trader in the investment bank’s global synthetic equities division. He was booking fictitious hedging trades in order to hide the fact that he was exceeding his risk limits. This action exposed the bank to a bigger chance of loss than it could see.  Adoboli also created a sort of internal slush fund where he and others could later cover daily losses. He never denied the methods he was using. Adoboli claimed that everything he did was done in order to make UBS more money, and that the bank turned a blind eye for years as his scheme was helping it to make millions in profit.

 

FX scandal - 2015

In 2015 six global banks agreed to pay $5.6bn to settle allegations that they rigged foreign exchange markets.

 

Four banks also agreed to plead guilty to conspiring to fix prices and rig bids in the $5.3tn a day forex market. This was one of the biggest cases of misconduct in banking since the global financial crisis.

Between December 2007 and January 2013, trades from JPMorgan Chase, Citigroup, Barclays and Royal Bank of Scotland used an exclusive chatroom and coded language to manipulate benchmark exchange rates. Describing themselves as “The Cartel”, they were trying to increase their profits. One of the traders wrote in the chat: : “If you aint cheating, you aint trying”.

 

The regulators in Switzerland, Asia, the United States and the United Kingdom started to investigate the $4.7 trillion per day of forex market.

Forex scandal involved the revelation, and subsequent investigation, that banks caused for at least a decade to manipulate the FX rates for their own financial gain.

“Bloomberg News reported in June 2013 that currency dealers said they had been front- running client orders and rigging the foreign exchange benchmark WM/Reuters rates by colluding with counterparts and pushing through trades before and during the 60-second windows when the benchmark rates are set. The behavior occurred daily in the spot market market and went on for at least a decade according to the traders.”

Source:  Vaughan, Liam; Finch, Gavin & Choudhury, Ambereen (12 June 2013). "Traders Said to Rig Currency Rates to Profit Off Clients". Bloomberg News. Retrieved 21 January2014.

 

J.P. Morgan - 2020

In 2020 JPMorgan Chase & Co. agreed to pay more than $920 million to resolve claims of market manipulation which involved two of the bank’s trading desks.This was the largest fine ever related to the illegal practice known as spoofing.

Over eight years, 15 traders at the largest bank caused losses of more than $300 million to other participants in precious metals and Treasury markets. For eight years banks were manipulating prices of Treasury contracts, as well as trading in notes and bonds in the secondary market. This caused $106 million in losses.

This case covers eight years and is related  to the practice called "spoofing," where traders put in large orders to buy or sell a security with no intention of executing them. This creates the appearance of demand or supply for a particular asset and helps move that asset in the trader's desired direction.

Under the regulations it's unlawful to submit and cancel orders in a strategy intended to deceive other traders.

The settlement ended as the criminal investigation of the bank that led to a half dozen employees being charged for allegedly rigging the price of gold and silver futures from 2008 to 2016. According to the settlement deal, ten JPMorgan traders caused losses of $206 million to other parties in the market.

 

Key take aways

Every year at least  one person in the world is fined for the market manipulation or insider dealing. Some of those fines are relatively small, some of them cost billions, and some will put you in prison.

The history shows that there is always someone who would try to scam the system.  A lot of people that are working in the financial industry have access to confidential information, which could be an everyday temptation to break the rules.

What companies, individuals and investors should keep in mind when it comes to the market wrongdoing:

-        The regulator will always requires companies to increase their risk controls

-        The companies have to make sure to implement the robust systems and controls to identify any suspicious activities and to report it immediately

-        The employees should not ignore any suspicious and report it to the management as soon as any identified

-        The regulators and companies should not base their assumption on the people’s reputation on the market and not ignore any complaints from the market participants(ex. Madoff)

-        There is always someone who will try to manipulate the market, so investors have to make sure to also protect their funds

-        Investors should not dealing with an unauthorised brokers and to submit their suspicious straight away to the regulator

-        The company should impose higher disciplinary actions for the employees that are failing to comply with the companies policies

-        It is true that you can make a quick profit while trading, but there is no such a thing as a free money

-        The truth will be revealed - a lot of market participants think that their actions will be unnoticed, but every single year regulators are increasing their controls and paying detailed attention to what is happening on the market

-        One wrongdoing actions can cause companies and investors to lose billions of money.

Last year the whole world faced a global pandemic Covid-19, which massively increased the chances of new ways of market manipulations and insider dealing. People working from home with unsecured networks and access to confidential information requires companies and regulators to find new ways to protect the market and investors. Additionally, social media is becoming a new hot spot for criminals that are trying to manipulate the market and make quick profits. If we want to protect the market and innocent people, regulators also should make it easier for companies to cooperate and report their suspicious.

 


 

http://antykorupcja.gov.pl/ak/retrospekcje/retro/5359,Mr-Boesky-z-Wall-Street.html

http://www.newsweek.pl/biznes/wiadomosci-biznesowe/wielki-powrot-marthy,17691,1,1.html

http://money.cnn.com/2013/12/10/news/companies/bernard-madoff-ponzi/index.html

http://www.aferyfinansowe.pl/afery-finansowe-na-swiecie/worldcom

http://mutualfunds.com/education/biggest-stock-market-villains

https://www.theguardian.com/business/2011/sep/15/who-are-worst-rogue-traders

http://www.businessinsider.com/ubs-rogue-trader-kweku-adoboli-banking-culture-compliance-2016-8?IR=T

https://www.businessinsider.com/how-bernie-madoffs-ponzi-scheme-worked-2014-7

https://www.nickleeson.com/biography

Vaughan, Liam; Finch, Gavin & Choudhury, Ambereen (12 June 2013). "Traders Said to Rig Currency Rates to Profit Off Clients". Bloomberg News. Retrieved 21 January2014

https://www.cnbc.com/2020/09/23/jpmorgan-to-pay-almost-1-billion-fine-to-resolve-us-investigation-into-trading-practices.html

Bloomberg

Financial Times

BBC

Investopedia

Business Insider

 

The author of the lesson: Tetyana Golovata, Compliance Officer at Schroders (Cazenove Capital), United Kingdom

 

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