Corruption and Fraud in Financial Markets E-Book
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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
Identifying malpractice and misconduct should be top priority for financial risk managers today Corruption and Fraud in Financial Markets identifies potential issues surrounding all types of fraud, misconduct, price/volume manipulation and other forms of malpractice. Chapters cover detection, prevention and regulation of corruption and fraud within different financial markets. Written by experts at the forefront of finance and risk management, this book details the many practices that bring potentially devastating consequences, including insider trading, bribery, false disclosure, frontrunning, options backdating, and improper execution or broker-agency relationships. Informed but corrupt traders manipulate prices in dark pools run by investment banks, using anonymous deals to move prices in their own favour, extracting value from ordinary investors time and time again. Strategies such as wash, ladder and spoofing trades are rife, even on regulated exchanges - and in unregulated cryptocurrency exchanges one can even see these manipulative quotes happening real-time in the limit order book. More generally, financial market misconduct and fraud affects about 15 percent of publicly listed companies each year and the resulting fines can devastate an organisation's budget and initiate a tailspin from which it may never recover. This book gives you a deeper understanding of all these issues to help prevent you and your company from falling victim to unethical practices. * Learn about the different types of corruption and fraud and where they may be hiding in your organisation * Identify improper relationships and conflicts of interest before they become a problem * Understand the regulations surrounding market misconduct, and how they affect your firm * Prevent budget-breaking fines and other potentially catastrophic consequences Since the LIBOR scandal, many major banks have been fined billions of dollars for manipulation of prices, exchange rates and interest rates. Headline cases aside, misconduct and fraud is uncomfortably prevalent in a large number of financial firms; it can exist in a wide variety of forms, with practices in multiple departments, making self-governance complex. Corruption and Fraud in Financial Markets is a comprehensive guide to identifying and stopping potential problems before they reach the level of finable misconduct.
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Table of Contents
Cover
Title Page
Copyright
About the Editors
List of Contributors
Foreword
Acknowledgements
Chapter 1: Introduction
References
Part I: What Are Manipulation and Fraud and Why Do They Matter?
Chapter 2: An Overview of Market Manipulation
2.1 Introduction
2.2 Definitions of Market Manipulation
2.3 A Taxonomy of the Types of Market Manipulation
2.4 Research on Market Manipulation
2.5 Summary and Conclusions
References
Notes
Chapter 3: A Taxonomy of Financial Market Misconduct
3.1 Introduction
3.2 Challenges in Research on Financial Market Misconduct
3.3 Defining Financial Market Misconduct
3.4 Defining Financial Fraud
3.5 Conclusion
References
Notes
Chapter 4: Financial Misconduct and Market-Based Penalties
4.1 Introduction
4.2 Notable Cases of Financial Reporting Fraud
4.3 Financial Reporting Misconduct and Legal Redress
4.4 Evolution of US Financial Regulations
4.5 Legal versus Market-Based Penalties for Financial Misconduct
4.6 Firm-Level Penalties for Corporate Financial Misconduct
4.7 Individual-Level Penalties for Corporate Financial Misconduct
4.8 Causes, Risks, and Moderators of Financial Misconduct
4.9 Other Non-Financial Misconduct
4.10 Concluding Remarks
References
Notes
Chapter 5: Insider Trading and Market Manipulation
5.1 Introduction
5.2 Regulatory Framework on Insider Trading and Market Manipulation
5.3 Recent Examples of Market Manipulation and Insider Trading
5.4 Conclusions
References
Notes
Chapter 6: Financial Fraud and Reputational Capital
6.1 Financial Frauds in the 2000s
6.2 The Effects of Fraud Revelation on Firm Value and Reputational Capital
6.3 The Effects of Fraud Revelation on Shareholders and Managers
6.4 Why Do Managers Do It? Motives and Constraints
6.5 Proxies and Databases Used to Identify Samples of Financial Statement Misconduct
6.6 Conclusion: Reputation, Enforcement, and Culture
References
Notes
Part II: How and Where Does Misconduct Occur?
Chapter 7: Manipulative and Collusive Practices in FX Markets
7.1 Introduction
7.2 Different Types of FX Order
7.3 The Unique FX Market Structure
7.4 Examples of Manipulative and Collusive Practices in FX Markets
7.5 The Reform Process
References
Notes
Chapter 8: Fraud and Manipulation within Cryptocurrency Markets
8.1 Introduction
8.2 Why Do Fraud and Manipulation Occur in Cryptocurrency Markets?
8.3 Pump and Dumps
8.4 Inflated Trading Volume
8.5 Exchange DDoS Attacks
8.6 Hacks and Exploitations
8.7 Flash Crashes
8.8 Order Book-Based Manipulations
8.9 Stablecoins and Tether
8.10 Summary and Conclusions
References
Notes
Chapter 9: The Integrity of Closing Prices
9.1 Why Closing Prices Matter
9.2 Painting the Tape and Portfolio Pumping
9.3 ‘Bang-the-Close’ Manipulation: The Response of Financial Intermediaries
9.4 Stock Price Pinning on Option Expiration Dates
9.5 Conclusion: Lessons for the Regulation and Design of Financial Markets
References
Notes
Chapter 10: A Trader's Perspective on Market Abuse Regulations
10.1 Introduction
10.2 Getting the Trading Edge
10.3 A Typical Trader's Market Window
10.4 Wash Trades
10.5 High Ticking/Low Ticking – Momentum Ignition
10.6 Spoofing
10.7 Layering
10.8 Smoking
10.9 Case Study: Paul Rotter a.k.a. ‘The Flipper’
10.10 The Innocent and the Guilty
10.11 What Are Exchanges Doing to Prevent Market Abuse?
10.12 What Are Trading Companies Doing to Prevent Abuse?
10.13 Will There Be an End to Market Abuse?
Notes
Part III: Who Are These Scoundrels?
Chapter 11: Misconduct in Banking: Governance and the Board of Directors
11.1 Introduction
11.2 Literature Review
11.3 Research Design
11.4 Empirical Results
11.5 Conclusion
References
Notes
Chapter 12: Misconduct and Fraud by Investment Managers
12.1 Introduction
12.2 Related Research
12.3 The Investment Advisers Act of 1940 and Mandatory Disclosures
12.4 Data
12.5 Predicting Fraud and Misconduct
12.6 Predicting the Initiation vs. the Continuance of Fraud
12.7 Firm-Wide Fraud vs. Fraud by a Rogue Employee
12.8 Out-of-Sample Prediction and Model Stability
12.9 Policy Implications and Conclusions
Appendix: Variable Definitions
References
Notes
Chapter 13: Options Backdating and Shareholders
13.1 Introduction
13.2 Stock Return Patterns around Option Grants
13.3 The Backdating Practice
13.4 Media Coverage, Restatement, and Investigation
13.5 Stock Market Reaction to Public Revelations of Backdating
13.6 Investor Reaction to (and Anticipation of) Public Revelations
13.7 Other Types of Misbehaviour Related to Option Grants
13.8 Connections with Questionable Practices by Corporate Executives and Other Agents
13.9 Conclusion
References
Notes
Chapter 14: The Strategic Behaviour of Underwriters in Valuing IPOs
14.1 Valuing IPOs
14.2 The Underwriter's Incentives in the Valuation of IPOs
14.3 Literature Review
14.4 Sample, Data, and Methodology
14.5 Results
14.6 Conclusions
References
Notes
Chapter 15: Governance of Financial Services Outsourcing: Managing Misconduct and Third-Party Risks
15.1 Introduction
15.2 The Four Components in Outsourcing
15.3 The Interaction between Contracting and Monitoring
15.4 Governance Mechanisms to Detect Misconduct in Financial Outsourcing
15.5 Conclusion
References
Notes
Part IV: Detection and Surveillance of Financial Misconduct
Chapter 16: Identifying Security Market Manipulation
16.1 Introduction
16.2 Background Legislation
16.3 Attributes of Manipulation
16.4 Detection Algorithms
16.5 Conclusion
Notes
Chapter 17: The Analytics of Financial Market Misconduct
17.1 Introduction
17.2 Financial Economic Analysis
17.3 Quantitative Techniques
17.4 Conclusion
References
Notes
Chapter 18: Benford's Law and Its Application to Detecting Financial Fraud and Manipulation
18.1 Introduction
18.2 Benford's Law and Generalizations
18.3 Usage of Benford's Law for Detecting Fraud and Deviant Behaviour
18.5 Policy Implications
18.6 Summary, Limitations, and Outlook
References
18.A Appendix
Notes
Part V: Regulation and Enforcement
Chapter 19: The Enforcement of Financial Market Crimes in Canada and the United Kingdom
19.1 Introduction
19.2 Existing Scholarship
19.3 Comparative Analysis
19.4 Reform
19.5 Conclusion
References
Note
Chapter 20: A Pyramid or a Labyrinth? Enforcement of Registrant Misconduct Requirements in Canada
20.1 Introduction
20.2 Definitional and Institutional Quagmires
20.3 The Compliance/Enforcement Continuum
20.4 Enforcement Options Available to Sanction Registrant Misconduct
20.5 Empirical Information Available about Registrant Misconduct in Canada
20.6 Analysis
Notes
Chapter 21: Judicial Local Protectionism and Home Court Bias in Corporate Litigation
21.1 Introduction
21.2 Institutional Background
21.3 Empirical Evidence
21.4 Conclusion
References
Notes
Index
End User License Agreement
List of Tables
Chapter 1
Table 1.1 Summary of Coverage in Chapters
Chapter 3
Table 3.1 Frequency of fraud by country.
Chapter 4
Table 4.1 Overview of studies on firm-level penalties.
Table 4.2 Overview of studies on individual-level penalties.
Table 4.3 Overview of studies on the causes, risks, and deterrents of fraud...
Table 4.4 Overview of studies on the enforcement, surveillance, and detecti...
Chapter 5
Table 5.1 The network of regulation and agencies involved in the detection,...
Table 5.2 Examples of white-collar crime investigated by the U.S. Federal B...
Table 5.3 List of recent events in financial markets linked to financial cr...
Chapter 7
Table 7.1 Manipulation of the WM/Reuters 4 p.m. fix (conversations).
Table 7.2 Manipulation of the WM/Reuters 4 p.m. fix (trading activity and F...
Chapter 8
Table 8.1 Largest reported cryptocurrency exchange hacks since 2011.
Table 8.2 Recent notable flash crashes.
Table 8.3 A timeline of key events in Tether and Bitfinex's history.
Chapter 11
Table 11.1 Time distribution of banks receiving enforcement actions.
Table 11.2 Descriptive statistics.
Table 11.3 Bivariate probit model estimation for board effectiveness and ba...
Table 11.4 Board effectiveness and bank misconduct: split-sample tests.
Table 11.5 Do effective boards alleviate shareholder wealth losses when mis...
Chapter 12
Table 12.1 Summary of investment fraud.
Table 12.2 Summary of fraud types.
Table 12.3 Summary of investment advisory firms.
Table 12.4 Predicting fraud.
Table 12.5 Initiation versus continuance of fraud.
Table 12.6 Firm-wide versus rogue employee fraud.
Chapter 14
Table 14.1 Valuation methods.
Table 14.2 IPOs valued using comparable firms.
Table 14.3 Valuation multiples: prospectus vs. algorithmic selection criter...
Table 14.4 Valuation bias with respect to algorithmic selection criteria by...
Table 14.5 Valuation bias with respect to algorithmic selection criteria by...
Table 14.6 Valuation multiples: prospectus vs. affiliated and unaffiliated ...
Table 14.7 Valuation bias with respect to affiliated and unaffiliated analy...
Table 14.8 Valuation bias with respect to affiliated and unaffiliated analy...
Table 14.9 Valuation multiples of added and removed peers by market.
Table 14.10 Valuation multiples of added and removed peers by industry.
Chapter 15
Table 15.1 Sample characteristics.
Table 15.2 Outsourced financial activities.
Table 15.3 Reasons for outsourcing.
Table 15.4 Areas of potential risks in financial institutions.
Table 15.5 Risks in the outsourcing relationship.
Table 15.6 Type of frauds that occurred in the financial sector.
Table 15.7 Methods to uncover misconduct.
Table 15.8 Termination in case of misconduct.
Chapter 18
Table 18.1 Empirical distribution of first digits of house numbers in Great...
Table 18.2 χ2-test statistic for different periods and different underlying...
Table 18.3 Drake and Nigrini (2000) propose the mean absolute deviation (MA...
Chapter 21
Table 21.1 Descriptive statistics of the sample.
Table 21.2 Abnormal stock returns and wealth effect.
Table 21.3 Multivariate analysis of wealth effects for defendants and plain...
Table 21.4 Heckman two-step analysis of CAR for sample selection bias.
Table 21.5 The analysis of the impact of home bias on the likelihood to app...
Table 21.6 The analysis of the impact of home bias on the appeal results....
List of Illustrations
Chapter 2
Figure 2.1 Taxonomy of manipulation techniques.
Chapter 3
Figure 3.1 Frequency of financial market misconduct (fraud) by industry.
Figure 3.2 Frequency of financial market misconduct (fraud) by firm type....
Figure 3.3 Classifying types of financial market misconduct.
Chapter 4
Figure 4.1 Lawsuit filings and number of companies listed in the United Stat...
Chapter 8
Figure 8.1 Cryptocurrencies as a subset of a broader category of digital cur...
Figure 8.2 Taxonomy of cryptoassets as described by FCA and EBA reports publ...
Figure 8.3 Comparative 2018 vs. 2019 daily crypto exchange revenue estimated...
Figure 8.4 Example limit order book as seen on one cryptocurrency exchange....
Figure 8.5 TRIG/USD price and volume during pump and dump event. Just before...
Figure 8.6 Global bitcoin trading volume.
Figure 8.7 Twitter reported DDoS incidents across the 30 largest global cryp...
Figure 8.8 Kraken DDOS event – ETH/USD trade price plotted with accompanying...
Figure 8.9 Kraken price impact during the DDOS event. ETH Kraken traded pair...
Figure 8.10 Historical timeline of notable exchange hacks. The size of each ...
Figure 8.11 A comparison of daily returns from ETH/USD, the Dow Jones Indust...
Figure 8.12 Five-minute candlestick representation of the GDAX ETH/USD trade...
Figure 8.13 BTC/EUR (a) 10-second snapshot (b) 10-minute snapshot best bids.
Figure 8.14 Illustrative example of order spoofing process
Figure 8.15 Tether issuance plotted against BTCUSD price as quoted on Coinma...
Chapter 9
Figure 9.1 Decomposition of Settlement Price Artificiality when the number o...
Chapter 10
Figure 10.1 Sidebar.
Figure 10.2 A trader's window of the order book.
Figure 10.3 Market window example 1.
Figure 10.4 Market window example 2.
Figure 10.5 Spoof study example.
Figure 10.6 Layering example.
Figure 10.7 Smoking example 1.
Figure 10.8 Smoking example 2.
Figure 10.9 The Bund.
Chapter 11
Figure 11.1 The percentage of directors classified as independent on US bank...
Figure 11.2 The estimated effects of board monitoring and board advising on ...
Chapter 12
Figure 12.1 Timeline for fraud committed by Veros Partners.
Figure 12.2 Fraud cases over time.
Figure 12.3 Model diagnostic performance.
Figure 12.4 Model performance over time.
Chapter 14
Figure 14.1 IPO premium.
Figure 14.2 The case of Geox.
Figure 14.3 Underwriters’ selection of comparable firms pre- vs. post-IPO....
Figure 14.4 Number of peers changed and valuation bias.
Figure 14.5 Firm diversification and number of peers changed.
Chapter 16
Figure 16.1 Key concepts associated with market quality.
Chapter 17
Figure 17.1 Number of cases and value of fines for cases of financial market...
Figure 17.2 Cumulative rejection frequency.
Chapter 18
Figure 18.1 The graphical display of the relative frequencies of first digit...
Figure 18.2 The graphical display of the relative frequencies of second digi...
Figure 18.3 The graphical display of the relative frequencies of the first t...
Figure 18.4 Development of the yearly number of academic publications using ...
Figure 18.5 Historical development of the one-month LIBOR and Treasury bill ...
Figure 18.6 Comparison of the distribution of second digits in the LIBOR sub...
Figure 18.7 Comparison of the distribution of second digits in the LIBOR sub...
Figure 18.8 Quarterly development of the sum of squared differences between ...
Figure 18.9 Quarterly development of the sum of squared differences between ...
Figure 18.10 Quarterly development of the sum of squared differences between...
Chapter 21
Figure 21.1 The Market-adjusted cumulated abnormal returns around the filing...
Figure 21.2 The defendant's market-adjusted cumulated abnormal returns aroun...
Figure 21.3 The plaintiff's market-adjusted cumulated abnormal returns aroun...
Guide
Cover
Table of Contents
Title Page
Copyright
About the Editors
List of Contributors
Foreword
Acknowledgements
Begin Reading
Index
End User License Agreement
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Corruption and Fraud in Financial Markets
Malpractice, Misconduct and Manipulation
Carol Alexander
Douglas Cumming
This edition first published 2020© 2020 Carol Alexander and Douglas Cumming
Registered officeJohn Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester, West Sussex, PO19 8SQ, United Kingdom
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About the Editors
Carol Alexander
Carol Alexander is Professor of Finance at the University of Sussex and Co-Editor of the Journal of Banking and Finance. Carol has been back at Sussex (her alma mater) since 2012. She was appointed the John von Neumann Chair at TU Munich for the year 2018 and in January 2019 she became visiting professor at the Oxford campus of Peking University Business School.
Prior academic appointments were as Chair of Financial Risk Management at the ICMA Centre in the Henley Business School at Reading (1999–2012) and lecturer in Mathematics and Economics at the University of Sussex (1985–1998). She holds degrees from the University of Sussex (BSc First Class, Mathematics with Experimental Psychology; PhD Algebraic Number Theory) and the London School of Economics (MSc Econometrics and Mathematical Economics). She also has an Honorary Professorship at the Academy of Economic Studies in Bucharest, Romania.
Carol has also held several positions in financial institutions: Fixed Income Trader at UBS/Phillips and Drew (UK); Academic Director of Algorithmics (Canada); Director of Nikko Global Holdings and Head of Market Risk Modelling (UK); Risk Research Advisor, SAS (USA). She also acts as an expert witness and consultant in financial modelling. From 2010–2012 Carol was Chair of the Board of PRMIA (Professional Risk Manager's International Association).
She publishes widely on a broad range of topics, including volatility theory, option pricing and hedging, trading volatility, hedging with futures, alternative investments, random orthogonal matrix simulation, game theory and real options. She has written and edited numerous books in mathematics and finance and published extensively in top-ranked international journals. Her four-volume textbook on Market Risk Analysis (Wiley, 2008) is the definitive guide to the subject.
Douglas Cumming
Douglas Cumming, J.D., Ph.D., CFA, is the DeSantis Distinguished Professor of Finance and Entrepreneurship at the College of Business, Florida Atlantic University in Boca Raton, Florida. Douglas is also a Visiting Professor of Finance at Birmingham Business School, University of Birmingham, UK, and the Royal Melbourne Institute of Technology, Australia. Previously, Douglas was a Professor and the Ontario Research Chair at the Schulich School of Business, York University, in Toronto, Canada from 2007–2018. He has held prior visiting appointments at Essex Business School, Kobe University, University of Bergamo, and EMLyon, among others.
Douglas has published over 180 articles in leading refereed academic journals in finance, management, and law and economics, such as the Academy of Management Journal, Journal of Financial Economics, Review of Financial Studies, Journal of Financial and Quantitative Analysis, and Journal of International Business Studies, and has been cited over 15,000 times according to Google Scholar. He is the Editor-in-Chief of the British Journal of Management (2020–2022) and the Journal of Corporate Finance (2018–2020). He is the Founding Editor-in-Chief of Review of Corporate Finance, and a former Co-Editor of Finance Research Letters and Entrepreneurship Theory and Practice.
Douglas has published 18 academic books. His most recent book is Crowdfunding: Fundamental Cases, Facts, and Insights (Elsevier Academic Press, 2019) complete with companion materials. He is the coauthor of Venture Capital and Private Equity Contracting (Elsevier Academic Press, 2nd Edition, 2013), and Hedge Fund Structure, Regulation and Performance around the World (Oxford University Press, 2013). He is the Editor of the Oxford Handbook of Entrepreneurial Finance (2013), the Oxford Handbook of Private Equity (2013), the Oxford Handbook of Venture Capital (2013), the Oxford Handbook of Sovereign Wealth Funds (2018), the Oxford Handbook of IPOs (2019), the Research Handbook of Finance and Sustainability (2018), and the Research Handbook of Investing in the Triple Bottom Line (2019).
Douglas has consulted for various private and governmental organizations in Australia, Canada, China, Europe, and the U.S. on projects ranging from stock market regulation, mutual fund fees, valuation, damages, and venture capital, among others. Douglas is a regular speaker at academic and industry conferences around the world. He has given recent keynote speeches at the British Academy of Management Corporate Governance Conference, Entrepreneurial Finance Association, Financial Research Network Corporate Finance Conference, French Finance Association, Infiniti Conference on International Finance, Vietnam Symposium in Banking and Finance, the Budapest Liquidity and Financial Markets Conference, and the Humbolt University of Berlin Fintech Conference, among numerous others.
Douglas' work has been reviewed in numerous media outlets, including the Chicago Tribune, The Economist, The New York Times, the Wall Street Journal, the Globe and Mail, Canadian Business, the National Post, and The New Yorker.
List of Contributors
Mike Aitken
Rozetta Institute
Anita Anand
University of Toronto
Sam Baker
SJB Capital Limited
Christina Bannier
Justus Liebig University Giessen
Jonathan A. Batten
RMIT University, Melbourne, Australia
Gennaro Bernile
University of Miami
Mary Condon
Osgoode Hall Law School
Ryan J. Davies
Babson College
Ai Deng
NERA Economic Consulting and John Hopkins University
F. Alexander de Roode
Robeco
Stephen G. Dimmock
Nanyang Technological University
Arman Eshraghi
Cardiff University
Corinna Ewelt-Knauer
Justus Liebig University Giessen
Joseph D. Farizo
University of Richmond
Michael Firth
Lingnan University
Priyank Gandhi
Rutgers Business School
William C. Gerken
University of Kentucky
Jens Hagendorff
University of Edinburgh
Shan Ji
Capital Markets Consulting
Jonathan M. Karpoff
University of Washington
Ann Leduc
Capital Markets Consulting
Johannes Lips
Justus Liebig University Giessen
Chelsea Liu
University of Adelaide
Igor Lončarski
University of Ljubljana
Andrew Mann
University College London and Coinstrats
Joseph A. McCahery
Tilburg University
Duc Duy Nguyen
King’s College London
Stefano Paleari
University of Bergamo
Tālis J. Putniņš
University of Technology Sydney and Stockholm School of Economics in Riga
Oliver M. Rui
China Europe International Business School
Alexis Stenfors
University of Portsmouth
Johan Sulaeman
National University of Singapore
Andrea Signori
Catholic University of Milan
Peter G. Szilagyi
Central European University
David Twomey
Coinstrats
Silvio Vismara
University of Bergamo and Ghent University
Peter Winker
Justus Liebig University Giessen
Wenfeng Wu
Shanghai Jiao Tong University
Alfred Yawson
University of Adelaide
Foreword
This book is intended for finance practitioners, regulators, lawyers, academics, and students in advanced undergraduate and graduate business school programs. Financial market manipulation and fraud covers all aspects of finance. The book includes chapters written by academics in finance, management, and law, as well as by practitioners with experience in trading, surveillance, and regulation. All the chapters are digestible by a wide audience and not written specifically for one type of reader. The timely nature of the material in this book is perhaps exhibited by the fact that one of the chapters had to be removed a few months before going to print due to a gag order associated with on-going litigation; as such, we made sure to cover the pertinent material in other ways to ensure as timely and comprehensive examination of fraud and manipulation as possible.
At a broad level, the book has two main parts: (1) market manipulation and (2) other types of fraud. Market manipulation refers to a wide array of trading practices on stocks, bonds, derivatives, commodities and currencies (including cryptocurrencies). These practices include price manipulation, volume manipulation and insider trading. Other types of fraud are money laundering, credit card fraud, financial statement fraud, options backdating, breach of contract, self-dealing, financial and intellectual property theft, procurement fraud, regulatory or compliance Breach, Ponzi schemes, and computer-intrusion fraud and hacking.
The coverage is very comprehensive: identifies and defines the full array of manipulative activities; discusses the different markets in which manipulation most commonly occurs; analyses misconduct amongst different types of players such as banks and advisors; deals with detection methods including quantitative techniques and surveillance; and describes regulation and enforcement.
Everyone with an interest in financial markets should be concerned with fraud and market manipulation. Navigating financial markets necessarily involves the assessment of risks, of which fraud and manipulation are the most serious and pronounced. An understanding of the causes and consequences of fraud and manipulation is a necessary step to investing in financial markets, studying the behaviour of players in these markets and designing appropriate surveillance systems and regulatory structures.
The concern with fraud and manipulation is particularly timely as this book goes to print in March 2020 with the COVID-19 pandemic spreading over the world. Panic and hysteria are the fuel of financial market volatility and Wall Street's fear gauge, the VIX, has just hit an all-time high as we write, exceeding the peak of the so-called ‘great financial crisis’ of 2008-9. The financial bomb of US toxic debt (or, more specifically, its derivatives) that was launched by the collapse of Lehman brothers seems nothing compared with consequences of the market activity at this time.
Since 2008 most central banks have employed quantitative easing, raising cash by issuing government securities and selling them to domestic and foreign investors. The US has about $19 trillion debt of which about $7 trillion is held by foreigners and of that over $2 trillion is held by China and Japan. However, since the US trade wars began in 2019 the demand for US government securities has fallen. China, for instance, built up their gold bullion reserves by 6% during 2019. So, in September 2019 the Federal Reserve re-introduced repurchase (repo) operations for the first time since the ‘great financial crisis’. That is, they buy their own securities from banks, hedge-funds and this way, they inject liquidity to financial markets for a limited period. At the time of writing, in March 2020, the Federal Reserve have cut benchmark rates and announced an unprecedented level and duration of repo operations that are worth trillions of US dollars. But still, as we write this forward and the book goes to press, the seventh circuit-breaker this month has been applied to attempt to limit the losses on the New York Stock Exchange.
As funds flow out of equities one would expect demand for safe havens like gold and bitcoin to increase. But gold and bitcoin have fallen at the same time. Manipulating the price of gold downwards by dumping huge naked shorts on COMEX gold futures has been documented for years yet, despite the Market Abuse Directive (which is described in Chapter 10) it still continues. With high-frequency trading algorithms now the norm, manipulation techniques are becoming even more advanced. For instance, on Friday 13 March 2020 a distributed denial of service attack, very similar to the Kraken attack documented in Chapter 8 during 2017, occurred on the BitMEX cryptocurrency derivatives exchange. Indeed bitcoin, originally termed ‘digital gold’ because of its safe-haven properties, has fallen well over 50% on the openly manipulative spoofing trades that are explained in many chapters in this book. The layering, spoof and pinging techniques described Chapter 7, on foreign exchange markets, could also be associated with the astonishing rise in the US dollar. This seems counter-intuitive because the US economy is struggling to cope with the impact of COVID-19 just as China appears to have recovered from the virus.
We encourage you to explore in detail each one of the chapters in this book. We hope this book will help improve the state of knowledge amongst investors, lawyers, regulators, students and academics alike. In turn, we hope that improved an understanding facilitates better due diligence amongst investors and better surveillance to mitigate the frequency and severity fraud and market manipulation. And we hope the material will inspire more in-depth analyses of fraud and market manipulation in the future.
Acknowledgements
We are foremost indebted to the authors of each of the chapters of this book. The authors are, alphabetically, Michael Aitken, Anita Anand, Sam Baker, Christina Bannier, Jonathan Batten, Gennaro Bernile, Mary Condon, Ryan Davies, Ai Deng, Alexander de Roode, Steve Dimmock, Arman Eshraghi, Corinna Ewelt-Knauer, Joseph Farrizo, Michael Firth, Priyank Gandhi, Will Gerken, Jens Hagendorff, Shan Ji, Jonathan Karpoff, Ann Leduc, Johannes Lips, Chelsea Liu, Igor Lončarski, Andrew Mann, Joe McCahery, Duc Duy Nguyen, Stefano Paleari, Tālis Putniņš, Oliver Rui, Alexis Stenfors, Johan Sulaeman, Andrea Signori, Peter Szilagyi, David Twomey, Silvio Vismara, Peter Winker, Wenfeng Wu, and Alfred Yawson. These authors are all world-leading experts on the subject matter covered in their chapters. It was a privilege working with them and having the opportunity to integrate their timely analyses into this book.
Carol Alexander would like to thank the University of Sussex Business School, and her colleagues in the Department of Accounting in Finance in particular, for such a friendly and supportive workplace. Douglas Cumming wishes to thank Sofia Johan for helpful comments on some of the work prepared here. Douglas Cumming is grateful to the Florida Atlantic University College of Business, and Dean Dan Gropper in particular, for offering a professional work environment consistent with the best practices in university administration.
Carol Alexander and Douglas Cumming, March 2020.
Chapter 1Introduction
Carol Alexander
University of Sussex
Douglas Cumming
Florida Atlantic University
This book covers two general areas of financial market misconduct:
Market manipulation in the course of financial trading on stock exchanges (hereafter referred to as “market manipulation” in this chapter), and
Financial fraud, or non-trading related fraud (hereafter referred to as “financial fraud” in this chapter).
The CFA Institute (2014) survey of its members shows that most practitioners believe that market manipulation and financial fraud are among the most important issues facing financial markets around the world. Indeed, market manipulation and both types of financial fraud are commonplace. For instance, Cumming, Dannhauser and Johan (2015) report that roughly 1.9%, 4.5%, and 5.1% of NYSE, NASDAQ, and pink sheet companies, respectively, face enforcement actions from the Securities and Exchange Commission (SEC) each year. Similarly, detected fraud cases affect approximately 3.8% of listed companies in China each year. But detected fraud is just the tip of the iceberg, so to speak, and Dyck, Morse and Zingales (2010, 2014) estimated that up to 14% of all US firms have engaged in fraud.
Enforcement varies significantly across countries. In fact, there are enormous differences in enforcement rates in Europe, despite countries having similar market misconduct rules (Cumming, Groh, and Johan, 2018). And there is scant enforcement in some emerging markets such as Brazil, which had its first ever reported insider trading case in 2011. Even in Germany, the (now defunct) Neur Markt, a small-company growth market, reported only four cases of fraud (Cumming et al., 2015).
The consequences of fraud are extremely severe to managers and shareholders alike. Karpoff et al. (2008a) shows that fraud costs firms 20–38% of a firm's long-term stock market value. Karpoff et al. (2008b) show significant negative career consequences to managers that engage in market manipulation and financial fraud: 93% lose their jobs, and 28% face criminal prosecution, serving an average of 4.3 years of jail time.
This book offers a unifying look at the different types of market manipulation and financial fraud. The chapters in this book:
Explain the various types of market manipulation and financial fraud;
Describe the factors that mitigate or exacerbate their occurrence;
Discuss their consequences in terms of penalties and/or financial market impact;
Provide evidence for the presence of fraud in specific markets, such as cryptocurrencies, LIBOR and foreign exchange;
Summarize the lessons to be learned about detection and enforcement of market manipulation and financial fraud.
The book is organized into five sections. Part I provides a general overview, where different types of market misconduct and financial fraud are defined, and the market and reputational penalties are explained. Part I comprises 5 chapters (Chapters 2–6) from leading authors around the world. The scope of the chapters is explained in Table 1.1, Panels A (for market manipulation) and B (for financial fraud). Chapter 2 by Tālis J. Putniņš provides a comprehensive overview of the different types of market manipulation. Chapter 3 by Ai Deng and Priyank Ghandi includes additional information on market manipulation and extends the discussion to financial fraud. Chapter 4 by Chelsea Liu and Alfred Yawson offers a comprehensive review of the market and reputational penalties associated with market manipulation and financial fraud. Chapter 5 by Jonathan Batten, Igor Lončarski and Peter Szilagyi provides detailed explanations of various issues in price manipulation and insider trading and describes detected cases of such misconduct. Chapter 6 by Jonathan Karpoff offers critical insights into the consequences of financial fraud based on findings from precisely compiled large-sample evidence.
Part II provides analyses of specific contexts and markets. Chapter 7 by Alexis Stenfors provides insights into the foreign exchange market based on his first-hand practical experience as well as his research on topic. Chapter 8 by David Twomey and Andrew Mann examines the cryptocurrency market. Chapter 9 by Ryan Davies offers a detailed look at the context of closing prices, which are frequently the subject of manipulation, since closing prices are used in determining various other things in financial market, such as executive compensation, whether options trade in or out of the money, and M&A prices and terms. Chapter 10 by Sam Baker provides insights into market manipulation and financial fraud cases from the experience and perspective of a financial market trader who has dealing with regulations on a daily basis for many years.
Part III considers different financial market players that engage in market manipulation and financial fraud. Chapter 11 by Duc Duy Nguyen, Jens Hagendorff and Arman Eshraghi analyses fraud among banks. Chapter 12 by Steven Dimmock, Joseph Farizo, and William Gerken examines fraud by investment advisors. Chapter 13 by Johan Sulaeman and Gennaro Bernile discusses how options backdating is a form of fraud. Stefano Paleari, Andrea Signori and Silvio Vismara provide an empirical analysis of misconduct in the context of pricing Initial Public Offerings, in Chapter 14. And in Chapter 15, Joseph McCahery and Alexander Roode examine the role of financial fraud through financial outsourcing to third parties and provide comprehensive survey evidence of the extent of the problems.
Part IV covers detection of market manipulation and financial misconduct. Chapter 16 by Mike Aitken, Anne Leduc and Sian Ji describes computer surveillance and technologies for detecting manipulation, and the computer software that is used by exchanges and their regulators. Chapter 17 by Ai Deng and Priyank Ghandi explains econometric and statistical tools to detect financial fraud. Chapter 18 by Professors Bannier, Ewelt-Knauer, Lips, and Winker provides an empirical review of Benford's Law and its application to detecting financial misconduct, with an illustration using data pertaining to the LIBOR scandal.
Part V provides an overview of financial market regulation relating to manipulation and fraud. Chapter 19 by Anita Indira Anand explains that empirical evidence around the world is consistent with the view that financial market regulation improves market efficiency and integrity and provides an in-depth analysis of regulation and enforcement issues in Canada and the UK. Chapter 20 by Mary Condon reviews issues surrounding registrant misconduct. Finally, Chapter 21 by Michael Firth, Oliver Rui and Wenfeng Wu provides empirical evidence supporting differential rates of enforcement depending on potential institutional biases, such as a “home court” advantage.
The coverage of each area of market manipulation and financial fraud in this book is summarized in Table 1.1. The range of topics is not completely exhaustive in this book. In some cases topics were excluded because authors faced confidentiality restrictions that precluded their publication. Nevertheless, we hope the broad range of materials in this book better informs and guides financial market participants, regulators, students, and academics alike. Individual cases of misconduct and outright fraud are reported frequently, whereas price and volume manipulation are so common that their occurrence is not usually conveyed to the general public. However, it is important to inform everyone about these practices, not only those directly participating in financial markets, because prices of final assets have a direct effect on the well-being of the global economy. We are, therefore, extremely indebted to the world leading authors that have contributed herein. We expect their analyses will continue to guide practice and policy for years to come.
Table 1.1 Summary of Coverage in Chapters
This table summarizes the topics in each chapter, and the scope of the chapters in terms of definitions, analyses of causes and/or consequences of fraud and misconduct, and case analyses or data. Panel A summarizes topics in financial market misconduct, Panel B summarizes topics in fraud. The different types of misconduct and fraud in the table are explained in detail in the chapters enumerated here.
Panel A. Topics in Financial Market Misconduct
Chapter
Authors
Topics
Price Manipulation, Reference Price Manipulation, and Benchmark Rigging
Circular Trading (e.g., wash, pool, matched or compensation trades; painting the tape; or warehousing), or Spoofing
Insider Trading, Collusion and Information Sharing
Improper Order Handling and Frontrunning
Misleading Customers
Abuse of Market Power, Corners, or Squeezes
Momentum Ignition, Pump and Dump, or Slur and Dump
Marking the Open (or Close or Set), Pegging or Capping
Layering, Advancing the Bid, Quote Stuffing, “Abusive liquidity detection”, “pinging”, or “phishing”
Section I. General
2
Putnins
Defining Fraud, Causes, Consequences
x
x
x
x
x
x
x
x
3
Deng and Ghandi
Defining Fraud, Causes, Consequences
x
x
x
x
x
5
Batten, Lončarski and Szilagyi
Definitions, Case Studies, and Regulations
x
Section II. Markets
7
Stenfors
Foreign Exchange Markets
x
x
x
x
x
8
Twomey and Mann
Cryptocurrency Markets
x
x
x
x
x
x
x
x
x
9
Davies
Closing Prices
x
x
10
Baker
Regulator's Perspective and Case Studies
x
x
x
x
x
x
x
x
x
Part III. Players
12
Dimmock, Farizo and Gerken
Investment Advisors. Data: SEC filings, Form ADV filing
x
13
Sulaeman and Bernile
Causes and Consequences of Options Backdating
x
14
Paleari, Signori and Vismara
IPO Valuation Bias: Data: Euronext, Germany, and Italy, from the EurIPO Database
x
15
McCahery and Roode
Third Party Financial Outsourcing; Authors' Survey Data
x
x
Part IV. Detection
16
Aitken, Leduc and Ji
Surveillance in Connection to Regulation
x
x
x
x
x
x
x
x
x
17
Deng and Ghandi
Quantitative Techniques for Detection
x
Part V. Regulation
19
Anand
Enforcement in Canada and the UK
x
x
20
Condon
Registrant Misconduct
x
x
Panel B. Topics in Financial Fraud
Chapter
Authors
Topics
Money Laundering, Credit Card Fraud
Financial Statement Fraud
Options Backdating
Breach of Contract or Loan Covenant
Self Dealing, Financial Theft, or Intellectual Property Theft
Vendor, Supplier, or Procurement Fraud
Regulatory or Compliance Breach
Ponzi Scheme
Computer Intrusion Fraud and Hacking
Section I. General
3
Deng and Ghandi
Defining Fraud, Causes, Consequences
x
x
x
4
Liu and Yawson
Market/Reputational and Regulatory Penalties
x
5
Batten, Lončarski and Szilagyi
Definitions, Case Studies, and Regulations
x
x
6
Karpoff
Reputational Penalties
x
x
Section II. Markets
8
Twomey and Mann
Cryptocurrency Markets
x
x
x
Part III. Players
11
Nguyen, Hagendorff and Eshraghi
Misconduct in Banking (Data on regulatory enforcement actions issued by the FDIC, FRB and OCC)
x
12
Dimmock, Farizo and Gerken
Investment Advisors. Data: SEC filings, Form ADV filing
x
x
x
13
Sulaeman and Bernile
Causes and Consequences of Options Backdating
x
14
Paleari, Signori and Vismara
IPO Valuation Bias: Data: Euronext, Germany, and Italy, from the EurIPO Database
x
15
McCahery and Roode
Third Party Financial Outsourcing; Authors' survey data
x
x
x
x
Part IV. Detection
16
Aitken, Leduc and Ji
Surveillance in Connection to Regulation
x
17
Deng and Ghandi
Quantitative Techniques for Detection
x
18
Bannier, Ewelt-Knauer, Lips, and Winker
Benford's Law; Libor Case Study
x
Part V. Regulation
19
Anand
Enforcement in Canada and the UK
x
x
20
Condon
Registrant Misconduct
x
x
x
21
Firth, Rui and Wu
Home Court Bias; 5,436 Cases from China
x
x
References
CFA Institute (2014). Global Market Sentiment Survey 2015: Detailed Survey Results. CFA Institute.
http://www.cfainstitute.org/Survey/gmss_2015_detailed_results.pdf
.
Cumming, D.J., Dannhauser, B. and Johan, S. (2015). Financial market misconduct and agency conflicts: A synthesis and future directions.
Journal of Corporate Finance
34: 150–168.
Cumming, D.J, Groh, A. and Johan, S. (2018). Same rules, different enforcement: Market abuse in Europe.
Journal of International Financial Markets, Institutions, & Money
54: 130–151.
Dyck, A., Morse, A. and Zingales, L. (2010). Who blows the whistle on corporate fraud?
Journal of Finance
65: 2063–2253.
Dyck, A., Morse, A. and Zingales, L. (2014). How pervasive is corporate fraud? Working Paper, University of Chicago.
Karpoff, J., Lee, D.S. and Martin, G.S. (2008a). The consequences to managers for cooking the books.
Journal of Financial Economics
88: 193–215.
Karpoff, J.M., Lee, D.S. and Martin, G.S. (2008b). The consequences to managers for financial misrepresentation.
Journal of Financial Economics
85: 66–101.
Part IWhat Are Manipulation and Fraud and Why Do They Matter?
Chapter 2An Overview of Market Manipulation
Tālis J. Putniņš
University of Technology Sydney Stockholm School of Economics in Riga
2.1
Introduction
2.2
Definitions of Market Manipulation
2.2.1
Legal Interpretation and Provisions against Market Manipulation
2.2.2
Economics and Legal Studies Perspective
2.3
A Taxonomy of the Types of Market Manipulation
2.3.1
Categories of Market Manipulation
2.3.2
Market Manipulation Techniques
2.4
Research on Market Manipulation
2.4.1
Theoretical Literature
2.4.2
Empirical Literature
2.4.3
Conclusions from the Research on Market Manipulation
2.5
Summary and Conclusions
References
2.1 Introduction
Market manipulation is as old as markets. Joseph de la Vega's description of the Amsterdam Stock Exchange in 1688 provides a vivid illustration:
Among the plays which men perform in taking different parts in this magnificent world theatre, the greatest comedy is played at the Exchange. There, … the speculators excel in tricks, they do business and find excuses wherein hiding places, concealment of facts, quarrels, provocations, mockery, idle talk, violent desires, collusion, artful deception, betrayals, cheatings, and even tragic end are to be found. – Joseph de la Vega (1688).
Many of the practices described by de la Vega would in today's markets be classed as market manipulation and in most jurisdictions would be illegal. Numerous other examples of market manipulation exist in history, such as when the influential Rothschilds sold large amounts of stock to create the false impression that Napoleon had defeated Wellington. Their actions caused prices to crash and allowed them to repurchase the stock at depressed prices (Griffin, 1980).
Today, market manipulation can be found in markets all around the world, in almost all asset classes, and in a wide variety of forms. The magnitude of manipulation's effects can be extraordinary; for example, the price of nearly bankrupt NEI Webworld Inc. shot up by 11,400% within a day in response to manipulators spreading rumours on the internet.1 Manipulation is not confined to small and illiquid companies; for example, multibillion dollar Lucent Technologies was successfully manipulated (Leinweber and Madhavan, 2001). The amount of funds used in manipulation and scale of profits can be immense; for example, in 2004 Citigroup netted €18.2 million profit from manipulation that involved placing €12.9 billion worth of sell orders in 200 different government bonds within 18 seconds and later repurchasing them.2 Manipulation is also not confined to sophisticated market participants; for example, Jonathan Lebed, a teenager from New Jersey successfully manipulated stocks 11 times by posting messages on Yahoo Finance message boards and made profits of $800,000 (Lewis, 2001). Similarly, Navinder Sarao made profits in excess of $10 million from manipulating S&P500 futures contracts, trading from his parents' home in London.3 Nor is manipulation confined to individual securities; for example, in 1996, Nomura Int. Plc. manipulated an entire market index (Australian All Ordinaries) by selling a $600 million basket of stocks (more than the average daily market turnover) within minutes of the close of trading.4
Recent examples of manipulation illustrate just how enormous the impact of market manipulation can be. Regulators and law enforcement agencies have uncovered manipulation of major financial benchmarks including LIBOR, other “IBOR” benchmarks such as EURIBOR and TIBOR, and foreign exchange rate benchmarks such as the key WM/Reuters forex benchmark rates. These benchmarks underpin the pricing of hundreds of trillions of dollars' worth of financial contracts and securities such as floating rate loans/bonds, swaps, forward rate agreements, futures, and options (e.g., Duffie and Stein, 2015). To put this into context, the notional value of the affected securities and contracts exceeds the total value of US GDP. It also exceeds the total market capitalization of all companies listed on US stock markets. In fact, it exceeds the value of global GDP and the value of all listed companies globally. The outcomes of decade-long investigations and legal proceedings include billions of dollars of fines, criminal sanctions including jail sentences, and reforms including new legislation and benchmark setting mechanisms. The direct losses to affected parties are in the billions of dollars. Yet the indirect costs of such manipulation cases, including loss of confidence and participation in markets, impacts on market liquidity, and regulatory/compliance costs, could be even larger.
Market manipulation takes many forms. Markets can be manipulated by trading or by placing orders in markets. But they can also be manipulated by releasing false information or performing misleading actions. Some forms of market manipulation involve inflating prices, some involve depressing prices, and some involve both, but at different times. Some manipulation schemes are contained within a single market, yet others involve multiple related markets (e.g. an underlying and derivative market, or a transparent and dark market) with manipulators making losses in one market in order to profit in another. Financial securities within markets can be manipulated, but so too can indices and financial benchmarks. Market manipulation occurs at many frequencies with some manipulations taking years to execute, while others are completed within seconds. Manipulation can be conducted manually, programmed and automatically executed by a computer algorithm, or involve human–computer collaboration. Some market manipulation schemes are carried out by a single individual, yet others involve complex collaborations by teams of market manipulators. Section 2.3 of this chapter develops a taxonomy of the different types of market manipulation and explains the main ways in which market manipulation is conducted.
Market manipulation is difficult to precisely define. In part, this is because it encompasses a very broad collection of highly varied trading strategies as noted above. But another reason, in particular for the vagueness in legal definitions, is to minimize the risk that manipulators circumvent the law by devising schemes that fall outside of a precise and narrow legal definition. The unifying feature of market manipulation techniques is that they involve trading, placing orders, or releasing information for the purpose of creating a false or misleading appearance of the supply of, demand for, or price of a financial security or benchmark. It follows that an important distinguishing feature of market manipulation is the intent to mislead others or influence market prices or volumes. Section 2.2 of this chapter discusses the issue of defining market manipulation, provides examples of how manipulation is dealt with in legislation, and provides perspectives from the law and economics literature.
Finally, research on market manipulation has made considerable advances in terms of understanding how manipulation is conducted and what its effects are, but there are still many areas in which our understanding of market manipulation is limited. These include issues such as how widespread is market manipulation, how it responds to various forms of regulation, and how it affects corporate investment decisions and the real economy. Research on market manipulation is made difficult by the fact that manipulators often go to great length to conceal their actions and therefore there is often a lack of information about instances of market manipulation other than those prosecuted by regulators. Prosecution samples usually reflect a small non-random subset of all manipulation, which further complicates empirical research. Section 2.4 of this chapter provides an overview of the theoretical and empirical research on market manipulation and suggests future research directions.
2.2 Definitions of Market Manipulation
There is no generally accepted definition of market manipulation. This may seem surprising given the long history of manipulation in world financial markets5 and the fact that more than three quarters of a century has passed since the inception of the US federal securities regulation against market manipulation.6 Legal definitions are often intentionally not explicit, and much of the finance and economics literature uses the term “market manipulation” in an imprecise manner. This situation has led to a long-standing debate over the definition of market manipulation.
2.2.1 Legal Interpretation and Provisions against Market Manipulation
Legal definitions vary across jurisdictions and in many cases are not explicit about what constitutes market manipulation. One reason for the vagueness in legal definitions is to minimize the risk that manipulators can circumvent the law by devising schemes that fall outside of a precise and narrow legal definition. The task of defining manipulation is largely left to the courts on a case-by-case basis.
For example, in the US, statutory law states that it is unlawful “to use or employ, in connection with the purchase or sale of any security … any manipulative or deceptive device or contrivance”.7 In Australia, statutory law prohibits “transactions that have or are likely to have … the effect of … creating an artificial price”.8 EU statutory law stipulates, “market manipulation shall mean transactions or orders to trade which give, or are likely to give, false or misleading signals as to the supply of, demand for or price of financial instruments, or which secure … the price of one or several financial instruments at an abnormal or artificial level”.9
Given that statutory law does not provide a precise definition of manipulation, one must turn to case law to understand what is viewed as manipulation by courts. For example, in the US, where perhaps the largest number of market manipulation cases have been brought to courts, case law has established a four part test for manipulation involving ability, intent to deceive, causation, and artificiality (Johnson, 1981).
Across a number of jurisdictions, arguably the two most important elements of market manipulation in case law, and often the most difficult to prove, are intent and artificiality. Intent distinguishes manipulative from non-manipulative trading. Legitimate, non-manipulative market participation can cause an increase in market activity or alteration of the market price. Therefore, both manipulative and legitimate trading can have the same effects on the market, but are distinguished by the fact that manipulation involves an impermissible purpose (Goldwasser, 1999
