DISCLAIMER This is not legal, financial or any other form of advice, any opinions expressed, or error or omissions that are made are not intended to mislead the reader or direct actions, and readers are encouraged to do there own research before making any decisions.
In the past month an otherwise obscure reddit group called Wallstreetbets (wsb) has come to rival a hedge fund, and demonstrated how independent investors working in concert can cause a buying trap for hedge funds of epic proportions.
Over the course of January 2021 a group of unprofessional investors managed to get one up on wall street by taking advantage of public information to create a short squeeze. An act which used no insider trading, nor anything that would amount to a market abuse as it involved many independent actors acting in concert – we must be clear most manipulation law is about individuals be they companies or one person that hold tremendous influence or knowledge that gives an unfair advantage. What wsb did was no unfair as it relied on public information. What has been happening the last few weeks with hedge funds and market makers is more likely then not to be illegal under UK civil law and possibly criminal law as well.
If you want to understand more about how wsb legally manipulated prices read here.
Manipulation under Criminal Law:
Currently the UK has one main regulatory body the Financial Conduct Authority who releases guidance on laws affecting stock trading with two primarily legislations concerning the civil (non-criminal) abuses and 2 concerning criminal abuses.
The first is the UK Market Abuse Regulations and the second the EU Market Abuse Regulations. There is a lot of cross over between what the two find illegal with only issues of jurisdiction and reporting being different. We will discuss the regulations in light of FCA Guidance later in the article.
Then we have the two criminal acts, the first is the Criminal Justice Act 1993 and the second the Financial Services Act 2012 with various bit of common law on both. Within the two acts they set out what behaviour constitutes insider trading offences and misleading (fraud) offences. The FSA deals with misleading statements, impressions and benchmarks as far as I am aware on one, not wsb or Robinhood, Citadel, Merlin Capital Corporation, Etoro, Trading212, or many others have been accused of any type of fraud at this stage so we will not look at FSA, if you are interested here is a link to the relevant law if you wish to check yourself [FSA s89 misleading statements, s90 misleading impressions, s91 misleading benchmarks].
Although what this space as the recent deleting of 100,000 bad reviews left on google of Robinhood might amount to a different kind of collusion to provide misleading impressions.
The Criminal Justice Act 1993 is however relevant to this discussion as it concerns ‘insider trading’ which is one of the common arguments raised unsophisticatedly by supporters of wsb and by its reddit members themselves. See one of the reddit post here, although be aware similar posts are being deleted by Reddit, this is also evidence in the interview Barstool CEO Dave Portney had with Fox News and calls that the Senate will need to investigate Robinhood and potentially other brokers over trade order bans.
Now the CJA 1993 Part V s52 explains what insider trading offences are:
“(1) An individual who has information as an insider is guilty of insider dealing if, in the circumstances mentioned in subsection (3), he deals in securities that are price-affected securities in relation to the information.
(2) An individual who has information as an insider is also guilty of insider dealing if—
(a) he encourages another person to deal in securities that are (whether or not that other knows it) price-affected securities in relation to the information, knowing or having reasonable cause to believe that the dealing would take place in the circumstances mentioned in subsection (3); or
(b) he discloses the information, otherwise than in the proper performance of the functions of his employment, office or profession, to another person.
(3) The circumstances referred to above are that the acquisition or disposal in question occurs on a regulated market, or that the person dealing relies on a professional intermediary or is himself acting as a professional intermediary.”
Now whilst the market marker is not directly selling these stocks, like Citron is, they could be liable for collusion by aiding and/or abetting in the offence under the Accessories and Abettors Act 1861 s8:
“Whosoever shall aid, abet, counsel, or procure the commission of [F1any indictable offence] , whether the same be [F1an offence] at common law or by virtue of any Act passed or to be passed, shall be liable to be tried, indicted, and punished as a principal offender.”
Essentially, if for example it could be proven that Citron or Merlin Capital Corporation had committed a criminal offence, through insider trading then those who knowingly aided, or abetted, or advised, or procured tools to assist in the process would be equally liable of being tried in the same way.
Applying the law to the facts, for Citron or similar hedge funds involved in the sell side of the trade or buy side to be held liable of insider trading, based on the law set out above they would need to meet the following criteria:
- They deal in price affected securities;
- They have insider knowledge
- They encouraged another to deal in securities affected by information on a regulated market
- The information was disclosed in an otherwise improper way outside of the proper performance of his functions of employment, office or profession to another person. With this requirements extending to all parties privy to the knowledge.
Now, the first requirement is met in that both the market markers and hedge funds deal in price affected securities. The second, third and fourth requirements are not met as there is no evidence which demonstrates there has been insider trading.
To explain where we are at this moment in time, we have a number of suspicious pieces of activity. We have on the one hand the market makers who facilitated trades, increased rates on Robinhood traders and then through on associated organisation provided significant capital to a known market participant who they were in a position to help. Shortly after providing the capital, they, along with a number of other platforms then closed, banned or restricted access to a number of retail market participants resulting in the affected securities falling significantly in price to the advantage of market participants they indirectly had dealings with. It is important to note one of the coincidences that has been highlighted suggesting collusion is the timing of the actions, the day before the restrictions came into place hedge funds were withdrawing funds from profitable assets in order to place more sell side pressure at the same time the bans came into place leading to an unusually favourable market for the professional seller. Crucially, the sell options were also denied to wsb and retail investors on a number of the securities meaning they could not benefit from a reversal either. When asked about why the move has taken place, the exchanges have claimed it was to protect retail investors by having the effect of losing them significant amounts of money. While also going beyond the guidance on retail trading in place by such organisations as the European Union.
Market Manipulation under Civil Law
Now whilst the criminal case will require possibly an investigation or whistleblower to prove. The civil side might be easier to prove with what amounts to illegal manipulation behaviour set out under FCA handbook on MAR 1.6.2 to focus on the most relevant:
(1) buying or sellingqualifying investments at the close of the market with the effect of misleading investors who act on the basis of closing prices, other than for legitimate reasons;,[Note: Article 1.2(c) Market Abuse Directive]
(2) wash trades – that is, a sale or purchase of a qualifying investment where there is no change in beneficial interest or market risk, or where the transfer of beneficial interest or market risk is only between parties acting in concert or collusion, other than for legitimate reasons;
(3) painting the tape – that is, entering into a series of transactions that are shown on a public display for the purpose of giving the impression of activity or price movement in a qualifying investment;
(4) entering orders into an electronic trading system, at prices which are higher than the previous bid or lower than the previous offer, and withdrawing them before they are executed, in order to give a misleading impression that there is demand for or supply of the qualifying investment at that price, and
(5) buying or selling on the secondary market of qualifying investments or related derivatives prior to the auction with the effect of fixing the auction clearing price for the auctioned products at an abnormal or artificial level or misleading bidders in the auctions, other than for legitimate reasons.”
AND MAR 1.6.4
(1) transactions or orders to trade by a person, or persons acting in collusion, that secure a dominant position over the supply of or demand for a qualifying investment and which have the effect of fixing, directly or indirectly, purchase or sale prices or creating other unfair trading conditions, other than for legitimate reasons; [Note: Article 1.2(c) Market Abuse Directive]
(4) an abusive squeeze – that is, a situation in which a person:
(a) has a significant influence over the supply of, or demand for, or delivery mechanisms for a qualifying investment or related investment or the underlying product of a derivative contract;
(b) has a position (directly or indirectly) in an investment under which quantities of the qualifying investment, related investment, or product in question are deliverable; and
(c) engages in behaviour with the purpose of positioning at a distorted level the price at which others have to deliver, take delivery or defer delivery to satisfy their obligations in relation to a qualifying investment (the purpose need not be the sole purpose of entering into the transaction or transactions, but must be an actuating purpose)
(7) trading on one market or trading platform with a view to improperly influencing the price of the same or a related qualifying investment that is traded on another prescribed market, and
(8) conduct by a person, or persons acting in collusion, that secure a dominant position over the demand for a qualifying investment which has the effect of fixing, directly or indirectly, auction clearing prices or creating other unfair trading conditions, other than for legitimate reasons.
[Note: Article 1.2(c) Market Abuse Directive and Article 36(1) and Article 37(b) auction regulation] “
Without having all the evidence it is had to paint a clear picture on what kind of illegal manipulation, if one can be proven took place by the involved parties. Although based on what has taken place there are some of these points which might be relevant:
MAR 1.6.2(1) which discusses deliberately bidding up or lower at price at closing influence a market and (5) exchanging securities on a secondary market to influence prices. The former might be easier to prove as looking at what has been taking place at least on Wednesday the ban came in after markets closed to retail investors and immediately in after hours many stocks began wsb stocks began to crash in price. Where they were also being traded in volume off the books to influence this is another matter.
Then there is MAR 16.4(1), (4) (7) AND (8) it is fairly clear how locking a significant portion of the trading volume out of a security would give those still able to trade a dominant position over the security and the ability to fix the price. As the hedge funds themselves noted as they actively destroyed the prices of the wsb stocks whilst retail investors where unable to influence the market. In relation to the abusive squeeze, it is noted Robinhood sells information on the actions and positions of its retail investors to hedge funds to help them determine how to invest. If they saw a large number of retail investors with high leveraged positions and no way to access those positions it would not difficult for them to work out what they need to do to tank the stock in order to squeeze out investors when shares reopened to give themselves a more dominant holding in order to further drive down share prices. As for (7) and (8) with most trading exchanges blocking retail investors but not professionals this seems to link to 4 in that the hedge funds could tank prices on their exchanges knowing the impact it would have on retail investors. As for (8) this would require evidence produced on investigation or from a leaked source.
At this point it is important to state as far as I am aware whilst there are calls for investigation nothing official has been reported. Further, whilst many commentators are calling for reforms of the system to address the manipulations no statements have been released for reform. As for criminal or civil cases, without evidence of collusion I have not seen any cases put forward as a class action or individual against the corporations involved. As such until the evidential situation changes or the political I suspect the Executives of Robinhood, Merlin Corporation, Citadel, Citron, the other market makers will not go to jail, will not be fined, and will not be penalised for their actions. They might lose retail investors in the short term. Having said that, there is a big if in the room, if evidence came to light of insider trading then evidence of collusion would not be too far behind. If that were to happen then the executive of Robinhood and others could go to jail as the max sentence for market manipulation is 7 years imprisonment and unlimited fines if a criminal offence.