Australia: Market manipulation - What is an "artificial price" and why does it matter?

The High Court's wider interpretation of the market manipulation provisions is good news for ASIC and the market. Expect to see ASIC become more active in this area with more prosecutions hitting the courts.

Effective market regulation demands that unfair practices like insider trading and market manipulation be prohibited and punished. While the focus is often on insider trading, last year the High Court affirmed the importance of the market manipulation provisions and its willingness to take a wider view of the provisions.

These provisions prohibit a person from engaging in a transaction that has or is likely to have the effect of creating an artificial price for trading in a financial product or maintaining at an artificial level the trading price in a financial product.

Effective anti-market manipulation provisions underpin the integrity of markets and ensure a lower cost of capital. One of the explanations for the abundant capital available to our market is the public perception that the market is basically fair.

Conversely, the economic damage caused by offences such as insider trading and market manipulation can also be significant (eg higher cost of capital). There is no doubt the significant increase in retail investors in our markets and perceptions of insider trading and market manipulation have sparked ASIC to increase its focus in this area: see D'Aloisio.

In Director of Public Prosecutions (Cth) v JM, the High Court took a pragmatic and sensible view of the market manipulation provisions.

The Court held that conduct, intentionally engaged in, which resulted in a price which does not reflect the forces of genuine supply and demand breached the relevant market manipulation provision (s1041A of the Corporations Act), adding that the forces of 'genuine supply and demand' are those forces which are created in a market by buyers whose purpose is to acquire at the lowest available price and sellers whose purpose is to sell at the highest realisable price.

The Court also held it was not necessary for ASIC to demonstrate, whether by some counterfactual analysis or otherwise, that the impugned transactions did create or maintain an artificial price. It is sufficient to show that the buyer or seller set the price with the sole or dominant purpose described.

In this case the defendant's daughter (at the defendant's request) had bought shares in a company at a price and in circumstances that prevented the day's closing price for the shares falling below the point at which the defendant's lender would be entitled to make a margin call requiring the defendant to provide additional collateral for the loan.

ASIC alleged the daughter had made the trades to ensure her father's lender could not make a margin call and this had the effect of creating an artificial price for shares.

In response, the defendant submitted the Court should take a narrow reading of the expression "artificial price" by reference to prices resulting from practices like "cornering" and "squeezing" (ie manipulating prices by rigging the supply or demand for a particular commodity).

In rejecting the defendant's narrow construction of the provision, the Court emphasised the importance of the market manipulation provisions generally and that they are not confined in their application to the creation or maintenance of an artificial price by a dominant market participant exercising that participant's market power.

It's good news for ASIC and the market since the case will remove any doubt that in order to make out the offence, ASIC need not establish that:

  • the price at which the transaction occurred was outside a notional "genuine" price in the market in order to determine whether an "artificial price" was created or maintained by the transaction; or
  • the transaction actually affected the behaviour of genuine buyers and sellers.

Instead, it is sufficient to show that the buyer or seller set the price with the sole or dominant purpose of setting or maintaining the price at a particular level rather than in circumstances reflecting the genuine forces of supply and demand.

This wider interpretation should embolden ASIC to seek more prosecutions in this area. Since 2009 it has had more than five outcomes (four convictions and one civil penalty) for market manipulation.

ASIC will continue to roll out its new real-time integrated market surveillance system and look to make out market misconduct cases based on provisions like:

  • insider trading (s 1043A);
  • creating a false or misleading appearance of active trading in a financial product or with respect to the market for, or the trading price of, a financial product (s 1041B);
  • maintaining, inflating, depressing or causing fluctuations in the trading price of a financial product through an artificial or fictitious transaction (s 1041C);
  • telling others that the trading price of a financial product will or is likely to rise or fall or be maintained because of an illegal market transaction (s 1041D); and
  • more generally, engaging in false or misleading conduct with respect to financial products (ss 1041E, 1041F and 1041G).

ASIC has for some time been anxious to be seen to focus on market integrity issues including insider trading, continuous disclosure, misleading statements and market manipulation. This decision will strengthen ASIC's hand.

The decision also raises an interesting side issue in the context of market stabilisation activities. This is the purchase of securities for the purpose of preventing, or slowing, any fall in the market price of those securities following an offer of those securities. For some time it has been unclear if those activities could be said to be undertaken for the sole or dominant purpose of maintaining the price of the securities at a particular level.

Market participants argue the need for market stabilisation most often arises as a result of perceived imperfections in the pricing and allocation of shares derived from the book build process. For that reason, ASIC has at least since the Telstra float in 1997 been allowing market stabilisation to take place in limited circumstances, primarily large IPOs, similar to the practice in various jurisdictions like the UK and the USA.

This limited relief was granted in the absence of a formal policy through no-action letters issued on the basis that stabilisation facilitates the offer of securities and is unlikely to create a false, misleading or uninformed market in the securities, given the disclosure of the arrangements and the conditions that must be complied with. ASIC may need to consider whether its draft 2005 policy, which has yet to be adopted, should be reviewed in light of this case.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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