A good governance structure in a company should not allow a major shareholder to manipulate share prices for personal benefit. Market manipulation is a practice of interfering with the normal operations of financial markets in a deliberate attempt to create artificial, false or misleading appearances with respect to the price of, or market for a security.
The Rules of the Securities and Exchange Commission of Sri Lanka Act no 36 of 1987 (as amended) state that, no person shall create, cause to be created or do anything that is calculated to create a false or misleading appearance or impression of active trading, or a false or misleading appearance or impression with respect to the market for or the price of any securities listed in a licensed stock exchange (Rule 12). Rule 13 indicates that no person shall by means of purchase or sale of any securities that do not involve a change in the beneficial ownership of those securities, or by any fictitious transactions or by any other means, create a false market in any securities listed in a licensed stock exchange.
Despite having these regulations, due to the weak monitoring and interference by officials market manipulations are considered the norm. Knowing the following ways of manipulation by major shareholders (not traders) would help strengthen governance structures to prevent or reduce such manipulations.
• Pump & dump
Placing buy or sell orders (or both) into the trading system in order to change or maintain the price of a stock. The motives for attempting to do this by a shareholder could be: to increase the value of a position in the market for finance purposes, to be able to issue new shares at a higher price or to attract other investors by creating a demand that the shareholder can sell into. Mostly, they use inside information to do this kind of manipulation.
• Hype & dump
The major shareholder through the control of the Board, releases information in an over-optimistic manner, in order to generate interest in the company’s securities or help a flagging market. In some cases this includes unsubstantiated or incorrect data, projections or evaluations or even non disclosure of a material fact that would impact the business negatively. When the price is right they would dump their shares.
• Bear raid
It is understood that at a critical point in the financial crisis (Nov 2007), the stock of Citigroup was attacked by traders by selling borrowed stock (short-selling) which may have caused others to sell in panic. The subsequent price drop enabled the attackers to buy the stock back at a much lower price. This kind of illegal market manipulation is called a “bear raid”. This looks like the opposite effect of hype & dump. Sometimes the major shareholder makes charges in the accounts to deliberately reduce profits or spreads incorrect information to give an indication of a negative trend, when the prices drop they raid the market to increase their controlling interest.
• Using the holding company
The major shareholder in the holding company, uses inside information to sell or buy into subsidiaries based on their future potential. The reverse is, selling personal loss making companies to the holding company through a complex structure, to syphon cash out. Eventually, the market for the listed share of the holding company is affected.