Section 9 and Prohibited Market Manipulation

Section 9 of the Securities Exchange Act of 1934 is a component of federal securities law in the United States. Its primary purpose is to ensure the integrity of the national securities exchanges by prohibiting the manipulation of security prices. The legislation aims to create a market where prices are determined by the genuine forces of supply and demand, free from artificial interference. This fosters fair and orderly markets, which builds investor confidence in the financial system.

Prohibited Manipulative Practices

Section 9(a) of the Act outlaws several forms of market manipulation. These prohibitions are designed to prevent a false or misleading appearance of active trading in a security. The rules target actions that could deceive investors about the true market value and liquidity of a stock.

Wash Sales and Matched Orders

Wash sales and matched orders are forbidden practices under Section 9(a)(1). A wash sale occurs when a transaction involves no change in the beneficial ownership of the security. For instance, an individual might simultaneously buy and sell the same security through different brokerage accounts, creating the illusion of trading volume without any change in their ownership position.

Matched orders achieve a similar result through coordination. This involves one party entering a buy order with the knowledge that another is simultaneously entering a sell order for the same number of shares, at the same time, and at the same price. For example, two traders could agree to place offsetting orders for 10,000 shares of a company at $50 per share, creating artificial trading volume.

False Trading and Misleading Information

The law also prohibits engaging in a series of transactions to create actual or apparent active trading for the purpose of inducing others to buy or sell. This is often referred to as “painting the tape,” where manipulators execute trades to make a stock appear more active than it is. This can artificially drive the price up or down, allowing manipulators to profit when legitimate investors are drawn in.

Furthermore, Section 9 makes it illegal for individuals with a financial interest in a security to disseminate false or misleading information to influence its price. This includes circulating rumors of a pending merger or a discovery that a person knows to be untrue. The goal is to prevent the spread of misinformation that could cause investors to make decisions based on fraudulent claims.

Elements of a Violation Claim

To successfully bring a claim for market manipulation under Section 9, a plaintiff must prove several legal elements. Merely showing that a prohibited act occurred is not sufficient. The requirements are designed to ensure that only intentional and impactful manipulation is penalized.

A central element is “scienter,” which is a legal term for intent or knowledge of wrongdoing. The plaintiff must demonstrate that the defendant acted with a manipulative purpose, meaning they intended to create an artificial price or a false appearance of active trading. Accidental actions that affect a stock’s price do not meet this standard, as the conduct must be shown to be deceptive or manipulative.

Beyond proving intent, the plaintiff must also establish causation and reliance. Causation means showing a direct link between the manipulative act and the financial loss suffered. The investor must prove the price at which they bought or sold the security was affected by the defendant’s illegal transaction. Reliance is often framed as “fraud-on-the-market,” where the plaintiff is presumed to have relied on the integrity of the market price distorted by the defendant’s manipulation.

Liability for Violations

Violating Section 9 can involve civil and criminal penalties. The Securities Exchange Act provides multiple avenues for enforcement to hold manipulators accountable and compensate victims. These liabilities serve as a deterrent against activities that undermine the fairness of the securities markets.

One enforcement mechanism is a private right of action granted under Section 9(e). This allows investors harmed by the manipulation to sue the responsible parties in court to recover their damages. If an investor can prove they purchased or sold a security at a price affected by the manipulative act, they can seek financial compensation. The court may also require the losing party to pay the costs of the lawsuit, including reasonable attorney’s fees.

The Securities and Exchange Commission (SEC) has the authority to bring civil enforcement actions against violators. The SEC can seek court orders, known as injunctions, to halt the manipulative conduct. It can also demand disgorgement, which requires the manipulator to give up any profits gained from their illegal activities. Additionally, the SEC can impose monetary penalties based on the severity and financial impact of the violation.

In cases of willful violations, the SEC can refer the matter to the U.S. Department of Justice for criminal prosecution. A criminal conviction for market manipulation can lead to fines and imprisonment. This reflects the gravity with which the legal system views intentional efforts to defraud investors.