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Market Abuse: The Invisible Fraud

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This species of securities fraud has an easier target and an unlimited potential to disrupt the capital markets. Its victims are random; they often have no connection to the financial institution that harmed them. The fraud often goes undetected because it is invisible. There are few if any clues to alert even the most sophisticated investor. Here are a few examples of this invisible species of fraud:

  •  Executives unload their stock, because as insiders they know the company will miss earnings;
  •  Stockbrokers use front running to gain an easy profit at the expense of their customers;
  •  High frequency traders conceal their deceptive conduct with speed and algorithms;
  •  Wall Street banks and hedge funds manipulate stock prices through naked shorting;
  •  Market makers collude with each other to manipulate the market price of a stock;
  •  “Pump and dump” schemes raise a stock’s price, before dumping it on the public;
  •  Hedge funds use insider trading as a “business model” to guarantee themselves a profit and others a loss.

As a concept, invisible fraud is nothing new. It was just as invisible in the 1920s when banks and brokers employed many of the same devices to cheat the public. Ferdinand Pecora, who headed the Senate investigation of the 1929 Crash, described why the public could not detect this type of fraud in the 1920s in words that ring true today:

The Public was always in the dark. It could not tell whether sales were due merely to the “free play of supply and demand,” or whether they were the product of manipulated activities…It all looks alike on the ticker. Nor did the public have access to the inside information on which the officers, the directors and the dominant shareholders act (emphasis added)

Today, “it all looks alike on” a computer screen.

Both state and federal securities acts provide private remedies for victims of insider trading and market manipulation. Nevertheless, few if any firms in this country define their practice areas to include the representation of those harmed by market abuse.

As a Senior Counsel with the SEC, Mr. Aguirre conducted one of the SEC’s largest investigations of a hedge fund for insider trading and market manipulation. In his June 2006 testimony before the Senate Judiciary Committee, Mr. Aguirre testified how lax SEC enforcement of securities laws against investment banks and hedge funds allows them to engage in “invisible fraud and manipulation” as they did in the years before the 1929 Crash. In its 108-page report, the Senate Finance and Judiciary Committees agreed with Mr. Aguirre:

The investigation of Pequot Capital Management could have been an ideal opportunity for the SEC to develop expertise and visibility into the operations of a major hedge fund while deterring institutional insider trading and market manipulation through vigorous enforcement. Instead, the SEC squandered this opportunity through a series of missteps….

Mr. Aguirre completed the investigation and proved Pequot had engaged in insider trading after he left the SEC and made news doing so. Forbes explains what happened: “After a scathing 2007 report by the Senate criticized the SEC’s handling of Aguirre’s Pequot investigation, and after Aguirre dredged up the smoking gun e-mails and passed them along to the Senate, the FBI and the SEC in late 2008, the SEC reopened the case in January 2009.” Pequot paid the SEC $28 million to settle the insider trading case uncovered by Mr. Aguirre. He now provides this expertise to the firm’s clients.


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