From the September 01, 2012 issue of Futures Magazine • Subscribe!

Defining market manipulation

Lessons from the commodity position limit rules

Understanding manipulation

The CEA prohibits the manipulation or attempted manipulation of the price of commodities and futures contracts and the prohibition may be enforced by the CFTC or a private party. Dodd-Frank amended the CEA so that it also prohibits manipulation on commodity swaps. The statutes don’t define the term “manipulate,” but both the CFTC and federal courts agree that manipulation means the intentional creation of an artificial price by forces other than legitimate supply and demand.

Courts have not created any single test to decide whether manipulation exists. Instead, manipulation cases get fact-specific, case-by-case consideration.

The two forms of market manipulation most discussed by courts are the market “squeeze” and the market “corner.” A corner happens when a dominant market player has a near monopoly holding of a cash commodity and also holds “long” futures contracts to buy in excess of the amount of the commodity actually available. The shorts — who either must provide the commodity or find offsetting long contracts to meet their future “sell” obligations — are then cornered into paying the price dictated by the dominant market player. In a squeeze, there may not be an effort to obtain an actual monopoly of the cash commodity, but supplies are low for other reasons and open interest on the futures market considerably exceed that supply.

Manipulation cases may also involve fraud, deceit, the use of false information or violation of exchange rules. A case involving a trader/supplier accused of using deceit and misinformation to manipulate the California electricity market serves as an example. To avoid losses on a long position and increase the price of electricity, the trader/supplier sought to create the appearance of an electricity shortage. The U.S. government indicted the trader on criminal charges for manipulation. The claimed manipulation included unnecessary plant shut-downs and the withholding of available electricity, as well as dissemination of false and misleading rumors and information about available electricity to market participants.

But actionable manipulation does not have to include fraud or a “corner” or “squeeze”. Legitimate transactions coupled with illegitimate intent or improper motive also can constitute market manipulation. Improper motive can serve as the basis of a claim for manipulation because motive is directly related to the legitimacy of the signals regarding value or worth that are the heart of a true market price. Wrongful intent distorts the legitimate forces of supply and demand that are otherwise assumed to have created the market price. One court said it this way: “Because every transaction signals that the buyer and the seller have legitimate economic motives for the transaction, if either party lacks that motivation, the signal is inaccurate. Thus a legitimate transaction combined with improper motive is commodities manipulation.”

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