Practice Note 5.12 False Trading and Market Rigging
Confidence in the financial system and effective intermediation of financial flow requires that markets be fair, orderly and transparent. Improper conduct which gives rise to a false or misleading appearance of trading activity, price movements or market information undermines market integrity and erodes investor confidence. SGX-ST seeks to ensure that its markets are fair and orderly and free of manipulative trading.
2. False Trading and Market Rigging
Rule 5.12.1 states that a Trading Member or a Trading Representative must not engage in any course of conduct that is likely to create a false or misleading appearance:(a) of active trading in any securities or futures contracts; or(b) with respect to the market for, or the price of, any security or futures contract.
Rule 5.12.1 prohibits false trading and market rigging. This trading misconduct involves an intentional interference with the free forces of supply and demand, such that a distortive effect is created vis-à-vis the market for, or the price of, the security or futures contract traded. This distortive effect occurs as a result of any trading strategy or practice that may be employed in order to artificially manage the market for, or the price of, the security or futures contract concerned.
SGX-ST's determination of whether a course of conduct is likely to create a false or misleading appearance will be made on an objective basis. In other words, the Rule does not require the Trading Member or Trading Representative to have intended to create the false or misleading appearance, or knew that it or he was in fact creating a false or misleading appearance. Rule 5.12.2 identifies the factors that SGX-ST may take into account when making the said determination.
The Rule does not prevent Trading Members and Trading Representatives from carrying out legitimate trading strategies that reflect the forces of genuine supply and demand. However, Trading Members and Trading Representatives must do so bearing in mind their obligations to maintain an orderly market, and to conduct their trading activities with an appropriate degree of care.
Trading Representatives (as licensed professionals) must not act as mere order takers and accept their customers' instructions blindly, without conducting any due diligence.
3. Guidance on Rule 5.12.2
Rule 5.12.2 identifies the factors that SGX-ST may take into account when making the determination of whether a course of conduct is likely to create a false or misleading appearance.
Rule 5.12.2(a): Whether the execution of the transaction is inconsistent with the recent trading activity in the security or futures contract, taking into account prevailing market conditions.
Trading Members and Trading Representatives would generally be familiar with the patterns of trading in each security or futures contract. They are therefore expected to exercise judgment, based on their experience and knowledge of trading in the security or futures contract, in assessing the likely impact of a proposed transaction on the market for a security or futures contract. This is especially so if the execution of the transaction would result in a significant change in the price (which is inconsistent with the recent trading activity in the security or futures contract, including the intra-day, daily, weekly or monthly price range) and represent a significant proportion of the daily traded volume in the security or futures contract.
Rule 5.12.2(b): Whether the execution of the transaction is likely to cause or contribute to a material change in the price of, or the market for, the security or futures contract, and whether the person involved or another person with whom the first person is collaborating may directly or indirectly benefit from alterations in the market or price.
In the absence of a good reason to buy or sell quickly, customers generally want to obtain the best price. A Trading Member or Trading Representative who receives an order that would materially alter the market for, or the price for, the security or futures contract, should consider whether it is genuine or manipulative.
Trading Members and Trading Representatives must also know their customers. Orders placed by a customer or a related party of that customer, who may have an interest in creating a material change in the market for, or the price of, a particular security or futures contract, should be closely examined.
Examples:(a) Orders placed by a large holder of a particular security or futures contract who may have an interest in inflating the value of that holding (e.g. window dressing for investment performance purposes), or decreasing the price of the security or futures contract (e.g. as a precursor to a takeover bid or for purposes which include lowering a conversion price).(b) Buying during the period of a rights issue by an underwriter, sub-underwriter or any other party which increases or maintains the price of the underlying security may include, as a purpose, inducing others to take up their rights entitlement under the issue.
Rule 5.12.2(c): Whether the execution of the transaction involves the placing of multiple buy and sell orders at various prices higher or lower than the market price, or the placing of buy and sell orders that give the appearance of increased volume.
A Trading Member or Trading Representative should not make large entries above or below the prevailing spread to facilitate filling an order on the other side of the market. The placing of buy (or sell) orders at various price steps below (or above) the market may create a false or misleading appearance that the entries are on behalf of genuine buyers (or sellers). The layering of orders also translates into a change in the depth screen and may mislead market participants with respect to interest in the counter.
Rule 5.12.2(d): Whether the execution of the transaction is likely to coincide with or is likely to influence the calculation of reference prices, settlement prices and valuations.
A Trading Member or Trading Representative should consider carefully any orders placed with instructions to execute them in or near the Closing Routine, particularly if a price target is set. A Trading Member or Trading Representative should also be alert to orders placed in or near the Closing Routine on the last trading day of the month, quarter or year, or on the expiry dates of options, warrants or futures contracts, which will move the price when executed.
A customer who, to the knowledge of the Trading Member or Trading Representative, declines the opportunity to obtain a better price during the day and prefers to pay a higher (or lower) price in or near the Closing Routine should be queried as to the strategy. This is important if the order is to buy (or sell) a small volume of the security or futures contract, which is likely to move the price and possibly fix the closing price. Further, if the Trading Member or Trading Representative received a series of similar orders over a number of days, each of which generated a price movement in or near the Closing Routine, the Trading Member or Trading Representative should be satisfied that the customer is not attempting to create a false or misleading appearance with respect to the price of the security or futures contract.
Examples:(a) A fund manager's quarterly performance will improve if the valuation of his portfolio at the end of the quarter in question is higher. By placing a large order to buy relatively illiquid securities and/or futures contracts, which are also components of his portfolio, to be executed in or just before the Closing Routine, his purpose might be to distort the price in his favour.(b) The expiry of futures contracts may require a timed unwinding of the countervailing security position. In these circumstances, price impact in some securities may be inevitable, particularly in less liquid securities. However, a Trading Member or Trading Representative should be alert to a customer seeking to cause unnecessary price impact to improperly generate a profit or move the index.
Rule 5.12.2(e): Whether parties involved in the transaction are connected or associated with each other.
Rule 5.12.2(f): Whether the order or orders for the purchase (or sale) of a security or futures contract is or are entered with the knowledge that an order or orders of substantially the same size, at substantially the same time, and at substantially the same price, for the sale (or purchase) of the security or futures contract has been or will be entered by or for the same or different parties (excluding Direct Business).
The time proximity of orders and the fact that they are for substantially the same price (particularly if the price is out-of-range) and quantity may suggest that the transaction is pre-arranged. Pre-arranged transactions have the effect of creating a false or misleading appearance of active trading, or improperly excluding other market participants from the transaction since the first bid or offer was not adequately exposed to the market.
Pre-arranged trading can create an unfair market as it is, in substance, executing risk-free transactions at pre-determined prices rather than at market prices. As the transfer of beneficial interest or market risk (if any) is only between persons who are acting in concert or collusion, there is essentially no legitimate commercial rationale behind pre-arranged transactions. Likewise, a Trading Representative who consistently matches his own buy and sell orders may be considered to have engaged in pre-arranged trading as the transactions are unlikely to be executed for a legitimate economic purpose.
The execution of crossings or transactions between the same parties for the same volumes, which are subsequently reversed at the same prices, also raises questions whether the transactions involve a change in beneficial ownership, or are for rollover of trades to extend settlement, or for a purpose of engaging in a circular trading scheme to create the impression of turnover.
Rule 5.12.2(g): Whether the execution of the transaction is likely to cause the price of the security or futures contract to increase or decrease, but following which the price is likely to immediately return to about its previous level.
The key question in this area is whether there appears to be any logical trading pattern to the price and volume of the security or futures contract, or whether it seems erratic. Trading is manipulative if it is intended to move the price of the security or futures contract.
Rule 5.12.2(h): Whether the bid (or offer) is higher (or lower) than the previous bid (or offer) but is withdrawn or amended to avoid execution.
This could indicate that the order is not genuine, especially where a distinctive pattern of such orders is observed. At the time the bid (or offer) was made, the Trading Member or Trading Representative did not intend to buy (or sell), but intended that the bid (or offer) would not trade and would be withdrawn eventually. Sometimes, such orders are entered to induce buyers (or sellers) into the market to facilitate the filling of an order on the other side of the market.
Circumstances that should be carefully reviewed by Trading Members and Trading Representatives include where there is a particularly high ratio of order to trade volume or a record of actively entering and amending orders on both sides of the order book but only trading on one side.
Rule 5.12.2(i): Whether the volume or size of the order or transaction is excessive relative to reasonable expectations of the depth and liquidity of the market at the time.
This Rule does not restrict Trading Members and Trading Representatives trading significant volumes where there is a legitimate purpose for the transaction and where the transaction is executed in a proper manner. However, trading significant volumes with the purpose of controlling the price of a security or futures contract will amount to manipulative trading.
A Trading Representative purchased substantial volume in a thinly traded counter, which accounted for a large proportion of the market volume, to establish a predetermined price. Sometimes, this may be followed by up-ticking the bid despite the absence of bona fide investor demand for the security or futures contract.
In the same vein, entering excessively large order(s) that is disproportionate to the depth of the order book may be manipulative, as it can create an imbalance between the quantum of demand and supply on the order book and in turn, mislead market participants with respect to interest in the security or futures contract.
Rule 5.12.2(j): Whether the buy (or sell) order is likely to trade with the entire best offer (or bid) volume and part of the offer (or bid) at the next price level.
If a customer regularly buys (or sells) on the up-tick (or down-tick) in the face of consistent selling (or buying) pressure, the Trading Member or Trading Representative should query whether the customer is a bona fide purchaser (or seller). Repetitive orders to clear the best offer (or bid) volume, particularly within a short time, suggest that the Trading Member or Trading Representative might be attempting to break the market. The trading spikes or troughs were meant to excite the market and attract spectators to join in.
Rule 5.12.2(k): Whether the buy (or sell) order forms part of a series of orders that successively and consistently increase (or decrease) the price of the security or futures contract.
If a customer places a sell order well above the best ask and one or more buy orders which would increase the price towards the customer's ask price, a Trading Member or Trading Representative should query the customer as to the strategy. It may be that the buy orders are intended to get the price running and facilitate the sale at the higher price. Illiquid securities or futures contracts, in particular, are susceptible to this type of improper trading.
Rule 5.12.2(l): Whether there appears to be a legitimate commercial reason for the transaction.
Many orders for legitimate commercial reasons can change the market for, or the price of, a security or futures contract when executed. Such orders are acceptable despite the volume and/or price impact, but the Trading Member or Trading Representative must consider any additional intentions that may exist and execute the order in an appropriate manner, bearing in mind its or his obligations, including the requirement to maintain an orderly market.
Examples:(a) A Trading Member conducting index arbitrage as principal and entering orders in an illiquid security or futures contract may have a material impact on the price of some securities or futures contracts, even with small orders. Index arbitrage orders are a legitimate commercial reason for trading, but the Trading Member must exercise sufficient care to ensure that the order did not result in a false or misleading appearance with respect to the price of a security or futures contract.(b) A Trading Representative accepting orders from a customer seeking to replicate an index at a time when one or more of the securities or futures contracts are being included or excluded from the relevant index, or when the size of the portfolio is being increased or decreased, should consider the impact the orders may have. If the Trading Representative attempts to execute a large proportion of the order during the Pre-Close phase, having ignored opportunities earlier in the day, and the order has a material impact on the closing price, it may result in allegations that the Trading Representative created a false or misleading appearance with respect to the price of that security or futures contract.(c) A Trading Member or Trading Representative trading as principal to hedge an exposure should be alert to the impact its trading may have on the market for, or the price of, a security or futures contract.
SGX-ST expects that Trading Members and Trading Representatives act as "gatekeepers" against market manipulation of any kind. Trading Members and Trading Representatives should provide frontline protection against manipulative activity and not contribute or act as an accessory to such trading misconduct.
In determining whether a course of conduct is likely to create a false or misleading appearance, SGX-ST will make the necessary inference from circumstantial evidence, such as an unusual pattern of trading, as well as a person's interest (whether genuine or ulterior motive) in the security or futures contract in question.
SGX-ST acknowledges that Trading Members and Trading Representatives may not always know if a customer's particular interest in a security or futures contract is genuine or not. However, a Trading Member or Trading Representative who receives an unusual order must be able to establish that it or he has made due enquiries and is satisfied as to the reason for the trading, i.e. taking into account the circumstances of the order, the purpose is unlikely to create a false or misleading appearance.
In the event that a Trading Member or Trading Representative reasonably suspects that an order may be for some other ulterior purpose but continue to facilitate the transaction, the Trading Member or Trading Representative must be aware that its or his contributing act towards the transaction may be unlawful.