The New Market Manipulation

Tom C.W. Lin is Professor of Law at the Temple University Beasley School of Law. This post is based on a recent article by Professor Lin.

Financial markets face a new and daunting high-tech mode of manipulation. With this new mode of market manipulation, millions of dollars can vanish in seconds, rogue actors can halt the trading of billion-dollar companies, and trillion-dollar financial markets can be distorted with a simple click or a few lines of code. Almost every investor and institution is at risk. This is the new precarious reality of our financial markets.

In my recent article, The New Market Manipulation, I examine this new, perilous financial reality, the emerging high-tech mode of new market manipulation, and the need for better pragmatic policies to address the rising technological threats to manipulate our financial markets. The article offers an original, early examination of the new high-tech forms of market distortions that it calls cybernetic market manipulation, explains the critical consequences of these dangerously disruptive actions on the marketplace, and proposes sensible policies to better protect investors and safeguard the financial system.

In contrast to the analog, human-driven methods of traditional market manipulation, new cybernetic market manipulation generally uses the electronic communications, information systems, and algorithmic platforms of the new, high-tech financial marketplace to unfairly distort information and prices relating to financial instruments or transactions. At its core, these distortive actions and effects tamper with the humans and computerized information and communications systems of the marketplace. They corrupt how humans and machines communicate between and amongst each other in the financial markets. While cybernetic market manipulation generally shares the same unscrupulous goals as its traditional counterpart, it can be much more impactful because of the unparalleled interconnectedness and unprecedented value of modern financial markets. In some instances, cybernetic market manipulation represents the use of new financial technology to carry out old illicit schemes. In other instances, it represents the use of new financial technology to carry out new illicit schemes.

A few of the more common and prominent methods of cybernetic market manipulation are pinging, spoofing, electronic front running, and mass misinformation. Each of these methods is made possible by the evolution of financial market operations from a manual enterprise to a computerized enterprise. The rise of autonomous, high-speed supercomputers running on smart algorithms makes cybernetic market manipulation possible and profitable since many of the new manipulative schemes require the rapid submission and cancellation of voluminous orders measured in seconds. Human traders and brokers who gather and execute trades in time increments measured in minutes and hours are simply too slow to execute these schemes in a profitable manner, given the voluminous and swift orders that are frequently necessary to makes these schemes worthwhile. For instance, with mass misinformation schemes, unscrupulous parties can now leverage the mechanisms of new media technology and new financial technology to quickly disrupt and distort financial markets for their own gains on an unprecedented scale by disseminating bad data, fake news, and fictitious filings into a high-tech marketplace that thrives on accurate information. Because the new financial marketplace is so reliant on interconnected information and communications systems, a distortion to one source of information can have a large, volatile cascading effect on the greater marketplace in the short run, and a confidence-jarring effect on the greater marketplace in the long run.

The emergence of cybernetic market manipulation presents serious challenges for policymakers and regulators due to resource constraints and ambiguities in applying laws designed for a human-driven marketplace to one driven by smart machines. In particular, policymakers and regulators will likely be at a resource disadvantage relative to high-tech schemers, and have a hard time detecting and taking enforcement action against cybernetic manipulation schemes that they perceive to be illegal.

While a consensus in the debates concerning the larger regulatory questions about the new modes of market manipulation remains forthcoming, there are, nevertheless, preliminary steps that can be taken to address the looming implications confronting institutions, regulators, and investors. In particular, near term action can be taken to enhance the integrity of financial intermediaries, improve financial cybersecurity, and safeguard the investments of ordinary investors. First, financial intermediaries must serve as stronger sentinels against market manipulation because attempts at manipulation frequently happen at the intermediary level, and not at the market level. The financial marketplace is truly a market of intermediaries of various types and sizes. As such, financial intermediaries serve as key arenas for market manipulation. To better combat market manipulation that frequently originates at the intermediary level, policymakers should adopt the organizing principle of intermediary integrity. This principle, as detailed in the article, advocates for intermediary practices that favor private supervision, investor neutrality, enhanced security, and fair access in its conduct with counterparties and other market participants. Second, there should be greater and more urgent emphasis on financial cybersecurity, since the new methods of manipulation frequently leverage cyber means for devious ends. Because much of the technological infrastructure of the financial marketplace is linked, privately held and operated, policymakers, regulators, and private firms all need to work better in a concerted fashion to enhance financial cybersecurity and guard against cybernetic market manipulation. Third, ordinary investors should adopt a boring, low-cost, low speed investment strategy in the new high-tech, high-speed financial marketplace filled with the perils of cybernetic market manipulation. To best maximize their long-term returns in this turbulent, high-tech marketplace, ordinary investors should invest via low-fee index funds, exchange-traded funds, or mutual funds that track the broad marketplace. This straightforward investment advice is not novel or original; famed investors like John Bogle, Warren Buffett, and Burton Malkiel have been advocating this approach for years. Nevertheless, though it may seem straightforward and simple, many ordinary investors still lose billions of dollars each year trying to beat the market.

In sum, the new methods of cybernetic market manipulation will pose some of the most vexing challenges for policymakers and regulators in the coming years. The emergence of market manipulation methods that leverage new financial technology, electronic communications, and information systems to unfairly privilege the few at the expense of the many will threaten the very integrity and credibility of our financial markets. Every investor and institution could be at risk of suffering direct and indirect losses. While clear corrective long term actions still remain forthcoming, certain near term actions can be taken to stem the potential harms of cybernetic market manipulation, and better safeguard the integrity of financial markets for everyone.

The complete article is available for download here.

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