Protecting Market Participants from Manipulative Trading

Shareholder Advocate Winter 2024

January 30, 2024

Vaccine vials in manufacturing plant

Raymond M. Sarola and Laura H. Posner

When Congress passed the Securities and Exchange Act of 1934, one of its main goals was to protect the marketplace from the kind of manipulative conduct that precipitated the Great Wall Street Crash of 1929. In the nine decades since, technology has evolved tremendously, and with it the methods devious traders use to manipulate stock prices. But the fundamental threat market manipulation poses to the integrity of securities markets remains unchanged. That’s why Cohen Milstein has developed a series of innovative cases to hold trading firms and individuals accountable when they engage in manipulative securities transactions.

In a class action on behalf of investors in XIV notes, for example, the firm alleged that Credit Suisse manufactured a crash in these securities to obtain illegal profit and we obtained a groundbreaking decision from the Second Circuit holding that these allegations sufficiently pled market manipulation claims. We also represent a class of shareholders in Overstock who allege that the company’s “short squeeze” manipulated the market for its own securities; those claims are currently under review by the Tenth Circuit. And when the Supreme Court considered the scope of key market manipulation provisions of the Exchange Act, we filed an amicus brief advocating for the position that the Court ultimately adopted in holding a broker liable for engaging in manipulative conduct.

Most recently, we filed two market manipulation lawsuits on behalf of dynamic companies in the biotech and information technology industries against some of the nation’s largest broker-dealers for allegedly manipulating the price of these companies’ shares for their own profit. The cases allege that the defendants engaged in “spoofing” to artificially drive down the price of the companies’ shares in order to purchase them at below-market prices.

Spoofing is a form of market manipulation that typically involves placing large “baiting” orders on one side of the market to induce other traders to follow suit, then buying or selling that security on the other side of the market at the artificial prices created by the spoofing, and finally cancelling the baiting orders before they are executed.

The particular mechanisms of spoofing can involve complex features of high-frequency trading algorithms in electronic trading venues. But the basic concept can be analogized to a headfake in sports. A trader fools the marketplace into thinking it is trading in one direction with the goal of moving other traders in that direction, allowing the trader to execute its true trading intention in the other direction, at a greater profit. In our two cases, we allege that the defendants wished to purchase the companies’ shares at artificially low prices and used baiting orders to sell in order to execute buy orders at better prices.

Spoofing in the age of high-speed trading has been prosecuted criminally and civilly by the Department of Justice, Securities and Exchange Commission, and Commodities Future Trading Commission. But private spoofing cases have been very rare. This is in part because government agencies, unlike private plaintiffs, have access to pre-suit investigative discovery tools to obtain and analyze nonpublic trading data.

In our cases, we responded to this challenge by conducting comprehensive and sophisticated analysis of multiple sources of publicly available trading data, matching orders and executions, and applying parameters to identify patterns that courts have held to be indicative of spoofing. These patterns include placing large baiting orders on the opposite side of the market from smaller legitimate orders, cancelling the baiting orders after the smaller orders have executed, leaving the baiting orders on the market for only a short period of time, placing baiting orders behind other legitimate orders to make them less likely to execute, and other conduct contrary to acting as an ordinary market maker.

In both of our spoofing cases, defendants have moved to dismiss the complaint. In the Northwest Biotherapeutics case, briefing has concluded, and oral argument was held on November 14, 2023 before Magistrate Judge Gary Stein in the Southern District of New York. Arguing for the plaintiffs, we explained how our allegations are exactly the type that courts have consistently held sufficient to plead spoofing claims. The defendants argued, as those accused of spoofing always do, that their conduct was normal trading activity, either making markets or trading on behalf of clients. Magistrate Judge Stein recently issued a report and recommendation that agreed with our position on the sufficiency of our allegations as to defendants’ manipulative conduct, scienter, and reliance, and concluded that only our loss causation allegations require more detail in an amended complaint. We await final orders from the district court judges in both cases.

Favorable decisions affirming the sufficiency of these complaints would be a major development towards fairer markets and remedies for companies and investors that have been victimized by manipulative trading schemes.