Do you know what a wash sale is?
It’s a form of market manipulation that involves an individual — or a group of people — buying and selling to each other; usually with the intent of driving up the price, an old tactic that has existed since at least the days of the roaring 20’s.
Up until recently (2013), it was completely illegal, but following several years of mergers and acquisitions, the industry had become concentrated into only a small handfull of multinational banking corporations, and as a result, firms were constantly running into each other on the exchange. To remedy this problem, they changed the rules on wash-sales to allow for algorithms from the same firm to buy and sell to each other so long as they were from different trading desks.
“The proposed rule change requires FINRA members to have policies and procedures in place that are reasonably designed to review their trading activity for, and prevent, a pattern or practice of self-trades resulting from orders originating from a single algorithm or trading desk, or from related algorithms or trading desks. Additionally, the proposed rule change states that transactions resulting from orders that originate from unrelated algorithms or from separate and distinct trading strategies within the same firm would generally be considered bona fide self-trades.”
….Two commenters support FINRA’s amendment to focus the proposed rule change on “self-trades,” rather than “wash sales.” One commenter supports FINRA’s replacement of the term “wash sale” with “self-trade,” explaining that, unlike wash sale transactions, self-trades can be inadvertent and bona fide.”
Let me guess? You’re probably thinking that this creates a whole host of opportunities for misuse, right?
If these mega-banks were to ever decide to engage in any kind of manipulative trading activity, doesn’t this new rule create a large opening for plausible deniability?
They employ some of the most sophisticated AI programs in the world, so couldn’t they just design some kind of specialized algorithm that could create the impression that they were engaging in legal “self-trades“, when in reality they were just intentionally manipulating the price?
Should we really put it past them? They’re always getting caught rigging markets. A trial lawyer even went so far as to create a virtual roulette wheel that details every single one of J.P. Morgans massive frauds.
Price manipulation is definitively nothing new. In fact, 100 years ago there was a Roman à clef written about the life of Jesse Livermore, a financial celebrity of his time, that provides a unique look into the techniques of a market manipulator.
He tells various tales of people paying him to increase the marketability of a relatively illiquid stock so they could unload enormous positions on unsuspecting investors, and he would do this by pumping up the share price, driving it down, and creating volatility with the hope that it would attract a crowd.
Theoretically, this is much easier to accomplish in the premarket and afterhours because there is less volume and activity. Even as far back as the days of the Tontin Coffee House, the afterhours was known known as a venue for back-alley dealings that would be deemed less than honest.
This happens quite frequently (practically on a daily basis) in the microcap sector, usually before stock offerings. Market makers call this “Gun and Run” in the industry. Once you see the crowd come in, you pump it up, then you sell it on the way down.
Although manipulation of this sort can be extremely hard to prove (almost impossible), sometimes it can be very obvious, even when one lacks anything that would be considered concrete evidence.
Back on Oct.16th, 2019, you can see something like this happening to Cronos Group in the after-hours.
The share price suddenly spiked 40% for no reason whatsoever, and before the open, people were contemplating potential buy-outs, new management, and social media activity was through the roof — but nothing came, and 4 weeks later, the price was down 50%.
You can read more about this by clicking the image below.
Why should we be surprised? Technically a stock broker is just a retailer, and what do retailers usually do best? Trick you into buying stuff that you don’t actually need at inflated price levels.
Think about it this way: if you can just pump up a $20 stock to $300 (TLRY), you might be able to sell 10x more shares on the way down than you initially had to purchase to get it up that high.
But a lots changed since the days Livermore. There was definitely no algorithms back then, and physical certificates still had to be trucked around from broker to broker on a daily basis.
Today this is no longer the case, and all shares are held electronically at the Depository Trust and Clearing Corporation — a private company that is wholly owned and controlled by the major banks and brokers that dominate the industry.
Ever heard of the term “FTD” before?
Yes, no, maybe?
It stands for failure-to-deliver. Sometimes when a broker executes a sell order to another broker, for whatever reason (could be a whole host of things), the client may be unable to deliver the shares in time for the sale to close.
This frequently happens with short sales. At times, the price simply looks too good to pass up, and a customer might execute a sell order based upon the belief that they will eventually be able to find the shares at a later time; then when it comes time to deliver, the shares may still be unavailable..
In the United States, you have 3 days to deliver the stock, and the brokers have 13 days before they will be forced by their clearinghouse to find the shares, and deliver them, irregardless of the price that they have to pay.
But doesn’t allowing people to sell stock that they don’t actually own theoretically give these brokers the ability to invent shares out of thin air?
The answer yes, it does.
But isn’t the industry controlled by only a small handfull of mega-corporations? The answer is yes: 6 companies account for 70% of the prime brokerage industry.
Wouldn’t this theoretically give these brokers the ability to control the supply and demand of equities by selling shares to investors that don’t actually exist?
The answer is, again, yes..it does.
You might also be thinking that this ability to invent shares out of thin air is something that could easily be abused. You are definitely right to think this, and it certainly can, as it enables these mega-banks and brokers to sell large volumes of stock at artificially inflated price levels, while also incentivizing market manipulation schemes that involve coordinated groups of people pumping up the share price so they can sell IOU’s to unsuspecting investors when there aught not to be any shares available for sale in the first place — something that was recently shown to have occurred when a market maker was caught selling fake shares in a variety micro-caps using his market maker exception.
There is probably no better example of a situation where this hidden clause could be used to rip off thousands of people than TLRY, a stock that had 17 million shares in circulation and went from $20 to $300+ in only a matter of a few months — all due to momentum and hype.
Under normal conditions, the market is supposed to regulate itself through supply and demand, but if you can just fabricate a parabolic move, then sell people rights to shares that are technically not in existence at the time of the sale, you’ve essentially just sold people stock at a fictitious price that otherwise would not have existed under normal market conditions.
But if these companies are forced to buy-in these artificial shares after 13-days, wouldn’t that limit their ability to manipulate the price? If they only exist temporarily, it can’t be that big of a deal, can it? Well, as we probably all know, it’s usually a little bit more complicated than that, and it’s been shown that certain people/companies will recycle these fake shares back and forth, constantly resetting the 13-day forced buy-in rule back to day #1.
Let me guess, you’re probably thinking that this is all just some kind of crazy conspiracy theory, right? There is no way anybody would allow something this to happen! Cycle the fake shares back and forth? Wouldn’t that technically enable these massive multinational banking organizations to invent artificial shares at will, and for as long as they wanted?
Yes, and they have…