Opinion ID: 1249351
Heading Depth: 3
Heading Rank: 1

Heading: Market Manipulation and Short Selling

Text: Section 10(b), in proscribing the use of a manipulative or deceptive device or contrivance, id. § 78j(b), prohibits not only material misstatements but also manipulative acts. Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 177, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994). Under the statute: Manipulation is virtually a term of art when used in connection with securities markets. The term refers generally to practices, such as wash sales, matched orders, or rigged prices, that are intended to mislead investors by artificially affecting market activity. Section 10(b)'s general prohibition of practices deemed by the SEC to be manipulative  in this technical sense of artificially affecting market activity in order to mislead investors  is fully consistent with the fundamental purpose of the [Exchange] Act to substitute a philosophy of full disclosure for the philosophy of caveat emptor. . . .  Santa Fe Indus. v. Green, 430 U.S. 462, 476-77, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977) (alteration in original) (citations omitted). Thus, manipulation connotes intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities. Ernst & Ernst, 425 U.S. at 199, 96 S.Ct. 1375. The critical question then becomes what activity artificially affects a security's price in a deceptive manner. Although not explicitly described as such, case law in this circuit and elsewhere has required a showing that an alleged manipulator engaged in market activity aimed at deceiving investors as to how other market participants have valued a security. The deception arises from the fact that investors are misled to believe that prices at which they purchase and sell securities are determined by the natural interplay of supply and demand, not rigged by manipulators. Gurary v. Winehouse, 190 F.3d 37, 45 (2d Cir.1999); see also Mobil Corp. v. Marathon Oil Co., 669 F.2d 366, 374 (6th Cir.1981) (stating that the Supreme Court has indicated that manipulation under § 10(b) refers to means unrelated to the natural forces of supply and demand); cf. Pagel, Inc. v. SEC, 803 F.2d 942, 946 (8th Cir.1986) (agreeing with the SEC that [w]hen individuals occupying a dominant market position engage in a scheme to distort the price of a security for their own benefit, they violate the securities laws by perpetrating a fraud on all public investors); Crane Co. v. Westinghouse Air Brake Co., 419 F.2d 787, 796 (2d Cir.1969) (holding that nondisclosure of large open market purchases combined with large secret sales to deter stockholders from participating in a competing tender offer violated Rule 10b-5 by distort[ing] the market picture and deceiv[ing] the [issuer's] stockholders). In identifying activity that is outside the natural interplay of supply and demand, courts generally ask whether a transaction sends a false pricing signal to the market. For example, the Seventh Circuit recognizes that one of the fundamental goals of the federal securities laws is to prevent practices that impair the function of stock markets in enabling people to buy and sell securities at prices that reflect undistorted (though not necessarily accurate) estimates of the underlying economic value of the securities traded, and thus looks to the charged activity's effect on capital market efficiency. [4] See Sullivan & Long, Inc. v. Scattered Corp., 47 F.3d 857, 861 (7th Cir.1995). The Seventh Circuit's focus on disruptions to the efficient pricing of a security is consistent with our view that in preventing market rigging, § 10(b) seeks a market where competing judgments of buyers and sellers as to the fair price of the security brings about a situation where the market price reflects as nearly as possible a just price. SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1466 (2d Cir.1996) (quoting H.R.Rep. No. 73-1383, at 11 (1934)). In an efficient market, trading engineered to stimulate demand can mislead investors into believing that the market has discovered some positive news and seeks to exploit it, see In re Initial Pub. Offering Sec. Litig., 383 F.Supp.2d 566, 579 (S.D.N.Y.2005), aff'd Tenney v. Credit Suisse First Boston Corp., No. 05-3450-cv, 2006 WL 1423785 (2d Cir. May 19, 2006); the duped investors then transact accordingly. To prevent this deleterious effect on the capital markets, the Third Circuit distinguishes manipulative from legal conduct by asking whether the manipulator inject[ed] inaccurate information into the marketplace or creat[ed] a false impression of supply and demand for the security . . . for the purpose of artificially depressing or inflating the price of the security. GFL Advantage Fund, Ltd. v. Colkitt, 272 F.3d 189, 207 (3d Cir.2001); see also Jones v. Intelli-Check, Inc., 274 F.Supp.2d 615, 627-28 (D.N.J.2003). Market manipulation is forbidden regardless of whether there is a fiduciary relationship between the transaction participants. See United States v. Russo, 74 F.3d 1383, 1391-92 (2d Cir.1996); United States v. Regan, 937 F.2d 823, 829 (2d Cir.1991). A market manipulation claim, however, cannot be based solely upon misrepresentations or omissions. Lentell v. Merrill Lynch & Co., 396 F.3d 161, 177 (2d Cir.2005). There must be some market activity, such as wash sales, matched orders, or rigged prices. See Santa Fe, 430 U.S. at 476, 97 S.Ct. 1292. Furthermore, short selling  even in high volumes  is not, by itself, manipulative. GFL, 272 F.3d at 209. Aside from providing market liquidity, short selling enhances pricing efficiency by helping to move the prices of overvalued securities toward their intrinsic values. See id. at 208; Sullivan & Long, 47 F.3d at 861-62 (discussing the defendants' short sales as arbitrage that eliminates disparities between price and value); In re Scattered Corp. Sec. Litig., 844 F.Supp. 416, 420 (N.D.Ill.1994); John D. Finnerty, Short Selling, Death Spiral Convertibles, and the Profitability of Stock Manipulation 2-3 (Mar.2005), available at http://www. sec.gov/rules/petitions/4-500/jdfinnerty050505.pdf; Ralph S. Janvey, Short Selling, 20 Sec. Reg. L.J. 270, 272 (1992). In essence, taking a short position is no different than taking a long position. To be actionable as a manipulative act, short selling must be willfully combined with something more to create a false impression of how market participants value a security. Similarly, purchasing a floorless convertible security is not, by itself or when coupled with short selling, inherently manipulative. Such securities provide distressed companies with access to much-needed capital and, so long as their terms are fully disclosed, can provide a transparent hedge against a short sale.