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 SHOULD THE LAW PROHIBIT "MANIPULATION"
IN FINANCIAL MARKETS?

Daniel R. Fischel* and David J. Ross"

I. INTRODUCTION

Much of the regulation of financial markets seeks to prevent ma-

nipulation. The drafters of the Securities Act of 19331 and the Se-
curities Exchange Act of 1934,2 for example, were convinced that
there was a direct link between excessive speculation, the stock market
crash of 1929, and the Great Depression of the 193os. Thus, section
2 of the Securities Exchange Act states:

National emergencies, which produce widespread unemployment and

the dislocation of trade, transportation, and industry, and which bur-
den interstate commerce and adversely affect the general welfare, are
precipitated, intensified, and prolonged by manipulation and sudden
and unreasonable fluctuations of security prices and by excessive spec-
ulation on such exchanges and markets .... 3

Of particular concern to the drafters, as they repeatedly emphasized

in the legislative history, were the well-publicized "pools" dating from
the mid-nineteenth century in which perceived combinations of is-
suers, underwriters, and speculators, by their trading activities, al-
4
legedly caused wild fluctuations in security prices.

Lee and Brena Freeman Professor of Law, University of Chicago Law School.
-:-:::
Ph.D. candidate, University of Chicago Graduate School of Business; Vice President,
Lexecon Inc.
The authors would like to thank Frank Easterbrook, William Landes, Louis Loss, Andrew
Rosenfield, and seminar participants at the Law and Economics Workshops at Harvard Uni-
versity and the University of Chicago for valuable comments.
I Pub. L. No. 73-22, 48 Stat. 74 (codified as amended at x5 U.S.C. § 77a-77aa (i988)).
2 Pub. L. No. 73-291, 48 Stat. 881 (codified as amended at i5 U.S.C. § 78a-7811(1988)).
" 15 U.S.C. § 78b(4) (1988).
4 The legislative history of the securities laws, including the concern about the "pools," is
exhaustively analyzed in Steve Thel, The Original Conception of Section ro(b) of the Securities
Exchange Act, 42 STAN. L. REV. 385, 424-61 (i99o) [hereinafter Thel, Original Conception];
and Steve Thel, Regulation of Manipulation Under Section io(b): Security Prices and the Text
of the Securities Exchange .lct of 1934, 1988 COLUmN. Bus. L. REv. 359, 362-82 [hereinafter
Thel, Manipulation Under Section 1o(b)]. See also TWENTIETH CENTURY FUND, INC., THE
SECURITY MARKETS 445 (Alfred L. Bernheim & Margaret G. Schneider eds., 1935) ("IT]he more
important [manipulative] market campaigns . . . are the work of groups organized into syndi-
cates, pools or joint accounts."); Norman S. Poser, Stock Market Manipulation and Corporate
Control Transactions, 40 MIAMI L. REV. 671, 691 (1986) ("Beginning at least as early as the
middle of the nineteenth century and continuing until the very time that Congress considered

503
 HARVARD LAW REVIEW [Vol. 105:503

To curtail the pools and related speculative excesses, Congress

proscribed certain trading practices deemed to be manipulative.6
5
Among the practices so classified were wash sales, matched orders,
short sales, 7 and a more amorphous practice believed to be charac-
teristic of the pools - trading in a security "for the purpose of
inducing the purchase or sale of such security by others."8 The stat-
utory provisions governing these practices were designed "to purge the
securities exchanges of those practices which have prevented them
from fulfilling their primary function of furnishing open markets for
securities where supply and demand may freely meet at prices unin-
fluenced by manipulation or control." 9
The regulation of futures markets also reflects concern about the
dangers of manipulation. For example, the Grain Futures Act of
1922,10 one of the first federal statutes governing futures markets, had
as a core premise that futures prices "are susceptible to speculation,
manipulation, and control."' Similarly, the stated purpose of the
Futures Trading Act of 1982,12 which amended the Grain Futures
Act, 13 was "to . . .provide a measure of control over manipulative
activity and speculative excesses that demoralize the market to the
injury of producers and consumers and the exchanges themselves. "14

the bill that was to become the Exchange Act, the most important market manipulations were
the work of groups of speculators known as pools.").
5See I5 U.S.C. § 78i(a)(I)(A) (I988) (defining wash sales as security transactions in which
the parties intend for there to be no actual change in beneficial ownership).
6 See id. § 78i(a)(I)(B), (C) (defining matched orders as orders entered for the purchase or
sale of a security "with the knowledge that an order or orders of substantially the same size, at
substantially the same time, and at substantially the same price . . . have been or will be
entered by or for the same or different parties").
7See id. § 78j(a) (making it "unlawful for any person . . . [t]o effect a short sale" in
contravention of rules adopted by the Securities and Exchange Commission).
8 Id. § 78i(a)(2). This provision has been described as "the very heart" of the securities acts.
Louis Loss, FUNDAMENTALS OF SECURITIES REGULATION 853 (2d ed. 1988) (quoting SEC,
REPORT ON PROPOSALS FOR AMENDMENTS TO THE SECURITIES ACT OF 1933 AND THE SECU-
RITIES EXCHANGE ACT OF 1934, at 5o (H.R. Comm. Print 1941)).
9 SENATE COMM. ON BANKING AND CURRENCY, STOCK EXCHANGE PRACTICES, S. REP.
No. 1455, 73 d Cong., 2d Sess. 30 (I934) (the "Fletcher Report"), reprinted in 5 LEGISLATIVE
HISTORY OF THE SECURITIES ACT OF 1933 AND SECURITIES EXCHANGE ACT OF 1934, at Item
No. 21 (J. S. Ellenberger & Ellen P. Maher eds., 1973).
10Pub. L. No. 67-331, 42 Stat. 998 (1922) (codified as amended at 7 U.S.C. §§ 1-26 (1988)).
11Id. § 3, 42 Stat. at 999. This section was amended by Pub. L. No. 97-444, 96 Stat. 2294
(1983), to read, "are susceptible to excessive speculation and can be manipulated, controlled,
cornered or squeezed, to the detriment of the producer." Id., 96 Stat. at 2298.
12 Pub. L. No. 97-444, 96 Stat. 2294 (1983) (codified as amended at 7 U.S.C. §§ 1-26 (x988)).
13 The Grain Futures Act had been renamed the Commodity Exchange Act, Pub. L. No.
49-675, 49 Stat. 1491 (1936) (codified as amended at 7 U.S.C. §§ 1-26 (I988)).
14 SENATE COMM. ON AGRICULTURE, NUTRITION, AND FORESTRY, 95TH CONG., 2D SESS.,
FUTURES TRADING ACT OF 1978, at 136 (Comm. Print 1979). See generally S. REP. No. 85o,
9 5th Cong., 2d Sess. 5-13 (1978) (summarizing the history of the Commodity Futures Trading
Commission).
I991] MANIPULATION IN FINANCIAL MARKETS

The Act requires that all boards of trade designated as contract mar-
kets prevent the "manipulation of prices and the cornering of any
15
commodity by the dealers or operators upon such board.'
Recent events have dramatically increased interest in the concept
of manipulation in financial markets. The widely publicized criminal
prosecutions of Michael Milken, Drexel Burnham Lambert, Ivan
Boesky, Dennis Levine, Boyd Jefferies, the GAF Corporation and
James Sherwin, Salim "Sandy" Lewis, Paul Bilzerian, and others all
involved allegations of manipulation of securities markets. 16 More
generally, the stock market crash of October 1987 raised anew the
question whether certain trading practices, such as program trading,
manipulated the market by causing a severe decline in securities
prices. 17
The story is much the same in futures markets. The Hunt brothers
acquired massive amounts of silver and silver futures contracts in the
late 197oS and early I98os. This acquisition activity, coupled with a
precipitous worldwide rise and later collapse in the price of silver, led
to a decade of litigation and governmental investigations centered on
the claim that the Hunts had manipulated silver prices by cornering
the futures market in silver.' 8 Another area of considerable contro-
versy has been the proliferation of new instruments such as stock
index futures contracts. The Commodity Futures Trading Commis-
sion, the Securities and Exchange Commission, and the Federal Re-
serve Board have actively scrutinized whether such contracts are more
susceptible to manipulation than traditional futures contracts.19

157 U.S.C. § 7(d) (I988).

16 For an overview of these recent cases and the law of manipulation in general, see Arthur
F. Mathews, Theodore A. Levine, Girard Citera & David Dana, Manipulative Practices:Past,
Present and Future, in TRADING PRACTICES, THE PORTFOLIO EXECUTION PROCESS, AND SOFT
DOLLAR PRACTICES 199o, at 99, 167-87 (Practising Law Institute ed., i99o) [hereinafter Ma-
nipulative Practices].
17 For a discussion of the relationship between concern over the role of program trading
after the October 1987 crash with the analogous concern over the role of short sales after the
October 1929 crash, see Jonathan R. Macey, Mark Mitchell & Jeffry Netter, Restrictions on
Short Sales: An Analysis of the Uptick Rule and Its Role in View of the October 1987 Stock
Market Crash, 74 CORNELL L. REv. 799 (1989) [hereinafter Restrictions on Short Sales].
IsSee Minpeco, S.A. v. Conticommodity Servs., Inc., 832 F.2d 739, 740 (2d Cir. 1987) ("[fin
1979 and 198o... the Hunts allegedly attempted to corner the silver market and reap enormous
profits thereby."); Korwek v. Hunt, 827 F.2d 874, 875 (2d Cir. 1987) (discussing "an alleged
conspiratorial manipulation of the silver futures market and the concomitant well-publicized
plummet of silver and silver futures prices"); cf. Reauthorization of the Commodity Futures
Trading Commission: Hearings Before the Subcomm. on Agricultural Research and General
Legislation of the Comm. on Agriculture, Nutrition, and Forestry, 9 5 th Cong., 2d Sess., pt. 2,
at 157-69, 470-80 (1978) (describing the Hunts' position in the soybean market).
19For an analysis of this issue, see Linda N. Edwards & Franklin R. Edwards, A Legal
and Economic Analysis of Manipulation in Futures Markets, 4 J. FUTURES MARKETS 333, 359-
61 (1984); and Daniel R. Fischel, Regulatory Conflict and Entry Regulation of New Futures
Contracts, 59 J. Bus. S85 (1986).
 HARVARD LAW REVIEW IVol. 105:503

Notwithstanding the recent focus on manipulation, however, no

satisfactory definition of the term exists. 20 Indeed, neither the Secu-
rities Exchange Act nor the Commodity Exchange Act attempts to
define the term, even though both have the prevention of manipulation
as a primary goal. Academic commentary in this area also has been
unhelpful. 2 1 An inability to define a type of prohibited conduct fre-
quently reflects conceptual confusion, and the concept of manipulation
is no exception. 22 As one commentator has noted, "the law governing
manipulations has become an embarrassment - confusing, contradic-
'23
tory, complex, and unsophisticated.
This article attempts to provide what the existing literature lacks
- a principled analysis of the concept of manipulation. We begin,
in Part II, by exploring existing definitions of manipulation. These
definitions focus on concepts such as interference with the legitimate
forces of supply and demand and the creation of artificial prices. We
demonstrate that these concepts are meaningless and conclude that
there is no objective definition of manipulation - manipulative trades
must be defined with respect to the intent of the trader. Part III
analyzes the critical difference between actual and phony trades and
discusses the distinction between fraud and manipulation.
Part IV considers whether the possibility of "trade-based" manip-
ulations (schemes in which profits are obtained from the trades them-
selves) provides a rationale for legal rules that prohibit actual trades
based on the intent of the trader. Part V addresses manipulative
schemes other than trade-based schemes. In these sections we discuss
the difficulty of identifying manipulative conduct through objective
means, the low probability that trade-based manipulations can succeed
and hence the self-deterring nature of manipulations, and the ability
of market participants to deal with the problem by contract. Together,
Parts II through V provide the conceptual core of our analysis.
Part VI discusses three prominent recent examples of alleged ma-
nipulations. Parts VII through IX then apply our analysis to other
areas of the law. Part VII examines the law regulating distributions.
Part VIII discusses the regulation of markups charged by brokers in

20 See LOSS, supra note 8, at 86o n.75 ("[The word 'manipulative' as used in §§io(b) and
i5(c)(i) has never had any precise meaning. .. ").
21 The best existing treatment of the concept of manipulation is Frank H. Easterbrook,
Monopoly, Manipulation, and the Regulation of Futures Markets, 59 J. Bus. S103 (i986). As
we demonstrate below, however, Judge Easterbrook's analysis, which focuses on futures markets,
accepts the validity of the concept of manipulation as a premise and contains many of the same
flaws found in more conventional treatments of the subject.
22 Insider trading is another example of this phenomenon. Cf. Dennis W. Carlton & Daniel
R. Fischel, The Regulation of Insider Trading, 35 STAN. L. REv. 857, 86o-6i (r983) (discussing
the differences between the legal and economic definitions of "insider trading").
23 Edward T. McDermott, Defining Manipulation in Commodities Futures Trading: The
Futures "Squeeze," 74 Nw. U. L. REv. 202, 205 (1979).
i991] MANIPULATION IN FINANCIAL MARKETS

secondary transactions. Finally, Part IX applies our analysis to the

problem of corners and squeezes in futures markets.
In a sharp departure from current law and commentary, we con-
clude that the concept of manipulation should be abandoned alto-
gether. Fictitious trades should be analyzed as a species of fraud.
Actual trades should not be prohibited as manipulative regardless of
the intent of the trader.

II. THE DEFINITION OF MANIPULATION

Although manipulation is defined nowhere in regulatory statutes,

courts and commentators have suggested various formulations. One
common approach is that if "manipulation means anything in partic-
ular, it means conduct intended to induce people to trade a security
or force its price to an artificial level." 24 Alternatively, manipulation
has been defined as "deliberate interference with the free play of
supply and demand in the security markets. '25 According to these
definitions, conduct is manipulative if it is designed to do one of three
things: (i) interfere with the free play of supply and demand; (2)
induce people to trade; or (3) force a security's price to an artificial
level. It is useful to consider each of these elements separately.
The first formulation (interference with the free play of supply and
demand) is unhelpful because the term "interference" is undefined.
Presumably, manipulative conduct constitutes "interference," but this
is circular absent a definition of manipulation. Moreover, all traders
are part of the forces of supply and demand. The concept of manip-
ulation assumes some traders have legitimate demand for a security
while others do not. But again, absent a definition that distinguishes
between legitimate and illegitimate demand, the concept of interfer-
ence with supply and demand does not advance the inquiry.
The second formulation (inducing others to trade) is in one sense
an improvement over the first formulation because the former iden-
tifies a particular type of conduct that should be deterred. Indeed,
the "inducement of trading . . . is sometimes said to be the essence
of manipulation. 2 6 The problem with this definition of manipulation
is that it is hopelessly overbroad - it includes value-maximizing
exchanges in which the transaction makes each party better off. If
A, by making an offer to B that B accepts, "induces" B to enter into
a transaction that makes both better off, this cannot be "manipula-
tion." It is irrelevant whether the subject of the transaction is a

24 Thel, Original Conception, supra note 4, at 393; see also id. at 393 n.36 (collecting a long
list of authorities adopting this approach).
25 TWENTIETH CENTURY FUND, INC., STOCK MARKET CONTROL 107 (Alfred L. Bernheim,
Evans Clark, J. Frederick Dewhurst & Margaret G. Schneider eds., 1934).
26 Thel, Manipulation Under Section io(b), supra note 4, at 410.
 HARVARD LAW REVIEW [Vol. 105:503

security. Traders may have different estimates about the value of a

security, different tolerances for risk, or different liquidity needs.
Trades may be mutually beneficial in any of these situations.
Firms may also act to induce trades. For example, a firm might
engage in one of a variety of signalling devices - such as purchasing
its own shares or changing its capital structure or dividend policy -
as a way of communicating information about the value of its secu-
rities. 2 7 Alternatively, the firm might disclose new information about
the value or riskiness of its securities directly to investors. All of these
actions will likely lead to increases in the volume of trading and thus
can be said to have "induced" trading.
The trading in the above examples has the common characteristic
of being for some purpose, such as repricing securities in light of new
information, portfolio rebalancing, or liquidity. Perhaps manipulation
is conduct that induces investors to trade for no purpose. But this
definition is also problematic. How can investors be "induced" to
trade (and incur transaction costs in the process) for no purpose? And
what categories of trades have no purpose? Existing definitions of
manipulation provide no answers to these questions and thus provide
no guidance on the distinction between beneficial and non-beneficial
trades.
The third formulation (forcing security prices to an artificial level)
has intuitive appeal because creation of artificial prices, unlike trading,
is socially undesirable. For this formulation to be operational, how-
ever, one must be able to define the difference between an artificial
and a non-artificial price. This task turns out to be much more
difficult than it might at first appear.
One possible definition is that any price change that results from
trading designed to produce such a price change is an artificial price.
This definition is unsatisfactory because trading with the purpose of
producing a price change is not necessarily harmful. Consider again
the example of an issuer that purchases its own shares to signal
investors that the shares are undervalued. In this example, the trading
moves prices in the correct direction and thus the resulting price
change should not be labeled "artificial."

27 Studies of share repurchases are consistent with the hypothesis that firms offer premia for
their own shares in order to signal positive information. See Larry Y. Dann, Common Stock
Repurchases: An Analysis of Returns to Bondholders and Stockholders, 9 J. FIN. ECON. 113,
116-36 (ig8i); Theo Vermaelen, Common Stock Repurchases and Market Signalling: An Em-
piricalStudy, 9 J. FIN. ECON. 139, 159-71 (98). Similarly, studies of dividend changes find
that announcements of such changes provide useful information to market participants. See,
e.g., Joseph Aharony & Itzhak Swary, Quarterly Dividend and Earnings Announcements and
Stockholders' Returns: An Empirical Analysis, 35 J. FIN. I, ii (i98o) ("[Q]uarterly cash divi-
dends provide useful information beyond that provided by corresponding quarterly earnings
numbers.").
i99I] MANIPULATION IN FINANCIAL MARKETS

An alternate approach is to focus on whether the trading moves

prices closer to or away from their correct level. But what is the
"correct level"? One possibility is the price that reflects long-run
conditions of supply and demand. Manipulation could then be defined
as trades that "do not move price more quickly in the direction that
reflects long-run conditions of supply and demand. '28 Judge Frank
Easterbrook has suggested this definition of manipulation. But this
definition is also unsatisfactory. What if the trades do not move prices
at all or move prices in the direction that reflects short-run conditions
of supply and demand? Most importantly, what happens if the trades
move prices in one direction because the trader genuinely believes
that prices will move in this direction, but the trader turns out to be
wrong and prices ultimately move in the opposite direction? Trading
based on a genuine belief that prices will ultimately move in the
direction of the trades is the essence of nonmanipulative trading.
To avoid the need to distinguish between short-run and long-run
conditions of supply and demand, the correct level of prices could be
defined as the level prices would be if all relevant information were
publicly disclosed. But this definition is also unhelpful. "All relevant
information" includes not only the information possessed by the trader,
but also the trades themselves. If prices move in response to trades,
the price cannot be said to be "artificial" unless the trades are defined
as illegitimate in some way. Once again we are faced with the prob-
lem of circularity - improper trades are trades that produce an
artificial price and artificial price is defined as a price produced by
improper trades.
Defining manipulation by reference to whether the trades move
prices closer to their correct level has another flaw: it jeopardizes
property rights in information. Absent a fiduciary relationship or
other special circumstance, traders do not have a duty to disclose the
information they possess that motivates their trades. 29 Disclosure
would cause the information to lose its value and thus eliminate the
incentive to acquire the information in the first place. Without such
an incentive, no one would search for information and securities
markets - which depend on new information to cause price changes
- would be destroyed. But trades, as well as disclosures, can reveal
information. The more information the trade reveals, the closer the
trade comes to a direct disclosure, which decreases the trader's ability
to capture the value of the private information in his possession. For
markets to exist, therefore, trades cannot be fully revealing. 3 0 Traders

23 See Easterbrook, supra note 21, at Sii8.

29 See, e.g., Chiarella v. United States, 445 U.S. 222, 230 (198o) (holding that there is no
duty to disclose absent "a relationship of trust and confidence between [the] parties to a trans-
action").
-30See, e.g., Sanford Grossman, On the Efficiency of Competitive Stock Markets Where
 HARVARD LAW REVIEW IVol. 105:50 3

must be allowed to disguise their trades to avoid disclosing the infor-

mation they possess to other traders. Accordingly, manipulation can-
not be defined as trading that does not move prices closer to their
"correct" level. Such a definition would deny traders the ability to
disguise their trades to capture the value of the information they
possess.
Thus, there is no objective definition of manipulation. The only
definition that makes any sense is subjective - it focuses entirely on
the intent of the trader. Manipulative trades could be defined as
profitable trades made with "bad" intent - in other words, trades
that meet the following conditions: (i) the trading is intended to move
prices in a certain direction; (2) the trader has no belief that the prices
would move in this direction but for the trade; and (3) the resulting
profit comes solely from the trader's ability to move prices and not
from his possession of valuable information. Traders who trade with
"good" intent - for the purpose of moving prices in the direction they
believe prices will move - are not engaged in manipulation. Simi-
larly, traders with private information who disguise their trades with
the effect that prices do not move in the correct direction, or even
move in the wrong direction, also trade with "good" intent and thus
are not engaged in manipulation because their ultimate profit is attrib-
utable to the private information they possess.

I1. MANIPULATION COMPARED WITH FRAUD

The relationship between manipulation and fraud has never been

clear. Judge Frank Easterbrook has stated that manipulation is a
species of fraud. 3 1 Another commentator has posited that manipula-
tion is "[r]elated to the field of fraud - but not altogether a part of
it as a matter of legal analysis." 3 2 Precisely how manipulation is
related to fraud, and how it is different, has never been analyzed.
For certain types of conduct, manipulation is best understood as
a species of fraud. For example, fictitious transactions - wash sales
or matched orders - are designed to mislead market participants into
believing that buyers and sellers are trading in a security when in fact
no transactions are taking place. Such transactions are a form of
fraud by conduct. Indeed, the concept of manipulation for this cat-
egory of cases is superfluous. The concept of fraud is sufficient. 33

Trades Have Diverse Information, 31 J. FIN. 573, 585 (1976) ("The price system can be
maintained only when it is noisy enough so that traders who collect information can hide that
information from other traders.").
,3 See Easterbrook, supra note 21, at Sxo6 ("'Monopoly' in a futures market ... turns out
to be a species of fraud.").
-2 Loss, supra note 8, at 843.
33This was recognized at common law in the nineteenth century. See Scott v. Brown,
i99x] MANIPULATION IN FINANCIAL MARKETS

Defining manipulation as a species of fraud does not work as well

in situations involving actual, as opposed to fictitious, trades. 34 Con-
sider the example of a trader who trades with "bad" intent - he
attempts to affect the price with no belief that the price would oth-
erwise move in this direction. Would such a trader be deemed to
have engaged in fraud? It could be argued that the trader has engaged
in fraud by acting (that is, trading) for the purpose of misleading
market participants about the true value of the security. But there is
a critical difference between the typical fraud and the trading in this
example. The typical fraud involves a bad act (a false statement) as
well as an intent to defraud. 35 In the fraud case, the intent question
becomes relevant only when there is a bad act as determined by an
objective test - whether the statement is false. Furthermore, one
can argue, the law is concerned only with conduct objectively deter-
mined to be wrongful. Absent wrongful conduct, there is no harm
and no loss - true statements are never punished. Hence, unless a
statement is false, no need exists to examine the speaker's intent.
Thus, the trader in the above example presents a very different
case from the one engaging in fictitious trades or making false state-
ments, because the former has not engaged in any conduct that can
be objectively determined to be socially undesirable. The only act is
trading, trading that cannot be distinguished from other trading using
objective measures. The only distinction is the intent of the trader.
In the case of manipulation, in other words, whether conduct is bad
depends entirely on the intent of the trader. In the case of fraud, by
contrast, whether conduct is undesirable depends on objective criteria
- whether there has been a false statement - and not solely on the
speaker's intent.
At first blush, this difference between fraud and manipulation
disappears in cases of nondisclosure as opposed to cases involving

Doering, McNab & Co., [x892] 2 Q.B. 724, 730 (C.A.) (finding "no substantial distinction
between false rumours and false and fictitious acts"). The Scott case was cited in Schreiber v.
Burlington Northern, Inc., 472 U.S. 1(985), to support the proposition that manipulation at
common law required a showing of deception. See id. at 7 n.4. The Supreme Court in recent
years has held that the term manipulation under the securities laws requires deception. See id.
at 8 (holding "that 'manipulative' acts under § 4(e) [of the Securities Exchange Act] require
misrepresentation or nondisclosure"); Santa Fe Indus. v. Green, 430 U.S. 462, 476 (I977) (holding
that the term "manipulative" in § iolb) of the Securities Exchange Act "refers generally to
practices, such as wash sales, matched orders, or rigged prices, that are intended to mislead
investors by artificially affecting market activity").
,4See Poser, supra note 4, at 699 (concluding, after surveying the common law, that "[tihe
effecting of actual transactions for the purpose of influencing its price by inducing others to buy
or sell a security, though commonly viewed as manipulative, remained legal in the United States
until the enactment of the Exchange Act").
35See, e.g., RESTATEMENT (SECOND) OF TORTS § 525 (1976) (defining fraud as, in part, "a
misrepresentation of fact, opinion, intention or law for the purpose of inducing another to act
or to refrain from action").
 HARVARD LAW REVIEW [Vol. 105:503

false statements. Because failure to disclose, like trading, is an am-

biguous act, it could be argued that nondisclosure cases are similar to
manipulation cases. But the analogy breaks down upon closer anal-
ysis. Nondisclosure in law is actionable only when there is a duty to
speak arising from objectively observable criteria, such as the rela-
tionship between the parties. 3 6 Absent such a duty to speak, there
can be no actionable nondisclosure, regardless of the intent of the
alleged wrongdoer. Once again, in fraud, but not in manipulation,
whether the act is wrongful does not depend solely on the intent of
the alleged perpetrator.
There is a second difference between fraudulent conduct and actual
trades with bad intent. Legal rules are needed more to deter fraud
than to deter actual trades with bad intent. False statements (putting
aside reputational effects) are not self-deterring. Such statements fre-
quently require trivial or no capital investment. Absent a legal rule
requiring, for example, disgorgement of gains or compensation for
losses, fraud can be highly profitable. This is much less the case with
actual trades, as we discuss immediately below.

IV. SHOULD LEGAL RULES PROHIBIT ACTUAL TRADES

BASED ON THE INTENT OF THE TRADER?

As we have seen, there is no objective definition of manipulation.

Everything turns on the intent of the trader. The question then arises
whether legal rules should ever attempt to prevent actual trades made
with "bad" or manipulative intent. To answer this question one must
assess the relative social costs and benefits of a legal rule of prohibition
compared with a rule of no prohibition.

A. The Probabilityof Successful Manipulation

One relevant inquiry in analyzing the desirability of a legal pro-
hibition is the likelihood that the conduct will occur in the absence of
a prohibition. In the case of manipulation, the likelihood is extremely
low.
Traders will attempt to manipulate the price of a security only
when they believe it is profitable to do so. Profitable (successful)
manipulations require two conditions: first, trading must cause the
price of the relevant security to rise; and second, the manipulator
must be aDle to sell at a price higher than the price at which the
manipulator purchased (plus transactions costs incurred). If the first
condition is not met, no possibility of profit exists because the manip-
ulator will be purchasing and selling at the market price and incurring
transactions costs in the process. Similarly, if the second condition is

36 See Chiarella v. United States, 445 U.S. 222, 232 (1980).

,991] MANIPULATION IN FINANCIAL MARKETS

not met, no possibility of profit exists because the proceeds received

in sale will not exceed the proceeds expended in purchase.
It is extremely difficult to satisfy both conditions simultaneously.
In most cases, anonymous trades will have no effect on security prices,
a violation of the first condition. To satisfy this condition, the ma-
nipulator will have to convince other traders that he has information
about the value of the security they do not have, or he will have to
expend huge amounts of capital. The consequence of this strategy,
however, is that the price of the relevant security is likely to rise
simultaneously with the trades but not to rise thereafter, a violation
of the second condition. Thus, the basic dilemma of the prospective
manipulator is to seem informed enough to cause prices to rise by
purchasing, but not so informed as to cause the price to rise simul-
taneously with purchase. Also, he must not appear informed at the
time of sale, lest his sales cause the price to fall. The relationship
between trading and price movements thus creates an intractable
dilemma for the potential manipulator.
r. The Relationship Between Trading and Price Movements. -
Most discus3ions of manipulation assume that there is a direct rela-
tionship between trading and price movements. 3 7 Because purchases
increase the demand for a security and sales increase the supply, it is
commonly assumed that trading affects securities prices. But the
actual relationship between trading and price movements is far more
complex.
The relationship between demand and supply shifts and securities
prices depends on the elasticity of demand and supply. 38 When supply
(demand) is relatively elastic, an increase in demand (supply) need not
affect price. 39 Portfolio theory provides powerful reasons to believe
that demand and supply are elastic. Investors hold securities to obtain

37 This was clearly the assumption of the drafters of the securities acts, who believed that
purchases raised prices and sales depressed them. See, e.g., S. REP. No. 792, 73 d Cong., 2d
Sess. 7-9 (1934), reprinted in 5 LEGISLATIVE HISTORY OF THE SECURITIES ACT OF 1933 AND
SECURITIES EXCHANGE ACT OF 1934, at Item No. 17 (J. S. Ellenberger & Ellen P. Mahar
eds., 1973).
3s Elasticity refers to the percentage change in quantity demanded or supplied for a given
change in price. To illustrate, if demand decreases by io% when price increases by io%, then
the elasticity of demand is -i. Similarly, if supply increases by xo% when price increases by
Io%, then the elasticity of supply is i. The relevant elasticity for determining how an increase
in demand would affect price is the elasticity of supply, because this elasticity determines how
much of a premium buyers must offer to induce suppliers to provide the additional quantity
demanded.
-19Even when supply and demand are relatively inelastic, most transactions will not affect
price because they are too small. Consider a security with a demand elasticity of only -. 5 (a
I% increase in supply causes a 2% decline in price). Assume further that there are io million
shares outstanding. In these circumstances, the sale of an additional i,ooo shares would cause
prices to decline by only 0.02%. In other words, most buyers and sellers would still behave as
price-takers no matter what the elasticity of supply and demand,
 HARVARD LAW REVIEW [Vol. 105:503

a stream of future income that can be used to finance future con-

sumption and investment. 40 To achieve this goal, they can choose
from many possible combinations of available assets. 4 1 Because it is
possible to find substitute assets that closely replicate the expected
stream of income provided by any particular security, the supply of
near-perfect substitutes for any particular security is likely to be much
larger than the supply of the security itself. 4 2 The availability of close
substitutes means that an investor seeking to purchase a particular
security should be able to convince current holders to sell the security
at the current market price. 43 Thus, theoretically, trading need not
have any effect on securities prices. This proposition is known as the
44
substitution hypothesis.
Considerable empirical evidence supports the substitution hypoth-
esis. Millions of shares of listed securities are traded every day with
no change in the market price. Studies of situations such as primary
and secondary offerings in which large amounts of securities are sold
(an increase of supply) have typically concluded that there is no per
se relationship between the size of the offering and price movements. 4 5
Similarly, a high percentage of block trades occurs at the existing
46
market price.
The substitution hypothesis posits that the demand and supply for
securities are sufficiently elastic that trading by itself need not affect
security prices. This does not mean, however, that no relationship
exists between trading and price. Investors who obtain information
that leads them to believe that a security is underpriced will want to

40 Most models of capital market equilibrium pricing imply that individual securities have
good substitutes. See, e.g., Robert C. Merton, An Intertemporal Capital Asset Pricing Model,
41 ECONOMETRICA 867 (I973); William F. Sharpe, Capital Asset Prices: A Theory of Market
Equilibrium Under Conditions of Risk, 19 J. FIN. 425, 429 (1964).
41 See Myron S. Scholes, The Market for Securities: Substitution Versus PricePressure and

the Effects of Information on Share Prices, 45 J. Bus. 179, 18x (1972).

42 See id. at 181-82.

43 See id. at 2o6.

44 See id. at 181-82.
45 For the evidence on new equity issues, see Alan C. Hess & Peter A. Frost, Tests for Price
Effects of New Issues of Seasoned Securities, 37 J. FIN. II, 24 (1982); Richard Kolodny &
Diane R. Suhler, Changes in Capital Structure, New Equity Issues, and Scale Effects, 8 J. FIN.
RES. 127, 135 (1985) (attributing negative returns to transaction costs, tax effects, and new
unfavorable information); and Richard H. Pettway & Robert C. Radcliffe, Impact of New Equity
Sales upon Electric Utility Share Prices, 14 FIN. MGMT. 16, 24 (1985). Secondary distributions
are considered in Paul Asquith & David W. Mullins, Jr., Equity Issues and Offering Dilution,
I5 J. FIN. ECON. 61, 77-79 (1986); Wayne H. Mikkelson & M. Megan Partch, Stock Price
Effects and Costs of Secondary Distributions, 14 J. FIN. ECON. 165, 192-94 (1985); and Scholes,
supra note 41, at 198-99. Asquith and Mullins find results consistent with both the information
hypothesis and the price pressure hypothesis. See Asquith & Mullins, supra, at 82.
46 See Robert E. Holthausen, Richard W. Leftwich & David Mayers, The Effect of Large
Block Transactions on Security Prices: A Cross-SectionalAnalysis, i9 J. FIN. ECON. 237, 245-
46 (1987) [hereinafter Large Block Transactions].
I991] MANIPULATION IN FINANCIAL MARKETS

buy it. Other investors who receive information leading them to

believe that a security is overpriced will want to sell it. The buying
and selling activity of these market participants may reveal the infor-
mation they have and cause prices to adjust accordingly. Such ad-
justment will result in a relationship between trading and price move-
ments.
Put differently, the price of a security at any point in time depends
on the value investors expect it will provide in the future. That future
value is uncertain. Investors who obtain information that the future
value is high relative to today's price will want to buy. Their pur-
chases, however, may lead other market participants to revise upward
their expectations about the value of the security and thus cause its
price to rise. Because the market price is a function of the information
available, trading may affect the market price by providing market
participants with additional information. This is known as the infor-
47
mation hypothesis.
Many studies support the information hypothesis as well. An-
nouncements of intentions by traders believed to be informed can
have significant consequences for stock prices. This is true both for
potential acquirors 4s and for issuers or underwriters in the case of
primary equity offerings 49 or secondary distributions.5 0 Similarly,
51
many block trades have stock price consequences.
Trading can result in price changes for another reason: liquidity
costs. 5 2 An investor who wants to buy or sell a large quantity of
shares immediately may be unable to do so at the market price because
at that moment there are not enough market participants willing to

47 See, e.g., Asquith & Mullins, supra note 45, at 62; Kolodny & Suhler, supra note 45, at
128-29.
45 See, e.g., Clifford G. Holderness & Dennis P. Sheehan, Raiders or Saviors? The Evidence

on Six ControversialInvestors, 14 J. FIN. EcoN. 555, 577 (985).

49 A typical finding is that announcements of primary equity offerings are associated with
stock price declines that average about three percent. These declines are usually attributed to
an information effect. See Asquith & Mullin, supra note 45, at 66; Kolodny & Suhler, supra
note 45, at 135; Pettway & Radcliffe, supra note 45, at 22-24; see also Avner Kalay & Adam
Shimrat, Fi n Value and Seasoned Equity Issues: Price Pressure, Wealth Redistribution, or
Negative Information, 19 J. FIN. ECON. 109, 125 (1987) (citing empirical evidence that new
equity issues by industrial companies are associated with a drop in stock price); Ronald W.
Masulis & Ashok N. Korwar, Seasoned Equity Offerings: An Empirical Investigation, 15 J.
FIN. ECON. 91, 1x6 (1986) (documenting a significant decrease in the value of common stock
on the announcements of primary and combination stock offerings); Katherine Schipper & Abbie
Smith, A Comparison of Equity Carve-Outs and Seasoned Equity Offerings: Share Price Effects
and CorporateRestructuring, i J. FIN. ECON. 153, 181 (1986) (concluding that announcements
of public offerings of parent common stock are associated with shareholder losses).
51 See Asquith & Mullins, supra note 45, at 70-74; Scholes, supra note 41, at 203-04.
51 See Alan Kraus & Hans R. Stoll, Price Impacts of Block Trading on the New York Stock
Exchange, 27 J. FIN. 569, 587-88 (0972); Large Block Transactions, supra note 46, at 238-39,
252-54, 264.
s2 See Pettway & Radcliffe, supra note 45, at 6.
 HARVARD LAW REVIEW [Vol. 105:503

take the other side of the trade.5 3 To induce others to participate, a

buyer (seller) may have to pay a premium (sell at a discount). Such
premiums (discounts) compensate intermediaries for the costs of main-
taining a short (long) position until another investor willing to sell
54
(buy) can be found. This is known as the liquidity hypothesis.
To some extent, all traders, large and small, bear such liquidity
costs because there is no single price at which securities trade.5 5 The
activities of specialists or other market makers, and the placement of
limit orders by customers, create two prices at any point in time: the
bid price and the ask price. 56 The bid price is the highest available
price at which a customer can sell a particular security and the ask
price is the lowest available price at which a customer can buy a
security.
The existence of a bid-ask spread necessarily results in a relation-
ship between trading and price. 5 7 To see why, suppose that a partic-
ular security always has a fixed bid price of $9 and a fixed ask price
of $io. All customer buy orders are executed at $io; all customer sell
orders are executed at $9. If the last executed transaction was a
customer sale, a buy order will cause the observed price to increase
(from $9 to $xo). Conversely, if the last executed transaction was a
customer buy, a sell order will cause the observed price to decrease
(from $io to $9). Sequential transactions on the same side will not
result in price changes, but sequential transactions on different sides
will. As buy and sell orders arrive randomly, some purchases will
follow sales and some sales will follow purchases. These will cause
temporary price changes: on average, buy orders will be associated
with price increases and sell orders will be associated with price
decreases until these price changes are reversed by trades on the other
side of the bid-ask spread.58
Finally, trading can cause price changes if the demand and supply
for securities are not perfectly elastic. This possibility is referred to
as the price pressure hypothesis.5 9 This hypothesis posits that secu-
rities possess unique characteristics and perfect substitutes do not exist;
therefore, increases in supply or demand can cause price changes.

53 See id.
54 See id.
55 See Victor Niederhoffer & M.F.M. Osborne, Market Making and Reversal on the Stock
Exchange, 61 J. Am. STAT. ASS'N 897, 905 (1966).
56 See id. at 904-05.
57 See id.; Richard Roll, A Simple Implicit Measure of the Effective Bid-Ask Spread in an
Efficient Market, 39 J. FIN. 1127, 1128-29 (1984).
SS See Niederhoffer & Osborne, supra note 55, at 905.
59 See, e.g., Christopher G. Lamoureux & James W. Wansley, Market Effects of Changes in
the Standard and Poor's 500 Index, 22 FIN. REV. 53, 55 (1987); J. Randall Woolridge &
Chinmoy Ghosh, Institutional Trading and Security Prices: The Case of Changes in the Com-
position of the S&P 500 Index, 9 J. FIN. RES. 13, 15 (1986).
1991] MANIPULATION IN FINANCIAL MARKETS

Unlike the temporary price changes associated with the bid-ask

spread, price changes resulting from price pressure are permanent.
Several recent studies analyzing the effect of additions to or deletions
from the Standard and Poor's (S&P) 500 Index provide some support
for the price pressure hypothesis. 60 These studies find significant stock
price reactions to the announcement of an addition to or deletion from
the index. 6 1 One interpretation of this result is consistent with the
price pressure hypothesis: the addition (deletion) of a security to (from)
the S&P 5o0 Index causes an increase (decrease) in demand for the
security by index and pension funds that 62
hold the S&P 5o0, which
results in an increase (decrease) in price.
2. Relevance to Manipulation. - The preceding discussion of the
relationship between trading and price movements illustrates the dif-
ficulty of carrying out a successful manipulation. If trading has no
effect on price because of the substitution effect, a successful manip-
ulation is impossible. But even if a relationship exists, a successful
manipulation is still unlikely to occur.
Consider price movements related to information effects. Trading
will affect prices only if the prospective manipulator can convince
others that his trading was informed. Trades in an anonymous market
are not likely to have this effect. Even when the probability is high
that a trader is informed, there is considerable uncertainty about
whether trades will affect price. Recall that nearly half of all block
63
trades occur with no change in price.
But overcoming the problem of appearing informed is not enough.
To be successful, the prospective manipulator needs prices to rise after
he purchases. The more informed he appears, the more likely prices
will rise simultaneously with the purchase and not thereafter. And if
a premium must be paid for liquidity reasons, 64 the price is likely to
fall after the purchase. This appears to be precisely what occurs.
Evidence on block trades shows that when block trades are associated
with price increases, the block transaction price (net of commissions)
is above both the previous transaction price and the subsequent closing

6o See Lawrence Harris & Eitan Gurel, Price and Volume Effects Associated with Changes
in the S&P 50o List: New Evidence for the Existence of Price Pressures, 4! J. FIN. 815, 828
(x986); Lamoureux & Wansley, supra note 59, at 64-65; Stephen W. Pruitt & K.C. John Wei,
Institutional Ownership and Changes in the S & P 500, 44 J. FIN. 509, 513 (1989); Andrei
Shleifer, Do Demand Curves for Stocks Slope Down?, 41 J. FIN. 579, 588 (1986); Woolridge &
Ghosh, supra note 5,9, at 23.
61 See Lamoureux & Wansley, supra note 59, at 68.
62 An alternative explanation, however, is that the price change is attributable to an infor-
mation effect. The increase (decrease) in institutional ownership by index and pension funds
may itself increase (decrease) the value of the included (excluded) firms because institutional
stockholders may monitor management more actively than other stockholders. See id. at 69.
63 See Large Block Transactions, supra note 46, at 245-46.
64 See infra p. 5 8.
 HARVARD LAW REVIEW [Vol. 105:503

price. 65 In other words, the price rises simultaneously with the block
trade and subsequently falls. This suggests that an attempted manip-
ulative purchase would generally be unprofitable because the manip-
ulator would anticipate buying at a relatively high price.
Moreover, the prospective manipulator faces significant problems
at the time of sale. Specifically, a manipulator who is able to convince
market participants that he is informed at the time of purchase must
do the opposite at the time of sale. If he cannot, he would realize
losses even if he were able to sell at the market price. If the sale
price were below the market price, as the evidence on block sales
implies it would be, 66 his losses would be even greater. The law need
not worry about such sure-to-lose strategies.
Liquidity costs further diminish the prospects for successful ma-
nipulation. To be successful, the manipulator must be able to sell
any shares purchased for more than the price paid. In the example
of a stock with a bid-ask spread of $9-$Io, a prospective manipulator
would expect to purchase at the ask price ($io) and sell at the bid
price ($9) for a loss of $i. This liquidity cost is a transactions cost
that makes a successful manipulation less likely. We need not worry
about a scheme to purchase at $io and sell at $9. Unless the pro-
spective manipulator can buy at $io and sell for more than this
amount, the scheme is completely self-deterring.
It is frequently asserted that thinly traded stocks are more prone
to manipulation than are actively traded securities, perhaps because
information and price pressure effects on stock prices may be accen-
tuated in this case. However, liquidity costs are likely to offset these
effects. With all else equal, the less actively traded a security, the
larger the bid-ask spread. 67 And the larger the bid-ask spread, the
greater the transactions costs that impede a successful manipulation.
Finally, price pressure effects do not appear to increase the prob-
ability of a successful manipulation. To the extent that the evidence
supports the existence of a price pressure effect, it indicates that
securities have supply and demand elasticities no smaller in magnitude
than 1.68 This means that a prospective manipulator must purchase

65 See Large Block Transactions, supra note 46, at 249-52.

66 See id. at 249-54, 264.
67 See, e.g., Harold Demsetz, The Cost of Transacting, 82 Q.J. ECON. 33, 41 (1968); Hans
R. Stoll, The Supply of Dealer Services in Securities Markets, 33 J. FIN. 1133 (1978); Jeha M.
Tinic & Richard R. West, Competition and the Pricing of Dealer Services in the Over-the-
Counter Stock Market, 7 J. FIN. QUANTITATIVE ANALYSIS 1708, 1721 (1972).
68 See, e.g., Large Block Transactions, supra note 46, at 264 (reporting a mean permanent
stock price decline of 0.34% for a sample of block sales averaging 1.63% of equity); Scholes,
supra note 41, at 193-94 (finding that in secondary distributions in which "the mean percentage
of the firm traded was 2% and the mean price effect appears to be 2%, the elasticity of demand
would appear ti be -I"); Shleifer, supra note 6o, at 580, 582 (reporting an average price increase
of 2.79% for S&P fund purchases thought to average 3% of outstanding shares).
i991] MANIPULATION IN FINANCIAL MARKETS

at least one percent of the firm's outstanding shares to cause a one

percent change in price. Such a large capital outlay exposes the
would-be manipulator to tremendous risk because the resulting price
increase (of, for example, ten cents for a ten-dollar security) may be
less than the transactions costs incurred. Even if the price rises by
more than the transactions costs incurred, there is no reason to believe
that the prospective manipulator will be able to sell for more than he
paid. Price pressure effects are symmetrical. If purchases increase
the demand and thus the price, sales will have the opposite effect.
Again, the scheme is completely self-deterring.

B. The Difficulty of Identifying Manipulative Trades

In addition to being self-deterring, manipulative trades are ex-

tremely difficult, perhaps impossible, to identify. This difficulty stems
from one simple fact - it is hard to read people's minds. For this
reason, the law typically requires an objectively harmful act before
sanctions are levied. Bad intent by itself is not sufficient. Even when
intent is an issue, it is typically determined by reference to objective
69
evidence.
To illustrate, suppose that the issue in a criminal case is whether
the defendant murdered someone or acted in self-defense. This in-
quiry will be undertaken only when someone is dead (an objectively
bad outcome). And the investigation of the killer's state of mind to
determine whether he acted in self-defense also will focus on objective
70
evidence (whether he reasonably believed he was in danger).
Allegedly manipulative trades present a far different situation.
First, there is no objectively harmful act or bad outcome. Only the
trades are observable, and they are indistinguishable from all other
trades. Moreover, inquiry into the state of mind of the trader is futile
because the objective acts taken by the allegedly manipulative trader
typically will be identical to those of the nonmanipulative trader.
The law of manipulation is not completely insensitive to these
problems. In fact, the difficulty of reading people's minds and thus
the need to infer manipulative intent from actions are explicitly rec-
ognized as a problem in the area. 7 1 The difficulty, however, is that
the objective conduct deemed to indicate manipulation is at least as
consistent, if not more consistent, with normal market activity.

69 See, e.g., In re The Federal Corp., 25 S.E.C. 227, 230 (x947).

70 See, e.g., CAL. PENAL CODE § 198 (West i988) ("[T]he circumstances must be sufficient
to excite the fears of a reasonable person . . ").
71See, e.g, The Federal Corp., 25 S.E.C. at 230 (noting that, "[s]ince it is impossible to
probe into the depths of a man's mind, it is necessary in the usual case .. . that the finding
of manipulative purpose be based on inferences drawn from circumstantial evidence").
 HARVARD LAW REVIEW IVo]. 105:503

Three types of conduct illustrate the practices commonly identified

73
as indicative of manipulative trading: 72 trading at the end of the day;
short sales; 74 and making bids at successively higher prices. 75 In fact,
none of these types of trades demonstrates the existence of manipu-
lative intent.
i. Trading at the End of the Day. - Trading at the end of the
day is often alleged to be strong evidence of manipulation, perhaps
because such trades are thought to be more likely to affect the closing
price. Yet studies have established that trading in organized securities
markets is heaviest in the period just before the market closes (as well
as when it opens). 76 Trading at the end of the day is common because
market participants monitor developments during the day before tak-
ing a position prior to the close of trading. Because legitimate trading
is concentrated at the end of the day, it is wrong to interpret trading
at the end of the day as evidence of manipulation.
Moreover, it is possible that trading at the end of the day is less
likely to be manipulative than trading at other times of the day. Recall
that a successful manipulation requires both that trading affect price
and that the trader be able to sell for more than he paid. Trading at
the end of the day could make it less likely that either condition will
be satisfied. Because trading is concentrated at the end of the day,
any trade at this time is likely to have less informational content than
a trade at another time. Thus, any individual trade has a higher
probability of affecting price if made at a time other than the opening
or closing of trading. The trader who buys at the end of the day also
bears more risk because he must hold his shares until the next day.
The longer holding period increases the possibility of adverse price
movements in the interim.
Trading at the end of the day is most likely to be manipulative
when the trading is designed to trigger contractual rights or benefits
linked to the closing price on a particular day. But even this situation
is ambiguous because legitimate trading is also concentrated during
this time. Moreover, as discussed above, it is harder to affect price
77
by trading at the end of the day than during other times.

72 For a general summary of various types of manipulative practices, see Manipulative

Practices, supra note 16, at 99-195.
73 See, e.g., United States v. GAF Corp., 928 F.2d 1253, 1256 (2d Cir. i99i).
74 See, e.g., 17 C.F.R. § 240. oa-i (I991). The prevalent view that short selling is a form
of manipulation is discussed in Restrictions on Short Sales, supra note 17, at 799-805.
75 See Manipulative Practices, supra note x6, at 113-15.
76 See Lawrence Harris, A Transaction Data Study of Weekly and Intradaily Patterns in
Stock Returns, i6 J. FIN. ECON. 99, 112 (1986).
77 There is, however, one situation in which trading at the end of the day is more likely to
affect price. If the very last trade of the day is a purchase, it might cause the closing price to
I991] MANIPULATION IN FINANCIAL MARKETS

2. Short Sales. - Short sales are also thought to be indicative of

manipulation and are heavily regulated as a result. 78 Again, however,
the premise that short sales reflect manipulative trading is extremely
suspect.
Selling short allows those who believe that the price of a security
will fall to act upon their "negative beliefs." If selling short were
prohibited, the ability of traders to express negative beliefs would be
limited by the number of shares currently owned. The claim that
short sales are evidence of manipulation requires an ability to distin-
guish between traders with negative beliefs and those with manipu-
lative intent. Because both classes of traders will act identically,
however, making this distinction is an extremely difficult task.
Moreover, an attempted manipulation by selling short is at least
as self-deterring as any other type of manipulative scheme. Like any
manipulative trader, the short seller must bear the costs created by
the bid-ask spread and convince other market participants that his
trading is informed. He must also hope that prices will fall after he
sells and will not rise again simultaneously with his subsequent pur-
chases. If anything, a short seller faces greater costs than other pro-
spective manipulators because he must post margin to cover his po-
sition and thus bear the risk that the stock price will rise and force
him to cover at a loss.
3. Successive Bids at Higher Prices. - This strategy seems the
least likely to result in a successful manipulation. Here the prospective
manipulator overcomes the difficulty of causing price increases by
offering to purchase at more than the market price. By doing so,
however, the manipulator increases the probability of loss and, hence,
the self-deterring nature of the scheme.
The prospective manipulator needs prices to rise after he purchases
to have a chance of selling at a profit. By purchasing at above the
market price to cause a price increase, the prospective manipulator
decreases the likelihood that he will be able to sell at a profit. In
addition, the prospective manipulator still has the problem of what
to do at the time of sale. If his sales cause prices to fall, the chance
of loss is greater still.
If successive higher bids are not motivated by manipulative intent,
why do they occur? A plausible explanation is that the price is rising
for other reasons at the same time the purchases are occurring. Thus,
as is the case for trades generally, it is extremely difficult to discern
the intent of a trader with objective evidence because manipulative
trades are indistinguishable from nonmanipulative trades.

be at the ask rather than the bid. Thus, the last trade of the day could affect price by the size
of the bid-ask spread.
73 See, e.g., 17 C.F.R. § [Link]-i (i99i).
 HARVARD LAW REVIEW IVol. 105:50 3

C. The Social Costs of ProhibitingManipulation

Legal rules prohibiting manipulation are costly in several respects.
Enforcement costs, for example, are higher for manipulation than for
other intentional torts. In the typical case, enforcement costs are
incurred only when an injury occurs. By contrast, manipulation de-
pends entirely on the state of mind of the trader. The observable acts
are indistinguishable from nonmanipulative trading. As a result, en-
forcement costs in the case of manipulation cannot be limited to
instances of observable injury.
A second type of social cost created by the legal prohibition of
manipulation is opportunity cost - the cost of the beneficial activity
foregone. This is most obvious in the regulation of short-selling.
Current regulation allows short sales only if the most recent price
change was an increase. 79 This prohibition of short sales on downticks
results in the elimination of legitimate short sales that would otherwise
occur whenever those who did not currently hold a particular security
received adverse information about the security. The result is to
decrease the speed at which information is reflected in market prices
and thus to reduce the efficiency of markets. 80
Similarly, current regulation prohibits short sales in advance of
public offerings. 8 ' The stated rationale is that short sellers might
otherwise drive down the price of the security prior to the offering
and then profit by covering at artificially low prices in the offering
itself.8 2 For reasons discussed above, 8 3 however, there is no reason
to believe that this type of trade-based manipulation is likely to suc-
ceed. Thus, the regulation provides no benefit. On the other hand,
the regulation imposes costs because it prevents those with negative
beliefs, perhaps created by the existence of the offering itself, from
acting on them by trading.
Even in the absence of a specific regulation, other beneficial activ-
ity will be foregone because of the general prohibition of manipulation.
The difficulty of distinguishing manipulative from nonmanipulative

79 See Restrictions on Short Sales, supra note 17, at 805-o6. For a discussion and critique
of this regulation, known as the uptick rule, see id. at 799-808, 822-35.
80 See Douglas W. Diamond & Robert E. Verrecchia, Constraints on Short-Selling and Asset
Price Adjustment to Private Information, 18 J. FIN. ECON. 277, 302-06 (1987).
81 See 17 C.F.R. § 24 [Link]-21(T) (prohibiting a short seller from covering a short sale of
equity securities of the same class as securities to be offered publicly with securities "purchased
from an underwriter or broker or dealer participating in the offering" if the short sale was made
after the filing of the registration statement). In adopting this rule in 1988, the Securities and
Exchange Commission identified the prevention of manipulation as its primary objective. See
Short Sales in Connection with a Public Offering, Securities Act Release No. 6798, Exchange
Act Release No. 26,028, [1988-89 Transfer Binder] Fed. Sec. L. Rep. (CCH) 84,315 (Aug.
25, 1988).
82 See id.
93 See supra pp. 517-19.
,991] MANIPULATION IN FINANCIAL MARKETS

trading means that error costs will be high. Because the sanctions for
engaging in manipulation are severe and include criminal penalties as
well as the possibility of a lifetime ban from the securities industry,
traders, particularly high profile traders such as takeover arbitrageurs,
will avoid conduct that might be characterized as manipulative.
Even a seemingly narrow legal rule focusing on "clear" evidence
of manipulative intent (assuming such "clear" evidence exists) is un-
likely to provide net social benefits. Any rule that addresses the
difficult problem of identifying manipulative conduct risks overdeter-
rence - causing society to bear the costs of foregone beneficial activ-
ity. But a rule sufficiently narrow to avoid overdeterrence is unlikely
to provide deterrence at all. Moreover, conduct that might be pro-
scribed by a narrow rule is not worth worrying about because such
conduct is self-deterring.

V. ALLEGED MANIPULATIVE SCHEMES INVOLVING

FACTORS OTHER THAN TRADING

Thus far we have focused on one type of manipulative trading

scheme: purchasing to cause prices to rise and then selling at high
prices before the price falls again. These schemes can be described
as "trade-based manipulations" because the trader's profit results di-
rectly from the trades. Trade-based manipulations, however, are not
the only possible type of manipulative scheme. In this section, we
consider two other possible types of manipulative schemes.

A. Contract-Based Manipulations
Contract-based manipulations are schemes in which the trader's
profit results from his ability to trigger a contractual right or benefit
by trading. An example would be purchases by a corporate officer
that raise the price of his firm's shares by an amount sufficient to
trigger a bonus clause in his compensation package based on the firm's
stock price.
One can argue that contract-based manipulations are more
properly the subject of legal concern. Such schemes are not clearly
self-deterring because the gains from triggering the contractual right
could outweigh the losses incurred by the alleged manipulator at the
time of sale. Moreover, a legal prohibition of contract-based manip-
ulations can be understood as government enforcement of an implicit
term in private contracts. An analogy exists to the moral hazard
problem present in insurance contracts. Fire insurance policies, for
example, do not cover arson by the insured because of the obvious
moral hazard insurance coverage would create. Allowing the corpo-
rate manager in the above example to trigger his bonus by trading
could create a similar moral hazard. Moreover, because trading in
anonymous securities markets is hard to detect, the firm may be
unable to monitor the moral hazard. Thus, government regulation
 HARVARD LAW REVIEW [VOL. 0o5:503

may be desirable to enforce the implicit term of the compensation

84
agreement.
But it is far from clear that courts should read such an implicit
term into the compensation agreement. The firm might not want to
prevent all trading by the insider because some trading could have
beneficial effects. Suppose the insider purchases because he knows
the shares are undervalued, and market participants eventually agree.
The insider's purchases, once disclosed or decoded, may be the reason
that market participants become more optimistic. In this situation,
the insider's purchases are beneficial and his receipt of the bonus after
the price has risen is of no concern. The possibility of such beneficial
trades, coupled with the difficulty of affecting the price by trading,
might make the firm reluctant to limit trades by insiders.
Thus, the fire insurance example is not entirely analogous. Be-
cause arson is unquestionably harmful, the insurer wants uncondi-
tional deterrence. The same is not true of trading by insiders.
Whether such trades are harmful depends solely on the intent of the
trader. Trades motivated by a belief that the shares are undervalued
are beneficial; identical trades motivated by a desire to move prices
in the wrong direction to collect the bonus are harmful. As a result,
conditional, not unconditional, deterrence is appropriate. It may be
too difficult, however, to distinguish between these two types of
trades, 85 and thus the only options are to allow or prohibit trading
altogether. No search for "manipulative" trades would then be nec-
essary.
Moreover, it is incorrect to assume that because trading is difficult
to monitor, private parties are unable to reduce the probability of
contract-based manipulation. On the contrary, when the possibility
of contract-based manipulation is a concern, contracts can be written
to deter the practice. Assume that the bonus clause in the above
example provided that the insider would get a bonus of $ioo,ooo if
the stock price of his firm is $io at the close of trading on a given
day. Assume further that the security had a bid-ask spread of $9/$io
as discussed above. If the last trade is a sale at $9, the insider might
be tempted to purchase a small quantity at $io on the last trade of
the day to collect the bonus. A firm concerned about this possibility,
however, has many alternatives. For example, the firm could write
a contract under which the bonus would be paid only if the stock
closed at $io and remained above $io for some given period of time.

84 The argument is similar to the defense of governmental regulation of insider trading. See
Frank H. Easterbrook, Insider Trading, Secret Agents, Evidentiary Privileges, and the Pro-
duction of Information, 1981 SuP. CT. REv. 309, 330-38. For a response to this argument, see
Carlton & Fischel, supra note 22, at 873-75 (arguing that prohibiting insider trading may not
be an efficient way to address moral hazard).
5 See supra Part IV.B.
1991] MANIPULATION IN FINANCIAL MARKETS

If the $io price is solely a product of the bid-ask spread, the price
will not stay at this level but will fluctuate between this price and $9.
Such a contract would effectively deter the trade-based manipulative
scheme.
That contracts can be written to deter trade-based manipulation
does not, however, definitively resolve the question whether a legal
prohibition is desirable. First, it is possible that the contract adap-
tation chosen to deal with the problem of contract-based manipulation
is inefficient for other reasons. Lengthening the time the stock price
must be above $io in the above example may force the insider to
bear too much risk that the price may fall for exogenous reasons.
This inefficient contract adaptation might be avoided with a legal rule
prohibiting contract-based manipulations. Second, no matter how the
contract is written (provided that the bonus is linked to stock price),
some possibility exists that the price in the absence of trades might
be close enough to the trigger price to make a trade-based manipu-
lation worthwhile. Thus, there may be some benefit, even if trivial,
to a legal prohibition of manipulation.
These arguments, however, are weak. The contractual adapta-
tions described above establish that private parties can minimize the
risk of manipulative behavior, albeit not perfectly, in the absence of
a legal rule. Moreover, the difficulty of negotiating, writing, and
enforcing perfect contracts does not establish the desirability of a legal
prohibition. The costs of such a prohibition must also be considered.
The law, for example, does not regulate the length of time corporate
managers take for lunch. The costs of doing so would be prohibitive.
Similarly, the costs of a legal prohibition on manipulation, as we have
emphasized, 8 6 are also high. The difficulty of identifying manipulative
trades makes it unlikely that a legal prohibition of manipulation will
8 7
produce net benefits.

B. Trading Combined with Disclosure

Cases in which traders attempt to profit by combining trading with
disclosure might also be thought to pose difficulties for the view that
legal restrictions on manipulation should be abandoned. Recall that
one of the problems faced by the prospective manipulator is that, if
price rises simultaneously with purchase, no possibility of profit exists.
The prospective manipulator needs both price to rise after he pur-
chases and then to be able to sell without depressing price. This is
extremely difficult to accomplish in pure trade-based manipulative
schemes. It is easier to accomplish, however, when trading is com-
bined with disclosure. Consider the case of an investment analyst

36 See supra Part IV.C.

87 See infra Part VI.
 HARVARD LAW REVIEW [Vol. 105:503

with a reputation for identifying undervalued securities. Assume that

the analyst purchases shares and then makes a favorable recommen-
dation to clients even though he privately believes that there is no
basis for his recommendation. Because of his reputation, the recom-
mendation causes the share price to rise. The analyst then quietly
profits by selling at the higher price.
Although such a scheme is not implausible, it is better understood
as a fraud than as a manipulation. The harm to other market par-
ticipants results from a false statement. The trades are relevant only
in that they provide the motive for such false disclosure. 8 8 The con-
cept of manipulation adds nothing to the inquiry.
If the hypothetical is altered by changing the disclosure from a
recommendation to clients to a statement of accumulation, it becomes
more difficult. If the statement of accumulation has the same price
effect as the recommendation, the possibility for profit is unaffected.
The increased difficulty occurs because the disclosure of accumulation
is literally accurate. Whether this disclosure should be actionable
under the law of fraud is a complicated question. If the statement is
equivalent to saying "I think the shares are undervalued and I have
no plans to sell," it could be characterized as misleading. On the
other hand, because the statement of accumulation is literally accu-
rate, it may be unfair to characterize it as a statement of future
intention.
The question whether a disclosure of accumulation, without more,
can ever be challenged as false thus presents difficult issues. The
problem is most likely to arise in the context of mergers and acqui-
sitions because of the magnitude of price movements that can occur
when takeover rumors abound. The law has dealt with this problem
by requiring any person holding more than five percent of a company's
stock to disclose his future intentions and to update the disclosure
when his intentions change. 8 9 This requirement extends the scope of
the prohibition of fraud by making it impossible to disclose accumu-
lations without also accurately disclosing future intentions. 90 Thus,
the question whether a disclosure of accumulation can ever be action-
able is merely a debate over the scope of the prohibition of fraud -
once again, the concept of manipulation adds nothing to the inquiry.

Ss Indeed, existing case law treats this as a species of fraud rather than manipulation. See,

e.g., Zweig v. Hearst Corp., 521 F.2d 1129, 1131 (9th Cir. 1975) (assuming without deciding
that writing an article praising a company's stock when the author had previously purchased
that stock is evidence of a securities fraud violation under Rule iob-5).
89 See i5 U.S.C. § 78m(d) (x988).
90 This disclosure requirement imposes costs of its own by weakening prospective acquirers'
property rights in information. See Daniel R. Fischel, Efficient Capital Market Theory, the
Market for Corporate Control, and the Regulation of Cash Tender Offers, 57 TEx. L. REv. i,
13-14 (1978). Outside the mergers area, the application of anti-fraud laws to trading after
disclosure is unclear.
i99i] MANIPULATION IN FINANCIAL MARKETS

VI. THREE RECENT CASES OF ALLEGED MANIPULATION

We now consider three recent cases involving allegations of ma-

nipulation: United States v. GAF Corp.,91 the Wickes transaction in
United States v. Milken, 92 and United States v. Mulheren.93 Two of
these cases (GAF and Mulheren) resulted in criminal convictions that
were reversed on appeal. 94 These mixed outcomes are not surprising
in light of the ambiguous nature of the objective evidence regarding
allegations of manipulation. The third case (Milken) was litigated in
an evidentiary hearing prior to Milken's sentencing; 95 it also illustrates
the difficulty of identifying manipulative trades.

A. United States v. GAF Corp.

GAF Corporation, its vice-chairman (James T. Sherwin), and cer-
tain subsidiaries were indicted on multiple felony counts relating to
false entries in books and records, improper margin loans, and ma-
nipulation. 9 6 There were three trials: the first resulted in a mistrial
because of a prosecutorial trial error, the second ended in a hung jury,
and the third resulted in convictions on all counts. 9 7 The Second
Circuit reversed the convictions and remanded the case for a new
trial. 98 At that point, the United States decided not to seek a new
trial and dropped all charges. 99
The case arose from the following series of events. In October
and November, 1986, GAF Corporation wanted to sell a large block
of Union Carbide Corporation's outstanding stock and was actively
soliciting bids from investment banking firms.' 0 0 On October 29,
Sherwin allegedly asked employees of Jeffries & Co., a registered
broker-dealer, to arrange for the price of Union Carbide, which had

91 928 F.2d 1253 (2d Cir. 199i).

92 759 F. Supp. 1o9 (S.D.N.Y. x99o).
93 928 F.2d 364 (zd Cir. i99i). Our analysis of these cases is for academic purposes only.
We express no opinion on what the parties actually sought to accomplish in these cases or on
the guilt or innocence of any party under existing law.
94 See GAF, 928 F.2d at 1263; Mulheren, 938 F.2d at 372.
95 See Milken, 759 F. Supp. at 122-23. Milken had pleaded guilty on unrelated matters.
See id. at xio.
96 See GAF, 928 F.2d at 1255, 1257 n.2.
97 See id. at 1257. The GAF case and its various outcomes were widely reported and
discussed by commentators. See, e.g., Manipulative Practices, supra note 16, at 113, 172-73.
The facts and circumstances discussed herein come from this source as well as the indictment.
See Indictment, United States v. GAF Corp. (S.D.N.Y. 1988) (No. 88 Cr. 962) [hereinafter
GAF Indictment].
98 See GAF, 928 F.2d at 1263.
99 See Milo Geyelin & Arthur S. Hayes, Upjohn Settles Liability Suit over Halion Sleeping
Pill, WALL ST. J., Aug. 12, 1991, at B2.
100 See GAF, 928 F.2d at 1256.
 HARVARD LAW REVIEW [VoL 105:503

been trading at prices ranging from $2 d4 to $2 I9, to close at or above

$22 on October 29 and October 30, and guaranteed Jeffries & Co.
against loss.10 ' The government alleged that the purpose of the ma-
nipulation was to "enrich the corporate defendants by manipulating
upward tho price of Union Carbide common stock to attract buyers
and to maximize the profits to be earned from the sale of Union
0 2
Carbide common stock owned by the corporate defendants.'
On October 29, 1986, Jeffries & Co. bought approximately 6o,ooo
shares of stock near the close of trading on the New York and Pacific
stock exchanges.' 0 3 On October 30, Jeffries & Co. bought approxi-
mately 40,000 shares near the close of trading on these same ex-
changes. 10 4 Union Carbide closed at $22 on both exchanges on Oc-
tober 29. On October 30, Union Carbide closed at $22j on the New
York Stock Exchange and $228 on the Pacific Stock Exchange. 0 5
Jeffries & Co. sold its shares on November 3 and November 4 at a
loss. 10 6 On November 6 and 7, Jeffries & Co. purchased an additional
20,500 shares shortly before the close of trading; it sold these shares
on November 10-12 without suffering any loss.' 0 7 GAF Corporation
sold five million shares (approximately half of what it owned) in a
negotiated transaction on November io. 0 8
These facts illustrate the ambiguous nature of alleged manipula-
tions. The government argued that Jeffries & Co.'s manipulative
intent was obvious because it purchased shares on October 29 and
October 30 near the end of the trading day. 10 9 But, as noted above, 11 0

end-of-the-day trades are common and therefore do not distinguish

manipulative trades from nonmanipulative trades. Indeed, the defend-
ants pointed out that Jeffries & Co.'s purchases on November 6 and
7, which were not alleged to be part of the manipulative scheme in
the government's bill of particulars at the third trial, also occurred at
the end of the day. 111

101 See id.

102 GAF Indictment, supra note 97, at 4.
103 See GAF, 928 F.2d at 1256.
104See id.
10 See id.
106 See id.
107 See id. at 1257.
108 See GAF Indictment, supra note 97, at 4.
109 See id. at 9.
110 See supra p. 520.
M The government amended its bill of particulars after the second trial. See GAF, 928
F.2d at 1258. The original bill of particulars alleged that the November purchases were part
of the manipulation by GAF. See id. In the third trial, the defendants argued that there was
reasonable doubt about who was responsible for the October trades because even the government
was uncertain about what trades were part of the alleged manipulation, but they were denied
leave to introduce the original bill of particulars into evidence. See id. The appellate court
1991] MANIPULATION IN FINANCIAL MARKETS

The government further contended that Jeffries & Co.'s purchases

caused the price increases on October 29 and October 30.112 But price
increases accompanying trades do not establish manipulative intent.
Moreover, other explanations for the price increases existed. Price
increases are common at the end of the day, 1 13 and the relatively
small price increases ($-8 on October 29 and $ on October 30) might
have been explained by liquidity costs, the bid-ask spread, or other
factors such as a rise in the overall market.
The government also argued that the guarantee against loss proved
that there was manipulative intent.1 1 4 But the existence of a guar-
antee - which was disputed at trial 1 5 - proves nothing because
such a guarantee might merely have been a means to allow Jeffries &
Co. to trade as GAF's agent.11 6 Moreover, the purpose of the alleged
manipulation is unclear. The government claimed that the scheme
was designed to increase the profits GAF earned from the sale of
Union Carbide common stock. 117 This explanation is implausible.
First, there is no reason to assume that small changes in the price of
Union Carbide stock at the end of the day on October 29 and October
30 would have any effect on the sale price of a large block of shares
eleven days later. As discussed earlier,1 18 any price increase attribut-
able to trading on October 29 and October 30 would be likely to be
temporary unless the trading communicated information about the
value of Union Carbide. In addition, parties negotiating a price on
November io would be expected to have considered all past price
movements as well as any other relevant information. The closing
price on any particular day, let alone a day almost two weeks earlier,
would have been of no particular significance. Finally, the shares
purchased on October 29 and 30 were sold at a loss on November 3
and 4, a week prior to the date of the block sale. This sale negated
any possibility of profit from the alleged scheme, which suggests that
there was never a scheme in the first place.

found that the district court's refusal to admit the initial bill of particulars was an error. See
id. at 1263.
112 See GAF Indictment, supra note 97, at 9.
113 See Harris, supra note 76, at 111-13, 115.
114 See GAF Indictment, supra note 97, at 9.
115 See GAF, 928 F.2d at 1256-57, 1263.
116 If Jeffries & Co. was acting as GAF's undisclosed agent, the alleged conduct may have
been undesirable, but for reasons having nothing to do with manipulation, At the time of
Jeffries & Co.'s purchases, GAF was prohibited by a standstill agreement it had with Union
Carbide from purchasing additional shares. Purchases by GAF or Jeffries & Co. as its agent
may have been in violation of the standstill. The alleged failure of Jeffries & Co. to record the
guarantee was charged as a records violation. See GAF Indictment, supra note 97, at 15-16.
117 See id. at 4.
118 See supra pp. 517-18.
 HARVARD LAW REVIEW [VOL. 105:503

B. Wickes

In United States v. Milken, n 9 Michael Milken was indicted on

multiple felony counts, several relating to the alleged manipulation of
Wickes Corporation common stock. These charges were dropped as
part of a 0 plea bargain agreement but were litigated in a sentencing
hearing. 12
At the relevant time, Wickes had approximately eight million
shares of $2.50 convertible exchangeable preferred stock outstanding,
which it had issued on April 24, I985.121 The indenture for the
preferred contained a redemption feature that gave Wickes an option
to redeem the preferred stock prior to May 1988, provided that the
closing price of Wickes common stock on the American Stock Ex-
change equalled or exceeded $69 per share (the "threshold price") for
at least twenty of thirty consecutive trading days prior to the call for
redemption. 122
As of the close of trading on April 22, 1986, Wickes common stock
had closed at or above the threshold price on nineteen of twenty-eight
consecutive trading days. 123 Therefore, a closing price at or above
$61 on either April 23 or April 24 would trigger the necessary condition
for redemption. Milken, a representative of Wickes's investment
banker (Drexel Burnham Lambert), allegedly asked a third party, the
Boesky organization, to purchase enough Wickes stock to cause it to 24
close at or above $6- and allegedly guaranteed Boesky against loss. 1
During the last half hour of trading on the American Stock Exchange
on April 23, 1986, the Boesky organization purchased 1.9 million
shares of Wickes common stock at prices ranging from $6 to $6- per
share. Wickes common stock closed at the threshold price on April
23.125 Wickes called the preferred for redemption on April 29, and
the redemption was completed on or about June 2. Drexel received
a fee of approximately $2.3 million for underwriting the redemp-
tion. 12 6 Wickes stock price declined after April 23, and Boesky sold
his shares at a loss.
These facts demonstrate that alleged contract-based manipulations,
like trade-based manipulations, can also be ambiguous. On one level,
the alleged scheme appears plausible. The price movement necessary
for the manipulation to succeed was small ($I). For this reason, a

119 759 F. Supp. io9 (S.D.N.Y. 199o).

120 See id. at io9.
121 For the facts and circumstances discussed herein, see Indictment, United States v. Milken
(S.D.N.Y. 1989) (No. 89 Cr. 4) [hereinafter Milken Indictment].
122See id. at 55-56.
123See id. at 56.
124 See id.
125 See Milken, 759 F. Supp. at 122.
126 See id.
1991] MANIPULATION IN FINANCIAL MARKETS

would-be manipulator willing to commit the necessary capital might

reasonably have hoped to cause the price to rise by the desired
amount. Moreover, because the desired upward price movement was
small, the manipulator might have reasonably expected to be able to
sell his shares at about what he paid for them. Therefore, expected
trading losses were small. Because the purpose of the manipulation
was to benefit from the contractual redemption provision, not from
the trading itself, such trading losses might not have deterred this
conduct.
But an alternative explanation for the trading is also plausible.
Milken, Boesky (who was alleged to be Milken's agent), or both might
have believed that the stock represented a good investment opportu-
nity. Similarly, they might have believed that the threshold condition
for redemption was likely to occur in any event and the price of
Wickes common stock would rise as a result. 127 It is impossible using
objective evidence to distinguish between the manipulative and non-
manipulative explanations for the ,trading.
In addition, the trading losses may have been more of a deterrent
than it may first appear. Although the expected trading losses may
have been small, so too were the expected benefits from the alleged
manipulation. The government claimed that the manipulation bene-
fited Drexel because Drexel received underwriting and advisory fees
in connection with the redemption of the $2.50 preferred stock. 1 28 At
the time, however, it seemed likely that Drexel would receive these
fees soon in any event. All that was required was a closing stock
price above $6 on April 23, April 24, or on any nine of the next
129
seventeen trading days (or any twenty of thirty days thereafter).

127 Academic studies have found calls of convertible debt to be something of a puzzle for
two reasons. First, in contrast to the expected benefit, stock returns are usually negative around
the announcement of a call. Second, calls occur significantly later than what is thought to be
optimal. These phenomena may be related. See Milton Harris & Artur Raviv, A Sequential
Signalling Model of Convertible Debt Call Policy, 40 J. FIN. 1263, 1264 (1985). To our
knowledge, no one has studied the stock price consequences of optimally timed convertible calls.
125 Wickes was not a defendant. However, the government claimed that Wickes, too,
benefitted from the manipulation because redemption reduced its obligation to pay dividends.
See Milken, 759 F. Supp. at 122. For the reasons discussed in the text, the expected value of
this benefit was likely to have been small. Also, note that the investment banking fees paid to
Drexel are an additional expense that Wickes had to pay as a result of the redemption. See
Milken Indictment, supra note 121, at 55-56.
129 In fact, as it turned out, Wickes common stock price never satisfied the necessary
conditions for a call after April 23. But no one could have known this on April 23. As stocks
generally have positive expected returns, market participants should have anticipated a continued
increase in the price of Wickes common stock. One piece of evidence suggests that market
participants believed that redemption was virtually certain. The preferred stock, which prior
to March had traded at a substantial premium to its conversion value, traded at or about its
conversion value during much of April. For example, on April 15, 1986, the closing price of
the preferred was $371; its conversion value was $38.52 given the closing price of the common
 HARVARD LAW REVIEW [Vol. 105:503

Thus, the expected benefits of early redemption were likely to be low.

It is not clear that these expected gains would have outweighed the
130
expected trading costs.

C. United States v. Mulheren

In United States v. Mulheren, 13 1 defendant John A. Mulheren,

Jr., the chief trader and general partner of Jamie Securities Co. (Ja-
mie), was indicted on the charges that he "conspired to and did
manipulate the price of" Gulf & Western Industries, Inc. (G & W)
common stock. 132 Mulheren was convicted at trial, but the conviction
33
was reversed on appeal.1
In 1985, arbitrageur Ivan Boesky's companies purchased approx-
imately 3.4 million shares of G & W, which represented approximately
4.9% of the outstanding shares. 134 In September and October 1985,
Boesky had discussions with Martin Davis, G & W's chairman, in
which he proposed taking control of the company, increasing his
position in the company, or selling his shares back to the company at
$45 per share. 135 These conversations were private, but the press
speculated about the possibility of a takeover of G & W and about
the size of the positions held by Boesky and Carl Ichan (another
36
arbitrageur). 1
After the close of trading on October i6, 1985, Boesky again
offered to sell his block of shares at $45 per share. 137 G & W stock
had closed on that day at $444A.13 8 Davis told Boesky that the com-
pany would buy his shares back, but only at the price at which
G & W stock last traded on the New York Stock Exchange at the
time of the transaction.1 39 Davis told Boesky to have his investment

($64) and its conversion ratio (6.16). See WALL ST. J., Apr. 16, I986, at 6o. The proximity of
the closing price of the preferred stock and the conversion value suggests that market participants
expected voluntary conversion to follow the expected forced call for redemption.
130 The Wickes example also illustrates the ability of market participants to reduce the
probability of contract-based manipulations by contract design. The preferred stock indenture
was designed to make such manipulations highly unlikely. The threshold provision depended
on the price of the stock on any 20 of 30 days. Milken, 759 F. Supp. at 122. At the time the
indenture was written no one would have expected the price of the stock on any one day to
matter.
1-31938 F.-d 364 (2d Cir. i99q).
132 See id. at 365.
133 See id. at 372.
134 See id. at 366.

135 See id.

136See id.
137 See id. at 367.
138See id.
139 See id.
i99i] MANIPULATION IN FINANCIAL MARKETS

banker contact G & W's investment banker to arrange the transac-

140
tion.
Boesky called Mulheren before xi:oo a.m. on October 17.141
Boesky testified that he told Mulheren that he "liked" G & W stock
but "would not pay more than 45 for it" and "it would be great if it
traded at 45. " 142 Mulheren replied, "I understand. 14 3 Shortly there-
after, Jamie placed an order to purchase 5o,ooo shares of G & W
stock at the market price.14 4 This order was filled at prices of $444
and $447 per share. 145 At i:o9 a.m., Jamie placed another order to
purchase 25,000 shares of G & W at $45 or less. 146 All 25,000 shares
were purchased at $45 per share at ii:io a.m. At H1:17 a.m., Boesky
(and Ichan) sold his stock back to G & W at $45 per share. 14 7 Trading
in G & W stock closed at $43-; Jamie sold its position at the end of
the day at a loss.'14
The government claimed that Mulheren's sole intent was to affect
the price of G&W stock in order to help Boesky.' 4 9 The Second
Circuit concluded that the government failed to carry its burden of
proof, 15 0 and found that the meaning of Boesky's cryptic conversation
with Mulheren was "at best, ambiguous." 15 1 It then concluded that
the observable characteristics of Jamie's transactions - including their
size, their method of execution, and their lack of profitability - were
at least as consistent with investment intent as with manipulative
intent. 152
The court's analysis is consistent with our own in two important
respects. First, the court's discussion shows that manipulative trades
cannot be distinguished from nonmanipulative trades without refer-
ence to the intent of the trader. Second, the court's analysis illustrates
that the observable characteristics of trades cannot distinguish trades
made with bad intent from trades made with good intent. Although
the court did not say so explicitly, its analysis calls into question
15 3
whether actual trades should be prohibited as manipulative.

140 See id.

141 See id.
142 Id.
143 Id.
144 See id.
145 See id.
146 See id. at 368.
147 See id.
14S See id.
149 See id. at 368-69.
1so See id. at 369.
151 Id.
152 See id. at 370-72.
I53 Significantly, the court found that none of the "traditional badges of manipulation" were
present in this case, id. at 37o, and listed matched orders, wash sales, fictitious accounts, and
dissemination of false literature as examples of manipulation, see id. at 370-7r. The court's
 HARVARD LAW REVIEW [Vol. 105:803

In the final analysis, therefore, the objective evidence leaves the

existence of manipulative schemes in GAF, Milken, and Mulheren
unclear. In each case, there are alternative explanations for the trad-
ing that are at least as plausible as manipulation.

VII. TRADING AND "STABILIZATION" DURING DISTRIBUTIONS

The legislative history of the securities laws, as discussed in the

introduction, is replete with extended discussions of the evil "specu-
lative pools." In their simplest form, the pools allegedly involved
agreements among issuers, underwriters, and others to raise the price
of a security after a public offering by active trading or other means;
they would then sell the security at inflated prices to the unsuspecting
public before the inevitable price collapse.

A. The Rules and Their Origins

To deter the pools and other perceived manipulative practices,
Congress enacted section 9(a)(2) of the 1934 Act, which makes it:
unlawful for any person, directly or indirectly, .. .[tlo effect, alone
or with one or more other persons, a series of transactions in any
security registered on a national securities exchange creating actual or
apparent active trading in such security or raising or depressing the
price of such security, for the purpose of inducing the purchase or sale
of such security by others.1 54
While section 9(a)(2) focuses on manipulation generally, other pro-
visions deal with particular practices. Section 9(a)(6), for example,
regulates the practice of "pegging.' l5 5 Unlike the commonly discussed
manipulative scheme in which the objective is to buy low, manipulate
the price upward, and sell high, pegging is an attempt to maintain a
security at a specific price. When undertaken by an underwriter or
its affiliates in connection with an initial public offering, pegging is
usually referred to as "stabilizing" the offering because it is an attempt
to maintain the market price of a security at the offering price. Section
9(a)(6) does not prohibit pegging or stabilizing per se; rather, it pro-
hibits:
any series of transactions for the purchase and/or sale of any security
registered on a national securities exchange for the purpose of pegging,
fixing, or stabilizing the price of such security in contravention of such
rules and regulations as the [Securities and Exchange] Commission

analysis is consistent with our distinctions between actual and fictitious trades and between
manipulation and fraud. See supra Part III.
154 15 U.S.C. § 78i(a)(2) (I988).
1S5See id. § 78i(a)(6).
I99X] MANIPULATION IN FINANCIAL MARKETS

may prescribe as necessary or appropriate in the public interest or for

the protection of investors. 156

By implication, pegging or stabilizing activity not in contravention of

rules promulgated by the Commission is permitted by section 9(a)(6).
In 1955, the Commission, pursuant to section 9(a)(6), adopted rules
that for the most part still govern trading during distributions. Rule
iob-615 7 provides, in essence, that it is a manipulative or deceptive
practice for any underwriter, issuer, broker, or other participant in
the distribution process, either alone or in concert with others, to bid
for, purchase, or advise others to purchase any security being distrib-
uted until he has completed his part in the distribution.' 5 8
Thus, the Commission replaced the prohibition of section 9(a)(2)
with a prohibition of all trading by certain individuals during distri-
butions. The idea was to remedy the vagueness of section 9(a)(2),
particularly its requirement that an individual not act "for the pur-
pose" of inducing others to trade, and substitute instead an objective
definition of specific, prohibited behavior.' 5 9 Underlying the adoption
of Rule iob-6 was the premise that making or inducing purchases
during distributions constituted manipulation per se; thus, there was
no need for inquiry into purpose or intent.
Rule Iob-6 as adopted contains many exceptions. In particular,
the Rule continues the more relaxed regulatory attitude toward sta-
bilizing transactions by including an exception for "[s]tabilizing trans-
actions not in violation of Rule iob-7.' 160 Rule Iob-7, in turn, delin-
eates the conditions under which a participant may stabilize an
offering of a security. 161
These rules have turned out to be a nightmare in operation. The
original goal may have been to provide simple and objective stan-
dards, but the result has been the opposite. Questions such as what
type of sale of securities qualifies as a distribution and who is subject
to the rule, when, and for how long have proven especially vexing. 162
Several illustrative interpretative problems have arisen. Must a firm
that is involved in some way in the distribution process but is also
the sole market maker in the security cease market making - thereby
drying up liquidity? Can a firm engaged in a "distribution" by issuing
shares in a stock acquisition purchase its own shares in the market

156Id.
157 17 C.F.R. § 240.1ob-6 (I99I).
1-5 See Exchange Act Release No. 5,194 [1952-56 Transfer Binder] Fed. Sec. L. Rep. (CCH)
. 76,35o, at 79,458 (July 5, 1955) (adopting Rules iob-6, 7, and 8).
159See Nicholas Wolfson, Ride zob-6: The Illusory Search for Certainty, 25 STAN. L. REv.
809, 8,o (973).
16017 C.F.R. § 2 4 [Link]-6 (i99I).
161See id. § [Link]-7.
162 These problems and others are discussed in Wolfson, supra note 159, at 815-31.
 HARVARD LAW REVIEW [Vol. 105:50 3

prior to the acquisition? Can a firm ever purchase its shares when it
has an outstanding issue of convertible securities (and thus arguably
a continuing distribution of the common stock)? 1 63
For our purposes, however, the interesting issue raised by Rules
iob-6 and Iob-7 is not the difficulty of implementation, but rather
the conceptual justification underlying the rules. The rules presume
that trades during distributions are obviously manipulative and that
a per se prohibition is therefore appropriate. The rules also assume
that there is a distinction between manipulative trades during distri-
butions, which are prohibited, and "stabilizing" trades, which are
permitted. Thus, the rules appear to distinguish between "bad" and
"good" manipulations. Trades that cause price increases are "bad"
manipulations, but trades that prevent price decreases are "good"
manipulations. We explore these issues below. First, however, we
examine the pools that provided the initial justification for the rules.

B. The Pools Revisited

Commentators at the time the securities laws were enacted de-
scribed the practices of the typical pool as follows:

The group first secures an option to purchase at a price higher than

the then market quotation a large block of a stock which possesses
actual or potential market appeal and an easily controllable floating
supply. It is the task of the pool manager and operator to raise the
market price above the option price, and, if the supply on the market
remains constant, this can be accomplished only by increasing the
demand. The most effective manner of inducing others to purchase
is to have a favorable ticker tape record which indicates to prospective
purchasers that others consider the security to be underpriced. The
manager opens a number of accounts with various brokers and, for-
tified by a knowledge of the condition of the market obtained from
the book of a specialist, enters both buying and selling orders with a
preponderance of the former so that the price is made to rise slowly
upon an increasing volume of transactions. In the cruder form of
operation many of these transactions will be washed sales in which
the operator is both buyer and seller of the same stock; in others
known as matched orders he enters orders to sell with the knowledge
that some confederate is concomitantly entering orders to purchase the
same amount of stock at the same price. As the price slowly rises, a
complex publicity apparatus is set into motion to aid the stimulation
of demand. The directors of the corporation whose stock is being
manipulated, who may be members of the pool, issue favorable, but
not wholly true, statements concerning the corporation's prospects;
brokers, likewise interested in the operations, advise customers
through market letters and customers' men to purchase the stock;

163See id. at 833-35.

199I] MANIPULATION IN FINANCIAL MARKETS

subsidized tipster sheets and financial columnists in the daily papers

tell glowingly of the corporation's future; "chisellers," "touts," and
"wire-pluggers" are employed to disseminate false rumors of increased
earnings or impending merger. As the market price passes the option
price, the operator exercises his option and, increasing his sales over
purchases, carefully unloads upon the public the optioned stock as
well as that acquired in the process of marking up the price. 164

This description is revealing in several respects. First, nothing in the

description of the "pool" turns on the existence of a distribution. The
same practices could occur in the absence of a distribution. Thus,
the description provides no basis for special rules governing distribu-
tions. Second, the events described are more accurately characterized
as a massive fraud than a manipulation. Phony transactions in the
form of wash sales and matched orders are critical to the scheme, as
is the dissemination of false information to the public.
So stated, however, it is difficult to understand the furor over the
pools. Fraud was already prohibited prior to the enactment of the
federal securities laws. If fraud was the concern, there would have
been no need to enact section 9(a)(2), described as "the very heart of
the Act,' 165 and to promulgate Rule iob-6, which prohibit actual
trades for the purpose of inducing others to trade even in the absence
of fraud. For actual trades, new legislation was necessary to achieve
the desired purpose because actual trades, unlike fraud, were not
prohibited at common law. Indeed, commentators have argued that
it was speculative trading, not fraud, that was perceived to be the
66
primary evil of the pools.1
Unfortunately, apart from extensive anecdotal evidence, the pools
that so dominated debate in the legislative history of the securities
laws have never been studied systematically. It is possible, for ex-
ample, that contemporary observers mistakenly attributed price de-
clines following the stock market crash of 1929 to the collapse of
artificially inflated prices resulting from pools, when the real cause
was the economic downturn in the Great Depression. Moreover, there
is reason to be skeptical of the simple story told in the legislative
history of the securities acts. Stripped of the elements of fraud, pools
are a classic trade-based manipulation scheme. As discussed above,
such schemes are likely to fail and thus will seldom be undertaken.
No reason exists to assume that pools, which are trade-based manip-

164 Comment, Market Manipulation and the Securities Exchange Act, 46 YALE L. J. 624,
626-28 (1937) (citations omitted).
165 SECURITIES AND EXCHANGE COMMISSION, 77TH CONG., IST SESs., REPORT OF THE
SECURITIES AND EXCHANGE COMMISSION ON PROPOSALS FOR AMENDMENTS TO THE SECURI-
TIES ACT OF 1933 AND THE SECURITIES EXCHANGE ACT OF 1934, at So (Comm. Print I941).
1I,6 See Thel, Manipulation Under Section ro(b), supra note 4, at 409 n.221 (collecting
citations).
 HARVARD LAW REVIEW [Vol. 105:503

ulative schemes in the context of distributions, are more likely to be

successful than any other such scheme.

C. Stabilizing Trades
As noted above, stabilizing trades to prevent price declines are
permitted under Rule Iob-7 as long as the possibility of such trades
is disclosed to investors. But it is far from obvious that an underwriter
or other participant in the distribution process would trade for this
purpose. It is not clear that the trading can prevent price declines.
In most cases, trading has no effect on prices and thus the scheme is
likely to fail.16 7 Moreover, disclosed trading for the purpose of "sta-
bilizing" the price may in fact cause prices to fall when they would
not have done so in the absence of the disclosure. Investors who
assume a relationship between trading and price will reason that the
plan of stabilization has artificially elevated the security's price, and
will, as a result, pay less for shares. In other words, the disclosure
of the plan to stabilize may act as a signal that the security is over-
valued - the opposite of the intended stabilizing effect. The more
logical way to stabilize the price would be to announce that none of
the participants in the distribution process will engage in stabilizing
trades.
This analysis suggests that stabilizing trades, if and when they
occur, are explained by something other than an attempt to prop up
the price to facilitate the distribution. One alternative is that stabi-
lizing trades are a form of investor insurance provided by underwriters
to investors. The aim of the trades under this alternative is not to
prevent a drop in prices, but rather to absorb losses if the price of a
newly issued security falls below a certain level. A second possibility
is that the purchases are designed to offset price pressure effects
created by the offering. Still another possibility is that the purchases
are designed to communicate the underwriter's private information
about the value of the security to market participants and thereby
cause them to revise upward their estimate of the security's worth.
Under any of these alternatives, disclosure of a plan to stabilize would
not have the perverse effect of causing the security's price to fall.
Unfortunately, none of these alternative explanations for stabilizing
trades is completely satisfactory. The investor insurance explanation
seems inconsistent with the riskiness of initial public offerings, which
is one of the common explanations for the underpricing of such offer-
ings.16 8 Y investors are insured against downside risk, they should

167 See supra Part IV.A.

163 See, e.g., Kevin Rock, Why New Issues Are Underpriced, 15 J. FIN. ECON. 187, 188
(i986) (arguing that the offering firm must price shares at a discount to guarantee that they are
purchased by uninformed investors); Ivo Welch, Seasoned Offerings, Imitation Costs and the
I99I] MANIPULATION IN FINANCIAL MARKETS

earn lower, not higher, expected returns in initial public offerings.

The price pressure explanation also is not entirely convincing. The
underwriter could avoid the problem by spacing out the offering over
a longer period, although at a cost of bearing increased price risk.
Moreover, studies of primary and secondary offerings have concluded
that there are no price pressure effects to offset (at least on average),
169
and, as a result, trading for this purpose is unnecessary.
Finally, the information explanation is not persuasive. As long as
the trading is anonymous, any signal will be noisy and thus ineffective.
Even if the trading is disclosed or otherwise decoded, the signal will
be meaningful only if the trades reflect a decision to buy and hold
until the private information possessed is revealed. A decision to buy
and immediately resell conveys little if any information to market
participants because no guarantee exists that the underwriter will bear
the loss if it has no private information about the security's value.
And because an announcement of an intent to purchase for the pur-
pose of stabilization contains no such guarantee, neither the announce-
ment nor the trades themselves should affect price.
In the final analysis, therefore, stabilizing trades are something of
a mystery. Perhaps they never occur or occur rarely for idiosyncratic
reasons that include the explanations discussed above. Thus, although
the insurance, price pressure, and information theories do not provide
a general explanation for trading by participants in the distribution
process, it is possible that one or more of these theories might explain
trading in a particular distribution. For example, there may be a
particular risk-sharing arrangement in some distributions (a form of
insurance), or some distributions may have unexpected price pressure
effects. Similarly, there may be an understanding in some distribu-
tions that the underwriter will buy and hold or otherwise commit to
bearing the costs of a buy and hold strategy even if the purchased
security is not held. A final possibility is that firms disclose an intent
to engage in stabilizing trades in order to trade for some completely
unrelated purpose such as investment. Until the practice is studied
seriously, however, the purpose of stabilizing trades, as well as the
frequency of the practice, will not be fully understood.

VIII. EXCESSIVE MARKUPS

Broker-dealers in over-the-counter markets are sometimes accused
of manipulation when they charge retail customers "excessive" mark-
ups. 170 Dealers typically quote both a bid price and an ask price in

Underpricing of Initial Public Offerings, 44 J. FIN. 421, 445 (1989) (describing how firms
underprice initial public offerings to obtain a higher price at a seasoned offering).
14" See sources cited supra notes 49-50.
170 See Manipulative Practices, supra note 16, at 128-29.
 HARVARD LAW REVIEW [Vol. 105:503

the interdealer or wholesale market. The bid price is the price at

which a dealer is willing to purchase shares from another dealer; the
ask price is the price at which he is willing to sell. A dealer who also
acts as" a retail broker (sometimes called an "integrated dealer") pur-
chases shares from customers at his bid (or, perhaps, at some mark-
down from his bid) and sells those shares to his customers at a markup
above the current interdealer ask price. If the markup (or markdown)
exceeds the prevailing market price by certain parameters, it is deemed
excessive.
What markups are excessive? Article III, section 4 of the NASD
Rules of Practice require that transactions be executed at a fair
price. 17 1 The Interpretation of this rule by the Board of Governors
establishes a five percent markup from the prevailing market price as
a guideline for determining a fair spread. 172 The SEC considers
undisclosed markups (or markdowns) in excess of ten percent of the
prevailing market price to be fraudulent. 173 Such excessive markups
are often alleged to be part of a scheme to manipulate the price of a
74
stock. 1
Nevertheless, the alleged wrong attributable to excessive markups
arises from a concern about either fraud or the exercise of monopoly
power; calling it manipulation does nothing to advance the analysis.
Note first that an excessive markup violates section io(b) only if the
broker-dealer failed to disclose it. 17 5 As discussed in Part III, non-
disclosure, when there is a duty to disclose, is properly viewed as a
form of fraud, not manipulation. To understand the concern about
monopoly power, note that the determination of the prevailing market
price depends on the characteristics of the interdealer market. When
there is an active interdealer market, the "prevailing market price"
for purposes of markup calculations is determined by reference to the
ask price. In contrast, when a sole market maker "dominates and

171See id. at 129.

172 See id.
173 See, e.g., In re Stuart-James Co., Inc., Exchange Act Release No. 26,700, 1989 SEC
LEXIS 659, at * (Apr. 5, x989) (announcing that proceedings had been instituted by the SEC
on the grounds that Stuart-James Co., a broker-dealer, violated the securities laws by charging
excessive undisclosed markups on the securities of UMB Equities, Inc., and Find SVP, Inc.);
In re Altstead, Dempsey & Co., Exchange Act Release No. 20,825 [1984 Transfer Binder] Fed.
Sec. L. Rep. (CCH) 83,607, at 86,740 (Apr. 5, 1984).
174 See Joseph I. Goldstein, Sarah B. Ackerson & Laura A. Wovack, Division of Enforce-
ment, SEC, An Overview of Market Manipulation: Legal and Practical Aspects 15 (Nov. 8,
199o) (Virginia Polytechnic Institute and the American Bar Association Conference) (unpublished
manuscript on file at the Harvard Law School Library).
175See id. at 21 (citing Charles Hughes & Co. v. SEC, 139 F.2d 434, 436-67 (2d Cir. 1943);
and Duker & Duker, 6 S.E.C. 386, 388-89 (1939)). Goldstein and his coauthors note that
nondisclosure is not an essential element in showing a violation of the NASD rules, but disclosure
is one of the factors the NASD considers in determining whether a markup was excessive. See
id.
,991] MANIPULATION IN FINANCIAL MARKETS

controls" the market for a particular security, the prevailing market

price is determined by reference to the broker-dealer's contempora-
neous cost. 176
To illustrate, suppose that the current interdealer market is $io
bid and $ii ask. Without domination and control, a market maker
could purchase from a customer at $9.50 (a five percent markdown
from $[Link]) and sell to another customer at $11.55 (a five percent
markup from $[Link]). However, if a broker "dominates and controls"
the market and purchased from one customer at $9.50, a price of
more than $9.975 (a five percent markup from the contemporaneous
cost of $9.50) in a subsequent sale might be considered excessive. The
usual rationale for ignoring the wholesale spread in this situation is
that the prices other dealers pay the "dominant" dealer are "artificial"
because the demand dealer, who "controls" the wholesale price and
has lower costs, can charge other dealers whatever it wants. Concern
about the ability to set price is what the regulation of monopoly is all
about. Calling this concern manipulation adds nothing.
Moreover, concern about the exercise of monopoly power in these
circumstances is unfounded. First, the premise that a sole market
maker has lower costs has no economic basis. None of the costs
generally borne by market makers can be avoided by a sole market
maker. In general, market makers bear holding costs (the costs attri-
butable to price changes during the period when a market maker is
holding inventory), information costs (costs attributable to trading
with informed investors), and the costs of maintaining a presence in
the market, searching for customers, and executing transactions.
Whenever a sole market maker trades, it necessarily bears these costs.
If anything, the costs incurred by a sole market maker may be higher
than the costs incurred by multiple market makers (in other stocks)
because sole market makers deal in particularly speculative and thinly
traded stocks and thus face higher holding and information costs. 177
Furthermore, there is no necessary relationship between the num-
ber of market makers and the existence of market power. A sole
market maker's customers are free to transact with other market
makers who might decide to make a market in the stock (as well as
in any other security). If spreads are excessive, the lure of profits is
likely to induce other broker-dealers to enter the market. In addition,
even if a sole market maker is able to quote spreads without regard
to the quotes of other, competing market makers, it cannot (without
fraud) affect the willingness of buyers (sellers) to purchase (sell) at the
prices it sets. As a market maker increases its ask price (reduces its

176 See In re Alstead Dempsey & Co., [I1984 Transfer Binder] Fed. Sec. L. Rep. (CCH)
T 83,607, at 86,739.
177 See Stoll, supra note 67, at 1137-42, 1144-46.
 HARVARD LAW REVIEW [Vol. 105:503

bid), the quantity that customers are willing to buy (sell) at that price
decreases. Furthermore, when choosing which stocks to trade, cus-
tomers may avoid securities that have large spreads. As discussed in
Part IV, when demand (supply) is elastic, suppliers (demanders) of a
particular security cannot have market power.

VIII. FUTURES MARKETS

Special characteristics of futures markets - particularly the expi-
ration of futures contracts - create the possibility of manipulative
schemes somewhat different from the manipulative schemes discussed
above. Nevertheless, the concept of manipulation serves no useful
function in futures markets, either.

A. Manipulation and the Economics of Futures Markets

A commodity futures contract is a standardized agreement to buy
or sell a fixed quantity and grade of a commodity to be delivered at
a specified time in the future. There is little concern about manipu-
lation in futures markets prior to the expiration of a futures contract
because at other times the market generally is extremely competitive
and, therefore, no single trader can affect the futures price. One
reason is that the market for the commodity (such as wheat) under-
lying futures contracts is typically competitive. Moreover, futures
contracts are easily traded by both hedgers (those who expect to
demand or supply the underlying commodity at expiration) and spec-
ulators (professional investors who hope to profit by successfully an-
ticipating price movements) because they have standardized terms and
performance guaranteed by a clearing house. Entry and exit are easy
because anyone can buy or sell a contract. The presence of profes-
sional investors who have access to capital and information also im-
proves the liquidity and efficiency of futures markets.
In addition, there are good substitutes for any particular futures
contract. A hedger who wants to sell a commodity can sell today or
store his commodity and sell it in the future. Similarly, a speculator
who wants to bet on a rise in the price of corn might choose among
various futures contracts that mature in different months, for delivery
in different locations, or for delivery of different grades of corn. The
competitive market for the underlying commodity, the ease of entry
and exit, the availability of capital and information, and the existence
of close substitutes ensure that in most circumstances futures prices
8
are competitive. 17

178 This is not to say that one should be unconcerned about fictitious trades such as wash
sales. As we noted above, however, such trades can be understood as a species of fraud. See
supra p. SiO. Here, we examine whether real trades ought to be prohibited because of concerns
about manipulation.
1991] MANIPULATION IN FINANCIAL MARKETS

These conditions, however, may not hold near the time when a
particular futures contract expires. At that time, the deliverable sup-
ply of the commodity is fixed (or can be augmented only by trans-
porting additional supply at some cost). The demands of "short"
futures traders for supplies of the commodity to satisfy their obliga-
tions to "longs" are inelastic. 179 For shorts, other contracts are a poor
substitute because they do not provide the underlying commodity at
the right time and in the right place. The absence of substitutes
means that market power can be achieved if the ownership of con-
tracts (and the underlying supply of the commodity) becomes suffi-
ciently concentrated relative to the competitive supply of the com-
modity at expiration.180 Such market power can lead to
noncompetitive pricing in both the futures market and the spot market
for the commodity.'18
The possibility of noncompetitive pricing distinguishes futures mar-
kets from other securities markets. A trader who is able to monopolize
the supply of, for example, IBM common stock (as implausible as this
seems) would not expect to be able to sell small quantities at prices
above the competitive market price. Attempts to sell at a higher price
would cause potential buyers to turn to other investments that pro-
vided a comparable return (depending on the amount of risk) at a
lower price. Such easy substitution is not possible when a futures
contract expires. Shorts must either satisfy their contractual obliga-
tions by purchasing the commodity in the spot market and delivering
it to the longs, or get longs to agree to a cash settlement - in effect
purchasing the commodity from the longs. If a trader obtains market
power through acquisitions of a substantial long position relative to
the deliverable supply held by others, shorts will probably have to
pay more than the competitive price for the commodity to satisfy their
obligations to the long (or pay more than the competitive price for
long futures contracts to offset their short position).

174 "Shorts" are traders who have agreed to sell the underlying commodity at expiration;
"longs" are traders who have agreed to purchase.
10 A "squeeze" is usually defined as a situation in which the open interest of an expiring
futures contract exceeds the deliverable supply. A "corner" is defined as a situation in which
the open interest of an expiring futures contract exceeds the deliverable supply of a commodity
because longs own and withhold part of the deliverable supply from the market. Both situations
result in noncompetitive pricing because the longs have market power.
161By noncompetitive pricing, we mean prices above those that would result if the ownership
of long futures contracts and the underlying spot commodity was unconcentrated. Many com-
mentators refer to high prices that may occur when futures contracts expire as "artificial,"
because these prices do not reflect "legitimate forces of supply and demand." See Richard D.
Friedman, Stalking the Squeeze: UnderstandingCommodities Market Manipulation, 89 IICH.
L. REV. 3o, 55 ('990) (criticizing this approach). As discussed below, high prices will occur
when supply is relatively short, demand is relatively high, or a trader obtains market power.
Such prices do reflect the existing conditions of supply and demand.
 HARVARD LAW REVIEW [Vol. 105:503

Such market power can arise through intentional conduct. For

example, a trader might secretly purchase a large amount of the open
futures contracts and deliverable supply of a particular commodity
with the hope that, when the contracts expire, he (or they) will have
sufficient market power to extract a high price from the shorts -
either in settlement of their contracts or for the purchase of the
underlying commodity needed to satisfy their contractual obligations.
Such market power may also arise, however, without any intention
on the part of a trader to obtain it. For example, a bullish trader
may purchase a substantial long position because he believes supplies
will be tight and prices will rise. If his position turns out to be
sufficiently large relative to the deliverable supply, he may find that
he has market power at expiration. Supply shocks (such as a poor
crop or a fire in a storage depository) or demand shocks (such as
unanticipated exports) may also create market power for longs.

B. The Definition of Manipulation in Futures Markets

The above discussion establishes that market power can arise from
legitimate trading activity. Presumably, any long trader wants to
make as much money as he can. Of course, a long trader who finds
himself with market power, whether or not he obtained it intention-
ally, will probably take advantage of the opportunity to charge prices
above the competitive price. Thus, unlike making a false statement,
noncompetitive pricing at expiration is not a bad act that provides an
objective test for identifying manipulative trading in futures markets.
There is no objective test that distinguishes the manipulative trades
from other trades that may or may not lead to the exercise of market
82
power. 1
As with securities markets, one must examine intent to distinguish
manipulative from nonmanipulative conduct in futures markets. Not
surprisingly, most commentators stress intent when defining the term
"manipulation." Thus, Edwards and Edwards find that the "'classic'
futures market manipulation(s) . . . all involve commonplace, bona
fide, futures trading activities, but activities which are alleged to be
undertaken in a manner calculated to produce artificial price ef-
fects.' u8 3 Johnson states that "the principal characteristics of a ma-

182Perhaps the exercise of market power is, in and of itself, a bad act that ought to be
prohibited. This is not completely obvious because the possibility of market power provides
incentives for traders who believe prices will rise (because future supply is insufficient) to go
long and incentives for shorts to obtain deliverable supplies to alleviate possible shortages.
Nevertheless, much of the current regulatory structure attempts to prevent the exercise of market
power without regard to its cause. Position limits and the occasional implementation of special
rules that require particular traders to reduce their holdings or prevent any traders from
increasing their net positions are examples of such regulation.
1s3 Edward. & Edwards, supra note i9, at 337 (emphasis added).
1991] MANIPULATION IN FINANCIAL MARKETS

nipulation are the ability to influence market prices, the intent to do

so, and the accomplishment of that purpose to create artificially high
or low prices. ' 18 4 Professor Friedman considers two alternative defi-
nitions of manipulation, both of which require intent to exercise mar-
ket power.' 8 5
Definitions that do not include intent fail to distinguish manipu-
lative conduct from legitimate market activity. For example, Mc-
Dermott defines a squeeze as "a trader's buying or threatening to take
delivery of" more than the maximum deliverable supply of a com-
modity owned by ethers. 18 6 Under this definition, a trader who pur-
chased futures contracts and deliverable supplies of a commodity
because he wanted to obtain a large quantity of the commodity and,
at expiration, found that the shorts were unable to obtain additional
deliverable supplies, would be guilty of manipulation.1 8 7 If he con-
cealed his position (as most buyers would), this conduct might also be
considered manipulative under Easterbrook's "reasonable economic
definition of manipulation" as "conduct in which the profit flows solely
from the trader's ability to conceal his position from other traders and
the trades d3 not move price more quickly in the direction that reflects
long-run conditions of supply and demand."18 8
But concealment does not distinguish manipulative trades from
legitimate trades. A trader who is able to predict that supplies will
be short and prices will rise would want to purchase a large quantity
of a commodity as cheaply as possible. To do so, he will probably
conceal his position and intentions from others. This secrecy is nec-
essary for him to profit from his ability to predict future conditions
of supply and demand. If the trader did not conceal his position,
current futures prices would rise to reflect the information the trader
had about future conditions. Recognizing this, Easterbrook distin-
guishes between "secret strategies necessary to capture the value of
new information about underlying conditions and secrecy designed to
cause prices to diverge from those that reflect the underlying condi-
tions." 189 This additional distinction requires the same inquiry into
intent (wh, t was the strategy designed to accomplish?) required by
the usual definitions of manipulation.

1-4 Philip M. Johnson, Commodity Market Manipulation, 38 WASH. & LEE L. REv. 725,
732 (981) (some emphasis omitted).
1, See Friedman, supra note 8i, at 35-36, 5o-5i. The initial approach, which Friedman
criticizes as incomplete, defines manipulation as conduct "motivated by the expectation that the
conduct itself would affect the market price." Id. at 36 (emphasis omitted). Friedman then
proposes a modified approach in which "intent is the central issue." Id. at 58.
ISS McDermott, supra note 23, at 204.
1S7 McDermott, of course, recognized that the definition of a squeeze could include trans-
actions that were "innocent and legal." Id. at 205 [Link].
i Easterbrook, supra note 21, at Six8.
1S9 Id.
 HARVARD LAW REVIEW [Vol. 105:503

The search for "artificial prices" also does not distinguish manip-
ulative trades from legitimate trades. What distinguishes an artificial
price from a non-artificial price? Commentators and courts have sug-
gested that "unusual" prices are artificial. 190 Futures prices are "un-
usual" if they result in unusual futures price differentials between
contract months, unusual intermarket spot price differentials (the
spread between the spot prices of different grades of the commodity
or the spread between spot prices of the same grade in different
locations), or unusual intertemporal variation in spot prices. 19 1 None
of these tests distinguishes artificial prices from non-artificial prices
because, whenever unusual conditions of supply or demand occur,
such comparisons will demonstrate that prices are "unusual." For
example, if the supply of a particular commodity in a particular
location is unexpectedly low at expiration but future supplies are
expected to return to normal levels, both the futures price differentials
and the intermarket cash price differentials will be high. Moreover,
because spot prices would first rise as the shortage develops and then
fall as it is alleviated, unusual intertemporal price variation will occur.
Scarcity will thus result in unusual prices; therefore unusual prices
alone cannot distinguish scarcity from noncompetitive prices.
Still, it may be possible to determine when unusual prices have
arisen becouse of the exercise of market power. Therefore, one could
define artificial prices as unusual prices that arise from the exercise of
market power. 192 But this definition does not distinguish manipulative
trades from nonmanipulative trades because, as discussed above, mar-
ket power can arise from legitimate trades. If the concern in futures
markets is the exercise of market power, the concept of manipulation

190 For example, Easterbrook suggests that "[slomeone searching for manipulation might look
for ... the telltale sign of sudden price fluctuations." Id. Staff economists at the Commodity
Futures Trading Commission reportedly rely on "an evaluation of changes in cash and futures
price levels, futures price differentials between contract months (spreads), cash and futures price
differentials (basis), and intermarket cash price differentials, particularly between delivery points
and other locations." STAFF OF SENATE COMM. ON AGRICULTURE, NUTRITION, AND FORESTRY,
96TH CONG., 2D SESS., REPORT OF THE COMMODITY FUTURES TRADING COMMISSION ON
RECENT DEVELOPMENTS IN THE SILVER FUTURES MARKETS i8-i9 (Comm. Print i98o) [here-
inafter REPORT OF THE CFTC]. The Cargill case discussed below also relies on unusual price
movements. See infra Part VIU.D.
191 Some commentators suggest as well that an unusual spread between the future and the
spot price of the commodity is also evidence of price artificiality. See, e.g., Easterbrook, supra
note 21, at Sii8. However, because the actual commodity can be used to satisfy the futures
contract, the future and spot prices must be closely related near expiration. In other words, if
the futures price is artificial, so too is the spot price. Therefore, an unusual spread between
the futures and the spot price is more likely to indicate poor price data than anything else.
192 This is the definition used by Edwards & Edwards. See Edwards & Edwards, supra
note 19, at 345 (construing "an artificial price to be any price other than one obtained when all
cash and futures market participants are price-takers" and defining a manipulator as "one who
has and uses monopoly power to effect an artificial cash and/or futures price").
19911 MANIPULATION IN FINANCIAL MARKETS

is superfluous. But if the concern in futures markets is trading that

creates market power, identifying such trading requires more than the
existence of noncompetitive prices at expiration. Again, just as with
other securities markets, we are left with no objective definition of
manipulation in futures markets.

C. Are Manipulations in Futures Markets Self-Deterring?

Successful manipulations appear to be more likely to occur in

futures ma-kets than in other securities markets. As discussed earlier,
successful manipulations require both that trading cause the price of
the relevant futures contract to rise and that the manipulator be able
to sell at a price higher than his purchase price. A manipulator may
be able to satisfy both conditions if he can secretly accumulate enough
futures contracts or deliverable supply of the underlying commodity
to obtain market power at expiration. Secret purchases would allow
the manipulator to buy at a price that did not reflect the coming
squeeze at expiration. The squeeze, caused by the exercise of the
manipulator's furtively acquired market power, might allow the ma-
nipulator to sell at a higher price than that at which he purchased.
But manipulation in futures markets is not easy. One reason is
that the acquisition of market power requires a large amount of
capital. A would-be manipulator needs to purchase a sufficient quan-
tity of contracts and, perhaps, stocks of the underlying commodity to
obtain market power. For some commodities, such as Treasury se-
curities, this is likely to be impossible. 193 For other commodities,
extensive capital is necessary to finance current margin requirements
and commodity purchases, and subsequent capital is needed to provide
for margin calls and to finance purchases at expiration.
There are also problems at expiration. To cause a price increase
at expiration, the manipulator, like any monopolist, must withhold
supplies of the commodity; if he provides the competitive supply, he
will receive only the competitive price. By keeping supplies off the
market, the manipulator may be able to obtain a high price on sales
of futures contracts or the underlying commodity to the shorts - but
what does he do with his remaining stocks of the unsold commodity?
Even if the manipulator continues to withhold supply, he is un-
likely to receive as high a price. Withholding supply causes prices to
rise at expiration because the shorts have inelastic demands; they must
fulfill their contractual obligations. After expiration, demand is likely

19-1Commodities that are readily available and can be easily transported cannot be cornered.
See Easterbrook, supra note 21, at Sio 9-io. Commodity contracts that allow for cash settlement
when the settlement price is determined in a reference market much larger than the futures
market, such as stock index futures, are also poor candidates for manipulation. See id. at S io;
Edwards & Edwards, supra note i9, at 359-6o.
 HARVARD LAW REVIEW [Vol. 105:503

to be far more elastic. Other grades of the commodity or related

commodities that could not be used to satisfy delivery requirements
under the terms of the futures contract may be good substitutes for
the underlying commodity in other uses. In addition, unlike the
shorts, other potential buyers of the commodity are not contractually
required to purchase at expiration; they may be able to substitute
intertemporally. Thus, the ability to obtain a high price at expiration
does not necessarily imply the ability to obtain a high price after
expiration. And additional sales by the manipulator are likely to push
the price down even farther.
Moreover, although a would-be manipulator in futures markets
may be confident that his position will cause prices to be higher at
expiration than would otherwise be the case (because of the inelastic
demand at expiration), he has no assurance that the price at expiration
will yield him a profit. An unexpected increase in deliverable supplies
or a reduction in demand could cause prices to be lower than antici-
pated. Even if such conditions do not occur at expiration, they may
occur before the manipulator has been able to unwind his position
after expiration.
For these reasons, attempted manipulations in futures markets are
extremely risky. In what is perhaps the best known recent alleged
manipulation, the Hunt family took substantial long positions in the
silver futures market and accepted large quantities of silver in EFP
(exchange futures for physical) transactions between September 1979
and March 1980.194 Allegedly as a result, the spot and futures prices
of silver rose substantially through mid-January 198o.195 Prices re-
mained high through March 198o but then began to fall as silver
stocks increased. 196 These price declines resulted in margin calls that
the Hunts were unable to meet. 19 7 Sales by the Hunts' brokers to
meet these margin calls caused additional price declines, 198 and the
Hunts reportedly lost more than a billion dollars.199 Legal rules are
unnecessary to deter such outcomes.
Another reason that legal prohibitions are unnecessary is that fu-
tures exchanges have incentives to adopt trading rules and contract
terms that reduce the costs associated with the exercise of monopoly

194 See SEVENTEENTH REPORT BY THE COMM. ON GOV'T OPERATIONS, SILVER PRICES AND
THE ADEQUACY OF FEDERAL ACTIONS IN THE MARKETPLACE, 1979-8o, H. R. Doc. NO. 395,
9 7th Cong., ISt Sess. 40-41 (i98i) [hereinafter SILVER PRICES].
195 See id. At least part of the silver price increase has been attributed to exogenous factors
such as a general increase in the price of precious metals. See, e.g., REPORT OF THE CFTC,
supra note 19o, at 40.
196 See SILVER PRICES, supra note 194, at 8, 36.
197 See REPORT OF THE CFTC, supra note 19o, at 83.

19s See id. at 46, 92.

199 See Easterbrook, supra note 21, at Siio n.5.
i99i] MANIPULATION IN FINANCIAL MARKETS

power that may result from corners and squeezes. Recall that the
terms of futures contracts are determined by the organized exchanges
on which futures trade. To survive, these exchanges must attract
business, compete with other exchanges, and compete with other se-
curities markets. This competition ensures that exchanges will adopt
contract terms and trading rules that reduce the costs of manipula-
tions. 20 0 There are several examples of such rules: position limits,
daily price limits, and special rules that require divestitures, prohibit
position increases, or change the terms of delivery to enlarge the
deliverable supply.
However, rules designed to prevent the exercise of market power
also have costs. First, such rules reduce the utility of the futures
contract as a hedge. Large positions cannot be hedged when there
are low position limits; large price swings cannot be insured against
when there are small price limits; and a concern about obtaining
supplies in one place (Chicago, for example) will not be alleviated if
the exchange allows delivery in another (Kansas City). Moreover,
rules designed to prevent the exercise of market power also reduce
the return to information about future prices and thus reduce the
incentive for market participants to gather such information. A trader
who must spend $io,ooo to learn whether contract prices will rise $i
would be unwilling to do so if he is allowed to buy only 3,000
contracts. Similarly, such rules may reduce the efficiency of futures
markets - a trader who is unable to act on his information is unable
to communicate information to other market participants through his
trades. Such rules, therefore, make future prices a poorer signal of
future spot prices than might otherwise be the case. Because rules
preventing the exercise of market power have costs as well as benefits,
optimal rules might not seek to prevent all exercises of market power.

200 This does not mean that exchanges necessarily will adopt the optimal amount of precau-
tions. Exchanges will continue to take additional precautions until the marginal private gains
equal the marginal private costs. This level of precaution will be optimal only if the private
gains and costs approximate the social gains and costs. But this is likely to be the case because
traders on the futures markets are those who bear most of the costs and receive most of the
gains from trading in these markets. See Easterbrook, supra note 21, at Sr13.
Some commentators have claimed that exchanges will not take the optimal amount of
precautions because exchanges do not take into account the interests of those who are affected
by futures prices but do not participate in the futures market. See, e.g., id. at Sx2-13. An
example is a farmer who looks at futures prices to determine how much to plant, but does not
hedge his crop in the futures market. It is not obvious, however, that the needs of these parties
are not taken into account, because such parties do transact in spot markets. Speculators in
futures markets take positions that ensure that futures prices reflect the information in spot
markets (and vice versa). This interaction between spot and futures markets may provide
incentives for exchanges to take the spot market into account in determining what precautions
to take.
550 HARVARD LAW REVIEW [Vol. 105:503

D. The Cargill Case

The case of Cargill, Inc. v. Hardin20 1 has been widely cited as
one of "the model 'squeeze situations"' 20 2 that is "part of the lore of
the markets. '20 3 An analysis of Cargill, however, reveals the same
conceptual confusion found elsewhere. What the court ultimately
objected to was Cargill's exercise of market power. Therefore, its
findings do not clarify the concept of manipulation in futures markets.
Cargill, Inc., was one of the largest grain merchandisers and ex-
porters in the United States. 20 4 In early 1963, Cargill had hedged its
inventory of soft red winter wheat by selling May 1963 wheat futures
contracts on the Chicago Board of Trade. 205 These contracts traded
until May 21 and could be satisfied at par by delivery of No. 2 soft
red winter wheat. In February and March 1963, Cargill sold sub-
stantial quantities of such wheat to mills in the southwestern United
States and learned that the Spanish Government had indicated interest
in purchasing soft red winter wheat. 206 Because of these develop-
ments, Cargill concluded that supplies of wheat would be tight in
May, liquidated its short position, and began to establish a long
position in the May futures. 20 7 Between April 15 and May 15, Cargill
increased its long position to 1,930,ooo bushels, just short of the
20 8
2,ooo,ooo bushel position limit.
On May ii, the Spanish Government offered to purchase 5o,ooo
tons (2,ooo,ooo bushels) of soft red winter wheat. 20 9 In response,
Cargill offered on May 14 to sell 12,500 tons of wheat at $2.13/2 per
bushel, and on May 15 Cargill offered to sell 15,ooo tons at $2.09 per
bushel. 2 10 Both offers were accepted on May 18.211 These sales and
other commitments left Cargill with approximately 50,ooo bushels of
wheat on hand on May 2o; others owned approximately 2o,ooo bush-
21 2
els.
On May 20, Cargill placed an order to sell May 1963 contracts for
ioo,ooo bushels of wheat at $2.19 (just below the highest permissible
price), but it was able to sell only 40,ooo bushels and the order was
cancelled. 213 At the opening of trading on May 21, the total open

201 452 F.2d 1154 (8th Cir. 1971), cert. denied, 406 U.S. 932 (1972).
202 McDermott, supra note 23, at 214.
203 Easterbrook, supra note 21, at Si6.
204 See Cargill, 452 F.2d at 1158.
205 See id.
206 See id. at iz59.
207 See id.
208 See id.
209 See id.
210 See id.
211 See id.
212 See id. at 116o.
213 See id.
199i] MANIPULATION IN FINANCIAL MARKETS

interest was approximately eight million bushels, of which Cargill

owned 1,89o,ooo.214 At 11:45 a.m., the future was trading at $2.20
and Cargill placed orders to sell its position at prices ranging from
$2.27 to $2.281 (just below the maximum permissible price). 2 15 Car-
gill's broker liquidated all but 365,ooo bushels prior to the close of
trading. 216 During the settlement period, Cargill agreed to sell ware-
house receipts to shorts at $2.28 , provided that the shorts redelivered
2 17
the receipts to Cargill in satisfaction of their futures contracts
Cargill liquidated 315,ooo bushels in this fashion and received 5o,ooo
bushels from other sources. 2 18 After settlement, Cargill had approx-
imately 88,ooo bushels of wheat, which it disposed of between June
2 19
4 and June 13 at prices ranging from $2.10 to $2.13 per bushel.
The Eighth Circuit based its conclusion that Cargill had manipu-
lated the market price on four findings of fact: that Cargill acquired
220
and held a controlling long position in the May 1963 wheat futures;
that the shorts had an insufficient supply of wheat available (without
coming to Cargill) for delivery on the futures; 2 2 1 that Cargill obtained
an artificially high price in liquidation of its futures contracts; 22 2 and
223
that the squeeze was intentionally caused by Cargill.
The first finding is merely a statement that Cargill had market
power - that is, the ability to control price. The second finding,
however, amounts to the same thing. 22 4 To reach this conclusion, the
court found that supplies of hard wheat in Chicago and surrounding
areas were properly excluded from the calculation of deliverable sup-
ply (even though hard wheat could be used to satisfy the delivery
requirement of the futures contract) because "[i]t would be more eco-
nomic to pay the long a premium than to pay the additional charges
for premium wheat plus shipping and handling charges. '225 But this
is merely a finding that Cargill had market power; Cargill would have
been unable to charge what it did for futures contracts if shorts could
have obtained and delivered hard wheat for less.

214 See id.

215 See id.
216 See id.
217See id. at 116o-6i.
216 See id. at ii6i.
219 See id.
220 See id. at 1164.
221 See id. at x67.
222 See id. at iI69.
22
1 See id. at 1172.
224 Note that the deliverable supply was insufficient to fulfill the contracts, even if it had
been owned entirely by others. The court emphasized that Cargill alone knew that it owned a
large fraction of the deliverable supply, see id. at I170, but it is unclear whether different
ownership would have averted the squeeze or affected the court's findings.
225Id. at ii66.
 HARVARD LAW REVIEW [Vol. 105:503

The court's finding that Cargill obtained an "artificial" price was

based on evidence that the May 1963 prices were abnormally high
compared to various historical benchmarks. 226 As discussed earlier, 227
such benchmark tests do not eliminate the possibility that unusual
supply and demand conditions created abnormally high prices. The
court did not recognize this, but it did conclude that Cargill caused
the artificially high price because Cargill's sell orders were at prices
of from seven to eight cents higher than what the future had been
selling for. 228 This latter finding distinguishes high prices caused by
unusual supply and demand conditions from high prices caused by
market power because it suggests that Cargill was able to "set the
market price by reason of its dominant long position. "229
Thus, none of the first three findings distinguishes Cargill's behav-
ior from the profitable exercise of market power. Neither does the
court's finding that Cargill intended to cause the squeeze. This finding
was based primarily on the observation that Cargill's "behavior in
liquidating its contracts was clearly intentional and was highly unusual
market behavior; and the method of liquidating the unresolved open
''23 0
interest . . . was also unusual and clearly controlled by Cargill.
But all this means is that Cargill tried to sell its position at the highest
possible price. Because it had market power, it was able to do so.
None of the court's findings distinguish Cargill's purported manip-
ulation from the profitable exercise of market power. Which of Car-
gill's transactions were manipulative? Perhaps the purchases of fu-
tures contracts between April 15 and May 15 were manipulative. But
the court found that Cargill made these purchases because it had
"concluded that supplies of wheat would be tight by . . .the end of
the crop year" and that prices might rise. 23 1 This is the essence of
speculation. Perhaps it was Cargill's sales to the Spanish government
that were manipulative. But these sales were at the market price and
were publicly disclosed. Clearly these transactions, which allowed
Cargill to obtain market power, were legitimate and normal market
behavior. All that is left to criticize are Cargill's profit-maximizing
sales at expiration. Monopoly theory is sufficient to analyze these;
calling them a manipulation adds nothing.

226 See id. at 1167.

227 See supra p. 546.
228 See Cargill, 452 F.2d at 1169-70.
229 Id. at 1171.
230 Id. at 1170-71. The Court also discussed an inter-office telegram and an interview of a
Cargill executive. This other evidence suggests that Cargill only believed it had the ability to
influence prices at the time of expiration; the evidence does not show that Cargill intended to
obtain such market power at the time it acquired its position.
231 Id. at 1159.
i991] MANIPULATION IN FINANCIAL MARKETS 553

IX. CONCLUSION
Manipulation is a fundamental concern of the regulation of finan-
cial markets. But manipulation is not defined in any of the regulatory
statutes and, despite much academic and judicial commentary, no
satisfactory definition of the term has been offered. The term is often
used to refer to conduct that is better understood as something else
- usually fraud or monopoly. In other cases, the term is used to
refer to trading made with "bad intent" when the underlying trans-
actions are otherwise indistinguishable from normal market activity.
"Trading with bad intent" does provide the term "manipulation" with
unique meaning, and such trading may be undesirable if manipula-
tions do affect securities prices. However, there is no compelling
reason to be concerned about such trading because it is likely to be
self-deterring. For this reason, and because the enforcement of pro-
hibitions is likely to be costly, actual trades should not be prohibited
as manipulative regardless of the trader's intent.