Chapter 11 – Three Hundred Years of Stock Market Manipulations



300 Years of Stock Market Manipulations – From the Coffeehouse to the World Wide Web’s Stock Manipulations

In previous chapters, we saw that many of the changes in securities markets brought about by information technology in general and the Internet in particular are positive, democratizing access to markets and information. We also saw that technology is not always an unadulterated boon, and there is ample opportunity to fool yourself by blind data mining, and to find people trying to fool you using an ever-expanding bag of tricks, cons, and manipulations.

As information technology has expanded the scope of resources available to legitimate investors and traders, the Web has also become the prime new venue for the old game of market manipulation. Institutional traders and other long-term market participants often comment that they see far more inexplicable price moves than they did in the pre-Web era. In many cases, these moves are tied to subtle, and not so subtle, attempts at market manipulation using the newfound power of the Internet to transmit and spread rumors, manipulate beliefs, and post incorrect information at little cost, while maintaining the cloak of anonymity.

Price distortions arising from manipulations may be short-lived, but they are real prices, and can dramatically affect the cost of trading and investment performance. The influence of the rumor machine is overlaid on the influences of more fundamental (and benign) factors that move stock prices. Therefore, interest in manipulations is not confined to the most obvious potential victims, specialists, dealers, and market makers but to all buy-side traders. This chapter examines the nature and characteristics of Internet market manipulations and their non-electronic precedents, going back 300 years.

The Real Economic Impact of Pump and Dump Stock Market Manipulations

In 1999, NEI Webworld, Inc. (NEIP) was an obscure, nearly bankrupt printing company. Its stock barely had a pulse. It had been kept alive as a shell company, used by firms that wanted to access the public markets, but without the scrutiny that comes with an initial public offering (IPO). The last trade had been over a year earlier, for a penny and a half.

Suddenly it rocketed up 106,600 percent in one morning. What happened? A miracle cure? A hit movie? Pokémon lunch boxes? No, none of these. NEIP’s move was propelled purely by the power of Internet message boards. Two (subsequently indicted) UCLA students dramatically demonstrated how the new technology of the Internet had dramatically transformed the old game of market manipulation.

The Internet raises market manipulation to a level only dreamed of by past shysters. It used to take a real effort, a PR firm, or a major newspaper column to reach millions of potential traders. Now anyone can do it from their desktop. The Internet era is defined by the unparalleled ability of the new style of manipulator to use the Internet to affect the perceptions of vast numbers of investors at lightning speed, all the while remaining completely anonymous. This article looks at market manipulations — from early scams of the 1600s to the high-tech frauds of today — and asks how the game has changed and what you can do to protect yourself.(1)

Who cares about this, anyway? Aren’t these just isolated instances of little concern to ordinary investors? Absolutely not! There are hundreds of well-documented cases involving message manipulation, with financial impacts running into the billions of dollars. And it’s not just micro-cap stocks; recently multibillion-dollar Lucent Technologies was the subject of a successful manipulation attempt. When the people who get burned complain to the authorities, the Financial Industry Regulatory Authority (FINRA), the Securities and Exchange Commission (SEC), New York Stock Exchange (NYSE), and National Association of Securities Dealers (NASD), all examine messages in their investigations.

The SEC set up an office back in 2000 just to deal with Internet scammers. These agencies are reactive — the investigators head for the message boards after someone complains that something suspicious has occurred in a stock.

Brokers, market makers, specialists, and traders, however, care in a proactive sense. They want early warnings of potential trouble ahead so they don’t get left holding the proverbial bag. The Web has become the new prime venue for the old game of market manipulation. But it is not just the most obvious potential victims — specialists, dealers, and market makers — who care about manipulations. All good buy-side traders care about manipulations. If you have an order to trade in size — say, one day’s average daily volume — you may be planning to execute the trade in parcels over three days. Price distortions arising from manipulations may be short-lived, but they are real prices, and can dramatically affect the cost of trading(2) and investment performance. The influence of the rumor machine is overlaid on the influences of more fundamental (and benign) factors that move stock prices. In an extreme case like NEIP, there are no other factors, but there are few if any stocks that are immune from these effects.

A Classic Market Manipulation – A Long History of Investment Manipulation

The ignoble history of stock market manipulations doubtless goes back to the most ancient markets. In one of the earliest accounts of manipulations, Joseph de la Vega, in Confusión de Confusiones , wrote of the Amsterdam Stock Exchange over 300 years ago (1688): The greatest comedy is played at the Exchange. There, . . . the speculators excel in tricks, they do business and find excuses wherein hiding places, concealment of facts, quarrels, provocations, mockery, idle talk, violent desires, collusion, artful deceptions, betrayals, cheatings, and even tragic end are to be found.(3)

In the Amsterdam market at the time, market manipulations were common. De la Vega provides a comprehensive model of the various manipulations used to trick unsuspecting investors, including early versions of such perennial favorites as “painting the tape” * , making small trades to move the price. De la Vega’s book, Confusión de Confusiones , was picked by the Financial Times as one of the 10 best investment books ever written.(4) [Painting the tape is the illegal practice in which traders buy and sell a specific security among themselves, in order to create an illusion of high trading volume. Traders profit when unsuspecting investors, lured in by the unusual market volume, buy the stock.]

In the Amsterdam market of the late 1600s, there were two active stocks — the Dutch East India Company and the Dutch West India Company — and most of the activity revolved around speculation about the cargoes of the ships of these companies entering the port. One of the most successful stratagems was the spreading of false rumors in Amsterdam coffeehouses ( coffy huysen in Dutch) frequented by traders and brokers. As de la Vega describes it: “The bulls spread a thousand rumors about the stocks, of which one would be enough to force up the prices.”(5) Manipulators would falsely bid up the prices of stocks through a variety of artifices, including painting the tape and the spreading of overly optimistic news. Brokers would hint that ships soon to enter port carried rich cargoes ( “No tea and spices — they’ve got furs and diamonds” ), and soon the rumors would get ever more extravagant ( “Lots of furs and really big diamonds” ), leading to large price run-ups. Some things in life are fairly constant.

The Very Model of a Modern Market Manipulator on Stock Market Message Boards

There is no de la Vega for the twenty-first century, but there is Tel212, an anonymous poster to Yahoo!’s message boards.(6) The remarkable message that follows contains much of the same material, updated for the Internet, 320 years later. …

>>>>>> READ MORE HERE < <<<<<<

All notes for this chapter about Stock Market Message Boards, Stock Recommendations, and Pump and Dump Stock Manipulations on Internet Social Media:

This article originally appeared in the Summer 2001 issue of the Journal of Investing. It is reprinted in Nerds on Wall Street with permission. To view the original article, please go to iijoi.com. My coauthor, Ananth Madhavan, was at the University of Southern California when we started this, was at Investment Technology Group (ITG) when we finished, and is now director of trading research at Barclays Global Investors.

1. Corners and short squeezes, including various railroad manipulations by Cornelius Vanderbilt and others at the turn of the twentieth century, represent another form of manipulation through scarcity as opposed to redirecting people’s beliefs. This chapter focuses on manipulations based on false information of one type or another.

2. The real cost of trading is the difference between the price at the time you decide to trade and the total price at the time you actually trade. Commissions are usually the smallest part of this. Market impact and the opportunity cost of delay far outweigh the commissions. See the discussion in Chapter 5.

3. Joseph de la Vega, Confusión de Confusiones (New York: John Wiley & Sons, 1995), p. 169.

4. Confusión de Confusiones and Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds (another of the FT editors’ top 10) are published together in the Wiley Investment Classics Series.

5. De la Vega, Confusión de Confusiones , p. 203.

6. The URL at the time the article was written was http://messages.yahoo.com/bbs? action=m & board=18185330 & tid=wgat & sid=18185330 & mid=16909 . However, this guide seems to have wisely been removed.

7. De la Vega, Confusión de Confusiones, p. 199.

8. Peter Wysocki, “Cheap Talk on the Web: The Determinants of Postings on Stock Message Boards” (Working Paper No. 98025, University of Michigan, 1999).

9. Tokyo Joe eventually settled with the SEC, paying $748,000 in fines but not admitting guilt. Gretchen Morgenson, “‘Tokyo Joe’ Settles Suit with S.E.C. over Web Site,” New York Times, March 9, 2001.

10. Gretchen Morgenson, “Internet’s Role Is Implicated in Stock Fraud,” New York Times, December 16, 1999.

11. SEC, Release No. 42483, March 2, 2000, Administrative Proceeding, File No. 3-10154.

12. This was written in 2001, and the prediction has proven correct. The entire genre of so-called pictograms — pictures of text touting a stock in spam e-mail — rose to a minor industry, and vanished as better anti-spam measures took hold.

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