What is Market Manipulation?: The High Court of Australia Weighs In.
In a recent decision, the High Court of Australia adopted an expansive approach to the market manipulation provision in that country’s corporations statute. In particular, the High Court rejected the notion that market manipulation is restricted to the misuse of monopolistic or dominant market power. The High Court instead held that purchasing shares for the sole or dominant purpose of creating or maintaining a specific price amounts to market manipulation, even in the absence of proof that the transaction affected the behaviour of genuine market participants. The High Court’s decision will likely make it easier to prosecute market manipulation in Australia and may have ramifications in Canada as well.
The accused (referred to as “JM”) was charged with 39 counts of market manipulation, and two counts of conspiring with others to commit market manipulation.
An entity associated with JM had borrowed money to exercise a large number of call options. These call options were for shares in a company (referred to as “X Ltd.”) that was listed on the Australian Securities Exchange. The shares in X Ltd. were used as collateral for the loan. In the event that these shares dropped below a certain value, the borrower was subject to margin calls requiring that additional collateral be provided.
The Commonwealth Director of Public Prosecutions (the “CDPP”) alleged that, on July 4, 2006, JM’s daughter (on behalf of a company controlled by her husband) bought shares in X Ltd. so as to prevent the day’s closing price for shares in X Ltd. from dropping below the value at which a margin call on her father’s loan would have been made. According to the CDPP, JM’s daughter made the purchase for the sole, or at least the dominant, purpose of preventing a margin call, and the transaction had the effect of creating or maintaining an artificial price for the shares, contrary to section 1041A of the Corporations Act 2001. JM pleaded not guilty to all charges.
A dispute arose between the CDPP and JM as to the meaning of “artificial price” in section 1041A. After the plea had been made, but before a jury was empanelled, the trial judge stated a case and reserved certain questions for determination by the Victorian Court of Appeal. The issue, in essence, was whether market manipulation under section 1041A should be narrowly construed, such that it only applies to transactions effected by a person who has monopolistic or dominant market power.
This issue arose in large part because the language in section 1041A, which applies to “financial products” (i.e., both securities and futures), originated in a predecessor futures statute. (Past legislation addressed securities and futures offences separately.) An explanatory memorandum, which was prepared at the time the predecessor futures statute was passed through Parliament, contained the following explanation of the futures market manipulation offence:
“The two main forms of manipulation are ‘squeezing’ and ‘cornering’ which involve attempts to manipulate futures prices by manipulating supply and demand for the physical commodities that are deliverable under futures contracts so that available supply is exceeded and artificial prices are created.”
The explanatory memorandum did not specifically define “squeezing” and “cornering,” but these terms were taken from American futures jurisprudence. In particular, a 1971 decision by the United States Court of Appeals (Eighth Circuit) described a “corner” as follows:
“In its most extreme form, a corner amounts to nearly a monopoly of a cash commodity, coupled with ownership of long futures contracts in excess of the amount of that commodity, so that shorts—who because of the monopoly cannot obtain the cash commodity to deliver on their contracts—are forced to offset their contract with the long at a price which he dictates, which of course is as high as he can prudently make it.” (Cargill Inc. v. Hardin, 452 F.2d 1154 at 1162 (1971))
A “squeeze” is “a less extreme situation than a corner” in which “there may not be an actual monopoly of the cash commodity itself,” but deliverable supplies of the commodity are low. (Ibid.)
As described in this American decision, cornering and squeezing involve the misuse of monopolistic or dominant market power. Thus, the issue in JM was whether the interpretation of section 1041A should be limited in this manner or, instead, whether section 1041A should be more expansively construed so as also to capture transactions in which the accused (though not having a monopolistic or dominant market position) has the sole or dominant purpose of maintaining the price at a particular level.
The Victorian Court of Appeal
The majority of the Court of Appeal favoured the narrow interpretation of section 1041A. The majority attributed significance to the use of “cornering” and “squeezing” in the explanatory memorandum. In addition, the majority traced the evolution of sections 1041B and 1041C, which address false trading, market rigging, and artificial setting and maintenance of prices. According to the majority (at para. 334), section 1041A is limited to market manipulation “of the kind typified by ‘cornering’ and ‘squeezing,’” whereas sections 1041B and 1041C are more general provisions.
By contrast, the minority favoured a more expansive interpretation of section 1041A and rejected the notion that the creation of an “artificial price” requires the misuse of market dominance. The minority held that an “artificial price” under section 1041A is “a price that is created by something other than genuine market forces of supply and demand.” (para. 257) This is not limited to cornering and squeezing and could include a transaction that is made for the sole or dominant purpose of creating or maintaining a particular price. The minority, however, added the proviso that section 1041A would not apply to the transaction in the absence of proof that “the transaction went on to affect the behaviour of genuine buyers and sellers in the market.”(para. 260)
The High Court of Australia
In a unanimous decision, the High Court overruled the majority’s narrow interpretation. Among other things, the High Court noted that sections 1041A, 1041B, and 1041C are not “separate watertight compartments where any given set of facts could constitute only one of the offences prescribed.” (para. 64) Further, the High Court observed that “cornering” and “squeezing” are terms that were developed in the futures context and that depend on the separation between the futures market and the market for the underlying commodity. These terms, however, cannot be readily applied to the securities market, which is also regulated by section 1041A. In addition, the High Court reviewed the above-mentioned 1971 American decision and concluded that the United States Court of Appeals (Eighth Circuit) did not intend to restrict the notion of market manipulation in the futures market to cornering and squeezing.
Instead of the majority’s narrow interpretation, the High Court favoured an interpretation that is largely consistent with that of the minority. According to the High Court, the interpretive touchstone for section 1041A is “genuine supply and demand”:
“The price that results from a transaction in which one party has the sole or dominant purpose of setting or maintaining the price at a particular level is not a price which reflects the forces of genuine supply and demand in an open, informed and efficient market. It is, within the meaning of s 1041A, an ‘artificial price’.” (para. 72)
Thus, the High Court agreed with the minority that section 1041A is not restricted to the misuse of a monopolistic or dominant market position. The High Court, however, disagreed with the minority that proof of an actual effect on genuine market participants is required. Because section 1041A prohibits transactions that are likely to create or maintain an artificial price, the Crown need not show that the impugned transactions did create or maintain an artificial price.
The High Court concluded by clarifying that transacting with the sole or dominant purpose of setting or maintaining an artificial price is not an element of the offence under section 1041A. It is, instead, one type of transaction that is caught by section 1041A. The High Court expressly noted that it was not deciding what other types of transactions would also be caught by section 1041A.
The High Court has taken a broad approach to the interpretation of section 1041A—broader than both the majority and the minority at the Court of Appeal. Unlike the majority, the High Court refused to restrict section 1041A to the misuse of a monopolistic or dominant market position. Unlike the minority, the High Court held that proof of an actual effect on genuine market participants is not required. In so holding, the High Court has likely enhanced the power of Australian regulators, and prosecutions under section 1041A may therefore be more frequent in the future.
The High Court’s broad interpretation may also have ramifications in Canada. In Ontario, for example, the Securities Act (section 126.1) and the Commodity Futures Act (section 59.1) both prohibit fraud and market manipulation. Although the language in the Ontario statutes is somewhat different from section 1041A, there is little Ontario case law interpreting these provisions, and it is therefore possible that an Ontario court would look to the High Court’s decision (and, in particular, to the expansive interpretive approach embodied in that decision) for guidance.
Date of Decision: June 27, 2013
High Court of Australia market manipulation purchasing shares Victorian Court of Appeal