FSB enforcement committee gets tough on trader

Gareth Stokes, FAnews Online Editor

Share prices are supposed to reflect the interaction of buyers and sellers in an open market. But there are cases – particularly with thinly traded companies – where traders or fund managers manipulate the price of certain shares for their own personal gain. There have been a number of market manipulation cases under the Financial Services Board’s (FSB) watch. Some involve asset managers trying to improve the value of a portfolio before quarter end, while others involve derivative traders trying to avoid massive margin calls.

Market manipulation is illegal and the FSB, through the Directorate of Market Abuse (DMA) and its enforcement committee, act ruthlessly in the event they apprehend someone engaging in this kind of activity. Their most recent case was against Timotheus Pretorius, a derivatives trader and the sole director of Origin SA Limited, which traded as Cortex Derivatives Brokers, who knowingly used manipulative, improper, false or deceptive trading practices between 20January 2009 and 10February 2009. He created false or deceptive appearances of the trading activity, or artificial prices, for shares of Cape Empowerment Trust Limited and Beige Holdings Limited.

The mechanics of the crime

Pretorius was accused of using manipulative, improper, false or deceptive trading practices on a number of occasions. On 20 January 2009, for example, he waited until 16h14 before purchasing 500 Beige shares at 12 cents per share, for his own account. The primary purpose of this transaction was to change the closing price of the Beige share from 11c to 12c/share. “This transaction created, or might have created a false or deceptive appearance of the trading activity in connection with Beige shares and/or created an artificial price for the Beige share.”

The DMA documents a number of charges (counts) for the same offence, namely purchasing thousands of Beige shares as near as possible to the market closing time to ‘boost’ the closing price from 11c to 12c/share. This happened on 27 January 2009 (Count 2), 28 January 2009 (Count 3) and 30 January 2009 (Count 4). Count 5 is slightly different in that Pretorius “directly or indirectly purchased at successively higher prices 13 000 Beige shares at 11c/share and 5000 Beige shares at 12c/share respectively on his own account – to improperly or unduly change the closing price of the Beige share from 10c to 12c/share.” But for Pretorius’ intervention Beige would have closed at 10c! He repeated this act on 5 February 2009 (Count 6) and 10 February 2009 (Count 7).

His wrongdoings in Cape Empowerment Trust were documented in Count 8 through 21. On 23 December he “directly or indirectly purchased 5 000 Cape Empowerment shares at 50c/share for his own account, specifically to change the closing price of the Cape Empowerment from 45c to 50c/share,” notes the DMA. Pretorius’ manipulation of the Cape Empowerment Trust share price continued until 10 February 2009, at which time he was purchasing shares at 40c/share – still trying desperately to maintain the share price at a level higher than the market warranted.

Why would a trader do this?

We can only speculate as to the motivation behind this market manipulation. Derivative traders can take sizeable positions in companies using geared financial instruments such as single stock futures (SSFs) and contracts for difference (CFDs). Each of these instruments requires the trader to deposit a significant amount of cash (called the margin) with their broker. In the even the share price moves against them the trader has to make additional deposits (called the margin call) to cover their losses.

If, for example, a trader wanted exposure to R1 million worth of Beige shares (at 12c/share) he could complete the transaction by purchasing 8 333 futures contracts requiring a margin deposit of around R125 000 (or eight times gearing). If Beige fell from 12c/share to 10c/share (a drop of 16.67%) the trader would have to deposit another R166 700 to cover the loss on his futures position. This margin is calculated on the shares closing price – which explains why it would be tempting to artificially prop up the share price minutes before market close. The trader could purchase 5 000 shares at 12c/share (for R600) or have to find R166 700 to meet a margin call.

A substantial fine

The Enforcement Committee of the FSB, established in terms of section 10(3) of the Financial Services Board Act, No 97 of 2090, considered allegations of contraventions of section 75 of the Securities Services Act, No 36 of 2004 (market manipulation) against Pretorius. The trader pled out the charges and the Committee imposed a penalty and a contribution to the cost of the FSB in the total amount of R2million.

Editor’s thoughts: There have been plenty of derivative related disasters on the JSE in recent years. Vox Telecoms shares plummeted when derivatives broker Dealstream Securities collapsed, because Vox directors were heavily overweight the share through geared instruments. And Nedbank is facing a massive lawsuit for its role in allegedly forcing up the share price of Acc-Ross Holdings. Should geared trades be subject to closer scrutiny? Add your comment below, or send it to gareth@fanews.co.za