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Published online by Cambridge University Press: 06 March 2019
Until recently, cheap fiction and corporate finance most famously met in the creative accounting of companies like WorldCom and Enron. Now, however, both the spoof James Bond, Austin Powers, and the securities regulators of Germany, the United Kingdom, Italy and France face common, twin malevolence: Doctor Evil and Mini Me. These reportedly were the names of a trading strategy devised at the London based European government bond desk of Citigroup Inc. to correct – as reported in the The Wall Street Journal Europe – what a senior bank executive had referred to as their not “making enough money for the firm.” According to the Journal, “Citigroup wanted to use the futures market to push up prices for bonds traded on the cash market, which tend to follow futures prices. Then they would dump a large amount of bonds in the cash market, reaping profits from their holdings and forcing down prices, to the detriment of other market participants.” At 10:00 am on August 2, 2004, six Citigroup traders launched “Mini Mi” by building up positions in the Eurex futures market, then at 11:29 am they unleashed the “Dr. Evil” trading program, which placed sell orders for various European government bonds, with a total aggregate value of € 83 billion, of which only € 12.4 found buyers; once “the price of the bonds had fallen because of the flood of sell orders, Citigroup bought back € 3.8 billion in bonds … and is estimated to have made around € 15 million in profit.” The spot sales were primarily conducted on the MTS fixed-income trading platform, and constituted 42% of the platform's total value for the day; the traders had cash positions of only about € 8 billion in the securities for which they placed sell orders of up to € 83 billion, which could have left them with a much larger short position than the € 4.4 billion they eventually had.
1 Ascarelli, Silvia, Citigroup Euro-Bond Push Sparked Market Firestorm, Wall St. J. Europe, 3 February 2005, at A1.Google Scholar
2 Id., at A6.Google Scholar
3 Id.Google Scholar
4 “The emergence of pan-European trading platforms has been an important force in the process of integrating the secondary market for European government bonds. The most important among them are MTS in the cash market, and EUREX in the futures market. MTS is a quote-driven, electronic trading platform …. Currently, MTS is the parent company that partially owns subsidiaries in all the euro-area countries and in Denmark, and trades government bonds in several Eastern European countries through its division “New EuroMTS” (since November 2003). MTS S.p.A. is owned by financial intermediaries …. The breakthrough in MTS's business model was the creation of EuroMTS, a pan-European inter-dealer platform that offered trading facilities for the largest and most liquid European government bonds and subsequently became the standard setter for European benchmark bonds, that is, the newly issued bonds at the 5- and 10-year maturities.” Marco Pagano & Ernst-Ludwig von Thadden, “The European Bond Markets under EMU” (Working Paper, November 2004), Forthcoming in the Oxford Review of Economic Policy.Google Scholar
5 Id.Google Scholar
6 Atkins, Ralph & Munter, Päivi, Trichet calls for ‘thorough’ Citigroup inquiry, The Financial Times, 4 February 2005, at 1.Google Scholar
7 Taylor, Edward & Pacelle, Mitchell, Wall St. J. Europe, 26 January 2004, at A1.Google Scholar
8 Ascarelli, supra note 1, at A1. The French Treasury has announced that it considers Citicorp's behaviour to have “tarnished the European markets,” and it gave Citicorp a lower rating in the secondary market (sixth place) than it would have otherwise. See Adam Bradbery & Anne Hardy, French Treasury Scolds Citigroup Over Bond Trade, Wall. St. J. Europe, 15 February 2005, at M1.Google Scholar
9 See infra note 33 and accompanying text.Google Scholar
10 The 2002 text of the section, in the author's translation, is as follows: “§ 20a Prohibition of Exchange and Market Price Manipulation. (1) It is prohibited for any person to: 1. provide incorrect information regarding circumstances that are significant for the valuation of a financial asset, or fail to disclose such information contrary to applicable provisions of law, if the disclosure or failure to disclose such information is capable of influencing the domestic exchange or market price of a financial asset or the price of a financial asset on an organized market in another Member State of the European Union or in another contracting state to the Agreement on the European Economic Area; or 2. undertake any other deceptive practice in order to influence the domestic exchange or market price of a financial asset or the price of a financial asset on an organized market in another contracting state to the Agreement on the European Economic Area.”Google Scholar
11 European Parliament and Council Directive 2003/6/EC of 28 January 2003 on insider dealing and market manipulation (market abuse), O.J. (L 96) 16.Google Scholar
12 Art. 18 of 2003/6/EC gave the Member States until 12 October 2004 to “bring into force the laws, regulations and administrative provisions necessary to comply with this Directive.” Germany implemented the Directive with The Investor Protection Improvement Act of 28 October 2004 (Das Gesetz zur Verbesserung des Anlegerschutzes vom 28.10.2004, printed in the German Federal Law Reports, BGBl, vol. I, page 2630).Google Scholar
13 Article 181 of the Unified Text Governing Financial Intermediation (Legislative Decree no. 58 of 24 February 1998) was abrogated by Article 8 of Legislative Decree no. 61 of April 11, 2002, which moved the applicable provision to the Civil Code and there inserted a new Article 2637 (Manipulation – Aggiotaggio): “Any person who disseminates false information, conducts simulated transactions or uses other devices (operazioni simulate o altri artifici) that are specifically suited (concretamente idonei) to cause a material change in the price of financial instruments, whether listed or not, or to significantly prejudice (incidere in modo significativo) public trust in the financial stability of banks or banking groups shall be punished with imprisonment from between one and five years” (author's translation). Like the German law, this amendment was prepared when 2003/6/EC was still in draft, but unlike the German law – as discussed below – the Italian provision does not require willing commission of the manipulation. However, Article 2637 is expressly limited to “simulated transactions,” and would thus seem to reduce the possibility of prosecuting the type of real trades involved in “Dr. Evil” and “Mini Mi.” Against this understanding of the Italian position is reference to CONSOB's prosecution of trade-based manipulation since Italian law began prohibiting manipulation in 1991. See Marcello Minenna, “The detection of market abuse on financial markets: a quantitative approach,” CONSOB Working Paper Series (Quaderni di Finanza), no. 54, May 2003, available from [email protected].Google Scholar
14 See Part VIII, Penalties for Market Abuse, Financial Services and Market Act 2000, 2000 c. 8.Google Scholar
15 On the implementation of 2003/6/EC in the United Kingdom, see Joe Coffey & Jonathan Overett Somnier, Driving You MAD – A Road-Map Of The Market Abuse Directive (I), 17.1 Compliance Monitor (2004) and The Financial Services Authority, “UK Implementation of the EU Market Abuse Directive (Directive 2003/6/EC), Consultation Document (June 2004).Google Scholar
16 The base, statutory provision is Article L 465-2 of the Code Monétaire et Financier, which in the author's translation states: “Any person who directly or indirectly, through a third party, effects or attempts to effect any action (manæuvre) for the purpose of prejudicing (ayant pour objet d'entraver) the normal operation of a market for financial instruments by inducing others into error shall be punished with the penalties provided for in the first subsection of Article L. 465-1.” The new regulation is found in Title III (Market Manipulation) of Book VI of the General Regulations of the French Financial Market Authority, issued on 24 November 2004, and available at http://www.amffrance.org/documents/general/5621_1.pdf. For a relatively up-to-date presentation of the French market manipulation rules, see Philippe Portier & Raphaële Navelet-Noualhier, Chapter on France, in Securities Transactions in Europe ¶ 80-175 (2004). An interesting older article comparing the philosophies of the French and U.S. rules on market manipulation is Hubert De Vauplane & Odile Simart, The Concept of Securities Manipulation and its Foundations in France and the USA, Brook J. Int'l L. 203 (1997).Google Scholar
17 During the interim period, the Mark, Franc, Lira and others were technically only variously denominated expressions of the euro. For a history of the transition, see Hanspeter K. Scheller, The European Central Bank: History, Role and Functions (2004), available at www.ecb.eu, and Hal S. Scott, International Finance: Law and Regulation 144 et. seq. (2004). Greece became the 12th member of the euro-zone in January 2001. Scheller, at 17; for additional accounts of the transition from national currencies to the Euro (and from those left out), see the “letters from Italy, Germany and England”, in 3 German L.J. (1 February 2002), available at: http://www.germanlawjournal.com/article.php?id=135.Google Scholar
18 Pagano, & Thadden, von, supra note 4, at 12.Google Scholar
19 See Eilís Ferran, Building an EU Securities Market 1 et. seq. (2004).CrossRefGoogle Scholar
20 The text of the Report is available at http://europa.eu.int.Google Scholar
21 For discussions and evaluations of the four-level approach, see Guido Ferrarini, “Contract Standards and the Markets in Financial Instruments Directive (MiFID): An Assessment of the Lamfalussy Regulatory Architechture,” Institute for Law and Finance Working Paper Series, No. 39 (2005), available at http://www.ilf-frankfurt.de/publications/ILF_WP_039.pdf; Ferran, supra note 19, at 61; and Niamh Moloney, Current Developments – European Union Law, 53.4 Int'l and Comp. L.Q. I.B (2004).Google Scholar
22 For a description of the EU legislative process, see Paul Craig & Gráinne de Búrca, EU Law 139 et. seq. (3rd ed. 2003).Google Scholar
23 See CESR's website at http://www.cesr-eu.org/.Google Scholar
24 See Art. 18, EU Directive 2003/6/EC, supra note 11.Google Scholar
25 Commission Regulation 2273/2003 of 22 December 2003, implementing Directive 2003/6/EC of the European Parliament and of the Council as regards exemptions for buy-back programmes and stabilisation of financial instruments, O.J. (L 336), 33.Google Scholar
26 Commission Directive 2003/124/EC of 22 December 2003 implementing Directive 2003/6/EC of the European Parliament and of the Council as regards the definition and public disclosure of inside information and the definition of market manipulation, O.J. (L 339), 70.Google Scholar
27 Commission Directive 2003/125/EC of 22 December 2003 implementing Directive 2003/6/EC of the European Parliament and of the Council as regards the fair presentation of investment recommendations and the disclosure of conflicts of interest, O.J. (L 339) 73.Google Scholar
28 Commission Directive 2004/72/EC of 29 April 2004 implementing Directive 2003/6/EC of the European Parliament and of the Council as regards accepted market practices, the definition of inside information in relation to derivatives on commodities, the drawing up of lists of insiders, the notification of managers’ transactions and the notification of suspicious transactions, O.J. (L 162) 70.Google Scholar
29 “The kinds of manipulation that the [Securities Exchange] Act effectively outlawed fall naturally into two categories. The first can be described as action-based manipulation, that is, manipulation based on actions that change the actual or perceived value of the assets…. The second category can be described as information-based manipulation, that is, manipulation based on releasing false information or spreading false rumors…. However, there is a third category of manipulation that is much more difficult to eradicate. We refer to this third category as trade-based manipulation. It occurs when a trader attempts to manipulate a stock simply by buying and then selling, without taking any publicly observable actions to alter the value of the firm or releasing false information to change the price.” Franklin Allen & Douglas Gale, Stock-Price Manipulation, 5 The Review of Fin. Studies 503, 505-506 (1992)Google Scholar
30 The definition goes on “unless the person who entered into the transactions or issued the orders to trade establishes that his reasons for so doing are legitimate and that these transactions or orders to trade conform to accepted market practices on the regulated market concerned.” Art. 1(2)(a), 2003/6/EC.Google Scholar
31 Section 9(a)(2) Exchange Act reads, in relevant part: “It shall be unlawful for any person, directly or indirectly … to effect … a series of transactions in any security registered on a national securities exchange or in connection with any security-based swap agreement … 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.Google Scholar
32 Loss & Seligman point out that this is the most litigated element of the trade-based manipulation provision. Louis Loss & Joel Seligman, Fundamentals of Securities Regulation 1131 (5th ed. 2004).Google Scholar
33 “The argument is simple. When a trader tries to buy a stock, he drives up the price. When he tries to sell it, he drives down the price. Thus, any attempt to manipulate the price of a stock simply by buying and selling requires the trader to ‘buy high’ and ‘sell low.’ This is the reverse of what is required to make a profit.” Allen & Gale, supra note 29, at 506. Also, our common understanding of what is unfair appears to center on false information and dissimulating actions. The very first English manipulation case, Rex v. de Berenger (3 Maule & S. 67, 74, 105 Eng. Rep. 536, 539 (K.B. 1814), discussed in Loss & Seligman, supra note 32, at 1121) involved both a stunt by impostures (action-based) and false information regarding the end of the Napoleonic wars. Another element to consider is that the flow of information in connection with listed companies and the sale of securities is generally considered fair game for regulation in most developed jurisdictions, and is subject to requirements governing offerings (such as the provisions found in §§ 5, 11, 12 and 17 of the U.S. Securities Act of 1933), disclosure requirements for continued listing and takeovers (such the as provisions found in §§9, 10, 13, 14, 14, 17 and 18 of the U.S. Exchange Act of 1934) and manipulation's close relative, insider trading (regulated in the United States with the series of rules issued under § 10(b) Exchange Act).Google Scholar
34 Daniel R. Fischel & David J. Ross, Should the Law Prohibit “Manipulation” in Financial Markets?, 105 Harv. L. Rev. 503, 519 (1991).Google Scholar
35 In the Matter of the Federal Corporation, 25 SEC 227, 330 (1947).Google Scholar
36 See Art. 4, 2003/124/EC.Google Scholar
37 Investor Protection Improvement Act, supra note 12. For a discussion of this Act and its legislative history, see Gerald Spindler, Kapitalmarktreform in Permanenz – Das Anlegerschutzverbesserungsgesetz, 48 Neue Juristische Wochenschrift 3349 (2004).Google Scholar
38 The term “financial instruments” derives in this context from Art. 1, no. 3 of 2003/6/EC, and has been implemented in § 20a(1) to mean securities, money market instruments, options, swaps and a number of other instruments and derivatives listed on a German exchange or traded on the German over-the-counter market and securities listed on an exchange in a Member State of the European Union.Google Scholar
39 The text of the provision as amended in October 2004 is, in relevant part and in the author's translation: Ҥ 20a Prohibition of Market Manipulation (1) 1 It shall be prohibited to:Google Scholar
1 disseminate false or misleading information regarding circumstances that are material for the valuation of a financial instrument, or to omit disclosure of such circumstances contrary to exiting law, if the information or the omission is likely to affect the domestic exchange or market price of a financial instrument or the price of a financial instrument on an organized market in another Member State of the European Union or another contracting state to the Agreement on the European Economic Area,Google Scholar
2 undertake transactions or issue buy or sell orders that are likely to give false or misleading signals as to the supply of, demand for or the exchange or market price of financial instruments or create an artificial price level, orGoogle Scholar
3 dmploy other deceptive practices that are likely to affect the domestic exchange or market price of a financial instrument or the price of a financial instrument on an organized market in another Member State of the European Union or another contracting state to the Agreement on the European Economic Area.Google Scholar
2 Sentence 1 applies to financial instruments that areGoogle Scholar
1 admitted to trading on a domestic securities exchange, or included in a regulated market or an over-the-counter market, orGoogle Scholar
2 admitted to trading on an organized market in another Member State of the European Union or another contracting state to the Agreement on the European Economic Area.Google Scholar
3 An application for admission or a public announcement of admission to trading on an organized market, or inclusion in a regulated market or an over-the-counter market, shall be treated as admission.Google Scholar
1 (2) The prohibition of subsection (1), sentence 1, no. 2 shall not apply if the transaction conforms to the permissible market practice on the relevant organized market or on the relevant over-the-counter market and the person who entered into the transactions or issued the orders to trade has legitimate reasons for so doing. 2 Permissible market practices shall be only those conventions that reasonable discretion would expect to find on the relevant market and that the Financial Services Supervisory Agency recognizes as permissible market practice within the meaning of this provision. 3 No market practice shall be deemed impermissible solely because it has not been expressly recognized in advance.Google Scholar
1 (3) Trading in a company's own shares in the context of a buy-back program and measures to stabilise the price of financial instruments shall in no case constitute a violation of the prohibition in subsection (1), sentence 1, if they are conducted pursuant to the requirements of Commission Regulation (EC) No 2273/2003 of 22 December 2003 implementing Directive 2003/6/EC of the European Parliament and of the Council as regards exemptions for buy-back programmes and stabilisation of financial instruments (O.J. EU Nr. L 336 p. 33). 2 The provisions of Regulation (EC) No 2273/2003 shall apply mutatis mutandis to financial instruments that are included on the over-the-counter or the regulated market.”Google Scholar
40 As the violation of § 20a triggers liability for criminal sanctions, the “guilty until proven legitimate” formulation used in this provision was hotly debated and apparently only accepted because it was decreed from on high by the European government. Further, the introduction of “safe harbors” in the form of market practices that the regulatory authority declares to be legitimate caused quite some concern because the concept of “safe harbor” was difficult to classify within German legal doctrine. See Spindler, supra note 37, at 3453 and Rudolf Streinz & Christoph Ohler, § 20a WpHG in rechtsstaatlicher Perspektiv – europa- und verfassungsrechtliche Anforderungen an das Verbot von Kurs- und Marktpreismanipulationen, 27 WM 1309, 1312 (2004).Google Scholar
41 See supra note 25, Arts. 3-11.Google Scholar
42 § 20a(3) Securities Trading Act.Google Scholar
43 Dreyling, Georg, Die Umsetzung der Marktmissbrauchs-Richtlinie über Insider-Geschäfte und Marktmanipulation, 1 Der Konzern 1, 4 (2005). For a discussion of the implementation of 2003/6/EC into German law with a focus on the supremacy of European law in relation to national law and the permitted relationship between the two systems, see Streinz & Ohler, supra note 40. For a general discussion of the structure and activity of the Federal Financial Services Supervisory Agency, see Kenneth K. Mwenda, Legal Aspects of Unified Financial Supervision in Germany, 4 German L.J. 1009 (2003), at http://www.germanlawjournal.com/article.php?id=327.Google Scholar
44 The German Financial Services Supervisory Agency published a guidance regulation for the 2002 version of § 20a, “Verordnung zur Konkretisierung des Verbotes der Kurs- und Marktpreismanipulation (KuMaKV) of 18 November 2003 (BGBl vol. I, page 2300), available at http://www.bafin.de/, and will almost certainly do so pursuant to new § 20a(5). Such a regulation will follow the lead of the EU second level implementing Directives, and may not conflict either with such Directives or with Commission Regulation 2273/2003 on safe harbors for buy-backs and stabilization.Google Scholar
45 Pagano & von Thadden, supra note 4, at 16.Google Scholar
46 Id. at 16.Google Scholar
47 Ascarelli, supra note 1, at A6.Google Scholar
48 Id.Google Scholar
49 Id. and Pagano & von Thadden, supra note 4, at 16.Google Scholar
50 Ascarelli, supra note 1, at A6.Google Scholar
51 Fischel, & Ross, , supra note 34, at 518.Google Scholar
52 Fama, Eugene F., Efficient Capital Markets: A Review of Theory and Empirical Work, 25 Journal of Finance 383, 415 (1970).Google Scholar
53 Andrei Shleifer, Inefficient Markets: An Introduction to Behavior Finance 2-3 (2000).Google Scholar
54 Gilson, Ronald J. & Kraakman, Reinier, The Mechanisms of Market Efficiency Twenty Years Later: the Hindsight Bias, 28 J. Corp. L. 715, 729 (2003).Google Scholar
55 Langevoort, Donald C., Taming the Animal Spirits of the Stock Markets: A Behavioral Approach to Securities Regulation, 97 Nw. U.L.Rev. 135, 161 (2002).Google Scholar
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57 Allen, & Gale, , supra note 29, at 506. See also Steve Thel, $850,000 in Six Minutes–the Mechanics of Securities Manipulation, Cornell L. R. 219, 241 (1994), and Fischel & Ross, supra note 34, at 513.Google Scholar
58 Pagano, & Thadden, von, supra note 4, at 16.Google Scholar
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60 Fischel, & Ross, , supra note 34, at 519.Google Scholar
61 Mahoney explains the strategic setting of the bid/ask spread: “Imagine that a market maker trades in a stock that has a value either of $20.00 or $30.00, each with probability 0.5. The market maker does not know the true value, but other traders may, and the market maker is aware of the latter fact… To avoid regret, he must determine the conditional expectation of the stock price, given the order flow he observes. Intuitively, a preponderance of buy over sell orders causes the market maker to increase his estimate of the stock's value, while a preponderance of sell orders causes the reverse…. [H]e sets bid and ask prices so as to generate zero expected profits, assuming competition among market makers. The zero expected profit condition means that the profits the market maker earns from uninformed traders just equal the losses to informed traders. In game theory parlance, informed and uninformed traders “pool” in the sense that the market maker cannot distinguish them ex ante and quotes the same prices to each.” Paul G. Mahoney, Market Microstructure and Market Efficiency, J. Corp. Law 541, 546-47 (2003).Google Scholar
62 Thel, supra note 57, at 234-35.Google Scholar
63 Pagano, & Thadden, von, supra note 4, at 14. An agreement to hold a spread ceiling, as used to promote liquidity in the MTS market thus allows a participant who is willing to abuse the pact to get immediacy without paying for it because the “pact” prevents the other market maker participants in the platform from raising the spread to protect themselves.Google Scholar
64 “Normally, when they suspect that they may be receiving orders from an informed trader, market makers protect themselves by widening their quotes or refusing to trade. But the MTS market-makers were committed to quote firm prices for large amounts and keep tight spreads, and this allowed Citigroup to trade such a large amount before they could react.” Pagano & von Thadden, supra note 4, at 16.Google Scholar
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66 See Bryan v. United States, 524 U.S. 184, 191, 118 S.Ct. 1939, 1944-1945 (1998).Google Scholar
67 Vogel, supra note 65, at 640, marginal note 98. For a discussion of the “knowingly” standards, see United States v. Bailey, 444 U.S. 394, 404, 100 S.Ct. 624, 632 (1980).Google Scholar
68 Vogel, supra note 65, at 642, marginal note 104.Google Scholar
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71 See Vogel, supra note 65, at 585, marginal note 9, and Gert Nicolaysen, Europarecht I: Die Europäische Integrationsverfassung 339 (2002).Google Scholar
72 § 37k Securities Trading Act.Google Scholar
73 § 39(1) no. 2 and (4) Securities Trading Act.Google Scholar
74 § 38(1) no. 4 in connection with § 39(1) no. 2 Securities Trading Act.Google Scholar
75 There is no direct action, or “private right of action” for an investor or other market participant under § 20a. The Federal Agency has an duty under § 20b(6) to refer cases of manipulation to the relevant district attorney for prosecution. See Vogel, supra note 65, 580, marginal note 2; Knut Sauer, Haftung für Falschinformation des Sekundärmarktes 44 (2004).Google Scholar
76 Vogel, supra note 65, at 648, marginal notes 116 et. seq.Google Scholar
77 Gilson, & Kraakman, , supra note 54, at 743.Google Scholar
78 Brav, Alon & Heaton, J. B., Market Indeterminacy, 28 J. Corp. L. 517, 537 (2003).Google Scholar
79 Hans Kelsen, Pure Theory of Law 28 (Max Knight, trans. 1967).Google Scholar
80 Mahoney, supra note 61, at 548.Google Scholar
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