Corruption and Fraud in Financial Markets: Malpractice, Misconduct and Manipulation

Cover
Title Page
Copyright
Contents
About the Editors
List of Contributors
Foreword
Acknowledgements
Chapter 1: Introduction
Part I What are Manipulation and Fraud and why do They matter?
Chapter 2: An Overview of Market Manipulation
2.1 Introduction
2.2 Definitions of Market Manipulation
2.2.1 Legal Interpretation and Provisions against Market Manipulation
2.2.2 Economics and Legal Studies Perspective
2.3 A Taxonomy of the Types of Market Manipulation
2.3.1 Categories of Market Manipulation
2.3.2 Market Manipulation Techniques
2.4 Research on Market Manipulation
2.4.1 Theoretical Literature
2.4.2 Empirical Literature
2.4.3 Conclusions from the Research on Market Manipulation
2.5 Summary and Conclusions
References
Chapter 3: A Taxonomy of Financial Market Misconduct
3.1 Introduction
3.2 Challenges in Research on Financial Market Misconduct
3.3 Defining Financial Market Misconduct
3.3.1 Price Manipulation
3.3.2 Circular Trading
3.3.3 Collusion and Information Sharing
3.3.4 Inside Information
3.3.5 Reference Price Influence
3.3.6 Improper Order Handling
3.3.7 Misleading Customers
3.4 Defining Financial Fraud
3.4.1 Credit Card Fraud
3.4.2 Money Laundering
3.4.3 Financial Statement Fraud
3.4.4 Computer Intrusion Fraud
3.5 Conclusion
References
Chapter 4: Financial Misconduct and Market-Based Penalties
4.1 Introduction
4.2 Notable Cases of Financial Reporting Fraud
4.3 Financial Reporting Misconduct and Legal Redress
4.4 Evolution of US Financial Regulations
4.4.1 Private Securities Litigation Reform Act (1995)
4.4.2 Sarbanes–Oxley Act (2002)
4.4.3 Dodd–Frank Act (2010)
4.5 Legal versus Market-Based Penalties for Financial Misconduct
4.5.1 Common Forms of Legal Penalties
4.5.2 Role of Market-Based Penalties
4.6 Firm-Level Penalties for Corporate Financial Misconduct
4.6.1 Direct Economic Costs Captured in Loss of Market Value
4.6.2 Loss of Firm Reputation
4.6.3 Spillover of Reputational Effect
4.6.4 Governance Risk and Insurance Premiums
4.6.5 Reduced Liquidity
4.6.6 Access to Financing
4.6.7 Reduced Innovation
4.6.8 Mergers and Acquisitions
4.7 Individual-Level Penalties for Corporate Financial Misconduct
4.7.1 Executive and Director Turnover
4.7.2 Impaired Career Progression
4.7.3 Loss of Reputation
4.7.4 Executive Compensation
4.7.5 Strengthened Monitoring
4.8 Causes, Risks, and Moderators of Financial Misconduct
4.8.1 Fraud Incentives
4.8.2 Risk Factors
4.8.3 Public Enforcement: Regulatory and Judicial Stringency
4.8.4 Public Enforcement: Detection and Surveillance
4.8.5 Private Enforcement
4.9 Other Non-Financial Misconduct
4.10 Concluding Remarks
References
Chapter 5: Insider Trading and Market Manipulation
5.1 Introduction
5.2 Regulatory Framework on Insider Trading and Market Manipulation
5.3 Recent Examples of Market Manipulation and Insider Trading
5.4 Conclusions
References
Chapter 6: Financial Fraud and Reputational Capital
6.1 Financial Frauds in the 2000s
6.2 The Effects of Fraud Revelation on Firm Value and Reputational Capital
6.2.1 Market Value Losses When Financial Misconduct Is Revealed
6.2.2 Spillover Effects
6.2.3 Reputational Losses for Financial Misconduct
6.2.4 Direct Measures of Lost Reputational Capital
6.2.5 Do Misconduct Firms Always Lose Reputational Capital?
6.2.6 Rebuilding Reputational Capital
6.3 The Effects of Fraud Revelation on Shareholders and Managers
6.3.1 Should Shareholders Pay? Do Managers Pay?
6.3.2 Do Shareholders Pay Twice?
6.3.3 Are Firm-Level Penalties Efficient?
6.3.4 Consequences for Managers and Directors
6.4 Why Do Managers Do It? Motives and Constraints
6.4.1 Motives for Financial Misconduct
6.4.2 Constraints on Financial Misconduct
6.5 Proxies and Databases Used to Identify Samples of Financial Statement Misconduct
6.6 Conclusion: Reputation, Enforcement, and Culture
References
Part II How and Where Does Misconduct Occur?
Chapter 7: Manipulative and Collusive Practices in FX Markets
7.1 Introduction
7.2 Different Types of FX Orders
7.3 The Unique FX Market Structure
7.4 Examples of Manipulative and Collusive Practices in FX Markets
7.4.1 Front Running
7.4.2 Triggering Stop-Loss Orders
7.4.3 ‘Banging the Close’
7.4.4 Collusion and Sharing of Confidential Information
7.4.5 Spoofing
7.4.6 Market Abuse via Electronic Trading Platforms
7.5 The Reform Process
References
Chapter 8: Fraud and Manipulation within Cryptocurrency Markets
8.1 Introduction
8.2 Why Do fraud and Manipulation Occur in Cryptocurrency Markets?
8.2.1 Lack of Consistent Regulation
8.2.2 Relative Anonymity
8.2.3 Low Barriers to Entry
8.2.4 Exchange Standards and Sophistication
8.3 Pump and Dumps
8.3.1 Case Studies
8.4 Inflated Trading Volume
8.4.1 Case Study: January 2017 and PBoC Involvement
8.5 Exchange DDoS Attacks
8.5.1 Case Study
8.6 Hacks and Exploitations
8.6.1 Exchange Hacks
8.6.2 Smart Contract Exploits
8.6.3 Protocol Exploitation
8.7 Flash Crashes
8.7.1 GDAX-ETH/USD Flash Crash
8.8 Order Book-Based Manipulations
8.8.1 Quote Stuffing
8.8.2 Order Spoofing
8.9 Stablecoins and Tether
8.9.1 Tether Historical Timeline
8.9.2 Tether Controversy and Criticism
8.9.3 Tether’s Significance in Cryptocurrency Global Markets
8.10 Summary and Conclusions
References
Chapter 9: The Integrity of Closing Prices
9.1 Why Closing Prices Matter
9.2 Painting the Tape and Portfolio Pumping
9.3 ‘Bang-the-Close’ Manipulation: The Response of Financial Intermediaries
9.4 Stock Price Pinning on Option Expiration Dates
9.5 Conclusion: Lessons for the Regulation and Design of Financial Markets
References
Chapter 10: A Trader’s Perspective on Market Abuse Regulations
10.1 Introduction
10.2 Getting the Trading Edge
10.3 A Typical Trader’s Market Window
10.4 Wash Trades
10.5 High Ticking/Low Ticking – Momentum Ignition
10.6 Spoofing
10.7 Layering
10.8 Smoking
10.9 Case Study: Paul Rotter a.k.a. ‘The Flipper’
10.10 The Innocent and the Guilty
10.11 What Are Exchanges Doing to Prevent Market Abuse?
10.11.1 CME Group
10.11.2 ICE
10.12 What Are Trading Companies Doing to Prevent Abuse?
10.13 Will There Be an End to Market Abuse?
Part III Who are These Scoundrels?
Chapter 11: Misconduct in Banking: Governance and the Board of Directors
11.1 Introduction
11.2 Literature Review
11.3 Research Design
11.3.1 Data
11.3.2 Empirical Design
11.3.3 Variables
11.4 Empirical Results
11.4.1 Main Results
11.4.2 Results for Different Classes of Enforcement Actions
11.4.3 Does Better Board Quality Alleviate Shareholder Wealth Losses?
11.5 Conclusion
References
Chapter 12: Misconduct and Fraud by Investment Managers
12.1 Introduction
12.2 Related Research
12.3 The Investment Advisers Act of 1940 and Mandatory Disclosures
12.4 Data
12.4.1 Investment Fraud
12.4.2 Form ADV Data and Variables
12.5 Predicting Fraud and Misconduct
12.5.1 Predicting Fraud by Investment Managers
12.5.2 Interpreting the Predictive Content of the Models
12.5.3 K-Fold Cross-Validation Tests
12.6 Predicting the Initiation vs. the Continuance of Fraud
12.7 Firm-Wide Fraud vs. Fraud by a Rogue Employee
12.8 Out-of-Sample Prediction and Model Stability
12.9 Policy Implications and Conclusions
References
Chapter 13: Options Backdating and Shareholders
13.1 Introduction
13.2 Stock Return Patterns around Option Grants
13.3 The Backdating Practice
13.4 Media Coverage, Restatement, and Investigation
13.5 Stock Market Reaction to Public Revelations of Backdating
13.6 Investor Reaction to (and Anticipation of) Public Revelations
13.7 Other Types of Misbehaviour Related to Option Grants
13.7.1 Forward Dating
13.7.2 Selective Disclosure
13.7.3 Option Exercise Backdating
13.7.4 Independent Director Backdating
13.8 Connections with Questionable Practices by Corporate Executives and Other Agents
13.9 Conclusion
References
Chapter 14: The Strategic Behaviour of Underwriters in Valuing IPOs
14.1 Valuing IPOs
14.2 The Underwriter’s Incentives in the Valuation of IPOs
14.3 Literature Review
14.4 Sample, Data, and Methodology
14.4.1 Sample and Data
14.4.2 Alternative Selection Criteria of Comparable Firms
14.4.3 Valuation Bias and IPO Premium
14.5 Results
14.5.1 Algorithmic Selections
14.5.2 Affiliated and Unaffiliated Analysts
14.5.3 Underwriters’ Selection of Comparable Firms Pre- vs. Post-IPO
14.5.4 Pre- vs. Post-IPO Selections and Industry Effects
14.6 Conclusions
References
Chapter 15: Governance of Financial Services Outsourcing: Managing Misconduct and Third-Party Risks
15.1 Introduction
15.2 The Four Components in Outsourcing
15.2.1 Efficient Outsourcing
15.2.2 The Four-Factor Governance Model
15.2.3 Misconduct in Outsourcing and the Ability of Financial Institutions to Monitor
15.3 The Interaction between Contracting and Monitoring
15.3.1 Characterization of Financial Institutions
15.3.2 Risks in Outsourcing Services
15.4 Governance Mechanisms to Detect Misconduct in Financial Outsourcing
15.4.1 Screening and Detection
15.5 Conclusion
References
Part IV Detection and Surveillance of Financial Misconduct
Chapter 16: Identifying Security Market Manipulation
16.1 Introduction
16.2 Background Legislation
16.2.1 Australia
16.2.2 UK
16.2.3 Hong Kong
16.2.4 Canada
16.2.5 Singapore
16.2.6 Malaysia
16.2.7 New Zealand
16.3 Attributes of Manipulation
16.3.1 How Traders Minimize the Resources Needed for Manipulative Trading
16.3.2 Difficulties in Determining Whether Trading Behaviour Is Manipulative
16.3.3 Surveillance Systems
16.4 Detection Algorithms
16.5 Conclusion
Chapter 17: The Analytics of Financial Market Misconduct
17.1 Introduction
17.2 Financial Economic Analysis
17.2.1 Benchmarking to Historical or Past Data
17.2.2 Benchmarking to Alternate Proxies
17.2.3 Benchmarking to a Model
17.3 Quantitative Techniques
17.3.1 The Principles of Fraud Detection
17.3.2 Popular Supervised Learning Techniques for Fraud Detection
17.3.3 Popular Unsupervised Learning Techniques for Fraud Detection
17.3.4 Dynamic Misconduct Detection
17.4 Conclusion
References
Chapter 18: Benford’s Law and Its Application to Detecting Financial Fraud and Manipulation
18.1 Introduction
18.2 Benford’s Law and Generalizations
18.2.1 The Basic Principle of Benford’s Law
18.2.2 Illustration of Benford’s Law
18.2.3 Testing for Conformity with Benford’s Law
18.2.4 Considering Further Digits with Benford’s Law
18.2.5 When Do Data Conform to Benford’s Law?
18.2.6 Limitations of Using Benford’s Law for Identification of Manipulations
18.2.7 Generalizations of Benford’s Law for Identification of Manipulations
18.3 Usage of Benford’s Law for Detecting Fraud and Deviant Behaviour
18.3.1 Forensic Accounting in the Context of Auditing, Internal Control Systems, and Taxation
18.3.2 Finance
18.3.3 Surveys and Research
18.4 A Case Study: Benford’s Law and the LIBOR
18.5 Policy Implications
18.6 Summary, Limitations, and Outlook
References
18.A Appendix
Part V Regulation and Enforcement
Chapter 19: The Enforcement of Financial Market Crimes in Canada and the United Kingdom
19.1 Introduction
19.2 Existing Scholarship
19.3 Comparative Analysis
19.3.1 Canada
19.3.2 The United Kingdom
19.4 Reform
19.4.1 Resource Allocation
19.4.2 Principles-Based Regulation
19.4.3 Targeted Regulatory Reforms
19.5 Conclusion
References
Chapter 20: A Pyramid or a Labyrinth? Enforcement of Registrant Misconduct Requirements in Canada
20.1 Introduction
20.2 Definitional and Institutional Quagmires
20.3 The Compliance/Enforcement Continuum
20.4 Enforcement Options Available to Sanction Registrant Misconduct
20.5 Empirical Information Available about Registrant Misconduct in Canada
20.5.1 Criminal Enforcement
20.5.2 CSA Non-Criminal Enforcement
20.5.3 Director’s Decision Data in Ontario
20.5.4 SRO Enforcement
20.6 Analysis
Chapter 21: Judicial Local Protectionism and Home Court Bias in Corporate Litigation
21.1 Introduction
21.2 Institutional Background
21.2.1 Decentralization and Local Protectionism
21.2.2 Judicial Independence
21.2.3 The Heterogeneity of the Legal Environment across Regions
21.3 Empirical Evidence
21.3.1 Sample
21.3.2 Basic Statistics
21.3.3 The Wealth Effect for Defendants and Plaintiffs around the Filing Announcements at Different Courts
21.3.4 The Impact of Court Location on the Wealth Effect
21.3.5 Regression Analysis of the Wealth Effects from a Filing Announcement
21.3.6 Heckman Two-Step Analysis of Sample Selection Bias
21.3.7 The Impact of Court Location on the Likelihood to Appeal
21.3.8 Sensitivity Tests
21.4 Conclusion
References
Index
EULA