Brattle Economists Author Article on Proof of Intent in the SEC

Brattle principals Shaun Ledgerwood and Paul Hinton recently authored the article “D.C. Circuit Clarifies that SEC Need Not Show Market Impact in Manipulation Cases” for the American Bar Association’s Securities Litigation Committee.

The authors discuss how recent appellate review of the Securities and Exchange Commission’s (SEC) prosecution of market manipulation cases may provide a “road map” to how the commission will evaluate trading activity to prove intent in future manipulation cases.

Dr. Ledgerwood and Mr. Hinton examine the case Securities & Exchange Commission v. Donald L. Koch & Koch Asset Management, LLC, in which the D.C. Circuit reviewed the SEC’s decision in an administrative action against an investment advisor who was found to have “marked the close,” or entering uneconomic trades at the end of the trading day to influence the price or other market outcome. Marking the close is a form of intentional uneconomic behavior that is actionable under the SEC’s Rule 10b-5, as well as the related fraud-based market manipulation rules of the Federal Energy Regulatory Commission (FERC) and the Commodity Futures Trading Commission (CFTC).

The authors explain that, as demonstrated in the Koch outcome, it is necessary to show that trades were placed with “an intent that is consistent with desire to seek best execution.” This standard of proof under the SEC’s Rule 10b-5 usually involves a combination of “economic evidence of uneconomic trading and documentary evidence confirming intent,” including trading data, emails, and recorded phone conversations.

It remains to be seen whether the clarity provided by the D.C. Circuit on the standard of proof needed in manipulation cases under the Securities Exchange Act will increase enforcement. However, although the SEC may impose sanctions for manipulation without proving market impact, all damages claims in private litigation will require a demonstration of how alleged manipulation affected securities prices.

The full article can be read on the ABA’s website.