A deep dive into market manipulation: Part 2

Continued from yesterday

False trading and market rigging

Section 128 addresses false trading and market rigging. The offence has two broad components. The first involves creating or causing a false or misleading appearance with respect to trading activity, or price. The second involves trading without a genuine change in beneficial ownership. A trade does not involve a change in beneficial ownership if a person, or an associated person, retains an interest in the securities both before and after the transaction. Trades between related parties, such as spouses, provide a common example.

Regional case law offers guidance on how these provisions are applied. In Public Prosecutor v Soh Chee Wen and Quah Su-Ling, the Singapore High Court identified three limbs of the offence. “Firstly, by actually creating a false or misleading appearance in respect of either the trading activity of, the market for, or the price of the security in question (the “first limb”). Second, by doing anything intended to create such an appearance (the “second limb”). Finally, by doing anything likely to create such an appearance (the “third limb”) “. It is clear the first and the third limb only focuses on the “act” and not on the “intent”. The prosecution does not need to demonstrate an intention, if the trading circumstances caused the share quantity or the price to be influenced. In this case, timing of the buy orders was premium evidence of the conduct. The series of buy orders within a short period of time created a strong case for influencing the price.  Importantly, the first and third limbs focus on the effect of the conduct rather than the trader’s intent. Where trading activity distorts price or volume, intent need not be proven. Timing and pattern of trades can be decisive. In the Singapore case, the timing of buy orders was central to establishing price influence.

For a securities market to function, confidence is essential. Investors must believe that prices reflect genuine supply and demand, that risks are understood, and that the system is not tilted in favour of a few insiders. Without this confidence, participation shrinks and capital formation suffers. Building and maintaining this confidence is one of the central responsibilities of the Securities and Exchange Commission of Sri Lanka

Sri Lankan law provides statutory defences. Section 128 allows an accused person to demonstrate that the purpose of the trading was not to create a false market. In such cases, the burden of proof effectively shifts to the defence. This represents a departure from the traditional rules relating to evidence, where the prosecution bears the burden of proof.

Where trades occur without a change in beneficial ownership, or where collusive matching of orders is evident, the law presumes misconduct. The accused must then show good faith and a lack of recklessness. Evidence of a legitimate trading rationale becomes critical.

Stock market manipulation

Section 129 prohibits transactions or series of transactions that influence the price or quantity of a security with the aim of raising, lowering, stabilising or maintaining it at an artificial level. The offence captures both direct trading and the making of express or implied invitations to buy or sell.

The scope is deliberately wide. It extends to indirect conduct, including the use of intermediaries or proxies. The law seeks to prevent individuals from benefiting through layered or concealed forms of solicitation.

False or misleading statements

Section 130 addresses the dissemination of false or misleading information likely to have a material effect on price or trading volume. The law imposes a duty of reasonable care. A person must take steps to verify information before circulating it and must not act recklessly.

Investigators will look for evidence that reasonable checks were carried out. Knowledge also matters. Where a person knew, or could reasonably be expected to have known, that information was false or misleading, liability may arise. Company directors and professional advisors are held to a higher standard, given their access to information and expertise in certain circumstances. As an example, a director of a company should refrain from circulating information about a merger if he knows that is untrue. 

Fraudulently inducing persons to deal in securities

Section 131 prohibits inducing others to trade through misleading forecasts, concealment of material facts, or knowingly recording or storing false information. Both intentional and reckless conduct are covered.

This provision has clear implications for research analysts. Forecasts must rest on sound assumptions and credible analysis. Retaining financial models and supporting documentation can be critical in demonstrating good faith if a recommendation is later questioned.

Manipulative and deceptive devices

Section 132 is a broad anti-fraud provision. It prohibits schemes or devices that operate as a fraud or deceit on any person, including the making of false or misleading statements in connection with securities trading. Similar clauses appear in many jurisdictions and are designed to capture evolving forms of misconduct.

Standards of conduct and defences

A key shift under the current Act is the criminalisation of recklessness. Sections 128, 130 and 131 all impose liability where reasonable diligence is lacking. To avoid breaching the law, market participants must meet defined standards of conduct.

Investment advisors are required to have a reasonable basis for their advice. Section 112 obliges them to consider a client’s investment objectives, financial situation and particular needs such as risk tolerance. Investment advisors must show that they have gauged the risk of the clients through their risk appetite statements to give them sound advice. Trading Participant Rules of the Colombo Stock Exchange require advisors to obtain clear instructions before placing orders, supported by call recordings or written confirmations.

Firms must be able to show that recommendations are supported by proper analysis and independent research. Research functions should operate free from undue influence, with recommendations grounded in robust financial models.

The Act also reflects international regulatory principles promoted by the International Organisation of Securities Commissions (IOSCO). IOSCO is the global standard setter for securities regulators. Emphasis is placed on managing systemic risk through internal controls, risk-based approaches and proper client disclosures.

Market manipulation offences are treated as red flags for money laundering by the Financial Intelligence Unit of the Central Bank. Surveillance is therefore shared through regulators and the exchange, with stockbroking firms expected to play an active role in monitoring trading behaviour.

Conclusion

Sri Lanka’s current regulatory framework equips the Securities and Exchange Commission with a far stronger enforcement toolkit than before. Criminal, civil and administrative penalties now sit alongside enhanced surveillance and disclosure obligations. For investors and intermediaries alike, awareness of these rules is no longer optional. Market integrity depends not only on enforcement, but on everyday discipline across the system.

This article forms the first part of a broader examination of market misconduct. The second will focus on insider trading under the same legal framework.

(Dr. K. Kanag-Isvaran is a Presidential Counsel and Suhadini Wickremasinghe is an Attorney-at-Law and NDB Capital Holdings’ Group Head of Legal and Compliance)