AUTHORS

GIACOMO GUALTIERI

giacomo.gualtieri@edhec.com

Market manipulation probably exists since the day a stock was traded for the first time. It has been a topic largely discussed and new regulations are created every year in the attempt to better address its specificities . The fact that leaders can influence the markets with simple tweets is nothing new. The line between what should be considered market manipulation and what should not is sometimes blurred, but it remains an issue for the stock markets’ integrity and efficiency. Times have changed, not too many years ago entrepreneurs and market leaders had to contact the press to release official statements in order to spread their message. There were spokespersons who were in charge of representing a company or a personality in public. Today, an entrepreneur can open his Twitter   account, type down two words, as for example “Use Signal” bringing the daily downloads of a specific app from 50,000   a day to 1.3 million  , in a matter of hours.

On March 18th, 2020, William Ackman, founder and CEO of Pershing Square Capital Management, gave an interview on CNBC, driving us through his point of view on future outcomes of the COVID-19 outbreak. At the time, coronavirus was spreading quickly in the US. He answered the questions with a stressful tone and describing a terrible forthcoming scenario. He hence scared the market community   and made large profits from a short position on corporate bonds while panic was overtaking the nation. Later on November 11th, 2020, he was interviewed by the Financial Times in a context of increasing optimism – with the US elections being over and two major pharmaceutical companies having announced very advanced stages in their vaccine preparation. We will analyze both interviews to better understand how credibility can earn you money when you are a renowned hedge fund manager. 

Market manipulation: a standing issue

Market abuse may arise in circumstances where financial market investors have been unreasonably disadvantaged, directly or indirectly, by others who: 

  • have used information which is not publicly available (insider dealing);
  • have distorted the price-setting mechanism of financial instruments;
  • have disseminated false or misleading information.

Market Abuse is split into two different aspects: 

  • Insider dealing: where a person who has information not available to other investors makes use of that information for personal gain;
  • Market manipulation: where a person knowingly gives out false or misleading information in order to influence the price of a share for personal gain.

Market manipulation is a type of market abuse where there is a deliberate attempt to interfere with the free and fair operation of the market and create artificial, false or misleading appearances with respect to the price of, or market for, a product, security, commodity or currency. 

Market manipulation is prohibited in most countries, in particular, it is prohibited in the United States under Section 9(a)(2) of the Securities Exchange Act of 1934.  

The US Securities Exchange Act defines market manipulation as “transactions which create an artificial price or maintain an artificial price for a tradable security”.  

There are different examples of market manipulation and some of the most commonly known include:  

  • Churning
  • Stock bashing
  • Pump and dump
  • Runs (aka painting the tape)
  • Ramping (the market)
  • Wash trade
  • Bear raid
  • Lure and Squeeze
  • Quote stuffing
  • Cross-Market Manipulation
  • Cross-Product Manipulation
  • Spoofing (finance)
  • Price-Fixing
  • High Closing (finance)
  • Cornering the market

Besides their specific technicalities, all these market manipulation techniques share a common feature: an investor (or a group of investors) convincing the target company’s affiliates and the whole market community that the future is going to be in their favor and everyone else should adopt their own   view.  

Let’s take Ramping as an example. Ramping the market implies a set of actions designed to artificially raise the market price of listed securities and give the impression of voluminous trading in order to make a quick profit. This artificial price manipulation can be implemented either by spreading fake rumors that works in your favor or by taking massive positions that let others think that you can’t be wrong. More commonly however, both techniques are applied together.

The market authority in charge of controlling that market manipulation and market abuse don’t happen is the U.S. Securities and Exchange Commission (SEC). The SEC holds primary responsibility for enforcing the federal securities laws, proposing securities rules, and regulating the securities industry, which is the US stock and options exchanges.

However, the SEC has been hugely criticized for not being able to effectively regulate and recognize market manipulation strategies often put in place by hedge fund managers. Some people will remember the resounding interview Jim Cramer released on TheStreet.com web site, a financial news company he co-founded. The interview was released in December 2006, but it got viral only years later after it was published on YouTube, which at the time was only 1 year   old. Cramer, former Goldman Sachs sales & trading employee,   before leaving to start his own hedge fund (Cramer & Co., later Cramer, Berkowitz & Co.) described how he could push stocks higher or lower, depending on if he was long or short, at his previous job running a hedge fund. In addition, he also explicitly admitted that everyone not only already does it  , but should always apply these strategies in order to make profits, because in any case “the SEC doesn’t even understand these tactics”.  

Elon Musk has also been quite skeptical with the SEC power over the market manipulation, as his 2018 tweet shows.

Source: Twitter

Despite being illegal, market manipulation is often difficult for regulators and other market authorities to detect given that these actions are often perpetrated through omnibus accounts. An omnibus account allows for managed trades of more than one person, and allows for anonymity of the persons in the account. Transactions within the account are carried out in the name of the broker, protecting the individual identities of the two or more people invested in the omnibus account.

When those fraudulent activities are identified the sanctioning scheme may turn out to be harder than expected. The widespread climate of alarm raised from the economic crisis and the financial scandals has generated a real wave of criminalization regarding market abuse. Criminal sanctions may range from imprisonment to financial penalties   and disgorgement of profits. A recent example of this regulation tightening dates back to September 2020 when JPMorgan Chase & Co. admitted wrongdoing and agreed to pay more than $920 million to resolve   U.S. authorities’ claims of market manipulation involving two of the bank’s trading desks. It turned out to be the largest sanction ever tied to the illegal practice known as spoofing, one of the techniques listed above.

Bill Ackman’s strategy analyzed  

The strategy that he has put in place both in February and November 2020 can be defined as an investment-grade credit hedge. This strategy consists of going long on equity and short these investment-grade corporate credits using Credit Default Swaps (CDS). In fact, prior to going on TV in March 2020, Bill Ackman, through Pershing Square, spent about $27 million to open a short position on corporate bonds.

Investment grade is a term used to describe a favorable rating for corporate and municipal bonds. Rating companies express an opinion on bonds’ credit risk with a similar system based on letters (AAA = high quality bonds, CCC = junk bonds). A grade designation of BBB is a medium quality bond. Investment grade bonds have a grade of BBB or above which means they have very low risk of default. Bonds rating have an important impact on the interest bond issuer must pay. If the bond is investment grade, the issuer can issue the bond at a lower yield and thus incur lower interest costs. An investment grade bond has such a low risk that even banks are allowed to purchase these bonds for use in their reserves.  

Ackman was considering that these yields   were even too low and did not properly reflect the market conditions. During an interview issued to the FT, that will be discussed later, he explicitly said “at 49 basis points the market is saying that the world is incredibly safe and everything expected   to go right will go right”. From this statement we can understand his overall strategy. In other words, he forecasted an increasing level of distressed among corporations that may eventually lead to default and bankruptcies in the future.

The low rates reflect the little risk these investment grade products entail. However with Covid crisis, the risks has generally increased, regardless of the specific geographical location of the bond issuer and the specific activity a business is conducting. 

How to short the corporate credit? Buying CDS. Ackman bet that these CDS would be executed provided a default in corporate bonds. He hence turned his initial $27 million investment into a $2.6 billion gain, representing a 100-fold return. Ackman’s hedge at its peak amounted to about 40% of the portfolio.

Ackman plays an asymmetrical game  , he utilizes all potential outcomes to his advantage. In fact, this short position can be either used as insurance policy for a 100% long equity fund, but if the insurance amount far exceeds     the insured asset value, it is only fair to call it a bet. This is exactly the difference between the strategy put in place in February and in November.   

The second branch of his strategy was to buy stocks, and here, he made his success out of two well-known   principles: market timing and security selection. The fear of the virus and the subsequent restrictive measures many countries took have put a huge pressure on stock markets in the short term. That’s where the success of the strategy comes from. The CDS position was opened and closed in a matter of days, and the timing is extremely relevant given that the stock market rebounded quite quickly after an initial shock. The security selection also played an important role in the success of the overall strategy because Ackman took the profit of the short bet and used them to buy more stocks of companies he already held in his portfolio like Hilton Worldwide Holdings, Berkshire Hathaway and Agilent. The right time combined with Ackman’s ability to pick the right stocks have been proven successful.

As an activist hedge fund manager, Ackman has a story of opening positions according to his own ideas. In particular, we remember his fight with Herbalife, which led to a loss on a $1 billion short – a failure that occurred because his action to demonstrate how Herbalife was a Ponzi pyramid scheme did not work. Except for this case, Ackman has a long list of profitable bets, to which the one of March 2020 must be added.

The power of credibility: the two interviews compared 

We often see fund managers on CNBC talking about specific stocks and markets and how they will perform in the future according to their own view. They do not always agree with each other, and can have divergent points of view, as shown by the recent Chamath Palihapitiya’s interview on Wall Street Bets’ coup. 

However the information they are presenting, their thesis, may, in fact, not always be based on reality but on their need and desire to move a security one way or another. If traders and hedge funds managers feel free to go on TV   to discuss about market trends is because the SEC seems to be constrained by fear of encroaching on the First Amendment which provides considerable protection of the freedom of speech and of the press. Besides the First Amendment, the other major obstacle that restrains SEC enforcement is the need to show that a trader acted “for the purpose of inducing the purchase or sale of such security by others (See Section 9(a)(2) of the Securities Exchange Act of 1934).” Aggressive directional trading — long or short — does not demonstrate, standing alone, the necessary intent to manipulate. As the Second Circuit wrote in 2007, “To be actionable as a manipulative act, short selling must be willfully combined with something more to create a false impression of how market participants value a security (ATSI Communications, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, at 101 (2d Cir. 2007)).”

Was there an intent to manipulate the market when Bill Ackman,   on March 18th on the phone with CNBC,   said “hell is coming”?  And what about the interview he issued to the Financial Times on November 11th?

These are the two discussions we try to analyze here. Obviously in between, during the 8 months that separate the two dates, the world has completely changed but Pershing Square Capital’s strategy didn’t exactly follow  . In fact, the main principle remained the same, but applied in different amounts.

What was Ackman’s real motivation behind the CNBC interview? The general idea is easy to grasp. Ackman took a huge short position on corporate bonds, so he would benefit from a halting economy. It then becomes tough not to perceive Ackman’s intervention as a tentative to further dampen the markets, leading to its targeted widening of credit spreads. This tactic has been criticized by several expert blaming Ackman of cross-market manipulation. Indeed, he talks about a nightmare and is very emotional in his voice tone and arguments. “Millions of Americans are gonna die”, “It’s killing young people, healthy people”, “Assume it’s going to kill your child”, “Businesses are going to zero” are among his statements. The way he talks does not leave room for interpretation; he expresses very firmly and clearly that the economic system will collapse. He also concludes by suggesting that “we need to shut the country for 30 days”. Even the 30 days repetition is not trivial: indeed the whole strategy has been executed quite. He opened this position by the end of February. On March 3rd he did put out a press release describing what he was doing saying that he was making this bet to try and protect a lot of the positions the fund held. At that point he said that the bet he made was worth $0. He put out a second release on March 9th disclosing that it was worth a lot of money at that point and the CDS had moved up on value. On March 12th the US stock market took the first hit due to the pandemic and plunged 10%, and that’s when Ackman started unwinding that bet, taking it off. It took him 10 days to get out of that. In the meantime on March 18th he tweeted to the president to shut down the country and released the interview that became   famous.

Source: Twitter

Ackman unwound the hedges by March 23rd and that day the US stock market bottomed. The impassioned and warning-full interview sparked controversy as other investors argued that his fund would profit from further market declines.

Finally, the FT interview tells us more about his real mindset. Ackman does not appear stressed or afraid anymore. He is not long on CDS, which means that he believes in a recovering economy. Anyways, the hedge fund manager seemingly believes that the current state will not get furtherly worse, and he takes his positions accordingly. “I hope I lose money on this latest hedge”, words very different from his interview after his first hedge. Nonetheless, the situation from a sanitary point of view was not very different from the one in February. Most countries were going through a second lockdown and despite the announcement of advanced studies in the vaccine production the number of losses in our society was not exactly on a downward trend.

Conclusion  

Activist hedge fund manager William Ackman, whose bets on companies are closely watched, updated investors on how his flagship fund earned a record 70.2% return in 2020 on Thursday February 18th, 2021,   in a socially distanced way by sending out a 57-page presentation. Ackman has plenty to celebrate after his Pershing Square Capital Management put up a second straight year of record returns in 2020. In 2019 the fund returned 58.1%. And 2021 is off to a strong start with an 8.1% return. 

Because of the COVID-19 pandemic, however, Ackman and his team continue to work remotely, something they started over a year ago, and there will be no public champagne cork popping or dinner tonight.  

It takes a man to demonstrate both intelligence and adaptability to create himself the best opportunities. Bill Ackman successfully did. Opening the short position was not the riskiest decision he ever took, but the way he emphasized the global pandemic consequences has positively impacted his outcome. 

The difference between the CNBC and the FT interviews are the purpose and positions of the billionaire. In the first one, he is betting against the economy, using the CDS as instruments, while in the second one, he hedges his long position on stocks by keeping put options on corporate bonds. The way his behavior adapts depending on the kind of position his fund has taken, combined with history of puzzling previous interventions on air, make us believe that they can be an element of prediction of his portfolio. Moreover, what this shows is that you can convince people to follow your opinion by using feelings in a simpler way than by developing rational arguments, especially if you have a longstanding reputation in your field of work. 

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