Stock buy manipulation?

March 3, 2006 7:38 PM

How easy is it for stockbrokers to manipulate the buy prices of shares on market orders placed through them?

Let's say I submit an order online to buy 500 shares of Wombat Industries, and set it as a market price order. To me, that means that I am going to buy at whatever the price is when the market opens, which should be at or close to the previous day's closing price.
If the price is 40.00 at open, say the agent for my broker buys the shares for $20,000 at 10 am. Suppose the price goes up to 41.50 during the day. Suppose the broker sells the shares at that price late in the day and then buys them right back, for a total of $20,750. (Essentially he is selling them to me at the higher price.) I get charged $20,750, and the agent or the broker makes a $750 profit on top of the commission I am charged.

Of course, if the price goes down by 1.50 per share, I simply get charged $20,000. The 10 am purchase is considered my purchase.

How would I ever know that this occurred? If I am sharp enough to know that the market price did not hit 41.50 until 2 pm, I could raise an objection, but how so? If I am simply told that the order did not get filled until 2 pm, how would I know otherwise?

Has this kind of abuse happened on a regular basis? Does it now? Is there any ethical rule that hopes to prevent it?

Or am I just a cynic?

posted by megatherium to work & money (11 comments total)

Megatherium, any broker that did this would go to jail pretty quickly. Trades happen much more quickly, for the most part, than what you describe, and prices are quoted throughout the day. You could easily tell what the opening price was, and know that you should have gotten the stock at that price.
posted by alms at 7:42 PM on March 3, 2006

alms is correct, it would be extremely easy for someone to detect this behavior, and the consequences would be severe.

So let's see... if I were a broker and going to cheat you, what would I do?

Well, the first thing I would do is be a broker in the first place. They were of use before internet trading came along, but now they're dinosaurs. You can place the trades much more cheaply and easily yourself through any number of internet brokers, and if you're relying on your broker for investment advice, forget it. Anyone capable of reliably beating the market is not answering the phone and placing stock trades for other people.

That aside, you could pull a scam like you're talking about over about two minutes time rather than a day. That would be much harder to spot, although it's still immoral and illegal.

A far more popular scam is for the broker to invest their own money in a stock (preferably a penny stock) and steer as many customers at it as he or she can before selling out their own shares at the newly high prices. This one is immoral, but not always illegal.

Then of course there is churning, the rapid buying and selling of many stocks which may or may not do well, but which certainly generates a lot of commissions. I'm not sure if that one is illegal or not, but there have been a large number of civil lawsuits about it.

A Google search turns up quite a bit on the topic, including a whole peck of lawyers out there who will be happy to sue your broker for you.
posted by tkolar at 8:11 PM on March 3, 2006

Let's say I submit an order online to buy 500 shares of Wombat Industries, and set it as a market price order. To me, that means that I am going to buy at whatever the price is when the market opens, which should be at or close to the previous day's closing price.

No, a market order is an order to buy a fixed number of shares at the market price as soon as possible, after the order has been submitted.

Suppose the broker [...]

As alms suggests what you describe is probably illegal. It doesn't quite sounds like frontrunning, but it isn't a normal order flow either.

If you are really worried about the exact price of your orders, setup an account with Ameritrade, ETrade, or one of the other online, deep-discount brokers. You can place your own market and limit orders, and watch them execute. Most of the time, market orders execute in well under a minute. Limit orders can take longer, depending on where the market is, what limit you set, and how the market moves. If you are ultra paranoid, pay the $10/month for level 2 quotes, and you can see more of the order book.

You can watch INET's order book for free, if you are just curious.

tkolar makes some good comments as well.
posted by b1tr0t at 8:15 PM on March 3, 2006

As for the "rule", the SEC mandates that a broker seek "best execution" on all orders placed. Here's their information on the definition of best execution.

It is my understanding that the SEC requires aggregate best execution information from brokerages, which it evaluates to determine compliance. Someone else might be able to provide more information on that process than I can, including to what degree the SEC actually polices this data.
posted by cacophony at 8:17 PM on March 3, 2006

It sounds like you have some information (I'm hoping it's public available) about a stock and you want to get in before the market jumps all over it. If the company is an actively traded stock, it won't be 2pm before it reaches its peak. Have a look what happened to Google last Tuesday when unfavorable news was released. It plummetted to its low within minutes. In such a case, it is pot luck where on the downslide your broker was able to get you out.

Why not just use online automated trading?
posted by DirtyCreature at 10:31 PM on March 3, 2006

To me, that means that I am going to buy at whatever the price is when the market opens, which should be at or close to the previous day's closing price.

Depends on what you mean by "close." A fluctuation of $1.50 on a $40 stock between open and previous close is not an everyday occurrence, but it happens with some frequency. I'd bet it happens no less frequently than a stock opening exactly at its previous close.
posted by Kwantsar at 10:45 PM on March 3, 2006

megatherium wrote...
Let's say I submit an order online...

Sorry, I missed the "online" part when I first read your post. If you're using an automated broker, your trades should be executed within one minute of the market opening, or within one minute period if the market is already open.

If you're seeing any variance on that, change brokers and talk to one of those lawyers....
posted by tkolar at 11:39 PM on March 3, 2006

You shouldn't place a market order after the close in reliance on it being executed at the closing price the next morning -- intervening news or market shifts can cause the opening price to be meaningfully lower, or higher, than the prior day's closing price.
posted by MattD at 7:34 AM on March 4, 2006

Most brokers offer after-hours trading, and such trades can cause a stock's price to fluctuate even after the market closes. If you order after the close, whether you are ordering for the following trading day or for after-hours trading, ALWAYS use a limit order, not a market order. This is especially important after-hours because the trading is much thinner, because some traders will place limit orders to buy much lower (or sell much higher) than the market, and if trading is light enough, THESE ORDERS MIGHT GET EXECUTED against people looking to sell or buy using market orders. Example: Stock's trading at $40, some guy places a limit order to sell at $50, you come in and place a market order and because it's after hours and hardly anyone is trading, it so happens that there are no other offers to sell besides this guy's $50 limit order, so your order gets executed at the $50 even though the last sell price might have been $40. Some traders do this on purpose to try to take advantage of n00bs and others just do it to legitimately set an exit point ("when the stock gets to $50 I want to sell it"), but either way, you don't want to get caught. Use a limit order yourself. And of course, use a broker that doesn't charge you extra for limit orders.
posted by kindall at 8:10 AM on March 4, 2006

Some traders do this on purpose to try to take advantage of n00bs

I might add that those who are doing it to take advantage of the n00bs probably don't even own the shares but are short-selling. They're going to borrow the shares from their broker, sell them to you at $50, then buy them at $40 and give them back to their broker, making a quick profit.
posted by kindall at 8:13 AM on March 4, 2006

seconding kindall, always use limit orders
posted by Sharcho at 10:28 AM on March 4, 2006