A full analysis of all the skulduggery present in the financial market's would fill a book so I am just going to look at the creation of buy and sell recommendations issued by financial institutions often in conjunction with or by the popular media with nothing but nefarious intentions.
Financial institutions or very wealthy individuals with connections often find themselves in a sticky situation when they have a lot of stock they want to sell to lock in profits or minimise losses.
[ Conversely when an institution has sold short a large amount of shares the they will have to buy them back. To keep this simple for anyone new to the inner workings of the financial system I will now exclude short selling from the discussion, so if you do not know what short selling is do not worry as you do not need to know to understand the rest of this article. Just be aware that you have to watch out for bogus sell recommendations as well as buy ones. ]
The problem for the institution is when these big sell trades hit the market they move the share price which costs them money i.e. there are not enough buyers to soak up the selling by the institution so for example any selling forces the price down which means they then have to take less for any further sales.
A solution for the institution is to create more buyers by issuing buy recommendation to the public in the hope of bringing them to market.
So for example, an institution has a truckload of shares in a company. The institution knows that the profits will be down in six months time and as a result the share price will fall, so it tries to sell off its stake. At first it will try to sell a few on the open market but if this significantly knocks the price down, the institution knows there are not enough buyers about to soak up their sells so the institution now prepares a bogus buy recommendation and distributes it to the public. The public read the recommendation and in their masses now come to the market and buy the share, the institution can now sell all its shares into the market without the price dropping by essentially selling to the fleeced public. Six months later the profits warning is announced and the shares quickly fall. The institution has successfully offloaded any losses onto the public.
Well that's the theory.
There is no doubt that some buy recommendations are genuine even though I would have to point out that it would be naive to think that most were not issued after the institution has bought or sold all the shares it required. I see no real problem with a buy recommendation after an institution has bought shares as long as the institution honestly thinks that the share price is still too low and the price will rise.
I do think there is a problem with bogus buy/sell recommendations where the institution is peddling a view that is the exact opposite of what they really think and this should be made illegal. Not to ban such practices is to ignore the current situation that allows institutions to essentially defraud inexperienced traders out of their hard earned cash. Why should inexperienced traders not be protected from such a scam? The various institutions should refrain from whining about this request and agree to to it on the grounds that it will clear the air and instil confidence in a sector that drastically requires it.
The following needs to happen:-
- Financial institutions have to be transparent with their holdings. This is something they and their lobbyists would fight vehemently against. In theory there are already some rules surrounding transparency in holdings but more often than not it is a game of smoke and mirrors and the rules are rarely enforced.
- Legislation to make sure that a buy/sell recommendation is not bias. In reality I expect this would have to be "clearly" bias as there may be more than one legitimate view based on unknown future events.
- As it is not realistic to expect the public to gather all the relevant holding information every time they read a buy/sell recommendation, all buy/sell recommendations appearing in the media or published by any institution should also clearly state the authors and institutional source of the recommendation including any other related entity involved in the recommendations creation and crucially any holding held by that source or related party.
- Enormous fines if it can be proved that recommendations have been used to offload losses onto an unsuspecting public who assumed that information was provided with good intention.
Such a system would not be perfect but would stop the majority of abuse. I expect the financial system will squeal like a pig if one of their most lucrative tactics is removed. In the meantime I suggest anyone takes any buy/sell recommendation with a barrel of salt.