high hedge fund ownership and low ownership of other institutions. This links the blips with hedge fund behaviour, not the actions of others. If one fund was engaging in manipulation at the end of a particular quarter, there was a strong chance it would happen in the next quarter, and the next, and so on. Funds may have needed to do it again because the only way to make up for the deficit incurred due to the return reversals they suffered on the first day of the quarter is to repeat the process. It becomes a never-ending cycle. But the practice was exposed by academics towards the end of the decade. WHAT HAPPENED NEXT? Our research looks at the patterns of portfolio pumping in the periods 20002010 and 2011-2020. While our work backs up findings that patterns of behaviour were strong before 2010, it also shows the magnitude, frequency and persistence of market manipulation decreased thereafter. The drop in the proportion of hedge funds manipulating markets is remarkable. Not only did the average level of manipulation decrease, but so did the percentage of funds often engaging in such actions. Those serial manipulators have gone. While academic – and general – exposure of practices played a role, there are other reasons for the dropoff, including regulation and scrutiny. INCREASED OVERSIGHT AND LITIGATION Since 2010, people have paid more attention to hedge funds’ actions during a quarter, and not just on the final day. External scrutiny, both from regulators and from media showing an interest in hedge fund fraud has helped to decrease manipulation. With regards to litigation, a look at international markets shows less misreporting in jurisdictions with tighter regulations. In the USA specifically, misreporting by hedge funds after they were required to register with the US Security and Exchange Commission (SEC) in 2004 declined, but increased again when those requirements were revoked in 2006. New rules in the 2011 Dodd-Frank Act requiring a majority of hedge funds to register with the regulator and granting the SEC powers to impose fines on fund managers, meant return misreporting fell once more. The pattern is clear – when the SEC has regulatory powers, the funds behave themselves much better. By examining litigation cases brought against hedge funds by the SEC, we see that in quarters with a higher number of cases there is less manipulation. More than this, we also see a reduction in pump and dump at times when there are more articles in the media about hedge fund fraud. This suggests public image plays a key role in hedge fund manager behaviour just as does the threat of regulator punishments. FREE SPENDING Another factor that correlates with the reduction in evidence of manipulation is the decrease in capital these funds have access to. It is easier to engage in manipulation if there is more capital floating around, when investors pour money into hedge funds or when borrowing is easy and cheap. If a hedge fund has less money, it cannot afford every quarter to buy extra stocks. And indeed, from 2011 onwards – when our results show a decrease in blips – there has been much less inflow of capital in the hedge fund industry, with several quarters even seeing a net outflow. SMARTER INVESTORS? The reward for manipulation is an increase in fund inflow following ‘excellent’ performance, and portfolio pumping tends to generate such performance. With the end-of-quarter reporting, investors are likely to learn this ‘positive’ news from the managers and funds themselves. It is common for managers to share their ‘wonderful’ performance with current and prospective investors, inducing more investment. Investors before 2010 rewarded such stock-manipulating hedge funds with higher inflows. Flows reacted positively to the extra return earned at the last day of a quarter. This pattern stopped in the later period, possibly after investors had learned of the dark side of the end-of-quarter results. In the absence of investors’ ‘appreciation’ of manipulated performance, the funds have little incentive to continue. NOT CLEAR-CUT Just because we are not seeing the same levels of market manipulation does not mean such actions do not exist. The scrutiny and lack of excess capital mean funds and individual investors need to find new, cleverer ways of achieving their goals. There will also be some market players who continue to manipulate prices using pump and dump or other more sophisticated strategies, but no longer with the same regularity or on the same scale. And despite increases in regulation, the hedge funds industry remains relatively lightly regulated. Ensuring proactive investigations and prosecutions of suspicious and unlawful activities of funds is of paramount importance to ensure there is no mass return to the practices of old. FIFTY FOUR DEGREES | 17 Professor Olga Kolokolva is Chair in Finance in the Department of Accounting and Finance at Lancaster University Management School. Her research spans areas including hedge funds, financial market regulation, mergers and acquisitions, and detecting fraud in financial markets. The article Do hedge funds still manipulate stock prices? by Dr Xinyu Cui, of the University of Bristol, and Professor Olga Kolokolova, of Lancaster University Management School, is published in the Journal of Corporate Finance. o.kolokolova@lancaster.ac.uk
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