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What is circular trading, and why is it illegal?

On Behalf of | Feb 24, 2023 | Blog, White Collar Crimes |

Stockbrokers in Michigan and around the country engage in circular trading when they submit sell order knowing that corresponding buy orders will be entered for the same number of shares at the same price. Circular trading does not change the ownership of shares, but it is considered a white-collar crime because it is a form of market manipulation. This kind of stock fraud is often associated with pump-and-dump schemes that are designed to increase the price of a company’s shares by making them appear to be more desirable than they really are.

Market manipulation

Circular trading is banned in most countries that have active stock markets because it can be used to maintain share prices artificially by making it appear that investors are interested in a stock. It also inflates the stock’s trading volume, which leads potential buyers to believe that the shares have liquidity and will be easy to sell at a profit. Before it became a white-collar crime, shareholders would sometimes agree to make circular trades when the price of their shares fell to a predetermined level in order to protect their investments.

Harsh penalties

Circular trading is a form of securities fraud and the penalties for committing it are harsh. These cases are usually prosecuted in federal court, and almost 90% of the offenders convicted of these crimes spend time in prison. Sentences are harsher when circular trading schemes have many victims, but they are sometimes reduced significantly when offenders agree to plead guilty.

Protecting the economy

The nation’s economy would be badly damaged if investors lost confidence in the stock market, which is why circular trading and pump-and-dump schemes are illegal and prosecuted aggressively. While circular trading does not pass shares from one party to another, it does manipulate the market by making it seem that stocks are in demand. This attracts investors who assume that the increased trading volume is being driven by market forces rather than fraud.