Financial mechanism in the system of countering unfair practices in the securities market

Malyshenko Marina Viktorovna ORCID: 0000-0003-1495-0632 Lecturer of the Department of Management and Tourism Business, V.I. Vernadsky Crimean Federal University 298635, Russia, Republic of Crimea, Yalta, Sevastopolskaya str., 2A iriska_3640@mail.ru

Introduction

The securities market is an essential component of the modern economic system. It is with its help that the distribution and redistribution of financial resources between sectors of the economy and individual entities is carried out, which ensures its sustainable development. Under the influence of the political factor, the securities market becomes a mechanism for ensuring economic stability and improving national welfare. Attracting internal financial resources through the participation of individual investors makes it possible to ensure the functioning and development of both industries and individual enterprises during a period of difficult economic and political relations. The Russian stock market is developing, the main problems of which include the imperfection of the legislative framework, a weak mechanism for internal control of participants, as well as regulation of insider activity and manipulation. The lack of a safe legal environment increases the level of risk for its participants, and the inefficiency of market regulation mechanisms casts doubt on the possibility of making a profit. As a result, confidence in the market decreases in the long term, which negatively affects its functioning. In this regard, the problem of ensuring the financial security of market participants through improving the system of countering insider trading and manipulation becomes the most urgent.

The works of many domestic and foreign authors are devoted to the study of this issue. Among Russian scientists, M.B. Tsvizhba should be noted – the scientist in his work analyzes the Russian system of regulation of insider activity ^[1]. In addition, the author compares its main components and effectiveness with the US regulatory system. Zaripov I.A. ^[2], Uglitskikh O.N., Klishina Yu.E. ^[3], Zueva A.S. ^[4], Myasnikov D.S. ^[5], Akimov D.S. ^[6], Kurnosov A.V. ^[7], Ovakimyan E.K. ^[8] also raise the issue of the effectiveness of the mechanisms currently in place to combat insider activity in the domestic market. Buinevich M.V. and Vlasov D.S. devoted their research to determining the main ways to detect illegal practices in the securities market ^[9]. It is worth noting that the detection system is one of the most important elements in the counteraction mechanism, as well as the market regulation system.

Arestova E.N. and Borbat A.V. analyze the effectiveness of the Bank of Russia as the main regulator of the securities market. The authors note that the current regulatory system in Russia is imperfect due to the fact that the functions that in a number of countries are distributed among the lower elements of the system (such as exchanges and self-regulatory organizations) are under the control of the main regulator. Such distribution, according to the authors, reduces the efficiency of the system and contributes to the spread of illegal practices ^[10].

The shortcomings in the legislation concerning the regulation of unfair transactions are pointed out by such authors as Lifshits I.M. and Yani P.S. ^[11], Adinyaev S. And ^[12-13]. The authors note the generality of the definitions of insider trading and manipulation established by law, which allows such activities to be interpreted differently from case to case, as well as fairly loyal penalties for perpetrators.

Among foreign researchers, the works of Merle R., Stekla T., Palan S., Schmidt D. are significant, in which the authors study the nature of the influence of insider activity on the securities market as a whole, as well as its individual participants, analyze the difference in the results of the functioning of regulated and unregulated markets in the short and long term, and also attempt to give an unambiguous assessment of this type of practice ^[14-16].

In general, most authors tend to conclude that insider transactions have a negative impact on the functioning of markets ^[17-20]. If in the short term there is an improvement in indicators characterizing the effectiveness of the functioning of markets, then the study of this influence over long periods of time gives the opposite results. Despite the fact that insider activity can stimulate the market by creating volatility that attracts new investors, both domestic and foreign researchers find that its regulation is still necessary, since it avoids more global negative consequences. 

The main part

Let's start by defining the key concepts. Unfair practices in the securities market are illegal actions of individual market participants or their associations, leading to unjustified changes in market indicators, which can subsequently lead to an unfair redistribution of profit amounts of other participants.

To date, there are more than 20 types of unfair practices in the securities market, differing in execution techniques, instruments of influence and the nature of the impact. However, they can be grouped into two main groups: insider activity and manipulation.

Insider activity is the illegal activity of market participants based on the use of information inaccessible to a wide range of people, not officially published, which can influence trading performance. Such activities include both the direct use of insider information for profit, as well as its transfer to third parties for similar use, as well as publication for manipulation purposes.

Manipulation is a more complex group, including a variety of techniques. Manipulative activity is considered to be aimed at changing the indicators of the securities market in order to disorient the bulk of market participants and obtain excess profits, or in order to reduce losses. Manipulation in the securities market is represented by several types, the most common of which is based on false news. The news stream is the basis for the formation of market instrument rates. Fake news, having an impact, forms a false course that would not have been formed under normal conditions, as a result of which unscrupulous participants can avoid losses or receive an overdraft.

Insider and manipulative activities are often interrelated. Insider information can be a tool for market manipulation. Let's take a closer look at the signs of insider and manipulative activity (Fig.1).

Fig. 1. Signs of insider and manipulative activity

As you can see, these types of unfair practices have certain differences, however, they serve the same purpose. In the long run, the unregulated activities of insiders and manipulators reduce confidence in the market as a whole. This leads to a number of consequences:

1. Outflow of investors;

2. Decrease in investment volumes;

3. The slowdown in market development;

4. The slowdown in the development of industries and the economy as a whole.

In this regard, the regulation of unfair practices is an essential component that ensures the effectiveness of the securities market in performing its main functions that contribute to the economic development of the country. The legislative framework for regulating unfair practices in Russia consists of the following documents:

- Federal Law No. 224-FZ dated 07/27/2010 "On Countering the Misuse of Insider Information and Market Manipulation and on Amendments to Certain Legislative Acts of the Russian Federation";

-     The Criminal Code of the Russian Federation (Article 185.3 "Market manipulation", Article 185.6 "Misuse of insider information", Article 183 "Illegal receipt and disclosure of information constituting commercial, tax or banking secrets", Article 185 "Abuse in the issue of securities", Article 185.1 "Malicious evasion from disclosure or providing information defined by the legislation of the Russian Federation on securities");

-     The Code of Administrative Offences of the Russian Federation (Art. 15.21 "Misuse of insider information", Art. 15.30 "Market manipulation", Art. 15.35 "Violation of the requirements of legislation on countering the misuse of insider information and market manipulation", Art. 15.19. "Violation of the requirements of legislation concerning the presentation and disclosure of information in financial markets";

-     Resolution of the Plenum of the Supreme Court of the Russian Federation dated 11/15/2016 No. 48 "On the practice of applying legislation by courts Regulating the specifics of criminal liability for crimes in the field of entrepreneurial and other economic activities";

-     Instruction of the Bank of Russia dated 11/21/2019 No. 5326-U "On the list of Insider Information of Legal Entities Specified in Paragraphs 1-3, 4, 11 and 12 of Article 4 of Federal Law No. 224-FZ of July 27, 2010, as well as on the procedure and timing of its disclosure;

-     Methodological recommendations on the establishment of criteria for significant deviations in price, demand, supply and trading volume (by types of securities and exchange-traded goods);

- Instruction of the Bank of Russia dated January 13, 2020 No. 201-I "On the Procedure for the Bank of Russia to conduct inspections of Compliance with the Requirements of Federal Law No. 224 FZ dated July 27, 2010 and Regulations adopted in accordance with it";

-     Instruction of the Bank of Russia dated 12/23/2021 No. 6033-U "On the Agreement with the Bank of Russia provided for in Article 11' FZ dated 07/27/2010 No. 224-FZ.

These legislative acts are the basis of the Russian securities market regulation system. It is represented by three main levels. Let's look at them in more detail:

1. The first level is represented by state bodies: the State Duma of the Russian Federation, the Arbitration Court and lower courts. At this level, the legislative function and the functions of the judiciary are implemented;

2. At the second level, regulation is carried out by the Bank of Russia. It is the main body controlling the activities of the securities market in the Russian Federation. The regulator has expanded powers, which include the adoption of necessary regulations, conducting inspections and investigations, requiring the provision of necessary documentation, as well as issuing orders, suspending and revoking licenses issued to market participants;

3. The third level is made up directly by the organizers of the trades (exchanges) and self-regulatory organizations (SROs). The organizers of the auction have the right to develop rules and standards, require information necessary for conducting inspections of participants' activities, monitor participants' compliance with legal requirements, as well as apply a number of measures to offenders. Self-regulatory organizations are an additional element exercising control at this level. Their competence includes the development of rules, requirements and standards for the organization of the activities of exchanges and the behavior of bidders. They also have the right to request information for conducting inspections of the activities of their members, their compliance with accepted rules and standards, as well as to apply certain measures to them in case of violations.

 It is worth noting that the main level of regulation in the Russian Federation is the second, while in foreign practice, SROs are endowed with the greatest powers. Membership in self-regulatory organizations is mandatory to participate in bidding in most markets. For example, in China, the main self-regulatory body is the Securities Association (SAC). The U.S. securities market is actively regulated by the National Association of Stock Dealers (NASD), as well as other self-regulatory organizations. Together with the Securities Supervision and Exchange Trading Commission (SESC), they actively regulate the SRO market in Japan. However, in comparison with the regulatory system of China and the United States, in Japan, SROs have much less influence, serving rather as bodies that optimize the process of collecting and transmitting necessary information, identifying suspicious transactions.

The system of regulation of the securities market of the Russian Federation, in turn, consists of subsystems, one of which is countering unfair practices (Fig. 2, block B). Its components are mechanisms, as shown in Figure 2.

Fig. 2. The mechanisms that make up the system of countering unfair practices in the Russian securities market

As can be seen from Figure 2, the system of countering unfair practices consists of the following mechanisms:

- legislative – is present in any regulatory system as the main element ensuring the establishment of rules and procedures for the processes in various industries;

- criminal law and administrative law are also present in all regulatory systems, ensuring the enforcement of laws;

- the monitoring and control mechanism is a key mechanism in the regulation of the securities market and the system of countering unfair practices; it allows you to identify violations and take certain measures to prevent them;

- the mechanism for collecting and analyzing information is auxiliary, ensuring the functioning of the monitoring and control mechanism, as well as necessary for improving criminal and administrative legal mechanisms and the legislative framework; most of all, this mechanism is important for the implementation of the functions of the regulator, since it provides prompt response to market processes and allows to increase its effectiveness.

The combination of the above mechanisms aims to ensure the implementation of laws and regulations established at the legislative level (Fig. 2, block C). The relevant body is responsible for the implementation of each of the considered components of the counteraction system.  Thus, the first level is represented by the State Duma and the courts. The State Duma fully implements the legislative mechanism. The courts ensure the functioning of the second and third mechanisms. The Bank of Russia, as the main regulator, has the authority to partially implement the administrative and legal mechanism (issuing regulations, suspending and canceling licenses of participants) and, to a greater extent, the fourth mechanism. The third level, represented by the organizers of the bidding and self-regulatory organizations, is responsible for the fifth mechanism and has the authority to partially implement the functioning of the monitoring and control mechanism (SROs do not participate in these processes).  

Thus, the fight against unfair practices in the securities market of the Russian Federation is currently being implemented through five mechanisms. In Figure 2, there is another element – the financial mechanism of counteraction (highlighted with a dotted line). At the moment, it is poorly expressed in the practice of the Russian Federation, however, as the experience of foreign countries shows, it makes it possible to increase the effectiveness of the fight against insider trading and manipulation.

The following definition of this concept can be given – it is a set of elements that ensure fair competition and financial security of participants by implementing specific algorithms for monitoring and identifying illegal practices and applying calculated amounts of damage compensation to violators as an administrative punishment. Its essence consists in creating an additional financial burden on the implementer of illegal practices in the form of collecting amounts of compensation for damage received by the market and individual participants.

The need to strengthen financial counteraction measures is illustrated by the effectiveness of foreign experience. Consider table 1, which provides data on measures to counter unfair practices in the world's leading markets. In China, violation of the law regarding insider activity and manipulation provides for the confiscation of the income received and the determination of the amount of the fine, depending on the severity of the crime, as a percentage of it. The financial mechanism for countering unfair practices in the Chinese securities market is quite detailed and provides for penalties for twelve enlarged groups of violations.

Japanese legislation also provides for tougher financial control measures. Thus, the amount of fines directly depends on the amount of damage caused, and can also be increased by 1.5 times in case of repeated violation of the law. It also provides for the confiscation of property and income received as a result of illegal actions. The United States is considered the country with the most stringent system of countering insider trading and manipulation – violators can receive criminal liability for up to 20 years, which is twice the period provided for by Japanese law. In addition, the perpetrators must pay a fine and compensation.

Table 1

Comparative analysis of systems for countering unfair practices in countries with the world's leading exchanges

As you can see, financial measures to combat unscrupulous participants are mandatory in the counteraction systems of the countries under consideration. In Russia, the fight against insider trading and manipulation involves administrative and criminal liability. So, in cases of detection of the fact of manipulation, the violator can receive up to 7 years in prison. If insider activity is detected – up to 6 years. However, in practice, criminal liability does not apply. Most often, the perpetrators bear administrative responsibility, expressed in the cancellation of a license, removal from office, prohibition of work on the securities market or payment of a fine. The fine is the only financial counteraction measure, however, in comparison with other countries, its size is extremely small. The maximum amount, both in the case of manipulation and insider trading, for individuals is 1 million rubles. (Criminal Code of the Russian Federation, Articles 185.3, 185.6) For individuals, the Administrative Code provides for the definition of a fine depending on the amount of losses that were avoided or the excess income received, but not less than 700 thousand rubles. (Administrative Code of the Russian Federation, articles 15.21, 15.30).  

As you can see, the financial mechanism for countering insider activity and manipulation in the Russian Federation is not fully formed today. The practice of applying punitive measures in Russia indicates that persons are more often brought to administrative responsibility than to criminal responsibility. In addition, amendments to the relevant articles of the Code of Administrative Offences will come into force from 05.01 2024. According to the changes, persons who have committed illegal actions have the opportunity to conclude an agreement, the amount of the fine for individuals is at least 5 thousand rubles, for officials - at least 30 thousand rubles, for individuals - at least 700 thousand rubles, For comparison: the average amount of the fine in China is 2 million yuan ("277.7 thousand dollars), in Japan – 10 million yen ("67.3 thousand dollars), in the USA – 2.5 million dollars. As you can see, the envisaged measures and the amount of fines do not allow you to compensate for losses caused to the market or individual participants.

Thus, today, in order to increase the effectiveness of the system of countering unfair practices in the Russian securities market, it is necessary to introduce a financial mechanism that would allow setting reasonable fines and compensations corresponding to the amount of damage caused.

Conclusion

Our analysis of the structure of the securities market regulation system made it possible to identify such an important component as a financial mechanism to counter insider trading and manipulation. As it was revealed, the Russian counteraction system is represented by standard mechanisms, without which its functioning would not be possible, namely: legislative, criminal law, administrative law, monitoring and control mechanisms, information collection and analysis. These components mostly serve to ensure the basic functions assigned to the regulator. At the same time, the analysis shows that in Russia, legislation provides for more loyal measures to counter unfair practices, compared with foreign countries. This is due to the specifics of the structure of the counteraction system, as well as the nature and scope of the powers assigned to the participants ensuring its functioning. An analysis of the structure of the systems of the leading stock markets shows the presence of such an important element as a financial mechanism. This is reflected in the developed legislative framework regarding the amount of fines for perpetrators, as well as the active application of measures such as imputation of compensation amounts, confiscation of profits, property obtained as a result of illegal activities, etc. In Russia, this mechanism has not been fully formed to date.

The proposed concept of a financial mechanism for countering insider and manipulative activities acts as a theoretical basis for developing a concept of its functioning and defines the purpose of its implementation. Thus, this paper defines the place of the financial mechanism and its role in the system of combating unfair practices in the Russian market.