As part of its work of revision and consolidation of regulatory acts, the Brazilian Securities and Exchange Commission (CVM) promulgated Resolution 62, on January 19 of this year, fully replacing the former CVM Instruction 8/79, which dealt with unlawful acts in the securities market. Maintaining the lean wording of the instruction repealed, the new resolution does not bring in changes of merit, but only adjustments to the wording that became effective last February 1st.
Without conceptual changes, the resolution reiterates the provisions of the previous rule by providing for the prohibition on creating artificial conditions of demand, supply, or price of securities, price manipulation, fraudulent transactions, and use of unfair practices.
Since the origin of the regulatory act, one opted for a description of the conduct that resembles open criminal acts, in relation to which it is up to the interpreter of the law, as an integrating agent of the rule, to classify behaviors and artifices that, despite not being expressly described, represent conduct that fits within the prohibition via interpretation.
Over the years, many have questioned the need for greater detail on the crimes described in Instruction 8/79, but the broadness of the wording is part of the regulatory technique with the objective of ensuring flexibility to the CVM's sanctioning action and its adaptation to any changes and modernization of the characterization of unlawful acts.
Each of the prohibited practices is discussed briefly below.
Creating artificial demand conditions
According to the resolution, artificial demand conditions are created "as a result of trades by which their participants or intermediaries, by malicious action or omission, cause, directly or indirectly, changes in the flow of orders to buy or sell securities. In short, the following are elements for the establishment of the unlawful act:
- the execution of trades that change the order flow; and
- the agent's malicious action or omission.
Unlike price manipulation, there is no need to induce third parties to trade. It suffices to create any process that maliciously changes the order flow.
One of the known forms of artificial demand creation is called money pass. The agent's objective is to take advantage of the organized securities market to obtain some benefit not from the trade itself, but from the disguise of a certain factual situation supported by the trading of the asset. In such cases, it is common for agents to try to mask money laundering (creation of profit) or tax planning (creation of loss).
Unlike price manipulation, in which the agent uses the order book to make the trade with an advantage, in money passing the advantage is not related to the trade itself, but to the result it produces for the agent. The harm to third parties is not so evident, but depending on the magnitude of the practice, it is possible that the asset might have its quotation altered with the consequent inducement of third parties to trade with it.
Subsection II of article 2 of the new resolution describes price manipulation as the "use of any process or artifice intended, directly or indirectly, to raise, maintain, or lower the price of a security, inducing third parties to buy or sell it.” The following are elements for the establishment of the unlawful act:
- the use of a process or artifice;
- the intention to affect the quotation of securities; and
- the influence on third parties to trade with the securities.
Two recognized forms of price manipulation are layering and spoofing practices. In both, the agent issues buy and sell orders for an asset, which, by the dynamics of the organized market, are registered on opposite sides of the order book. The objective is to arbitrate the value of the asset and complete the trade at the price created by the agent, and not at the asset price under market conditions. Such practices create an unrealistic price, inducing third parties to trade in assets whose values have been manipulated. They were recognized as irregular by the joint committee in CVM PAS 19957.006019/2018-26 and RJ 2016/7192.
In the first case, of layering, the CVM found that the accused inserted, without legitimate economic motivation, orders that he did not intend to execute just to create a "false impression of supply and demand". As a result, there was pressure from the buyer or seller side that led third parties to trade the securities based on the false condition created by the accused. To find willful misconduct, the reporting judge highlighted the pattern of the offers and the recurrence of the conduct. The agent was sentenced to pay a fine equivalent to one and a half times the economic advantage obtained, totaling more than R$2.2 million. In the second case mentioned, of spoofing, the accused inserted buy or sell offers with large lots of shares and options that were cancelled thereafter, in a short period of time, in order to attract counterparties. A monetary fine totaling approximately R$2.3 million was imposed on the accused.
It is the transaction that uses "a ruse or artifice intended to induce or maintain third parties in error, with the purpose of obtaining an unlawful advantage of an asset nature for the parties to the transaction, for the intermediary, or for third parties. It is established based on the following elements:
- use of a particular artifice;
- intent to mislead third parties in securities transactions; and
- objective of obtaining an asset advantage.
It is very similar to the misappropriation provided for in article 171 of the Penal Code, the fraudulent transaction has as its main objective to maintain or induce third parties into error.
In PAS CVM SP 2014/0465, a fraud modality known as churning was discussed, in which people with control of third-party funds conduct a high volume of trades on behalf of a client in order to generate fees and commissions for themselves or third parties. In this case, the investor, having established a relationship of trust with the person responsible for his funds, is misled and ends up authorizing transactions that are not in his best interests. The accused was ordered to pay a monetary fine of R$250,000.
Subsection IV describes an unfair practice as one "that results, directly or indirectly, actually or potentially, in treatment of any party in securities trading that places it in an unbalanced or unequal position vis-à-vis other participants in the transaction.” According to the CVM's case law, the following are necessary elements for the establishment of the unlawful act:
- the securities transaction;
- the unbalanced or unequal position of the party to the transaction in relation to the market; and
- the improper nature of such imbalance (CVM administrative sanctioning proceedings CVM SP 2017/315, CVM 03/2015, and CVM 04/2010).
One recognized development is so-called front running. In Portuguese translation, the practice represents the act of "running ahead" and occurs, for example, when a broker has access to information about a client's order and tries to take advantage of this by making an early move. Given the characteristics of the unlawful practice, the agents that are usually most likely to commit the practice are brokers, managers, analysts, and other agents that manage funds.
The unfair practice is also related to the prohibition on insider trading, which is regulated by Law 6,404/1976, the Securities Law, and CVM Resolution 44/2021, which prohibit trading based on material information not disclosed to the public. The rules establish penalties of a civil, criminal, and administrative nature and include preventive and repressive rules.
In practice, the difference between the two situations is the fact that the agent of insider trading is usually present at the origin and formation of the inside information, while in front running and other unfair practices, the agent usually receives the information. In the CVM's case law, however, the accusation of insider trading cases has already been based on the specific paragraph of Instruction 8/79.
All the offenses mentioned are considered serious by the Securities Market Law, and the conduct can be punished with the penalties of temporary disqualification, suspension of authorization, or registration, and temporary prohibition, in addition, of course, to fines and warnings.