On Wash-Sales and Market Making/ Manipulation (MM)

My last blog on A Day with Market Manipulators and Shariah Compliant Token Peddlers invited some unexpected bouquets and brickbats for me. Like other fellow humans I loved those bouquets; the brickbats were no less interesting. What I believed to be clear cases of “market manipulation” were being defended as “market making” that was being undertaken in collective interest. So I decided to raise all the pertinent issues during a recent webinar addressed by Mufti Faraz Adam.

My questions were as follows (listen to the recording of the webinar from 44.42 – 45.44) 

As we know “wash trades” are essentially trades that cancel each other out and have no commercial value. In crypto markets also we have seen wash trades being used to generate fake volumes to pump up the prices of a crypto token. However, a justification for this is often provided that

• this is not an example of “market manipulation”, but of “market making” and 
• this is essential to protect the interest of token holders, as without such support the prices of the tokens may fall flat harming all token holders. 

Another justification for such practice is that: 

• high volumes are a precondition to listing on large centralised Exchanges. 

Do these reasons stand the test of the Shariah. What shall we call them, haraam or halaal?

I am indebted to the honorable Mufti for his crystal-clear responses. (listen to the recording of the webinar from 45.45; expressions in brackets added for clarity)

“It’s a very very good question. From the Shariah perspective there are multiple layers of governance and regulation. We have a very clear framework at the top level, (or) high level like the do’s and the don’ts. You have for example: you can’t be involved in riba; you can’t do this, and you can’t do that. There’s a second layer of governance which is (about) practices which are misrepresentation, manipulation (and) deception. These are types of practices which you can’t really quantify; rather these are more descriptive. It’s not something which (has a binary answer), is like a yes or no. It just depends on what’s actually happening. 

We have multiple examples in the Shariah whereby market manipulation is prohibited. Market manipulation is discouraged, prohibited (makrooh), as scholars clearly mentioned. So for example, the idea of intercepting caravans or “imports” and then selling them in the cities – this is an example in Shariah. If there’s a city and there’s an interceptor, somebody who goes out and intercepts these caravans and imports and then manipulates a price, and he earns a spread and with intention to harm, that’s prohibited. That’s discouraged because now he’s manipulating the supply chain. 

The famous hadith we all know about tas’ir, which is price fixing. Why did the messenger of Allah (pbuh) not favor tasi’r and why is price fixing is like having a command economy in Shariah, not encouraged at all? Islam doesn’t promote a command economy, and beautifully Islam really goes for a mixed economy. That’s what it is. There is some government participation. Of course, there will always be. We have some state influx and we have some private and public, but having the centrally planned or central command economy is not something favored in Shariah, because it’s manipulation. The government will manipulate and artificially impact. No entity in this world is able; rather if you do manipulation you are now competing with God. Because it’s God, it’s Allah who is the one who has this kind of what Adam Smith called, the “invisible hand”. It’s a similar concept here that Allah is behind the prices and price discovery. 

if you do manipulation you are now competing with God. Because it’s God, it’s Allah who is the one who has this kind of what Adam Smith called, the “invisible hand”. It’s a similar concept here that Allah is behind the prices and price discovery

So thereby, if there are activities like manipulation and all these things in the crypto markets and wash trading, and these things are to manipulate prices, and artificially inflate (them, then) you’re harming an economy here. You’re harming – forget the investors, that’s just one group – look at the larger group of people potentially that can be impacted or how this can be manipulated further. So these types of practices – whenever there’s manipulation – there’s a cause of concern, but it’s very difficult to put a ruling from a Shariah. Rather (there) needs to be a regulator. From a regulatory perspective a regulator can ban this practice altogether immediately and that’s what should happen from a Shariah perspective. Sharia leaves governance also to people in matters which have many variables. So this is one of those issues. But yeah, I would say it’s not encouraged even from my personal view. This matter is definitely discouraged because there’s clear manipulation.”

Notes and Observations (Mine)

According to a hadith reported by Anas “one person came to the Prophet and requested him to fix prices in the market but he refused. Another man came and made the same request; the Prophet said it is Allah who pushes prices up or down, I do not want to face Him with a burden of injustice”. (Sunan Abu Dawud, Kitabul buyu’, babul tas’ir)

A research paper on “Price Control in an Islamic Economy” (perhaps the best written in recent times, to the best of my knowledge) provides ample references in favor of free play of demand and supply forces in setting prices. There are instances where the state/ market regulator not only takes punitive action against market players who indulge in bad practices resulting in artificially inflated or deflated prices, but also take steps to effect corrections in prices to bring them to their normal levels. Such corrective actions cannot be offered as justification by private parties (groups of investors) intervening in the market to set them at their own desired levels to protect their “collective” interests.

Deception has no place in Shariah. However, as the Shaykh rightly asserts, Shariah requires people to act. It requires regulators (market inspectors) to move in and “punish” the wrongdoers and ensure that the aggrieved parties receive compensation for the financial losses suffered by them due to actions of the wrongdoers. The absence of regulators in the market by no means implies that the practices are Shariah-compliant.

When Bad Actors Intervene in Demand or Supply:

• Najash Sale (Intervention on Demand Side)

A form of prohibited sale (ba’i batil) in which a person or group of persons connive with a seller to bid up the price of a commodity offered for sale through an auction (mazad), not meaning to purchase but only to entice an unsuspecting bidder to offer higher prices, and eventually have him stuck with the object of sale. The ensnared buyer will have to pay an artificially determined price (a much higher price than fair or normal price). Najash sale is sale by a fraudulent auction or sale by a manipulative overpricing. This sale is based on collusion (tawatu’) between a seller and a fake or pretending bidder. Najash literally means concealment, rousing and chasing the game for the purpose of entrapping it. Najash sale is also known as tanajush sale.

• Ihtikar ((Intervention on Supply Side)

A market manipulative practice (black marketeering, monopoly) that involves the creation of artificial shortages in the supply of a specific commodity (wheat, sugar, food oil, etc) by hoarding up large quantities thereof in warehouses and withholding them from sale. Monopolistic traders (muhtaker- pl. muhtakeroon) characteristically aim to keep supply shorter than demand in order to profiteer at the expense of others (often consumers), exploiting their needs. This commercial hoarding is strictly prohibited by Shari’a because it badly affects the very sustenance of people and distorts the market price.

While the above two are extreme examples of market manipulations, satan has many other ways to create market imperfections rooted in fraud and deception, causing injustice to masses. All such cases call for action by the market regulator who is governed by the principles of Shariah in Islamic markets.