Is the SEC 'Rumorgate' Push a Waste of Time?

Enforcement via press release. Arrrgghh.

The Securities and Exchange Commission wants Wall Street to believe that it is going to punish hedge funds for spreading “false” rumors, and they’ve opened an “investigation” into the matter. Undoubtedly, the mere threat of an investigation is meant to chill the rumor mill, which is being blamed for the collapse of Bear Stearns (BSC) earlier this year and the current pressure on Lehman’s (LEH) shares.

I paid close attention to the Bear process, and I seem to recall something about C$20 billion of risky assets, defunct hedge funds, weak i-banking revenue and subprime mortgages (see prior post “JP Morgan inks the deal of the year” March 16-08). However, with Lehman Brothers’ stock (LEH:NYSE) now on the ropes again (see prior post “It’s Lehman’s turn in the woodshed” March 17-08), the pressure is on the SEC to stop the allegedly “false rumors” that push down stocks. I think we already know how successful that’s going to be.

The campaign kicked off with some fanfare on Friday (from the WSJ):

The SEC began its antirumor campaign Friday, calling several hedge funds to warn that subpoenas for their trading records related to Lehman were imminent, people familiar with the matter said. SEC officials weren’t specific about what period of trading they planned to examine, these people said.

 

Officials at Lehman and other firms have expressed to the SEC their concerns about false market rumors. Many top Wall Street executives have complained privately about the apparent lack of action, saying traders knowingly spreading false rumors were in part responsible for the unraveling of Bear Stearns Cos., which was sold to J.P. Morgan Chase & Co. in March for a fire-sale price.

 

The SEC’s enforcement division has asked several hedge-fund advisers to provide trading records, emails and other information covering the weeks before the sale. So far, the SEC hasn’t filed charges related to stock or option trading in the shares of investment banks.

Between the SEC and the NYSE, they are going to focus on “abusive short-selling and rumor-mongering”, the spreading of “false and misleading rumors.” For the life of me, I can’t imagine how the SEC will be able to prove that an individual knowingly spread a false rumor, unless an email trail is discovered where Trader X told Institutional Salesman Y last week:

Short 250,000 LEH at $22.40 or better, and then tell all of your friends that you’ve just heard that SAC has stopped trading with Lehman. I just made it up; we’ll cover later in the day once the rumor makes its way around the desks.

More than likely, if any emails are found at all, they’ll look a lot more like this, from Institutional Salesman X to Hedge Fund Manager Y:

I just got off the phone with my guy at SAC. They’re worried about LEH’s 25 to 1 leverage, and are going short big time. I wonder if they’ve stopped depositing money there overnight. You should get on the bus and short some yourself.

You can imagine plenty of conversations and emails like that over the past week or two. But there’s nothing about that imaginary patter that will get the SEC a conviction, although the salesman in question may be in the doghouse with SAC for talking about their trading directions. Even then, SAC is fully aware that the market needs to know what it is short so that the stock in question will go down - and the trade will be a success.

If the NYSE wanted to do something useful, they could always bring back the “uptick rule” (see prior post “Bring back the ‘uptick’ rule” September 9-08). The "uptick rule" prevented a firm from shorting a stock straight into the ground; it could only short if there had been an “uptick” on the prior trade. A much slower and tedious process for all concerned. One of the key elements of the market’s volatility of the past 12 months can be tied to that inexplicable rule change.

The SEC could go one step better and ban all of the MSN Chat, Yahoo (YHOO) and similar instant messaging programs that link many traders and their investment banks. Tidy way to avoid the taped telephone calls. Since there are no email trails in Instant-Message-Land, it’ll be tough for the SEC to find the smoking gun - if there is one - in this particular investigation.

As for the rumor mill, we happened across the “Bear may go bankrupt” rumor before Bloomberg and Reuters did, and you read it all here (see prior post “Bear rumor speaks volumes” March 10-08). It seemed plausible at the time, and that’s why we posted it. The notion that people should only discuss “true” rumors is entirely ludicrous; they’re called rumors for an obvious reason, and they’ve been the currency of humankind for thousands of years.

Bear Stearns was in trouble long before people started to fuss about Chapter 11. That’s why the rumor had merit (see prior post “Bear Stears catches subprime cough, Australian corporate bonds get a cold” June 26-07). The trick is to figure out which ones have merit. Shorting stocks on silly rumors will ultimately end many a hedge fund career.

To quote Sir William Gilbert:

Oh! a private buffoon is a light-hearted loon,
If you listen to popular rumor.

Disclosure: None

Comments

[pelican]

You sound like an apologist for people who knowingly spread false rumors. Indeed, you almost seem to applaud the whole idea of rumors..."currenc... of mankind for thousands of years..." and don't seem too concerned about whether the law is being broken. This is not about spreading a rumor you may have heard so please don't try to obfuscate the issue. This is about going after those people who knowingly spread false rumors for the purpose of financial gain. Surely, you must agree that people do that sometimes, right? If you answer is yes, then surely you must agree they should be held accountable.

You wrote: "For the life of me, I can’t imagine how the SEC will be able to prove that an individual knowingly spread a false rumor unless an email trail is discovered where Trader X told Institutional Salesman Y last week...I can't imagine how the SEC can get a conviction." Well, guess what. It's not always about getting a conviction, although that happens from time to time. Like going after insider traders, its often about penalizing the perpetrators financially, often heavily. I just spent maybe 12 seconds doing a quick google search after typing in a few keywords and the first story that came up was this.

dealbook.blogs.nytimes.../

I get the impression you are mocking the SEC but they are doing the right thing by pursuing this. Its too bad you don't agree.

[kevintx]

Good points. Knowingly spreading false information for profit is wrong and should be penalized and the SEC bureaucracy should do that as possible, e.g. in the small fraction of cases with high dollar amounts and co-conspirators tattling. In other cases it could have a chilling effect on free speech and impede information flow. Rumors have power only insofar as they may be true. People are always going to have to weed out the BS.
I agree about the uptick rule, not sure why it was discontinued given avalanche shorting tactics. Selling short does not have the consent of the shareholder whose shares are borrowed so should be considered and regulated separately.

[wardco]

Thanks for bringing up the ineffective tactics of the toothless SEC. The foxes (huge banker/brokers) have been guarding the hen house for a long time. Now that they are out of hens and attacking each other, they want protected. The SEC is riding to the rescue. Save the banks !! What about all the companies naked shorted to death? A non taxable event. Unless all the fraud stops very soon...game over. No one will continue to play a game that has a certain outcome.

[mikeg3]

As the story at pelican's link shows, IM messages are in fact logged. The example message in the story begins "I just got off the phone with my guy at SAC. ". If the was no such phone call, I guess we're talking about fraud.

[ponchovilla]

SEC TO HIRE LUCENT RETIREES FOR RUMOR POLICE

I heard a vicious rumor that the SEC is planning to significantly increase the size of their organization by hiring Lucent retirees as rumor police. No Nortel folks can apply as they are Canadian (US citizen who works for a Canadian Co is per se illegal) and are considered illegal aliens. “A person said “ (anonymous source) that a budget of $50.0 B per year (off balance sheet) is being proposed. Funding for the organization will be on balance sheet by charging a $10.00 fee to each blogger who posts a “rumor” without substantiated facts. Google will receive $1.00 for each blog deemed a “rumor” that is forwarded to the SEC. The FTC will study whether or not a single source contract with Google violates any anti trust laws. An opinion is expected by 2050 as this is a complex issue and requires “scientific data “ to prove or disprove any allegations of potential violations of the law. Of course the President can issue an executive order providing blanket immunity. Google does not have to substantiate the blog as a rumor too much as their legal department will define rumor based on a Henry Paulson explanation (what did he say?) Estimated revenues are more than $500 B per year. However Congress has already lined up to spend this new source of revenue on “bookmarks” as earmarks are out of favor and not politically correct.

In another news flash the SEC is alleged to be cracking down on naked shorts but only as they relate to Fannie and Freddie. After all who wants to piss off the Politically connected Wall Street friends as the fee structure for naked short transactions are a high profit “financial instrument”.

I hope all of this is true as our Government will demonstrate substantial creative thinking: THINK OUT OF THE BOX

Also it is claimed that a web site will be established where a blogger can pre pay $10.00 for each rumor. No disclosure would be required except a notation PPR ( PrePaid Rumor)

[Kinabalu]

"I can’t imagine how the SEC will be able to prove that an individual knowingly spread a false rumor"

Your imagination capability needs some work. As pointed out by 219640, your second example would in fact be quite easy to prove. The problems arise because of the difference between "fact statements" and "value statements". Someone trying to start a rumor will normally use fact statements because they carry more weight. For example, "I heard the CEO of Company X and the CEO of Company Y talking in a coffee shop about merging" carries more weight than "I think Company X and Company Y might merge". A fact statement is, by definition, provable.

The SEC will probably confine its investigation in the beginning to the major investment banks and hedge funds but if they expand it to cover internet sites they can find plenty of violations. Right here on Seeking Alpha there are contributors that regularly make false statements of fact to encourage short positions in stocks.

You didn't mention it in your article but the SEC's investigations will also look at naked shorts. this will also be easy to prove. In fact there was an article on Seeking Alpha quite recently where the author, in the eighth comment after the article, bragged about having naked shorts.

seekingalpha.com/artic...

[bill d]

Pretty simple - FOLLOW THE MONEY !!!