Did unfounded rumors of liquidity problems help push Bear Stearns over the edge?
Executives at the investment bank have complained that the flight of capital was part of the reason it turned to JPMorgan Chase & Co. and the Federal Reserve Bank for financing and to stave off its outright collapse.
In a briefing to its clients last week, Weil, Gotshal & Manges forewarns that such “short and distort” conduct is at the very least being taken seriously by regulators here in the U.S. and the U.K. in anticipation of criminal indictments and possibly new regulations.
Testifying last week before the Senate Banking Committee, Securities and Exchange Commission Chairman Christopher Cox said that the SEC “takes very seriously its responsibility to investigate allegations [concerning the spreading of rumors designed to affect the market value of an issuer’s equity securities], and there have been ample allegations made.”
Similarly, in a joint news release issued late last month by the Financial Industry Regulatory Authority (FINRA), NYSE Regulation, and participants of the Options Regulatory Surveillance Authority said that “[m]arket participants should be especially aware that intentionally spreading false rumors or engaging in collusive activity to impact the financial condition of an issuer will not be tolerated and will be vigorously and aggressively investigated.”
Moreover, the U.K.’s Financial Services Authority (FSA) issued a warning stating it would “not tolerate market participants taking advantage of the current market conditions to commit abuse by spreading false rumors and dealing on the back of them.”
“Short and distort” conduct was also a topic at the annual Compliance and Legal Seminar of the Securities Industry and Financial Markets Association were enforcement officials from the SEC, FINRA and the FSA indicated that they are investigating this type of conduct.
Spreading false rumors in order to induce others to trade in a company’s securities may constitute market manipulation under Sections 9 and 10(b) of the Securities Exchange Act of 1934. On the Self-Regulatory Organization front, NYSE Rule 435(5) and its FINRA corollary prohibit member firms from circulating “in any manner rumors of a sensational character which might reasonably be expected to affect market conditions on the Exchange,” the Weil, Gotshal memo pointed out. Criminal charges were brought against the Toronto-based insurance conglomerate Fairfax Financial Holdings Ltd. against S.A.C. Capital Management and other defendants, alleging a “massive and fraudulent disinformation campaign” coupled with short-selling.
“The increased awareness of possible ’short and distort’ practices, the strong statements by securities regulators and the number of investigations currently pending suggest that an increase in regulatory enforcement and litigation in this area is likely,” the law firm memo concluded.