The US Securities and Exchange Commission (SEC) announced on Sunday that it and other regulators would immediately begin examining rumor spreading intended to manipulate securities prices.
The timing of the announcement, made before the markets opened in Asia, was meant to warn broker-dealers, hedge funds and investment advisers to quell any spreading of rumors before trading started yesterday.
The SEC, the Financial Industry Regulatory Authority (FINRA) and New York Stock Exchange Regulation Inc (NYSE Regulation), will examine the controls put in place by the brokerage firms and financial advisers to prevent such manipulations.
The SEC has been engaged in an internal debate over what kind of investigation to mount with respect to rumors. The turbulence in the markets last week, with rumors adding to concerns about fundamentals affecting commercial banks, investment banks and the government-chartered enterprises Fannie Mae and Freddie Mac, sped the decision to begin the examination and make it public.
“The examinations we are undertaking with FINRA and NYSE Regulation are aimed at ensuring that investors continue to get reliable, accurate information about public companies in the marketplace,” SEC Chairman Christopher Cox said.
“They will also provide an opportunity to double-check that broker-dealers and investment advisers have appropriate training for their employees and sturdy controls in place to prevent intentionally false information from harming investors,” Cox said in a statement.
“Traders know there is false information in the market. They need to think twice if they are going to pass it on,” said Lori Richards, director of the SEC’s Office of Compliance Inspections and Examinations.
“It’s important that firms be aware of their supervisory and compliance obligations to prevent violations of the securities law,” Richards said.
“It’s like robbery is always illegal and the police are now going to be doing extra patrols up and down the streets of our neighborhood,” said David Beim, a Columbia Business School professor.
The examinations were expected to begin yesterday and will focus on what policies firms have in place to prevent the passing of false information. The intent is to stop malicious rumors without hampering the natural exchange of information in the marketplace.
Since the almost-overnight collapse of Bear Stearns earlier this year, top Wall Street executives have been pleading with regulators to investigate what they see as efforts by short sellers to plant false information and profit from it.
Lehman Bros, for example, faced rumors last week that two major clients had stopped doing business with the firm. Lehman’s stock dived almost 20 percent before recovering somewhat as both clients denied the rumors.
The issue is a notoriously challenging one for the SEC. Rumors have long been a part of Wall Street’s fabric, and proving rumor-mongering is a difficult task, especially with 24-hour news and communications technology like instant messaging and text messaging.
But Wall Street executives insist that false information is permeating the marketplace as never before. Because Wall Street firms are highly leveraged businesses that need outside financing, confidence is crucial, and rumors can overshadow the strength of their businesses, executives say.
Short sellers deny that they plant false information and argue that Wall Street is as vulnerable as it is because it invested in risky businesses that backfired.
The examinations will focus on compliance and supervisory policies. In addition, continuing investigations will look at potential wrongdoing.
In April, the SEC settled securities fraud charges against Paul Berliner, a trader formerly with the Schottenfeld Group. The SEC said he had spread a false rumor about the price of the Blackstone Group’s potential acquisition of Alliance Data Systems, and profited from short-selling Alliance’s stock.
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