Pssst…. The New York Attorney General's Office is doing it. So is the Securities and Exchange Commission, and even the FBI. They are all looking into market manipulation through false rumors and short selling, particularly by hedge funds and other large, non-public investors. The danger to you is that if an employee trades on or passes along a rumor, it may run afoul of the rules against market manipulation or insider trading, leaving your company—and yourself—facing scrutiny and possible liability.
With the criminal and regulatory authorities under pressure to hold persons accountable for infractions contributing to the current financial crisis, now is a good time to take steps to make sure you stay out of trouble. Below, we examine the "rumor sweep" and offer practical points on doing business in this environment.
What Is Wrong with a Rumor
We've all heard them, and your company may have even been the subject of a rumor from time to time. While access to information is what Wall Street is all about, the use of false information to manipulate markets is illegal. It can lead to a loss of confidence in the market, which can lead to panic selling, which in turn is further exacerbated by short selling. So the government is acting to deter it.
This year, the SEC brought the first case in its 74-year history for market manipulation through the spreading of false rumors. The SEC charged Paul S. Berliner, a trader, with securities fraud and market manipulation for intentionally disseminating a false rumor concerning the Blackstone Group's acquisition of Alliance Data Systems Corp. ("ADS"). Several months after Blackstone agreed to acquire ADS at $81.75 per share, Berliner disseminated a false rumor that Blackstone was going to acquire ADS at $70 a share, a significantly lower price. ADS stock plummeted 17 percent that day and Berliner profited by short selling and then covering as the price declined. Berliner settled his case with the SEC for, among other things, a $130,000 civil fine and a lifetime bar from the industry.
SEC Chairman Christopher Cox stated that the message of the case was "simple and direct," and that the SEC would "vigorously investigate and prosecute those who manipulate markets with this witch's brew of damaging rumors and short sales." New York Attorney General Andrew Cuomo has also stated that he would investigate whether short sellers have spread rumors in the market in deliberate attempts to drive down share prices.
While short selling is generally legal, it is illegal to use false rumors to manipulate stock price in order to profit. It is also illegal to agree with others (i.e., conspire) to distribute misinformation to purposely drive down the price of a stock, and then profit from the decline.
Trading on a true rumor, in the form of material, non-public, inside information, in order to profit, is illegal as well. This is simply insider trading—the buying or selling of a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Those liable for insider trading include the person "tipping" such information, and any person knowingly trading on the tipped information (the "tippee"). To constitute material, non-public information, the information must be specific and more private than general rumor. For example, information about the date of a merger announcement and the acquisition price have been deemed more than general market rumors, particularly if it is specific, reliable information received from a credible source.
What You Should Do to Protect Yourself and Your Firm
In this environment, market participants should take steps to ensure that employees are careful not to cross the line when gossiping with Wall Street colleagues about the market. Below are some practical steps you can take to help prevent rumors from resulting in a civil or criminal action against you, your firm or your employees:
What This Means To You
Businesses should not be complacent. Make no mistake about it—both insider trading and illegal marketing manipulation are forms of fraud, and may be subject to criminal prosecution. Therefore, while most hedge funds and other financial institutions are preoccupied trying to survive these severe market conditions, they must address the issues raised by these new circumstances, and proceed with the utmost caution when handling governmental inquiries.
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Copyright © 2008 Herrick, Feinstein LLP. The Securities Law & White Collar Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.