Lest you think “fake news” is solely a political dilemma or modern experiment in the dark arts of election manipulation, recent enforcement actions by the Securities and Exchange Commission have shed light on the threat to public companies.
In fact, the SEC has decades of experience hunting down the sources of rumor, innuendo, and falsity. Lessons learned from those past crackdowns can help firms implement controls even as technology and the world of online media keeps evolving.
“There are rules on the books about this, and the issues go back in time quite a ways,” says Kathleen Marcus, co-chair of the Stradling law firm's Enforcement Defense & Investigations practice group and a former enforcement officer with the SEC. “It has taken various forms and continues to evolve as technology evolves. There are tweaks that have impacted the stock market now that we wouldn’t have seen 10 years ago, but the idea of a ‘pump and dump’ has been around for many decades.”
The latest SEC offensive on fake news took place on April 10, when it announced enforcement actions against 27 individuals and entities behind various alleged stock promotion schemes.
Investigations uncovered scenarios in which public companies hired promoters or communications firms to generate publicity for their stocks. These firms hired writers who, under the guise of impartiality, posted bullish articles about companies. In a notable twist, the rumor-spreading writers worked their way into well-known, mainstream financial news websites like Benzinga, Seeking Alpha, and Wall Street Cheat Sheet.
“If a company pays someone to publish or publicize articles about its stock, it must be disclosed to the investing public,” Stephanie Avakian, acting director of the SEC’s Division of Enforcement, said in a statement. “These companies, promoters, and writers allegedly misled investors by disguising paid promotions as objective and independent analyses.”
According to SEC complaints filed in federal district court, deceptive measures were often used to hide the true sources of the articles from investors. One writer wrote under his own name as well as at least nine pseudonyms, including a persona who claimed to be “an analyst and fund manager with almost 20 years of investment experience.” Another stock promotion firm had writers sign non-disclosure agreements that prevented them from disclosing the compensation they received.
The SEC also alleged that some writers engaged in scalping—recommending a stock to drive up the stock price and then selling shares of the stock at inflated prices to generate profits.
Of those who settled charges brought against them, penalties ranged from approximately $2,200 to nearly $3 million, based on frequency and severity of their actions.
In conjunction with the enforcement sweep, the Commission released an investor alert.
“Investors looking for objective investment information should be aware that fraudsters may use these websites to profit at investors’ expense,” says Lori Schock, director of the SEC’s Office of Investor Education and Advocacy.
Stock promotion schemes, the alert warns, may be conducted through social media, investment newsletters, online advertisements, e-mail, Internet chat rooms, direct mail, newspapers, magazines, television, and radio. If a company’s stock is promoted more heavily than its products or services, this may be a red flag of investment fraud, it says. Microcap stocks, some of which are penny stocks, are particularly susceptible to stock promotion schemes and other forms of market manipulation.
The SEC has battled against misleading rumors, releases, disclosures, and media coverage for decades. One of the first notable cases was in the 1940s, when a company president was caught issuing pessimistic statements about company earnings while simultaneously purchasing company stock at its newly discounted price point.
Similar market manipulations would be uncovered in later years. In October 1998, following a nationwide sweep, the SEC announced enforcement actions against 44 individuals and companies for committing online fraud.
“Investors looking for objective investment information should be aware that fraudsters may use these websites to profit at investors’ expense.”
Lori Schock, Director, SEC’s Office of Investor Education and Advocacy
The perpetrators used e-mail “spamming,” online newsletters, message board postings, and websites to tout more than 235 Microcap companies, by either lying about the companies or lying about their own "independence" from the companies.
In August 2000, the SEC filed a complaint against a California man for perpetrating an Internet hoax that, in just 16 minutes, caused a Southern California high-tech company, Emulex, to lose $2.2 billion in market value.
The perpetrator was an employee of Internet Wire, a press release distribution company, and a student at El Camino Community College. Using the school’s computers, and purporting to act on Emulex's behalf, he issued a fake press release intended to manipulate the stock price and cover a short position. The release disseminated fabricated claims that the SEC was investigating Emulex’s accounting practices, that its CEO had resigned, and that it would revise its earnings to report a loss instead of a profit.
In November 2015, the SEC filed securities fraud charges against a Scottish trader whose false tweets caused sharp drops in the stock prices of two companies. He tweeted multiple false statements about the two companies on Twitter accounts that he deceptively created to look like the real Twitter accounts of well-known securities research firms.
The fake tweets caused one company’s share price to fall 28 percent before Nasdaq temporarily halted trading; another firm’s stock price suffered a 16 percent decline. On each occasion, the perpetrator bought and sold shares of the target companies in a largely unsuccessful effort to profit from the sharp price swings.
Even the SEC’s EDGAR filing system is not immune to fake news. In June 2015, the Commission sued a Bulgarian trader, Nedko Nedev, behind fake tender offers that were posted to the online database. Nedev claimed, on behalf of private equity firm PTG Capital Partners, that PTG had offered to buy cosmetics giant Avon for $18.75 a share. In less than 30 minutes, $91 million worth of Avon shares changed hands before trading was halted by the NYSE. There was no such offer and the disclosure was fraudulent.
In 2012, another fraudulent takeover bid for the Rocky Mountain Chocolate Factory was announced on EDGAR. The SEC placed Nedev behind that scheme as well as a similar effort in 2014 to manipulate the stock price of insurance company Tower Group International with a fake press release announcing that it was the target of a takeover bid.
Other recent, but unrelated, EDGAR-based scams, have targeted Berkshire Hathaway, Phillips 66, and Alphabet/Google.
The following is from an investor alert issued by the Securities and Exchange Commission's Office of Investor Education and Advocacy.
When you read an article on an investment research website, be aware that the article may not be objective and independent. For example, the writer may have been paid directly or indirectly by a company to promote that company’s stock. In some cases, the writer may not disclose compensation received or may go so far as to claim falsely that compensation was not received. Keep in mind that fraudsters may generate articles promoting a company’s stock to drive up the stock price and to profit at your expense.
Stock promotion schemes also may be conducted through social media, investment newsletters, online advertisements, email, Internet chat rooms, direct mail, newspapers, magazines, television, and radio. Be wary if you receive communications (including new posts, tweets, text messages, or emails) promoting a stock from someone you do not know, even if the sender appears connected to someone you know. If a company’s stock is promoted more heavily than its products or services, this may be a red flag of investment fraud.
Microcap stocks, some of which are penny stocks and/or nanocap stocks, may be particularly susceptible to stock promotion schemes and other forms of market manipulation.
The SEC has taken enforcement action against companies and individuals for generating deceptive articles on investment research websites. The SEC recently charged 27 parties – including public companies, firms, and writers – with fraud for generating articles that promoted certain stocks when some or all of the writers allegedly:
Failed to disclose that they received payment, even though they had been paid directly or indirectly by the companies;
Used different pseudonyms to publish multiple articles that promoted the same stock; and/or
Used fake credentials (for example, misrepresenting that the writer was an accountant, fund manager, or research analyst who had certain academic degrees).
Additionally, the SEC alleged that some writers engaged in scalping (recommending a stock to drive up the stock price and then selling shares of the stock at inflated prices to generate profits).
Even if articles on an investment research website appear to be an unbiased source of information or provide commentary on multiple stocks, they may be part of an undisclosed paid stock promotion. Never make an investment based solely on information published on an investment research website. Before investing in a particular stock, research the company thoroughly and make sure you understand its business. As with any investment decision, carefully review all of the materials available to you and if possible, verify what you are told about the investment.
Over the years, regulators and self-regulatory organizations have built up an arsenal of rules for combatting fake news, rumors, and market manipulation. Among them:
NYSE Rule 435(5) prohibits the circulation of false or misleading rumors “of a sensational character, which might reasonably be expected to affect market conditions”
FINRA Rule 6140(e) prohibits the circulation of any information that is false or misleading or would improperly influence the market price of a security.
SEC Rule 10b-5 prohibits false or misleading rumors, fraud, deceit, or intentional omissions in connection with the sale of any security that may be considered manipulative.
FINRA Rule 2010, a concise requirement that registered persons “observe high standards of commercial honor and just and equitable principles of trade.”
FINRA Rule 2030 is a prohibition on rumor circulation, defined as “a false or misleading statement or a statement without a reasonable basis.” To address concerns and legal protections on commercial speech, it carves out an exemption for statements that “are clearly an expression of an individual’s or firm’s opinion, such as an analyst’s view of the prospects of a company.”
Regulation Fair Disclosure, although not directly targeting false news, mandates that publicly traded companies must disclose material information to all investors at the same time, without favoritism or to a select audience.
The Financial Crisis in 2008 triggered a renewed focus on rumors, after innuendo was blamed, in part, for hastening meltdowns at Lehman Brothers and Bear Stearns.
Also, in April of that year, the SEC charged Paul Berliner, a Wall Street trader, with securities fraud and market manipulation for intentionally spreading false rumors about the Blackstone Group’s acquisition of Alliance Data Systems while selling the latter firm short.
Berliner was accused of disseminating fake news through instant messages to traders at brokerage firms and hedge funds. Those messages ultimately spread to media sources.
The result: Heavy trading in ADS stock ensued. Within 30 minutes, rumors caused the stock price to plummet 17 percent decline. Berliner profited by short-selling the stock during its precipitous decline.
The Enforcement Division was prompted to issue a statement that “abusive short-selling, market manipulation, and false rumor mongering for profit by any entity cuts to the heart of investor confidence in our markets” and “such behavior will not be tolerated.”
“We will root it out, expose it, and subject the guilty parties to the full force of the law,” it threatened.
Soon thereafter, the SEC (through its Office of Compliance Inspections and Examinations), the Financial Industry Regulatory Authority, and the New York Stock Exchange announced examinations targeting the intentional spread of false information intended to manipulate securities prices.
Among other things, examiners reviewed whether broker-dealers and investment advisers’ controls are reasonably designed to prevent the intentional creation or spreading of false information intended to affect securities prices, or other potentially manipulative conduct.
FINRA added surveillance relative to the spreading of rumors as a priority on its examinations beginning in 2009.
As part of its review, FINRA requested that that firms provide examiners:
Copies of firm policies, written supervisory procedures, and surveillance procedures pertaining to compliance with applicable rules.
Detailed descriptions of how the firm monitors the activities of its personnel to ensure that false or misleading rumors are not being circulated.
How the firm monitors electronic communications, including external and internal e-mails, vendor terminals, instant messages, message boards, and Internet chat rooms.
Details on software used to monitor for communication pertaining to false or misleading information.
Statements on whether sales and trading personnel are permitted to use external e-mail vendors or personal smartphones.
A description of the firm’s policies with respect to how sales and trading personnel handle inquiries or comments pertaining to false or misleading rumors from clients and internal or external members of the broker-dealer community.
That year’s FINRA offensive can be applied to current opportunities to establish and enhance “fake news” controls.
Among the takeaways: reviewing existing, relevant compliance policies; ensuring that personnel are adequately trained; considering whether additional communications or training is needed; establishing an in-house chain of command for dealing with rumors, media leaks, and fake reporting; and reviewing sales materials and advertising campaigns to ensure they are free of ambiguities or misleading information.
Ramping up efforts to conduct spot checks and monitor social media mentions of the company may also be worth review and reconsideration.
“We’ve also had some of our clients fall victim to fake websites that are putting out false information,” says Stradling’s Marcus. “It has actually been what I would refer to as a ‘bear attack.’ They have a short position in the stock and are leaking false negative information into the market in order to cause a temporary drop in the stock price so they can take advantage of their short position.”
“One of the compliance measures that we put in place at our companies is to have only a few designated people who can speak on behalf of the company,” she suggests. “That limits your risk if all personnel understand the policy.”
When false or misleading information does leak into the wild, speed is of the essence.
“When companies learn that they are the victim of fake news, a false Website, or false information being put into the marketplace, the best approach is to send a cease-and-desist letter to the creator of that false information and try to get it removed promptly,” Marcus says. “If there was a significant change in the stock price, a notification to investors might be appropriate if there was a material effect on the stock price …You may see companies put out a press release or an 8-K filing to say they were a victim.”
As for Reg FD violations, ensuring a quick response is also crucial.
“Selective disclosure of information is always a risk for companies and, even though there are only a limited number of enforcement actions under Reg FD, I think company executives always have to be careful that they haven’t answered a question from an analyst or an investor that takes them one step out from what they have publicly disclosed to the market,” Marcus says. “When you do have a Reg FD misstep, there are disclosures that must immediately happen. Companies must be very diligent about making sure that occurs.”
“Reg FD is still alive and well, but I see it more as companies making appropriate disclosures after they have had that accidental release of information, than a lot of enforcement activity,” she adds.