SEC rumourgate 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” rumours, and they’ve opened an “investigation” into the matter. Undoubtedly, the mere threat of an investigation is meant to chill the rumour mill, which is being blamed for the collapse of Bear Stearns earlier this year and the current pressure on Lehman’s shares.

I paid close attention to the Bear process, and I seem to recall something about $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 rumours” 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 rumour, 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 rumour 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 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 rumour mill, we happened across the “Bear may go bankrupt” rumour before Bloomberg and Reuters did, and you read it all here (see prior post “Bear rumour 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” rumours is entirely ludicrous; they’re called rumours 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 rumour 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 rumours 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 rumour.”

MRM