SEC wants to hurt stock spammers
The SEC in the United States resorted to an interesting subterfuge while suspending trading in 35 stocks touted in email campaigns. Most of the SEC’s press release appears to suggest that this is merely intended to protect gullible investors who might fall for the spam. But the fag end of the press release coupled with the very different tone of its actual order tell us that the true intent of the SEC is something different – it wants to inflict heavy losses on the spammers.
If successful, this strategy of hurting the spammer rather than just protecting investors could very effectively deter future spam campaigns. The question is the legal and ethical justification for what the SEC is trying to do.
The core of a spam campaign is well described by Frieder and Zittrain in their January 2007 SSRN paper Spam Works: Evidence from Stock Touts and Corresponding Market Activity:
The evidence accords with a hypothesis that spammers “buy low and spam high,” purchasing penny stocks with comparatively low liquidity, then touting them – perhaps immediately after an independently occurring upward tick in price, or after having caused the uptick themselves by engaging in preparatory purchasing – in order to increase or maintain trading activity and price enough to unload their positions at a profit. We find that prolific spamming greatly affects the trading volume of a targeted stock, drumming up buyers to prevent the spammer’s initial selling from depressing the stock’s price. Subsequent selling by the spammer (or others) while this buying pressure subsides results in negative returns following touting. Before brokerage fees, the average investor who buys a stock on the day it is most heavily touted and sells it 2 days after the touting ends will lose approximately 5.5%. For the top half of most thoroughly touted stocks, a spammer who buys at the ask price on the day before unleashing touts and sells at the bid price on the day his or her touting is the heaviest will, on average, earn 5.79%.
The SEC’ action has the potential to inflict heavy losses on the touts by making his holding of the touted stock worthless. Not only can he not sell his holding for the 10 days for which the suspension is in force, but the SEC is making it more or less clear that it would not like these stocks to trade any time soon. As the SEC points out:
For stocks that trade in the OTC or the over-the-counter market, trading does not automatically resume when a suspension ends. (The OTC market includes the Bulletin Board and the Pink Sheets.) Before trading can resume for OTC stocks, SEC regulations require a broker-dealer to review information about a company before publishing a quote. If a broker-dealer does not have confidence that a company’s financial statements are current and accurate, especially in light of the questions raised by the SEC, then a broker-dealer may not publish a quote for the company’s stock.
In its press release, the SEC makes its intentions very clear on this point:
Further, broker-dealers should be alert to the fact that, pursuant to Rule 15c2-11 under the Exchange Act, at the termination of the trading suspensions, no quotation may be entered unless and until they have strictly complied with all of the provisions of the rule. If any broker-dealer enters any quotation that is in violation of the rule, the Commission will consider the need for prompt enforcement action.
The interesting point is that unlike the press release which talks at length of spamming, the actual order itself mentions nothing about spamming. For each company, the order states that “Questions have arisen regarding the adequacy and accuracy of press releases concerning the company’s operations and performance” or something similar. This is clearly designed to make it impossible for any broker or dealer to have the “reasonable basis under the circumstances for believing” that the information required under Rule 15c2-11 is “accurate in all material respects”. The statute itself does not require the SEC to raise questions about the accuracy of available information to suspend trading in the stock. Section 12(k) of the Securities Exchange Act allows the SEC to order suspension for 10 days “[i]f in its opinion the public interest and the protection of investors so require”.
Clearly the temporary suspension permitted by law might help protect investors, but an indefinite suspension does not do so – it hurts those genuine investors who were holding the stock. An indefinite suspension is needed to hurt the spammers by making their initial investment worthless. Unfortunately, the statute does not give the SEC the power to do this. Hence the subterfuge is needed. I find this action disturbing because (a) it turns the regulator into a stock price manipulator even if it is for a just cause and (b) it compromises the honesty and integrity of the regulator.
Posted at 2:43 pm IST on Fri, 9 Mar 2007 permanent link
Categories: equity markets, manipulation, regulation
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