July 16, 2008

SEC AND SROs CRACK DOWN ON MANIPULATIVE

RUMOR-MONGERING, SHORT-SELLING

No doubt seeking to halt the intentional spread of false information intended to manipulate securities prices, the Securities and Exchange Commission has announced that it, FINRA and NYSE Regulation will “immediately” commence examinations of broker-dealers and investment advisers.

The probes, unusually announced in a weekend press release, will focus on the supervisory and compliance controls of advisers and broker-dealers, asking whether they are reasonably designed to prevent intentionally creating or spreading false information intended to affect securities prices, or other potentially manipulative conduct.

The release comes on the heels of several recent and related developments:

  • In late March, FINRA issued a news release warning market participants against spreading false rumors and other abusive market activity.

  • Over the past week the SEC issued more than 50 subpoenas to investment advisers seeking trading and communications data related to short-selling and options trading in several distressed financial institutions.

  • According to the same report, NYSE Regulation sent a letter Monday to a number of its “largest member firms” requesting details on how those securities firms monitor compliance with rules prohibiting circulation of false and misleading rumors.

  • On Tuesday, the SEC took emergency action to limit short selling in the shares of Freddie Mac and Fannie Mae by imposing a “pre-borrow requirement” on short sales of those mortgage-financing companies.

It is clear from this flurry of activity that the SEC and self-regulatory organizations are concerned that the spreading of false rumors has affected trading in the securities of certain distressed financial institutions. If further rumor-mongering is not aggressively halted, it could adversely impact the US financial sector.

Accordingly, investment advisers and broker-dealers should proceed with the understanding that transactions in the securities of distressed financial institutions, particularly short selling and options trading, likely will be closely scrutinized by regulatory authorities. Remind employees that spreading false rumors may violate the anti-fraud and anti-manipulation provisions of the federal securities laws, NYSE Rule 435(5) and NASD Rule 5120(e).