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July 15, 2008 4:58 PM

Considering the SEC's False Rumor Crack Down

Posted by Nate Raymond

The Securities and Exchange Commission announced Sunday that it and other regulators were examining the intentional spread of false rumors to manipulate stock prices. As part of the examination, the SEC has issued 50 subpoenas to hedge fund advisers, including Citadel Investment Group LLC in Chicago and SAC Capital Advisors in Stamford, according to The Wall Street Journal, which cites a person familiar with the matter. If the report is accurate, the subpoenas will likely keep lawyers busy for months as investigators comb through e-mail exchanges and conduct depositions to learn, among other things, whether hedge funds were responsible for the fall of Bear Stearns & Cos. Inc.

We checked in with Davis Polk & Wardwell partner Joseph Hall, a former managing executive for policy at the SEC from 2003 to 2005, for his take on the SEC move.

What do you think is going on?
It looks more like a street sweep. The press release that they put out says it's just an exam being conducted by the [SEC's Office of Compliance Inspections and Examinations], and that's something that's sometimes done by just sending a letter.

How hard will it be for the SEC to bring charges related to false rumors?
It would be really difficult. If they could find a smoking gun where a trader deliberately fabricated a rumor and started passing it along, then I think they could definitely go after that trader for having engaged in that kind of deceptive conduct. But just passing along a rumor? Markets trade on information, and if you have somebody who's unconnected to the issuer and is not participating in an offering by the issuer, [that person] certainly has no obligation to verify information that he or she hears before trading on that information or passing that information along.

What will make investigating false rumors difficult?
A lot of these conversations are going to take place, obviously, orally. There's not necessarily going to be an e-mail trail or an IM trail.

Assuming the subpoena reports are accurate, what likely is the SEC looking for?
I'd have to see what it says. If I were the SEC and I really wanted to find the needle in the haystack, I might be looking for all e-mails that reference a particular name over a course of a particular period.

So anything that says "Bear Stearns," for example?
Yeah. You have to think of it from the SEC's perspective of finding the source of these things. They have to figure out how to use their resources. So talking to people who have shorts or talking to people who have been out making public statements about these issuers may be one way they may go about it. If they figure out one guy passed a rumor along to another via e-mail, you can certainly imagine them going back to the guy who passed the information along and saying, okay, where did you hear this. That way, try to track it back to its source.

If they can't find someone, though, what's the point?
Regardless of whether they actually are able to locate the smoking gun, this is certainly an excellent way to get people's attention. It's good to get that message out to people because some people may think all's fair in love and war.

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