THERE is a growing chorus of calls for regulatory action in the United States against traders who spread false rumors to manipulate stock prices, but I think at least half of the problem lies with companies themselves — and poor investor relations practices in particular.
In today’s New York Times, Dealbook writer Andrew Ross Sorkin writes about how market rumors are given added impact by new technologies like instant messaging and Blackberries that enable gossip to spread like wildfire and often be untraceable.
He uses as his main example recent trading in Lehman Brothers, whose stock is down almost 70% this year on persistent speculation that it is in financial trouble and could be the next Bear Stearns. Last week, the stock dropped 11% in three hours amid false rumors the investment bank was about to be sold to Barclays plc for less than its current value.
Lobbying for regulatory action against shorts is misplaced
Ross Sorkin concludes: “There’s no way to quantify whether rumors are more rampant today than they used to be or whether they are just traveling faster. But what is clear is that there seems to be little being done about it. It might be difficult to make a case, but you’d think you’d see subpoenas flying at least as fast as the rumor mill.”
In other words, he’d like to see more regulatory action. His article also quotes JPMorgan chairman James Dimon saying in a recent television interview: “I think if someone knowingly starts a rumor or passes on a rumor, they should go to jail. This is even worse than insider trading. This is deliberate and malicious destruction of value and people’s lives.”
Those are strong words, but they pale in comparison to what has happened in the UK. In June, the UK’s Financial Services Authority invoked special powers to introduce new disclosure of short positions in shares undergoing rights issues. It gave market participants, hedge funds mostly, only one week to prepare and comply.
“This measure appears to be in response to the need to recapitalise the banking system,” said Andrew Baker, Deputy CEO of the Alternative Investment Management Association, a hedge fund lobby group, after the FSA announced its drastic measure.
The FSA’s surprise move came after the debacle at mortgage lender HBOS, which saw its shares driven down in wild trading amid rumors it was in financial trouble. The HBOS incident prompted an unprecedented and widely criticized move by the central Bank of England to hold a press conference with reporters to deny the rumors.
So it seems to me there is some strong lobbying going on for regulators to take steps to stamp out rumors or at least make life less comfortable for short-sellers. And I agree. Deliberately spreading false information about a company to manipulate its stock price is bad, whether perpetrated by hedge funds or ever-optimistic corporate executives.
Companies fail to follow disclosure rules for handling rumors
But the answer to the market rumor mill does not rest with more regulation. In fact, if regulators were better at enforcing existing regulations, not just against manipulators but against corporate management, rumor-mongering would be much less feasible than it is now.
A big part of the problem is that companies aren’t effective at countering rumors. They lack the requisite credibility and their communications practices have failed to keep up with technological advances.
I don’t think it is a coincidence that Lehman Brothers and HBOS have had trouble with negative gossip. Both firms have poor online communication practices. And as the Times‘ Ross Sorkin points out, it is the Internet that is enabling the rumormongers’ success.
If you visit these companies’ websites, you will have a hard time finding any reference to the rumors that are causing trouble for their share prices. From what I can tell, they have ignored the topic entirely in their formal communications with investors.
In fact, during the most recent rumors, Lehman told TradeTheNews.com that the investment bank does not respond to market rumors. In other words, it ignores them, as a matter of policy.
And that’s the real problem. Think about it. If you are going to short a company and help your bet by spreading false rumors, wouldn’t you target a company that lacks the ability or wherewithal to defend itself? Of course, you would.
But here’s the thing that really makes no sense: Lehman’s policy actually runs counter to the rules of the New York Stock Exchange, where its shares are listed. The NYSE Company Manual makes it clear that the exchange expects companies to confirm, deny or clarify rumors:
202.03 Dealing with Rumors or Unusual Market Activity
The market activity of a company’s securities should be closely watched at a time when consideration is being given to significant corporate matters. If rumors or unusual market activity indicate that information on impending developments has leaked out, a frank and explicit announcement is clearly required. If rumors are in fact false or inaccurate, they should be promptly denied or clarified. A statement to the effect that the company knows of no corporate developments to account for the unusual market activity can have a salutary effect. It is obvious that if such a public statement is contemplated, management should be checked prior to any public comment so as to avoid any embarrassment or potential criticism. If rumors are correct or there are developments, an immediate candid statement to the public as to the state of negotiations or of development of corporate plans in the rumored area must be made directly and openly. Such statements are essential despite the business inconvenience which may be caused and even though the matter may not as yet have been presented to the company’s Board of Directors for consideration.
202.05 Timely Disclosure of Material News Developments
A listed company is expected to release quickly to the public any news or information which might reasonably be expected to materially affect the market for its securities. This is one of the most important and fundamental purposes of the listing agreement which the company enters into with the Exchange.
A listed company should also act promptly to dispel unfounded rumors which result in unusual market activity or price variations.
Stop blaming shorts and take a look in the mirror
Interestingly, Ross Sorkin quotes an unnamed executive at Lehman as saying: “A rumor travels better than the truth. All you can do is deny, deny, deny. But it’s like being asked, ‘When did you stop beating your wife?’ ”
That’s nonsense for a couple of reasons:
- First, Lehman hasn’t denied anything formally because they don’t respond to market rumors.
- Second, what really matters is the believability of the denial. If you have no credibility, then people won’t believe your denials about beating your wife. But if you have a good reputation and have built strong relationships with your stakeholders, they will give you the benefit of the doubt.
The trouble is that Lehman hasn’t tried. When I visited their website just a little while ago the imp
re
ssion I got was of an organization in denial. You would think everything is going swimmingly and no one is saying nasty things about the firm’s future viability.
Another problem is that Lehman’s investor relations website is little more than a repository for compliance documents. It does nothing to reach out proactively to its shareholders.
What do you think the number one question is on many Lehman’s shareholders’ minds right now? If Lehman’s investor relations FAQs are to be believed, the most pressing question on shareholders’ minds right now is what the company’s ticker symbol is.
Give me a break! The FAQs are made up and don’t reflect the questions the company is actually getting from investors. They’re not frequent questions, they’re fake.
When people see that kind of thing, they know you don’t really give a damn about communicating with them. They know they can’t trust you to be forthcoming and responsive. And, of course, some of them realize you’re a sitting duck for malicious rumors.
A lot of companies are in this position because their investor relations departments still think that the most important communication tool is the one-on-one meeting on the golf course or on the telephone.
They forget that when rumors start, most people will turn immediately to a company’s website for an official response or reassurance. In 99% of cases, they’ll find neither.
That’s the real problem, not a lack of disclosure laws. The only way to make rumor-mongering unprofitable is to nip it in the bud and have enough stored up credibility that you will be believed when you say something is not true.
For what it’s worth, while researching this post, I took a look at a number of other companies’ policies around market rumors. Here’s a sample:
Washington Mutual’s policy is that it may respond to market rumors under certain circumstances, as it did most recently on June 11, 2008:
Responding to Market or Media Rumors
The Company does not generally comment on market rumors or speculation. The Company may, however, respond to rumors or speculation in certain circumstances including (i) upon request by a stock exchange or regulatory agency or (ii) if the Company determines such response is appropriate. Employees should refer such requests to the Investor Relations Group or Corporate Communications Group.
India’s Reliance Energy has a formal process for responding to enquiries about rumors:
Responding to market rumours
The Compliance Officer shall immediately consult the concerned Departmental head for verification of any market rumours or queries forwarded by the Stock Exchanges. The Compliance Officer or the concerned Departmental head shall reply to the queries or requests for verification of market rumours within 48 hours of receipt or such further period as may be allowed by the Stock Exchange. As and when necessary the Compliance Officer may in consultation with the Chairman and Managing Director make a public announcement for verifying or denying rumours before making the disclosure.
In their investor relations policy, which is posted on their website, Progressive Corp. states:
“Responding to Market Rumors
Spokespersons will respond consistently to rumors, saying, “It is our policy not to comment on market rumors or speculation.” We do not comment on questions associated with pending acquisitions or litigation or on loss reserves for specific events. The CEO will decide if circumstances warrant making a policy exception.”
Johnson Controls has a similar policy, but it is not clear how the company responds when it is the source of market rumors:
IX. Responding To Market Rumors – So long as it is clear that JCI is not the source of the market rumor, JCI’s spokespersons will respond consistently to those rumors concerning potentially material developments by saying, “It is our policy not to comment on market rumors or speculation.” Should the NYSE request JCI to make a definitive statement in response to a market rumor that is causing significant volatility in JCI’s stock, the Disclosure Committee will consider the matter and make a recommendation to the CEO on whether to make a policy exception.
Scotiabank says it monitors the web for rumors and may respond if the rumors are causing volatility:
Responding to Market Rumours
It is the Bank’s general practice not to comment on market rumours or speculation, particularly where it is clear that it is not information from the Bank that is the source or basis of the market rumour. Investor Relations periodically monitors Internet chat rooms and other sites in order to identify statements being made about the Bank, with a view to anticipating the source of a market rumour. After consultation with the Disclosure Committee, the Bank’s spokesperson may respond, if a rumour is causing market volatility or ifa stock exchange or securities regulator requests that the Bank make a statement.
Alberta-based ATCO Group presumably responds to rumors, or maybe not:
Responding to Market Rumours
The Corporation will not comment, affirmatively or negatively, on market rumours. This also applies to rumours on the Internet.
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