The SEC took the unusual step of issuing a press release on Sunday to discuss its enforcement efforts concerning rumors and the possible manipulation of securities prices. In the release, the SEC announced that it will immediately “conduct examinations aimed at the prevention of the intentional spread of false information intended to manipulate securities prices.” Those examinations will be conducted by the Office of Compliance Inspections and Examinations. The SEC will be aided in these efforts by the Financial Industry Regulatory Authority and the New York Stock Exchange Regulation, Inc. Securities Regulators to Examine Industry Controls Against Manipulation of Securities Prices Through Intentionally Spreading False Information (July 13, 2008).

According to the release, the focus of the examinations will be procedural controls at broker-dealers and investment advisers over their employees to prevent “intentional manipulation of securities prices through rumor-mongering and abusive short selling ….” Previously, FINRA, NYSE Regulation and the Options Regulatory Surveillance Authority reminded industry firms about intentionally spreading false rumors or participating in collusive activity to impact the “financial condition of an issuer …. ”

The SEC announcement came on the same day that the U.S. Treasury Department announced a plan to shore up Fannie Mae and Freddie Mac, the two giants of the mortgage market. Last week, shares of both companies tumbled amid rumors about their liquidity and solvency and speculation about a possible government bail-out.

On Monday SEC, Chairman Cox amplified the Sunday press release in an interview on Bloomberg, noting that they are being undertaken in conjunction with the Enforcement Division’s on-going investigation of the circumstances surrounding the collapse of Bear Stearns. There, the SEC reportedly is probing the rumors and trading that surrounded the downward tumble of the giant investment bank’s share price in the days before its government arranged take-over, although the Chairman noted that the inquiry is broader than the situation regarding Bear Stearns.

The Sunday press release appears at least in part to be a preemptive strike taken in conjunction with the controversial Treasury plan announced at the same time to shore up the mortgage firms and avoid what regulators seem to think may have happened to Bear Stearns. Clearly, continued deterioration of confidence in the financial viability of Fannie May and Freddie Mac would be harmful to an already fragile market.

No doubt everyone agrees with the Chairman’s stated goal of preventing intentional market manipulation. At the same time, announcements about (and investigations into) speech in the marketplace must be undertaken with care. Information is crucial to the marketplace and their price discovery mechanism. Indeed, information and the ability to freely communicate it are at the heart of liquid markets, as the SEC well knows. It is thus essential that market professionals, analysts, traders, the press and in fact everyone be permitted to state their beliefs, positions and opinions freely and without concern of unwarranted government intervention. This is the essence of not just the markets, but the constitutional guarantees of free speech. In this regard it is essential that the SEC and other regulators tread carefully in this area, regardless of how well intentioned their motives might be to avoid damaging the markets they seek to protect.

The SEC filed another settled, years-old, financial fraud case on Friday. This time the case was filed against the El Paso Corporation, two of its subsidiaries and five of its former executives. SEC v. El Paso Corporation, Civil Action No. 4:08-CV-02191 (S.D. Tex. July 11, 2008). In addition to the company, the complaint named subsidiaries El Paso CGP Company LLC and El Paso Exploration & Production Co. and Rodney D Erskine, former president of El Paso’s Exploration and Production business segment, Randy L. Bartley, the former senior vice president of El Paso’s Exploration and Production business Segment, and Steven L. Hochstein, John D. Perry and Bryan T. Simmons, former vice presidents of El Paso’s Exploration and Production business segment.

The complaint is based on alleged fraudulent conduct which occurred between 1999 and 2003, largely in the two subsidiary defendants. In 2004, the company restated its financial statements, correcting its filed financial statements.

Four years after El Paso’s restatement detailing the errors, the SEC filed its complaint. The Commission alleged that El Paso materially overstated its proven oil and gas reserves, overstated its standardized measure of future cash flows and overstated its capitalized costs relating to its natural gas and oil producing activities.

The inflated results were accomplished in three key ways: 1) the company improperly attributed proved reserves to unproved oil and gas reserves; 2) they improperly recorded reserves as proved without having sufficient supporting geological or engineering data as required by SEC rules; and 3) the company failed to reduce reserves despite negative drilling and production data.

This conduct followed pressure from Messrs. Erskine and Bartley to maximize oil and gas reserves. The vice presidents in the Exploration and Production segment in turn certified false reports. According to the complaint, the inadequate internal controls of the company facilitated the overstatements. In 2001, Defendant Erskine adopted a reporting structure in which reserve estimates were made in the geographical districts and certified by the vice presidents. This structure contributed to the inflated results.

To resolve the case:

• El Paso consented to the entry of an injunction prohibiting violations of Section 17(a)(2) of the Securities Act and the books and records provisions of the Exchange Act.

• The two subsidiaries consented to the entry of an injunction prohibiting violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and the Exchange Act books and records and internal control provisions.

• Messrs. Erskine and Bartley consented to the entry of injunctions prohibiting future violations of Section 17(a)(2) of the Securities Act and various Exchange Act books and records and internal provisions. In addition, Mr. Erskine consented to the entry of an order requiring him to pay a $75,000 civil penalty, while Mr. Bartley consented to the entry of an order requiring him to pay a $40,000 penalty.

• Messrs. Hochstein, Perry and Simmons each consented to the entry of a permanent injunction prohibiting future violations of the antifraud provisions of the Securities Act and the Exchange Act and the books and records and internal control provisions of the Exchange Act. In addition, each consented to the entry of an order requiring the payment of a $40,000 civil penalty.