The SEC, Speech And The Market

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.