Editor’s Note: The author is a former senior Securities and Exchange Commission enforcement lawyer.
By Mike Dicke, Partner, Fenwick & West
On April 10, the Securities and Exchange Commission filed sweeping charges against 27 companies and individuals that it accused of a simple stock promotion scheme — namely pretending that they were providing independent and objective analyses when in fact they were being paid to tout a stock.
The case has garnered much attention in an age when there’s a raging debate about how to combat “fake news.” One headline about the SEC case blared: “SEC Signals No Patience for Fake News on Stocks.”
If only that were true. Unfortunately, commentators are ignoring an uncomfortable fact: the SEC is quick to jump on issuers for all kinds of perceived wrongdoing — including making overly optimistic statements or paying for promotion — but it rarely pursues short sellers, the name for investors who make money when stock prices go down, not up. These individuals daily spew misleading or downright false information in order to turn a quick profit and deserve more scrutiny from the SEC.
This enforcement imbalance deceives potential investors, damages existing shareholders, and harms innovation as emerging companies struggle against the steady drumbeat of deceptive information disseminated by short sellers.
The new SEC chairman ought to seize on this issue and direct his enforcement staff to right this imbalance and go after those who intentionally spread malicious information about U.S. companies.
The SEC’s April 10 sweep focused on bullish commentary disguised as independent and objective research, which appeared in Seeking Alpha, Benzinga and similar websites. In reality, corporate issuers had paid promoters to write the articles and comments. The SEC alleged violations of a specific statute, Section 17(b) of the Securities Act of 1933, which requires publishers of information about securities to disclose if they were compensated for their opinions. In the more egregious cases, the SEC also brought fraud charges against both the promotional firms and the issuers who paid them.
Although the media treated the SEC’s announcement as groundbreaking, the Commission has been bringing similar cases for years. All the way back in 1998, while we were still in the era of dial-up internet service, the SEC brought an even larger sweep under Section 17(b) against 44 defendants, and has brought numerous cases since.
While it is salutary that the Commission is again going after unscrupulous stock touts, it is troubling that the SEC has not shown the same appetite to reign in the far more abusive practice of short sellers who initiate or pay for misleading hit pieces on U.S. companies. Occasionally, SEC officials have talked tough, such as former Chairman Christopher Cox’s colorful 2008 promise that “the Commission will vigorously investigate and prosecute those who manipulate markets with this witch’s brew of damaging rumors and short sales.” Yet, the promised enforcement crackdown never came. As a 2013 article concludes, the Commission is “not likely to pursue fraud charges against a short seller or its affiliates…absent egregious conduct and persuasive evidence.” SEC Enforcement Actions and Issuer Litigation in the Context of a “Short Attack,” The Business Lawyer (2013).
Certainly, SEC enforcement staff must be aware of the plethora of shady characters making unsubstantiated attacks targeting public company stocks – many on the same sites used by the promotional firms called out in the recent SEC actions. So what’s behind the hesitancy to pursue cases against short sellers? One reason may be that SEC staffers have come to believe the short sellers’ refrain that they provide a valuable service by exposing fraud at public companies. While this claim may be true in a handful of cases, it should not insulate the numerous bad actors pedaling misinformation for profit from SEC scrutiny.
Another important reason for the SEC’s inaction is that there is no analogue statute to Section 17(b) requiring an author of a negative article to disclose if he is being paid by short interests, or would benefit from a fall in the stock price. This statutory gap requires the SEC to build a case under the general anti-fraud provisions of the federal securities laws – a much more daunting task. Yet, these burdens did not stop the SEC in several of the matters filed on April 10 from alleging the full panoply of fraudulent acts under the general anti-fraud provisions of the securities laws, alleging that the promotion firms and the issuers engaged in a fraudulent “scheme to deceive investors.”
These same theories could be applied to the unscrupulous false rumor-mongering and short-driven schemes on stock sites and through social media. The SEC has the tools to battle the purposeful misinformation being spread by short sellers about U.S. listed companies. Let’s hope that the new incoming Commission chairman encourages his enforcers to use them.