SEC Orders Hedge Funds to Disclose Trading Information (Now We’re Getting Somewhere!)

September 26, 2008 by  
Filed under Investing, Money and Behavior

Manipulation of Stock Prices by Hedge Funds? 

According to a story reported by the Wall Street Journal yesterday, the Securities and Exchange Commission has ordered two dozen hedge funds to turn over stock trading records.  Apparently, the SEC is concerned that these hedge funds were manipulating the stock prices in six financial services companies (Goldman, Lehman, WaMu, AIG, Morgan Stanley, and Merrill Lynch).  More specifically, the investigation will focus on whether these hedge funds spread false rumors about the companies’ health so as to drive their stock prices down.  This would allow the hedge funds to make huge profits by selling the stocks short. 

The SEC has the Power and is Finally Using it 

Mr. ToughMoneyLove is pleased to hear of this investigation.  I hope they find something.  Being an attorney in my day job, I am often curious about the legal basis for government investigations and the possible outcomes.  I do not work in the securities area so I did a little checking and thought I would share it with you.   I think it helps us all better understand the activity swirling around us if we know a little something about the legalities involved.

First, Congress has given the SEC broad rule making authority to investigate and enforce the provisions of the SEC Act.  The SEC Act includes multiple statutes that regulate behavior in the markets and exchanges.   One of those statutes is codified at 15 U.S.C. §78j: 

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange- (a)(1) To effect a short sale, or to use or employ any stop-loss order in connection with the purchase or sale, of any security registered on a national securities exchange, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. 

Probably the best known rule adopted by the SEC to enforce the statute is the general “securities fraud” rule.  It is famously known as Rule 10b-5 because it is found at § 240.10b-5 in Chapter 17 of the Code of Federal Regulations.  

Rule 10b-5 provides that it is unlawful for any person, directly or indirectly: 

1. to employ any device, scheme or artifice to defraud,

2. to make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or 3. to engage in any act, practice or course of business that operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. 

So if you combine the scope of the statute and associated rule together, the SEC has clearly outlawed the making of false statements in conjunction with the sale of stock, and specifically including short sales.  Hedge funds make their living on short sales and with the precipitous drops in the share prices of the named companies, there is reason to suspect that manipulation was involved. 

The Penalties are Severe

The best part of my investigation was learning what the penalties might be if the SEC discovers and can prove a case of stock price manipulation by use of false rumors.  Those penalties are in the statute found in 15 U.S.C. § 78ff: 

Any person who willfully violates any provision of this chapter …. or any rule or regulation thereunder the violation of which is made unlawful ….. shall upon conviction be fined not more than $5,000,000, or imprisoned not more than 20 years, or both, except that when such person is a person other than a natural person, a fine not exceeding $25,000,000 may be imposed; but no person shall be subject to imprisonment under this section for the violation of any rule or regulation if he proves that he had no knowledge of such rule or regulation. 

Sweet.  I like that part about 20 years in prison.  Wouldn’t you enjoy seeing some Wall Street fat cats go to prison for willful actions contributing to what has caused and will continue to cause market chaos and monumental losses to the taxpayers?  I would.  Stay tuned.

Feed Mr. ToughMoneyLove

FREE UPDATES: If you enjoyed this, please subscribe to receive the newest hard truth from Mr. ToughMoneyLove automatically by RSS feed (what is RSS?) or by spam-free Email.

  • Banner

Speak Your Mind

Please leave a comment and tell us your version of the hard truth...

You must be logged in to post a comment.