Wall Street regulators are examining whether securities firms adequately police rumor-mongering used to manipulate stocks after shares of Lehman Bros. Holdings Inc., Fannie Mae and Freddie Mac tumbled last week.
The Securities and Exchange Commission's inspections unit; the Financial Industry Regulatory Authority, which monitors brokerages; and the New York Stock Exchange's regulatory arm are checking whether firms have controls in place to prevent the intentional spread of misinformation, the SEC said Sunday. The agencies also will look at whether employees have been adequately trained.
"The examinations we are undertaking with FINRA and NYSE Regulation are aimed at ensuring that investors continue to get reliable, accurate information about public companies," SEC Chairman Christopher Cox said.
Regulators already are hunting for traders who may have sought to profit illegally from the credit crisis by falsely stoking panics about the stability of such companies as Bear Stearns Cos., which collapsed in March amid speculation that clients were pulling out their business.
Cox told the Senate Banking Committee on April 3 that the agency took such manipulation "very seriously" and that lawmakers' hopes for a crackdown would be "met or exceeded." In March, the agency opened probes into whether hedge funds and other traders spread lies about Bear Stearns and Lehman after those stocks plunged, people familiar with the matter said at the time.
Bear Stearns was forced to sell itself to JPMorgan Chase & Co. on March 16 at a fraction of its previous market value.
Publicly declaring inspections "may be the most effective step they could take" to stem the malicious use of rumors, said James Cox, a securities law professor at Duke University in Durham, N.C., who isn't related to the SEC chief.
Still, "it's a little like the Dutch boy with his finger in the dike." Many traders, including hedge funds, aren't subject to the inspections, he said.
FINRA and NYSE Regulation will join the SEC in examining the manipulation of securities prices through rumor-mongering and abusive short- selling, the SEC said. FINRA and NYSE rules bar their members from spreading "sensational" rumors that can affect markets, even if people aren't using them to defraud others.
Lehman's shares fell last week amid speculation that Pacific Investment Management Co., manager of the world's biggest bond fund, and hedge fund SAC Capital Advisors were backing away from the firm. The companies denied it, and Pimco fund manager Bill Gross told CNBC that there's "no question" about Lehman's solvency. Its shares are down 78% this year.
"Lehman is very susceptible to any kind of negative talk," said Rebecca Engmann Darst, an options analyst at Interactive Brokers Group. "Its shares respond big and bad to any negative, more so than other brokers, because since March it's been perceived as the next in line after Bear Stearns to suffer a similar fate."
Lehman dropped last week alongside Fannie Mae and Freddie Mac, which plunged on concern that the home-loan financing companies may be required to raise more capital. The declines forced Treasury Secretary Henry M. Paulson Jr. to pledge support for them.