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Ed. note: Stock market manipulation schemes are coming to life on social media platforms and within inboxes of unsuspecting investors. This two-part series will discuss the problem and the tension between truth and tainted information. In part two, we will delve into what companies can do to get out in front of disinformation campaigns through attribution and other measures.
Disinformation is on track to disrupt Wall Street, and this growing trend is picking up steam. The Securities and Exchange Commission (SEC) initiated enforcement actions against 27 individuals and entities in 2017 for improper stock promotion schemes after uncovering deceptive scenarios in which communication firms hired to generate publicity for published positive articles promoting the stocks that “left investors with the impression they were reading independent, unbiased analyses on investing websites” when in fact they were reading paid advertisements propounded by investment research websites hired to pump the stock.
The SEC’s enforcement actions hammering back against company-initiated disinformation underscores the agency’s commitment to weeding out this deception when it relates to investments.
And while market manipulation is top of mind for the SEC, there is another disinformation-based scheme that is flummoxing companies and regulators alike — “short and distort” — a form of securities fraud wherein an investor takes a short position on a stock and then publicly berates the stock to influence it to drop. Inversely, the disinformation-based “pump and dump” scheme involves overpromotion of speculative stocks before selling out at the top. Pumping and dumping works best in a bullish market and shorting and distorting works best in a bear market.
According to global law firm DLA Piper, once all of the elements have been successfully proven, both schemes are de facto securities fraud by merit of the following elements: (1) misrepresentation to the market through articles, blogs, and social media; (2) materiality, especially when false statements discuss a company’s financial condition or viability; (3) an intent to deceive through market manipulation; and (4) connection to the purchase or sale of securities. State securities, consumer protection statutes, and common law can all apply too.
The Wildfire Effect of the Internet
Online forums and social media channels — which allow disinformation to spread quickly and often anonymously — are here to stay. So wrongfully targeted companies are getting more proactive around identifying the bad actors who are playing in this space and working to shut them down through attribution and law enforcement referrals.
It’s still too soon to see what type of role the platform companies can play in helping identify fake news around targeted companies especially since these discussions can be nuanced and encompass a level of opinion that, while unfounded, may appear credible to a news tagger. And email is no better. In 2015, in what has been described as one of the biggest cybercrimes in history, the data of over 100 million people was stolen from a dozen companies’ computers and used by a vast global network of cybercriminal accomplices to turn it into hundreds of millions of dollars. The weapon of choice — email addresses and other customer information that was stolen from the likes of J.P. Morgan and used to spam those customers with false information that led cybercriminals to successfully short and distort various stocks. Similarly, fake press releases and fake news websites, when sent to or viewed by the right audience, can create the same effect.
In the face of these challenges, companies are not sitting idle, and success stories exist. For example, homebuilder Lennar Corp., which was the subject of a short-and-distort campaign conducted by a developer and his associate caused Lennar’s market cap to decline by nearly half a billion dollars, brought suit for extortion and defamation. Lennar was awarded a $1 billion judgment, with the defendant also convicted on criminal charges.
First Amendment Versus Falsehoods
On the other hand, the courts are not inclined to deny investors an opinion about a company’s value or behaviors. In 2012, when SilverCorp, a Canadian silver producer listed on the New York and Toronto stock exchanges, sued a hedge fund and group of investors who had published two separate reports alleging that the company was engaging in fraud, the court dismissed the defamation case on the grounds the reports were composed of constitutionally protected opinions and therefore not actionable. Among the considerations that tipped the lawsuit in favor of the defendants were the court’s findings that the reports expressly disclosed that the reports were opinions and that the authors of the report were not disinterested because they held short positions in the company. Perhaps due to precedents of that nature, lawsuits against short sellers have been considered rare, given free speech protections and companies’ hesitancy to submit themselves to the distraction and exercise of regulatory review.
But there has been movement by the SEC to crack down on these exploits. On September 12, 2018, the SEC filed a complaint alleging that George Lemelson and Lemelson Capital Management LLC issued false information about a company after Lemelson took a short position in the company on behalf of Amova Fund, a hedge fund he advised and partly owned. According to the SEC, as a result of Lemelson’s short and distort scheme, and through disseminating reports, conducting interviews, and using social media platforms, the company lost more than one third of its value. The case survived a motion to dismiss in 2019. If the SEC is successful, this case is thought to pose a significant deterrent to would-be market manipulators.
According to DLA Piper, by its actions, the SEC also further opens the door for defrauded companies and investors who have been, or may be, targeted by short and distort schemes to pursue civil litigation to recover their damages. The SEC’s involvement could help companies overcome prior difficulties in identifying the real person behind an online alias or obscure entity. Companies and private investors may also be more willing to pursue such actions if they feel that the SEC or other regulators will back them up by taking bad actors to task in separate civil or criminal proceedings.
In the next part of this two-part series, we will address how companies have successfully deterred or strategically mitigated the fallout from short and distort campaigns.
Jennifer DeTrani is General Counsel and EVP of Nisos, a technology-enabled cybersecurity firm. She co-founded a secure messaging platform, Wickr, where she served as General Counsel for five years. You can connect with Jennifer on Wickr (dtrain), LinkedIn or by email at dtrain@nisos.com.