The Whisper Factory in Action

Source: Emergence Marketing 917-520-2836: NYSE 2005 Cases of Note: Bill Singer, securities lawyer and author of the sadly neglected Broke and Broker Web log, is always a great source for blow-by-blow accounts of life in the business. Here, he takes up a violation of

NYSE Discilplinary [sic] Rule 435(5): Circulation of rumors

(5) [Members are forbidden to c]irculate in any manner rumors of a sensational character which might reasonably be expected to affect market conditions on the Exchange. Discussion of unsubstantiated information published by a widely circulated public media is not prohibited when its source and unsubstantiated nature are also disclosed.

Report shall be promptly made to the Exchange of any circumstance which gives reason to believe that any rumor or unsubstantiated information might have been originated or circulated for the purpose of influencing prices in listed securities.

In this case, a medical devices analyst huddled with a bunch of other analysts outside a press conference at which results of clincial trials were being previewed to the business press, under an embargo on publication until the official release time of the announcement — a common practice.

The analyst “heard rumors” in the halls after the press conference that the results compared favorably with the performance of a competitor’s product, then received a call from a journalist confirming that general evaluation, but not the specific number.

So the fellow fired off a “research alert,” got more feedback from the “rumor mill” by e-mail, then got on the squawk box to advise in-house traders of an impending up-side surprise, after conferring with the firm compliance officer.

You would think that these are exactly the kind of loopholes Regulation FD was designed to close, but Bill finds more fault with the implementing rule than with the analyst — who was suspended for two months and fined $50,000, and later fired.

I just don’t know with this case. First off, I absolutely abhor such rubbery rules — I mean, come on, what the hell is the difference between a “rumor” and a rumor “of a sensational character”? Worse, you have to contrast the prohibition against “sensational” rumors with the obligation to disclose “any” rumor or unsubstantiated information that you think was originated or circulated to influence prices. Frankly, this just strikes me as a terribly drafted rule that relies upon far too many opinions and circumstances to be of much use.

Moreover, the problem here wasn’t simply with Lemaitre — I think a strong case could be made that he was doing his job as an analyst . . . putting together bits and pieces of information and drawing inferences. In my opinion XYZ handled the disclosure in a manner calculated to cause problems. Perhaps the NYSE needs to better examine the realities of these disclosures.

Is it sensible to have press-only disclosures that require a good-faith embargo by third parties for hours? Should third-parties even be permitted on premises during the press conference and prior to the public release?

Are analysts supposed to be warned against inferring anything from the smiling faces of company execs who have just departed a press conference? If a reporter calls an analysts and essentially asks what he or she thinks about the positive comments that were purportedly just made at a press-only conference, is that the analysts fault”

Ultimately this is flawed rulemaking and questionable enforcement. My professional experience has taught me that regulators need to speed up the public disclosure of virtually all announcements and comments, and that efforts to buffer or delay the “public” release create a devil’s playground. To a large degree, Lemaitre seems to have done his job. [Would] that NYSE and the issuer community were as diligent!

It certainly does. And it doesn’t help that the rule is filed under “Miscellaneous Prohibitions,” either.

The argument for the defense here — that it is licit, and even essential, for analysts to seek a competitive edge for their clients by drawing inferences from permitted chunks of data — reminds me strongly of the government’s justification for data mining telephone records, then triangulating that data against other databases to produce new “knowledge” that is greater than the sum of its parts, as it were.

The journalist’s role in this is also troubling — especially since journalists are, in principle, self-regulated (but see If Judy Joined the Business Press) and therefore not subject to sanctions from a presumably neutral abitrator of professional ethics.

But note that this scenario puts journalists in a double-bind as well.

Firms release news under an embargo in order to provide the lead time needed to get timely coverage. Technically speaking, however, reporters cannot solicit comment or analysis until the hard facts are officially out, which means they must use some ingenuity if they want to avoid running an uncritical summary of the press release.

As Kevin Mitnick said at a dinner I went to where he spoke last year, it’s a fact about bureaucratic environments that “social engineers” — hackers who talk their way into information and access — rely on: When the rules are stupid and vague and pressure is on a group of people to produce results — and often, in a newsroom, to “do more with less” — solidarity with the collective goal of getting done on time for soccer practice or The Simpsons will win out over the technical proprieties every time.

So I tend to agree with Bill: rather than trying to handicap the horse race, let everybody break from the starting line at the sound of the gun. Good reporters and analysts will have gamed the likely scenarios in advance and lined up their ducks accordingly.

Interestingly, NYSE’s approach seems very similar to the kind of safe harbor finding on IPO disclosures and public communications that Reuters America managing editor Wong was lobbying the SEC for last year.


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