Market Rumors: Inevitable

Andrew Ross Sorkin today tackles the issue of market rumors. He's with Jamie Dimon, and doesn't like them:

As Schulte Roth said in its note to clients, which include SAC Capital Management and Jana Partners, two big hedge funds, "spreading false rumors in order to induce others to trade in a company's securities constitutes market manipulation."
James Dimon, the chairman of JPMorgan, says rumor-mongering is unconscionable. "I think if someone knowingly starts a rumor or passes on a rumor, they should go to jail," he said on Charlie Rose's program on Monday night. "This is even worse than insider trading. This is deliberate and malicious destruction of value and people's lives."...
There's no way to quantify whether rumors are more rampant today than they used to be or whether they are just traveling faster. But what is clear is that there seems to be little being done about it. It might be difficult to make a case, but you'd think you'd see subpoenas flying at least as fast as the rumor mill.

The problem is that Dimon and Sorkin have a very specific behavior in mind here: speculators who are short a stock and who knowingly propagate a baseless yet potentially self-fulfilling rumor that the company in question is in trouble. Yes, that's illegal. But it's not what Ivan Boesky did (he was more in the business of trading on true insider information, which is an entirely different kettle of fish) - and Boesky's the only wrongdoer name in Sorkin's column.

It's very hard to prosecute this kind of thing. Why? For one thing, simply propagating a rumor is not, contra Dimon, illegal. In order to be breaking the law, you not only need to propagate the rumor and be short, but you also need to know that the rumor is false. Dimon's "deliberate and malicious" formulation is not so much a description of illegal rumor-mongering as a precondition for it.

If you're selling Lehman stock because you heard the company might get taken over at $15 a share, that's legal. If you told someone else what you were doing, that's legal too. It's only illegal if you know for a fact that the rumor is false, and you spread it anyway. And the only way to know that for a fact is if you made it up yourself and deliberately started disseminating it in an attempt to drive the price down.

In other words, of the thousands of people through whom the Lehman rumor passed, only one or two could conceivably have been guilty of anything illegal. And rumors are like tornadoes: while it's possible to try to trace back a chain of causality, they do have a habit of simply appearing out of nowhere when the preconditions are right. Here's Sorkin again:

Amid the desperation of a bear market -- and the pervasion of technology that allows traders to communicate virtually untraceably -- the art of the rumor has become increasingly powerful, even democratized. Absurd rumors can have legs, like the Lehman-Barclays one, which Richard Bove, an analyst at Ladenburg Thalmann, said "ranks up there with the moon is made out of green cheese in terms of its validity."

This is entirely correct, to the point at which it actually explains why we're not seeing those subpoenas flying. All the preconditions for crazy rumors are in place: the desperation of a bear market, the pervasion of technology, an important precedent in Bear Stearns. Given all those preconditions, rumors are inevitable, and no stern words from Schulte Roth or Jamie Dimon can stop them. Regulators should spend more time thinking about what to do when rumors start, rather than embarking upon a quixotic quest to prevent them from happening in the first place.

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