Cohodes: Pump-And-Dump Stock Trading Needs New Rules For The Digital Age

Submitted by Marc Cohodes, first published in the FT

The fairness of capital markets is under threat due to the rise of digital media.

We live in an era where some stock promoters and short sellers open large positions prior to publishing market-moving information about a company, and rapidly close those positions after inducing a buying or selling frenzy.

Whipping up hype and hysteria is an easy way to make quick, riskless profit. In my view, it is also wrong. It goes against the spirit of our laws, and it is bad public policy. Whether you own shares or are betting against a company, I believe it is misleading to tell investors that you have a specific view on a company and then profit from a trade in the opposite direction.

A US circuit court said as much as part of the 1979 case of Zweig v Hearst Corp, which found that a newspaper columnist touting a stock could be sued for securities fraud for failing to disclose he owned the security and “his intent to sell when the market price rose”.

More recently, in the 2018 case of Lidingo Holdings, a writer was charged civilly with fraud for selling “stock at a profit soon after his article was published, which was contrary to the advice he gave in his articles advocating holding for the long-term”. This year he consented to a judgment without admitting or denying the allegations.

The two legal cases deal with people accused of trying to push prices up through publicity and then selling. US regulators should extend the rule, and make clear that it is equally unacceptable to encourage the sale of a security while planning to purchase shares to cover a short position soon afterwards.

Existing US law also fails to address fundamental changes to the media environment that are giving rise to new forms of market manipulation. Many bloggers and social media personalities who promote or attack stocks do not conduct a deep investigation of the companies involved. Instead, they republish theses acquired elsewhere and buy and sell quickly to make a fast buck. If you truly believe that a stock price is off — either because the company is a hidden gem or a fraudulent trash heap — he or she should be willing to hold open a position consistent with the advice he or she is giving to other investors.

It is time for Congress to enact a ten-day minimum holding period that would apply to any stock promoter or short seller who opens a large position and disseminates market-moving information, whether by publishing a report, going on media outlets such as CNBC, Fox or Bloomberg, speaking at conferences or posting on social media.

The idea is simple: if both longs and shorts are required to hold open a position they have advocated for 10 days, the market is given an opportunity to evaluate the quality and credibility of the information. If the promoter is worried that the price might crash back to earth within 10 days, they should not be touting the stock to begin with.

Similarly, if a short seller is concerned that the price might rebound in that window, investors are better off not selling in the first place. I recognise that a 10-day holding period is relatively brief, but short sellers already face expensive borrowing costs to hold open a position. A longer holding period might very well be cost prohibitive.

This is a modest rule which protects investors from predatory hedge funds seeking to exploit hype or hysteria about a public company. This is a fair and even-handed approach that avoids tipping the scales in favour of public companies or their critics. This is a simple way to protect the integrity of our capital markets, and it is one that the entire investment community — both long and short — can get behind.