Tipping the Market : Stock Hoax: Now a Game of Amateurs
Officials of Manufacturers National Bank were a little curious one summer day in 1985, when they saw a television news crew interviewing a young man outside their Detroit headquarters. Curiosity turned to chagrin when they learned that the WKBD-TV reporter was talking to 18-year-old Mark D. Anderson about his just-announced plan to take over the bank’s holding company, the third-largest in the state with about $6 billion in assets.
For five days, as the bank officials tried to learn more about the young would-be raider, the bank’s stock edged higher and trading in it churned along at three times the usual volume. By the sixth day, the Securities and Exchange Commission had decided the takeover offer was bogus, and it got a court injunction to halt the bid.
Second ‘Offer’ Hinted
The story does not end there. Two weeks later, Manufacturers National got a call from a man who identified himself as an executive of “Middle East Associates.” The man said he wanted to talk about buying the company.
Michael Maurer, a bank vice president, advised him of the stiff penalties for false takeover offers and the caller hung up, never to resurface. Yet, Maurer said, “it makes you wonder how many people out there are thinking about something like that.”
It seems a lot of people have thought about trying to manipulate the price of some stock by making a phony announcement. In the last three years there have been three major hoaxes, and unsuccessful attempts to manipulate stocks via bogus reports occur every few months.
The most recent major case took place last July 28, when a manipulator ignited the price of General Cinema Corp. shares by mailing the SEC a phony document indicating that a fictitious London investor had been accumulating the stock.
A Costly Vulnerability
These incidents, which can inflict millions of dollars in losses on investors, demonstrate the vulnerability of even the most heavily traded stocks. Indeed, while classic stock manipulations are the elaborate schemes of market insiders, these cases show how even an amateur can unhinge the market in a matter of minutes.
Such episodes also underscore the broader problem that market regulators face because of the daily traffic in bogus reports and rumors, which some experts say has become more widespread as the continuing boom in mergers has stimulated speculation in take-over-related stocks.
The stock market is particularly vulnerable to false reports about real or potential corporate takeovers.
“Even two or three years ago, the market wasn’t this sensitive to news about changes of corporate control,” Lawrence Iason, the SEC’s regional administrator in New York, said. Increased takeover speculation in stocks has brought increased volatility to the market, he said, and “more vulnerability to phony information.”
The market’s explosive reaction even to fabricated takeover announcements is in part a result of the habits of takeover-stock speculators, whose trading on some days accounts for one-sixth of the market volume. They search for any sign that a stock is caught up in the takeover whirl, often relying on special information services that tell them instantaneously of regulatory disclosures, takeover rumors, even of trips taken and conversations held between corporate executives who might be involved in deals.
When they smell a takeover, the speculators jump to buy--often without verifying the report. Spending time to check out rumors may mean losing profits as the stock price rises, they figure.
“A lot of people just want to get ahead of the curve, and sometimes that means acting on the flimsiest sort of talk,” said Peter J. Romatowski, a securities lawyer in Washington and former federal prosecutor.
The market’s vulnerability was evident in the Manufacturers National episode. The holding company’s stock was trading at $64 a share the day before Anderson announced, in a 2-inch-square newspaper ad, that he wanted to buy 70% of the company’s stock at $66 a share.
For several days, it was difficult to find out anything about Anderson or Eastern Exchange Group, which he named as his company. Even with the absence of hard information, the stock had risen 14%, to $72.75 a share, within a week of the advertisement. The run-up increased the total value of the company’s stock by more than $200 million.
The stock stayed far above its usual trading price long after many who were close to the drama had grown skeptical of Anderson’s offer. That suggests that many of the buyers--many who got burned by the hoax--were small investors far from the flow of market news.
Despite news reports that the offer was real, bank officials had their suspicions from the start. Before his ad appeared, Anderson called the company’s chief financial officer to ask, among other things, whether the bank would be interested in helping to finance its own takeover.
The bankers could not find much to suggest that there was money behind Eastern Exchange or Valdosta Ltd., a firm Anderson said was associated with him in the deal. “The joke around here was that Valdosta was the planet these people were from,” Maurer recalled.
When the facts were assembled, Anderson turned out to be a young man with a great interest in high finance and assets of less than $10,000. “He seemed to just want to make the stock take off, and it did,” said one observer who was knowledgeable about the investigation.
‘Offer’ Talk Cut Off
The SEC did not prosecute Anderson, but it got him to sign an agreement barring him from further public discussion of the offer.
The Manufacturers National case could hardly be more different from a classic stock manipulation.
Such cases usually involve shadowy operators who try to lure investors into buying the stock of a small company by creating an appearance of heavy demand for it. Often, the manipulator will buy the rights to a defunct company, give it a high-tech name for added investor appeal, and begin phony buying and selling through accounts across the country to give an impression of widespread demand.
Such phony trading is often timed for the beginning or end of a day, to generate trading activity that investors are most likely to notice. Once enough outsiders have bought the stock to lift its value by several dollars a share, the manipulators often sell their holdings--leaving the stock to collapse.
One of the most sophisticated manipulations came to light with the prosecution of Edward Gilbert, a New Yorker convicted in 1980 of tampering with the stock of a legitimate company, Conrac Corp. Using phony sales between some 90 accounts in this country and overseas, Gilbert stoked trading volume to 40,000 shares a day from a previous 10,000 shares daily, securities lawyer Romatowski said.
Trading Looked Real
Part of Gilbert’s secret was his knack for coordinating the phony trading so it would appear legitimate to investors who followed the stock market tape, Romatowski said.
But while Gilbert’s scheme gestated over months, the counterfeit report that jolted General Cinema’s stock was effective in minutes.
That report said a London investor named Kile Johnasen had purchased 6.1% of the stock of General Cinema, a theater, bottling and retailing company based in Chestnut Hill, Mass. The document, known as a Schedule 13D, was mailed to the SEC’s document room in a plain envelope with a New Jersey postmark.
Such disclosures often come before a takeover offer. As word of the filing reached investors, General Cinema jumped to $23.25 a share from $20.875. After General Cinema officials challenged the authenticity of the filing, the stock fell back abruptly and closed at $21.75.
An investigation found there was no Kile Johnasen and that the London address given was also non-existent.
Notice Raised Suspicion
General Cinema officials were immediately suspicious, in part because, several months earlier, they had received a letter from a Texas insurance company notifying them that the insurer had acquired a large block of General Cinema stock. When they checked, they discovered that the letter was a phony one written on the insurance company’s stationery.
While questions about that filing quickly brought the stock price back to earth, the episode again demonstrates the heedless haste of investors.
If investors had done a bit more checking, they might not have bought the stock at all, since a takeover of General Cinema could not be consummated without gaining control of its Class B shares, nearly all of which are held by the family of the chairman, Richard Smith.
The SEC would not comment on the progress of the General Cinema case, but one person familiar with the investigation said that, six weeks after the hoax, authorities are not close to bringing charges.
Indeed, although the perpetrators of some hoaxes have been immediately known, in other cases it may be very tough to identify who is responsible, SEC officials said.
Culprits Hard to Spot
Today’s sophisticated market-surveillance equipment can lead authorities to stock-trading accounts in which suspicious buying and selling activity took place before and after a fake announcement was made, but there may be many accounts that bought the stock before the fake report and dumped it afterward. It is hard to build a chain of circumstantial evidence leading to the culprits, “particularly if they have been trading through some overseas entity,” William McLucas, an associate director of the SEC, said.
Bogus takeover news has also seeped into the markets through the financial news services that try to report information to the markets as soon as it happens.
In June, 1987, an adviser to a small investment firm in Ohio made a phony offer of $6.8 billion for retailer Dayton Hudson Corp. that forced the New York Stock Exchange briefly to halt trading in Dayton Hudson stock.
P. David Herrlinger, a mild-mannered Cincinnati resident who is fond of gardening, called the Dow Jones News Service and announced that a family-controlled investment firm he represented was offering $70 a share for Dayton Hudson stock.
In initial checks made by the news service, Herrlinger’s story seemed to hold together. The 47-year-old Herrlinger sounded knowledgeable in discussing the intentions of the firm, which he said represented the wealthy Stone family of Cincinnati. Herrlinger lived in a good part of town and was, in fact, a member of the Stone family.
When Dayton Hudson notified the stock exchange that it knew nothing of the offer, the Big Board temporarily halted trading in the company’s shares. But the stock had climbed from an opening price of $54 to as high as $60 a share before retreating to a daily closing price of $53.12.
Anthony Covatta, Herrlinger’s attorney, says that his client was suffering from mental illness, for which he was hospitalized for a month. Fired the day of the hoax, Herrlinger was selling cars in Cincinnati until he quit that position recently.
“This man’s more like Clark Kent than Asher Edelman,” Covatta said, referring to the New York corporate raider.
Herrlinger still faces an SEC lawsuit. The agency alleged in court papers that he intended to deceive, and it has frozen $6,300 that he made trading stock options on the hoax. Also pending are three suits filed by investors who want to recover about $20,000 they say they lost when the stock declined.
Everett Groseclose, managing editor of the Dow Jones wire service, says that each year there are two or three attempts to move the market through use of bogus information. “They range from the very sophisticated to some clown calling from a phone booth in a subway,” he said.
Rumors of Losse
The bogus information sometimes concerns company earnings rather than takeover news. When toy manufacturer Mattel Inc. was losing money in 1983, a man called the Wall Street Journal (owned by Dow Jones & Co.), identified himself as a Mattel employee and said he wanted to report quarterly earnings to the Dow Jones News Service.
His figures suggested that Mattel’s losses were deeper than expected, but when John Andrew, a Journal reporter, made a routine call to Mattel to confirm the figures, he discovered the company had put out no such release.
Before long, the mysterious caller phoned again to find out why his press release had not appeared on the wire. “The guy seemed to be getting pretty angry,” Andrew recalled.
Journal staff members tried to keep the caller on the line long enough to trace the call, but he hung up and disappeared. The staffers assumed the man was trying to “short” Mattel stock--that is, pursue a trading strategy that would turn him a profit if Mattel stock fell.
Those who have tried to dupe the markets with fake takeover information include Dennis B. Levine, the one-time investment banker who was a central figure in the Wall Street insider-trading scandal.
Tips to Newspapers
On at least one occasion, Levine anonymously sent a copy of a secret takeover document to several newspapers, hoping to create the mistaken impression that a deal had been completed and thus drive up the price of a stock he held, said Charles M. Carberry, who formerly headed the Manhattan federal prosecutor’s insider trading investigation.
When the takeover was not announced as soon as he wanted, “he thought he’d give the stock a push,” said Carberry, now a securities lawyer in Manhattan. SEC officials would not elaborate on the episode, presumably because it is related to the current investigation of Wall Street corruption.
Market authorities say the bogus announcement is one of several forms false reports or rumors take as they wash daily across the markets. The problem is as old as the markets themselves and has been a major legal issue since 1814, when nine Englishmen were convicted of conspiring to influence the markets with rumors of Napoleon’s death.
Many knowledgeable observers believe that heightened takeover speculation has created a new class of traders whose entire focus is trading on rumors and, occasionally, fabricating them themselves. “It’s really become sort of a cottage industry,” said Robert M. Romano, a securities lawyer in Manhattan.
The rumor-mongers use a variety of means to ensure that their talk moves the markets. They direct it to the investors who are regularly followed by the rest of the market--a trader on a major firm’s trading desk, for example, a certain securities analyst or a portfolio manager who controls billions in investments.
Targets of ‘Leaks’
Or they may “leak” a rumor to publications regularly read by market participants. Barron’s, the weekly stock market magazine, several times has been accused by companies of writing stories based on rumors from “short sellers"--traders who stand to profit if a stock’s price drops. A year ago, after a negative article in Barron’s, officials of Home Shopping Network asked the SEC to investigate rumors about a management reorganization, its sales and inventory levels.
Some companies, including the investment firm Merrill Lynch & Co., have publicly complained of persistent false rumors that they are takeover targets.
From the standpoint of market authorities and the target companies, a vexing aspect of this problem is that these traders are willing to buy when the rumor starts and sell soon thereafter, to make just a small profit.
“These guys just need the stock to go up an eighth of a point or two,” Romano said, “so whether the rumor is true doesn’t matter.”
Of course, if some bogus takeover announcement trips the market’s fuse, he adds, “they think that’s just fine.”