In Wake of Emulex Hoax, Blame Game Begins

Live by the quick trigger, die by the quick trigger.

Investors burned by last week’s Emulex hoax are blaming financial-news organizations for rushing out headlines based on a bogus news release. In fact, the lawsuits already have started flying.

Others complain that the Nasdaq Stock Market halted trading in Emulex too slowly, or too quickly, or perhaps shouldn’t have halted trading at all.

Then there are those who found that steps they’d taken to protect their investments actually backfired in the chaos brought on by the hoax. These investors are left wondering whether such time-honored tools as “stop-loss” orders can function properly in a fast-moving market.

With instant information at every fingertip and with online trading a growing influence on U.S. markets--especially in shares of technology highfliers like Emulex--split-second judgments by newspeople, regulators and investors carry ever greater consequences, experts say.

One specialist in market psychology thinks the Aug. 25 debacle shows that everyone needs to be more skeptical of every piece of information, regardless of how reputable its source.

“People jumped from the 20th floor, but there wasn’t a fire,” said Meir Statman, a finance professor at Santa Clara University.

The Emulex hoax, which resulted in the arrest Thursday of 23-year-old stock trader Mark Simeon Jakob, caused shares of the Costa Mesa-based firm to plunge 62% in 16 minutes before Nasdaq halted trading.

During the halt, word got out that the alarming news release--supposedly announcing an earnings restatement, an SEC investigation and the resignation of Emulex’s chief executive--was phony. When trading resumed that afternoon, the shares bounced almost all the way back, but many who sold during the plunge lost money.

Authorities accuse Jakob, an El Segundo resident and student at El Camino Community College, of plotting to drive down Emulex shares so he could recover from a disastrous wrong-way bet on the stock and then profit from the inevitable rebound. Investigators say he made $241,000 on a series of trades.

Jakob allegedly exploited some holes in the market’s shield against false information, authorities say: As a former employee of corporate-news distributor Internet Wire, he knew how to trick employees there into thinking his news release was genuine and had been approved by Internet Wire higher-ups. And, based on the timing of the release--9:30 a.m. Eastern time, but only 6:30 a.m. Pacific--authorities believe Jakob shrewdly reckoned that news services would have trouble reaching Emulex officials for confirmation but might run stories or headlines anyway.

Just as Jakob allegedly hoped, Bloomberg News, Dow Jones, CNBC and other outlets all carried items--either headlines, stories or brief mentions--based on the phony news release. The stock already had begun sliding after Internet message boards had spotted and repeated the news release.

At Bloomberg, Editor in Chief Matthew Winkler said Friday the problem in this case wasn’t a lack of appropriate guidelines for newsroom personnel but a failure to follow them.

Like Dow Jones and other news organizations, Bloomberg has policies requiring information to be confirmed for accuracy before publication.

“We spend a lot of time explaining our rules and requirements--the biggest one being, ‘Never assume,’ ” Winkler said.

“Our value is our critical judgment and ability to think under pressure. ‘How do we know this is true?’ ‘Does this make sense?’ Those are questions we should always ask,” he said.

A lawsuit was filed Friday by a Florida investor against Bloomberg and Internet Wire, accusing them of “recklessly disseminating materially false and misleading information concerning Emulex.” Neither defendant would comment on the suit.

On Internet message boards, some traders have turned their ire at Nasdaq for the way it suspended trading.

The halt came after the stock had crashed to $43 a share from $113.06 the day before. When the suspension was lifted after the hoax was exposed, the first trade was at $120 a share. Some investors complain that without a halt, they might have been able to buy back shares on the way up, thus cutting their losses.

“Consenting adults ought to be allowed to trade with or without accurate information,” said Junius Peake, finance professor at the University of Northern Colorado and a longtime foe of mandated trading halts.

Nasdaq officials, however, say that there are times when allowing trading to continue can be unfair to investors.

“Any time there is information disequilibrium out there, you’ve got to try to put everyone back on an equal footing,” a senior Nasdaq official, who asked not to be identified, said in a telephone interview Friday. Trading halts also make sense when an event such as a corporate takeover is driving a stock skyward but has yet to be announced, the official said.

Some investors are complaining on Internet message boards that the use of stop-loss orders--which are orders to sell a stock if it falls below a specified price--hurt them because the orders were triggered automatically during the Emulex plunge. In some cases, the market was moving too fast for the orders to be executed at the specified price, so the actual sale price was lower.

Experts said the fault isn’t with stop-loss orders per se. Just as with the “portfolio insurance” that failed during the crash of 1987, there is no insurance program that can get an investor out instantly during a bout of panic selling, and there certainly is no system to prevent an investor from missing out on the bounce back after the stock has been sold.

While investors are assessing blame, they also should look to themselves, Santa Clara’s Statman said.

“People forget that this entire trading game is an adversary game,” he said. “You are not playing against ‘the market’ but against other traders. You should be very careful about assuming that your information is better than [that of] the person on the other side.”