A bear raid is a form of stock price manipulation in which a false and nasty rumor is circulated and stock speculators capitalize on their rumor by shorting the stock and perhaps the debt securities of the target. It was popular a century ago and would appear to have reemerged as a trading strategy today.

Key to the success of a bear raid are the plausibility of the rumor, and the existence of ample time before an effective response by the target. Banking rumors are particularly powerful today, given the skittishness of the market, the numerous surprise writedowns, and the sluggishness and ineptitude of the responses by targets. Some of the stocks of big banks have looked a lot like they have been the subject of bear raids recently. The Barclays story stands for many similar tales, around the world and in the US as well. Reuters:

British bank Barclays Plc categorically denied rumors it was about to announce a $10 billion write-down and see its top management quit, after such market talk sent its shares tumbling over 9 percent. “There is absolutely no substance to those rumors,” a spokesman for Britain’s third biggest bank said when asked about a possible $10 billion write-down. The denial failed to fully dispel fears that Barclays has a sizeable exposure to deepening credit market turmoil, which was sparked by a U.S. subprime housing crisis and has seen many of Wall Street’s biggest banks write down billions of dollars.

The Barclays spokesman also said there was “absolutely no substance” to talk the bank planned an emergency rights issue or that John Varley, its chief executive, or Bob Diamond, head of its Barclays Capital investment bank unit, planned to resign. He declined to comment on talk that the bank may issue an emergency statement, but reiterated it planned to issue a trading update on Nov 27.

By 1615 GMT, Barclays shares had pared losses but were still down 2.9 percent at 472 pence. The shares had earlier crashed to 442p, their lowest level since July 2004, as talk swirled that it faces big credit market related losses. The London Stock Exchange temporarily suspended trade in Barclays shares, which is automatic after a big move in a stock.

Losses accelerated after Wachovia, the fourth-largest U.S. bank, said it had incurred about $1.1 billion of further losses in October from credit market turmoil. It followed warnings of even bigger writedowns at U.S. banks Citigroup, Merrill Lynch and Morgan Stanley.

In 1938 the SEC took steps to stop bear raids. One of the measures was the “uptick rule,” which said that you could only short a stock following an uptick in its price. It just so happens that the SEC eliminated the uptick rule in June of this year, as stock were marching steadily towards an all-time high. Here’s some of what the SEC said in its ruling:

We have carefully considered all the comments we received regarding the proposed amendments. In particular, we note the comments regarding the need for price test restrictions to prevent the use of short selling to drive down the market in “bear raids.” One of the Commission’s stated objectives when it adopted Rule 10a-1 in 1938 was to prevent short sellers from accelerating a declining market by exhausting all remaining bids at one price level, causing successively lower prices to be established by long sellers. In addition, in the Proposing Release, we noted that although short selling serves useful market purposes, such as increasing market liquidity and price efficiency, it also may be used to illegally manipulate stock prices.

Because of the Commission’s stated objective when it adopted Rule 10a-1 and our concerns about the potential use of short sales to manipulate stock prices, OEA examined the Pilot data for any indication that there is an association between extreme price movements and price test restrictions. OEA, however, did not find any such association. We also note that although we are removing current price test restrictions, today’s markets are characterized by high levels of transparency and regulatory surveillance. These characteristics greatly reduce the risk of undetected manipulation and permit regulators to monitor for the types of activities that current price test restrictions are designed to prevent. In addition, we note that the general anti-fraud and anti-manipulation provisions of the federal securities laws continue to prohibit activity designed to improperly influence the price of a security.

Despite the self-congratulatory rhetoric in the SEC’s ruling, there were shortcomings in the agency’s approach. It based its conclusions in part on a pilot program in which no deleterious effects emerged from eliminating the rule. But the pilot program was flawed in at least one respect — there were no periods of unusual volatility and market declines in the pilot program, which is precisely the environment that the market has seen with alarming frequency for the last four months. The SEC noted this shortcoming itself in comments it had received on its ruling:

A “bear raid” involves the active selling of a security short to drive down the security’s price in the hopes of convincing less informed investors of a negative material perception of the security, triggering sell orders. Falling prices could trigger margin calls and possibly forced liquidations of the security, depressing the price further. This unrestricted short selling could exacerbate a declining market in a security by eliminating bids, and causing a further reduction in the price of a security by creating an appearance that the security’s price is falling for fundamental reasons. At the time, many people blamed “bear raids” for the 1929 stock market crash and the market’s prolonged inability to recover from the crash….

The NYSE also noted its concern about unrestricted short selling during periods of unusually rapid and large market declines. This commenter stated that the effects of an unusually rapid and large market decline could not be measured or analyzed during the Pilot because such decline did not occur during the period studied.

We are certainly not expert in this field, but we’ve seen many scams over the course of years, and bear raids are one of the granddaddies of all time. It would not be at all surprising if bear raids were now making a comeback in the current tempting environment, particularly given the methodological flaws in the SEC’s pilot program. Further, the self-congratulatory rhetoric of the SEC on the transparency of markets and the effectiveness of enforcement appears less than compelling in a world full of secretive international hedge funds and incredibly complex financial transactions. It would at least appear appropriate to re-examine the SEC decision based on events now transpiring in the marketplace.

This entry was posted on Saturday, November 10th, 2007 at 12:54 pm and is filed under General, Republicans, business. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.