Corporate & Securities Law

By Jim Hamilton

The hedge fund industry is concerned that a proposed FINRA rule designed to prevent the intentional circulation of rumors for the purpose of manipulating the market will interfere with the beneficial free flow of investment ideas. In a letter to FINRA, the Managed Funds Association said that proposed Rule 2030 would impair the ability of money managers to receive and investigate the validity of market information and have a negative impact on the overall efficiency of the marketplace. The MFA urged FINRA to revise proposed Rule 2030 to focus on compliance with existing anti-manipulation rules and require member firms to adopt policies for handling rumors, bolstered by surveillance.

The proposed rule would prohibit FINRA members from circulating rumors concerning any security if the member knows or has reasonable grounds for believing that the rumor is false or misleading or would improperly influence the market price of such security. The rule would also require a member to promptly report to FINRA any circumstance which reasonably would lead the member to believe that any such rumor might have been circulated.

The MFA believes that a rule focused on the circulation of unsubstantiated information is both overbroad and impractical, especially since the modes of communication have changed and continue to change so dramatically. It would undermine the legitimate search for information. In addition, the MFA is concerned that the arbitrary application of the rule could make seemingly legitimate communications a violation. Moreover, Rule 2030 fails to distinguish between the legitimate circulation of unsubstantiated information and the intentional circulation of false information for the purpose of manipulating the market.

It also lacks clear standards in determining a violation and is ambiguous as to the meaning of reasonable grounds for believing and improperly influence the market price. As drafted, said the MFA, Rule 2030 would capture legitimate and beneficial market activity.

In addition, the MFA is concerned that Rule 2030?s self-reporting requirement, which turns on a reasonable belief that rumors might have been circulated, is also broad and imprecise. The rule would cause FINRA members to over-report rather than risk being second guessed with the benefit of hindsight.

The MFA suggested that a better approach would be for FINRA to require member firms to adopt policies and conduct surveillance and training concerning the circulation of rumors. An effective compliance program addressing rumors could include written guidelines, active training of employees, and continued monitoring of a firm?s communications and trading. The MFA recommended following the example of the UK FSA?s Notice on Rumors, which discusses best practices and common elements, including the definition of a rumor, prohibitions on creating rumors; and trading based on rumors.

Full post as published by Jim Hamilton's World of Securities Regulation on January 07, 2009 (boomark / email).