Regulating short-term trading, social media, tweets and legal action

I am a firm believer in the market economy but one with desirable and effective regulation. While the market economy I speak of provides abundant freedom to think, create, conceptualise, invent, innovate and execute, it is also not one which enables the freedom of the wild entrepreneur or market participant, who abuses the consumer, the investor, the market or rules or regulations.

Background

The market economy and regulation, the open economy and privatisation are themes under which I have written extensively, made presentations on, participated in interactive sessions in public and private fora, moderated discussions, and endeavoured to share thoughts in print media, in my column ‘The Thought Leadership Forum’ launched in 2005 and incorporated with the Registrar of Companies, in 2008.

Beyond enabling statutes

Having served as a regulator on the Accounting and Auditing Standards Monitoring Board; as one of the three members of the first Consumer Affairs Council the apex body of the Consumer Affairs Authority; as a Commissioner of the SEC for several years, in an ex officio capacity as well as, as the subject Minister’s appointee, concluding with my appointment to the office of Chairman SEC Sri Lanka, there is a guiding philosophy I adopt. That is that regulation must be aware, up to date, relevant and fair, just and equitable and of course timely.

Under reaction, overreaction, delayed intervention

Under reaction, delayed intervention, as well as overreaction followed by withdrawal of circulars takes away from the respect and credibility, essential for effective regulation.

It is against the background described in the preceding paragraphs, that I find the March 2021 case where the SEC – USA announced fraud charges and an asset freeze and other emergency relief against an Irvine, California-based trader who used social media to spread false information, noteworthy.

Learning from the lessons of the US-SEC

During my brief 18-month term of office as Chairman, I had the opportunity to attend a two-week session at the headquarters of the SEC USA in Washington DC, where representatives of almost all members of IOSCO (the apex organisation of securities commissions worldwide) were present. 

We had healthy insight into the variety of approaches adopted by the US and many other jurisdictions. I must say I felt reassured that we were a reasonably good regulator but could well progress further if we had an open mind, and were passionate and committed to capital market development, side by side with regulation.

Investor education and advocacy

While enjoying the beautiful cherry blossoms in full bloom, during my short walk between the high security, imposing SEC headquarters building and the Hilton Hotel, each morning and evening, many creative initiatives developed in my mind, for implementation when I got back home. One among them, was what the US terms ‘Investor Education and Advocacy’.

Might I add in lighter vein that I was unable to return home in time for the Sinhala and Tamil New Year, and with last year’s COVID-19 induced New Year, and thus two consecutive incomplete New Years, I hope April 2021 will usher in a much better time for us.

External relations

Immediately on my return, I proposed that we rename the External Relations Division, headed by Director Tushara Jayaratne, as the SECSL’s ‘Office of Investor Education and Advocacy,’ on lines similar to the US SEC. Tushara and his Manager Sheena Gooneratne were eager to improve their divisions responsiveness and we performed a comparative analysis of several similar units, in multiple jurisdictions, the title given to the divisions, its terms of reference, etc.

Capital market education and training

Another division, the Capital Market Education and Training Division, was to be merged with the External Relations Division, given also that managers and assistant directors in the latter – experienced, good, seasoned men and women, were not necessarily ‘up to their necks’ with work as it were.

Organisational restructuring and repositioning

The idea of restructuring two divisions and repositioning them as one division to combine investor education, advocacy, training and capacity building within capital market participants, was to achieve what I termed

• A necessary, wholesome, enjoyable, educational task
• A strategy to minimise and mitigate risks of less than aware, less than experienced (for example retail, short-term) investors who today, will invest, inter alia, based on a variety of less than credible sources including social media which may be through innocent “forwards” as well as schemes with the intention, to defraud and mislead.

Guidance bulletins

An ‘investor education and advocacy bulletin’ of the US SEC as recently as January 2021 states that “Retail investors may seek to profit from volatile markets by buying individual stock, including stock in heavily-promoted companies with smaller market capitalisations. Some of these stocks may be discussed in social media, news aggregators, investment research websites, online investment newsletters, ratings websites, message boards, chat rooms, and discussion forums. It can be tempting to jump on the bandwagon and follow whatever the crowd seems to be doing. Sometimes, however, following the crowd may lead to significant investment losses.” 

Short-term and margin trading, options et al

The bulletin further states that “Short-term trading, including trading aided by the use of margin or options, can lead to significant and unanticipated losses for retail investors.” It says “Investors should keep in mind these behaviours when considering investing in a volatile market including:

•  Investing in bubbles or manias – Financial ‘manias’ or a ‘bubble’ is the rapid rise in the price of an investment, reflecting a high degree of collective enthusiasm or exuberance regarding the investment’s prospects. This rapid rise is usually followed by a contraction in the investment’s price. The contraction, or ‘panic’ occurs when there is wide-scale selling of the investment that causes a sharp decline in the investment’s price.
• Momentum investing – Another investing strategy that can pose high risks for retail investors is ‘momentum investing’. An investor using a momentum investing strategy seeks to capitalise on the continuance of existing trends in the market. A momentum investor believes that large increases in the price of an investment will be followed by additional gains and vice versa for declining values. If that belief turns out to be incorrect, it can lead to significant losses.
• Noise trading. A third related strategy is ‘noise trading’. Noise trading occurs when an investor makes a decision to buy or sell an investment without the use of fundamental data (that is, economic, financial, and other qualitative or quantitative data that can affect the value of the investment). Noise traders generally have poor timing, follow trends, and overreact to good and bad news in the market.”

Short sales, volatility, pumps and dumps

“Guidance is given on margin trading, options, short sales, rules designed to address market volatility in stocks with ‘Limit up-Limit Down’ caution regarding fraudsters using online platforms to spread false or misleading information to manipulate a company’s stock price, pump and dump schemes, the need to consider time horizons for investing, etc.”

Within the context of all of the above, I thought the following media release of the SEC USA, dated 15 March is of immediate practical relevance to us in Sri Lanka. For the benefit of all market participants, the SEC SL and the CSE, I thought I will reproduce it, in its entirety:

SEC charges California trader with posting false stock tweets

(Washington D.C., 15 March 2021)

“The Securities and Exchange Commission today announced fraud charges and an asset freeze and other emergency relief against an Irvine, California-based trader who used social media to spread false information about a defunct company, while secretly profiting by selling his own holdings of the company’s stock.

“According to the SEC’s complaint, which was filed under seal in federal court in the Central District of California on March 2, 2021 and unsealed today, Andrew L. Fassari used the Twitter handle @OCMillionaire to tweet false statements about Arcis Resources Corporation (ARCS), a defunct Nevada company with publicly traded securities, during December 2020. Specifically, the complaint alleges that, on Dec. 9, 2020, Fassari began purchasing over 41 million shares of ARCS stock shortly before tweeting false information about ARCS to his thousands of Twitter followers, including falsely claiming that ARCS was reviving its operations, expanding its business, and being backed by “huge” investors.

“The complaint further alleges that, between Dec. 9 and 21, 2020, Fassari made approximately 120 tweets that referenced “$ARCS,” dozens of which were false and misleading. For example, he tweeted, “$ARCS 380,000 indoor cultivation 1 Million+ sq ft processing. WEEEEEEEEE This CEO has big plans for us” and “a ton of news coming and backed by huge investors for its #cannabis operation[.]” In seeking an injunction, the SEC alleges that Fassari continued to tweet about other stocks as recently as January and February 2021.

“The complaint further alleges that, over the next several days, ARCS’s share price skyrocketed, ultimately increasing over 4,000%. The complaint also alleges that Fassari made false statements about his own trading in ARCS. Between Dec. 10 and 16, 2020, Fassari allegedly sold all his shares in ARCS for profits of over $929,000, all while continuing to publish false and misleading information about ARCS and his trading in ARCS.

“We allege that Fassari profited by using social media to deceive investors,” said Melissa R. Hodgman, Acting Director of the SEC’s Division of Enforcement. “The SEC is committed to protecting investors by proactively monitoring suspicious trading activity tied to social media, and by charging those who use social media to violate the federal securities laws.

“The SEC’s complaint charges Fassari with violating the antifraud provisions of the federal securities laws, and seeks a permanent injunction, disgorgement, prejudgment interest, and a civil penalty from Fassari. In addition, on March 2, 2021, the SEC issued an order temporarily suspending trading in the securities of ARCS.

“The SEC’s investigation, which is ongoing, is being conducted by John Dwyer, Leslie Hughes, Jeb Wildschut, and Kerry Matticks, with the assistance of Stephen Glascoe and Jessica Regan in the Office of Investigative and Market Analytics, and is supervised by Danielle R. Voorhees, Jason J. Burt, and Kurt L. Gottschall. The SEC’s litigation will be led by Ms. Hughes, under the supervision of Gregory A. Kasper. The SEC appreciates the assistance of the Financial Industry Regulatory Authority.”