Published September 25, 2009

Should rumours be regulated?

By R SIVANITHY

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EVERY stock market player would agree that rumours play an important role in daily trading. Yet, most fair-minded players would also agree that rumours which ultimately have a damaging effect on the market or are maliciously and intentionally spread in order to make an unfair profit at the public's expense should not be tolerated. Which then leads to the intriguing question: Should rumours be regulated?

If one accepts that market integrity can be compromised by rumours, then it is incumbent on regulators to develop guidelines for the proper and responsible handling of rumours.

In Australia, the UK and the US, the answer given by regulators is 'yes'. Earlier this month, the Australian Securities & Investments Commission (ASIC) released Consultation Paper 118 titled 'Responsible Handling of Rumours', very much in line with a June 2009 Regulatory Notice 'Origination and circulation of rumours' by the US Financial Industry Regulatory Authority (FINRA) and a November 2008 UK Financial Services Authority (FSA) paper on how to handle rumours.

In a nutshell, the proposed approach by the three overseas regulators is this: if one accepts that market integrity can be compromised by rumours then it is incumbent on regulators to develop guidelines for the proper and responsible handling of rumours.

In order to do this, it is proposed that brokers and other financial service providers (FSPs) have in place written policies and procedures to guide employees on how to deal with rumours.

While brokers are expressly prohibited from originating rumours, they can communicate them internally and externally only if those rumours are already 'widely circulated' and it is reasonable to pass them on. FSPs must also ensure staff receive formal training in their firm's policies and procedures and install internal surveillance to ensure compliance.

Brokers and FSPs will also have to maintain a 'rumour log book' to assist regulators in tracing rumours to their originators. 'A log also provides a useful tool for (brokers and FSPs) to monitor their employees' and representatives compliance with their policies and procedures,' said ASIC.

Before going further, it's best to define clearly what exactly constitutes a rumour. The US's FINRA definition is 'a false or misleading statement or a statement without reasonable basis', while the UK's FSA's is 'information that is circulated purporting to be fact but which has not yet been verified'.

Australia's ASIC has perhaps the most comprehensive definition: 'a statement containing unverified information, purporting to be fact, that a reasonable person would expect to have a material effect on the price of a security if it were widely circulated'.

In effect, the three overseas regulators are looking to make brokers act as the market's screening agents, who will have to sift through the dozens of vague stories floating around every day and who, after performing their own checks, will have to decide which stories are plausible enough to warrant being conveyed to internal and external contacts and which ones are likely to be frivolous and without substance. This way, it is hoped, 'bad' rumours can be weeded out or their impact minimised.

Perhaps not surprisingly, given the costs involved and that brokers thrive on rumours (of all sorts, bad and good), the ASIC's proposals have been widely criticised by the Australian finance industry.

The biggest concern is the stifling of information flow because brokers will be reluctant to pass on rumours for fear of liability later (lawyers, it has been said, would be the main beneficiaries of the proposals).

Other worries are how to decide if a rumour can be reasonably transmitted, the likely large compliance costs involved and, of course, not to put too fine a point on it, the uncomfortable truth that the stock market is actually one big rumour itself.

Yet, you have to admire the fortitude of the regulators who formulated these proposals. As noted at the start of this column - if left unchecked, rumours can undermine confidence and sway markets unfairly. Yet, as everyone would readily acknowledge, some amount of rumour circulation is necessary for all markets to survive. So what regulators in the US, the UK and Australia are trying to achieve is to settle on an acceptable middle ground, difficult though this may be.

None of these countries have yet formalised their proposals - feedback is still being sought and fine-tuning would undoubtedly be needed, so it would be months before any concrete changes are made.

But it'll certainly be interesting to keep an eye on developments on this front to see what comes out of it and whether local regulators might consider following suit.