There’s a first time for every novel unfairness in the securities industry or otherwise. There has to be. If novelty justified stasis, the law would become a petrified forest.
Take billionaire hedge fund manager Bill Ackman’s short selling the shares of Herbalife Ltd, a multi-level marketing nutrition company. (Mr. Ackman’s fund is named Pershing Square, which recently lost staggering sums purchasing shares of Valeant Pharmaceuticals, which specializing in buying and spiking the price of patented drugs.)
In December 2012, Mr. Ackman took a short position approximating $1 billion, meaning he would profit enormously if he could make Herbalife’s stock price plunge. He thus publicly maligned the nutrition company as the “best managed pyramid scheme in the history of the world,” and opined its stock price would tumble to zero.
Standing alone, Mr. Ackman’s disparagement of Herbalife did not give him a trading advantage over other investors. While his statements defamed Herbalife by accusing it of criminal fraud, they were in the public domain to digest as investors saw fit.
But Herbalife’s price did not free fall as Mr. Ackman had expected. Like all narcissists, Mr. Ackman believed his words and predictions would be acted upon as gospel.
Mr. Ackman then unsheathed his Plan B to move the price of Herbalife to zero that he did not share with the public. He employed his considerable wealth to contrive or to unearth evidence of Herbalife fraud; and, lobbied members of Congress and law enforcement officials to prosecute and bankrupt the company.
According to the public record, among other things, Mr. Ackman retained agents to create websites, place advertisements, post notices, and establish 1-800 numbers to collect and excite adverse information or criticism of Herbalife. He solicited nonprofit organizations and concerned citizens to complain about Herbalife to the Federal Trade Commission (FTC). He urged PricewaterhouseCoopers to withhold signing Herbalife’s financial statements. He made presentations to the FTC, Securities and Exchange Commission, United States prosecutors, and Canadian competition authorities urging investigations of Herbalife. He successfully solicited United States Sen. Ed Markey, Massachusetts Democrat, to write letters to the FTC and SEC casting doubt on certain features of Herbalife’s business and calling for the federal agencies to open investigations. (Agencies pay attention to the views of Senators and Representatives because the latter determine the appropriations necessary for agency operations).
Knowledge of an investigation routinely causes the target company’s stock to tumble—at least in the short run. Thus, Herbalife’s shares lost 12 percent of their value within 10 minutes of Senator Markey’s announcement of his twin letters to FTC and SEC.
Despite Mr. Ackman’s expensive, comprehensive and best efforts, Herbalife was neither charged with criminal fraud nor were its shares rendered worthless. The company settled a civil complaint filed by the FTC on July 15, 2016, requiring alterations in its business model and a $200 million payment to consumers. But during the ensuing nine months, Herbalife’s stock price has remained stable at approximately $58 per share—far above Mr. Ackman’s prediction and hope of zero.
At present, securities laws prohibit “any course of business or practice which would operate as a fraud or deceit upon any person in connection with the purchase or sale of any security.” Whether Mr. Ackman’s non-public efforts to move the price of Herbalife downwards by convincing law enforcement to investigate or prosecute falls within that prohibition is uncertain. As the market reaction to Mr. Markey’s disclosure of his letters to the FTC and SEC demonstrates, the probability of a law enforcement investigation, simplicter, depresses the stock price of the target company.
Accordingly, to insure a level playing field for investors, the SEC by rule should require disclosure of all material efforts by an investor to persuade law enforcement to investigate or prosecute a traded company. Lobbying law enforcement toward those ends with a boost from members of Congress is a luxury that only the rich can afford.