Academic journal article Journal of Corporation Law

The Emulex Stock Hoax: Potential Liability for Internet Wire and Bloomberg?

Academic journal article Journal of Corporation Law

The Emulex Stock Hoax: Potential Liability for Internet Wire and Bloomberg?

Article excerpt

I. INTRODUCTION

The purpose of this Note is to analyze whether members of the Internet media may face liability under section 10(b)1 and Rule lOb-52 of the Securities Exchange Act of 1934 for their participation in the Emulex3 stock hoax. Although the media acted with sufficient recklessness, the media will probably not face liability under section 10(b) and Rule lOb-5 because of heightened pleading standards for securities litigation and wellestablished protective First Amendment policies developed in defamation case law. This Note recommends ways in which various market actors can modify their behavior in order to minimize the risk of future market manipulation. Additionally, this Note considers whether the courts may impose a "duty to readership"4 on the media.

II. BACKGROUND INFORMATION

On August 24, 2000, shares of Emulex closed at $113.06.5 That same afternoon, 23year-old Mark Simeon Jakob sent a fabricated press release via e-mail to his former

employer, Los Angeles-based Internet Wire, Inc.,6 reporting that the SEC was investigating Emulex, that profits were to be restated, and that CEO Paul Folino had resigned.7 Jakob sent the false press release using an unauthorized e-mail account from El Camino Community College, where he was formerly enrolled as a student. 8 As a former employee of Internet Wire, Jakob allegedly knew that the Internet Wire night shift would be "typically short-handed" such that he could "fast-talk his way around standard fact checks."9

Jakob's press release, described as "clumsily worded," contradicted recent news that Emulex's revenues had doubled and earnings were up 150%.10 Nonetheless, Internet Wire issued the unconfirmed information at 9:30 a.m. Eastern Standard Time (EST) and the news quickly spread over the Internet.II Reputable news sources, including TheStreet.com, CNBC, Bloomberg, and the Dow Jones Newswire also picked up the story. 12 Jakob's plan was well-timed. Employees at Emulex had not even arrived at the office before the stock price plummeted, causing NASDAQ13 to halt trading at 10:30 a.m. EST, with share prices hovering around $65.14

Despite the devastating hoax, Emulex has recovered from the fraud and has not made plans to file a lawsuit.15 Michael E. Smith, Emulex's vice president, stated, "[w]e quickly refocused on the business. It's done and past."16 Nearly one month after the hoax, Emulex shares were trading at $172.19.17

Jakob will not be able to refocus on his life for some time. FBI agents apprehended him just five days after perpetrating the hoax. 18 On August 31, 2000, the SEC charged Jakob with securities fraud and wire fraud.19 His profit from the hoax amounted to

approximately $240,000,20 which pales in comparison to Emulex's $2 billion market value loss.21

Worse yet, reports estimate that investors collectively lost almost $50 million in the hoax.22 Very few Emulex trades transacted during the hoax were block trades.23 Consequently, mostly individual traders, not institutional investors, fell victim to the fraud.24 This victimization of individual investors is disheartening to those who participate in the burgeoning practice of on-line trading and rely on the Internet for relevant news affecting their portfolios. The Internet has become a "highly accessible" source for stock market information.25 The Emulex hoax demonstrates that even reputable Internet news sources can be the tools of a market manipulator like Jakob.

A. The Efficient Market Hypothesis

One version of the Efficient Market Hypothesis (EMH), the "semi-strong" version, "posits that at any given time, share prices in an efficient market will incorporate all publicly available information relating to publicly traded companies."26 Of course, an important assumption underlying the EMH is that investors act rationally in response to disseminated information. One commentator argues that the Emulex hoax should "affirm our faith in the market" because Emulex's stock price reacted so quickly on the false news release. …

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