(The article featured
below is a selection from Hedge
Funds and Private Equity: Risk Management and Regulatory Update, which is
available to subscribers of that publication.)
Hedge Fund Industry Opposes FINRA
Rule on Circulation of Rumors
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.
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