I too have been receiving a ton of stock spam lately. [I wonder why certain email addresses are prone to receive certain types of spam.  Virtually all of the stock spam goes to my email address which is part of a distribution list for the board of an organization – e.g., <<[email protected]>>.  That’s a topic for another day.]  Two links (Professor Bainbridge and Techdirt) note that stock spam actually works for the spammers, but not so much for the recipients, who lost on average “5.25% in the two day period following the touting” [bbc article explaining the method here].

Professor Bainbridge links to a scholarly article (Mueller, Holger M. and Philippon, Thomas, "Concentrated Ownership and Labor Relations" (July 2006).) which explains that heavy touting results in increased activity.  Stocks which are touted experience an explosion of activity on the day of touting and the preceding day.  The touters obviously have the timing down so they take advantage of the increased trading and typical short term increase in price.  The recipients (who are these people anyway??) end up losing money.  Techdirt notes this as well, and also links to a site which tracks “a portfolio of stocks made up entirely of ticker symbols promoted in various spam messages.”  As of August 27, here are spamstocktracker’s latest figures:

    Total Cash Outlay:       $70,987.00
    Total Current Value:     $24,325.90
    Net Profit:                    ($46,661.10)

In the face of this evidence, the recent conclusion of a federal district court that the SEC was not entitled to summary judgment in a stock spam fraud case was, to my untrained (from the securities point of view) eye, surprising.  The case is SEC v. Meltzer, 2006 U.S. Dist. Lexis 46319 (July 10, 2006).

In Meltzer the Defendant was a typical stock spammer who created multiple internet identities in order to flood the internet with promotional materials.  The SEC was going after him for fraud, in violation of the Securities Act of 1933 and the Securities Exchange Act of 1934.  The emails “invariably spoke in . . . glowing terms about the subject issuers’ situations and prospects.”  The Defendant had not performed the research and arrived at any conclusion regarding the stock which was being recommended.  Defendant (and the underlying promoters) received compensation for making and disseminating the recommendations.  Ruling on the parties’ cross-motions for summary judgment, the court concluded there was no dispute as to two of the four elements: (1) Defendant’s actions occurred in connection with the purchase or sale of securities and (2) the emails contained misrepresentations.  The two disputed issues were whether Defendant had scienter, and whether the statements were material.  After concluding Defendants had the requisite scienter (and could not rely on the defense of advice of counsel) the court addressed the materiality issue.

In the court’s view the critical issue was whether the buy recommendation offered by Defendant was actually supported by research (someone’s research, somerwhere).  The SEC cited to a case where a securities dealer was held liable for representing that its “research department” (which actually consisted of one individual) performed independent research.  The court distinguished that case and noted that in the present case there was some dispute as to whether Defendant touted stocks based on actual research performed by third parties (the underlying promoters).  The court also noted “it is not clear whether a reasonable investor would have found the misstatements material.”   

The Court glosses over what I thought was a critical issue underlying the misrepresentations.  Defendant and the underlying promoters both received compensation and Defendant failed to disclose the full extent of the compensation (i.e., “I am receiving X shares of stock for sending out these mailers.  I will sell these shares within the week and likely make $XX,XXX dollars . . . .”).  Now that would have been “full disclosure”.  The Court also found that Defendant “deliberately removed [information regarding compensation (including to the underlying promoters)] from [the] materials before publishing and disseminating them in his websites and spam emails.”   To me these seemed like critical omissions.  I’m not terribly familiar with the investing industry or securities laws, but if someone sends me an email touting a stock, the fact that the emailer and the person providing the information were both heavily compensated would very likely be a red flag.  On the second point, I don’t have a sense of what constitutes a “reasonable investor”.  The data cited by Prof. Bainbridge and Techdirt indicate that stock spam certainly influences some investors.  Whether these folks should be labeled as unduly gullible and their views marginalized in the reasonable investor analysis is a substantive question of securities law that I don’t know the answer to.

It’s possible the SEC in cases such as Meltzer will ultimately prevail at trial.  But I’m surprised the court didn’t more clearly chart the course for liability.  Particularly since it’s quite possible that the stock spam in question did not violate CAN-SPAM (e.g., except for the securities-related mis-statements maybe the emails were largely accurate)?  The court’s order almost leaves the impression that it’s not an open and shut case and that the Defendant could end up being absolved of violating securities law and of violating CAN-SPAM.

Stock spam seems to cause actual harm.  I’m surprised the court didn’t make it easier for the SEC.