August 25, 2000 3:45 PM PDT
Hoax briefly shaves $2.5 billion off Emulex's market cap
Around the same time trading began for the day, at 6:30 a.m. PT, a press release purportedly from Emulex was posted on Internet Wire, a Web-based distributor of corporate announcements that charges $275 for the service.
According to the release, which contained formats similar to previous Emulex announcements and listed an actual investor relations executive as a contact, the company's chief executive was resigning and recent quarterly earnings were being revised from a profit to a loss.
Reaction was swift and devastating: In about an hour the shares plunged to as low as $43 from yesterday's close of $113.06. Volume during the brief period topped 3 million shares.
Other shares were swept up in the sell-off as investors reasoned that Emulex's woes might be part of a sector-wide problem.
Shares of Brocade Communications Systems, a storage area networking company, opened at $216.53 but fell as low as $206. Shares of Qlogic also tumbled, reaching as low as $74 from yesterday's close of $109.69
Officials with the Nasdaq Stock Market halted trading in Emulex shares after being notified by the company that the release was phony.
Emulex CEO Paul Folino appeared at least twice on CNBC to reassure investors that the release was a hoax. "This was a fictitious press release that was released this morning. We are not restating our fourth-quarter or annual earnings," he said. "Obviously I haven't resigned and am on the job."
The release was reported by online news services TheStreet.com, Bloomberg News, CBS MarketWatch and Dow Jones, which followed with corrections.
When trading resumed around 10:30 a.m. PT, the shares quickly recovered and closed at $105.75, down just $7.31. Brocade closed at $211.88, down $6.44, and Qlogic closed at $103.88, down $5.81.
Although the share prices in all three companies were largely restored, the investigations and questions have just started.
Emulex is the latest victim of several high-profile hoaxes in recent years, a development that investors and regulators fear will only increase as the Internet plays a larger role in the financial industry.
The Internet allows for lightening-fast transmission of news--real or fake--and allows investors to react with "sell" or "buy" orders almost as quickly.
In one of the most widely known stock manipulation cases, PairGain Technologies, a manufacturer of high-speed digital subscriber line (DSL) Internet connection equipment, endured a roller-coaster stock ride last year after a bogus news article said the company would be acquired.
A former PairGain employee was sentenced to five years of probation and ordered to pay more than $93,000 in restitution after pleading guilty to disseminating the fake news story.
Who made a profit?
According to Folino, the Nasdaq, the U.S. Securities and Exchange Commission and the FBI are investigating today's incident. "The first place people will look" is at large "short" positions, he said.
Shorting is investing in reverse--a way to profit from a declining stock. Instead of buying today and selling tomorrow, hoping the stock will increase, shorters sell today and buy tomorrow, hoping the stock will dive.
For example, a Charles Schwab customer might borrow 100 shares of a company that is trading at $80 and immediately sell the shares for $8,000. If the shares later fall to $40, the investor could purchase the 100 shares for $4,000 and return them to Charles Schwab, netting a profit of $4,000.
In the case of Emulex, a total of 623,000 shares were shorted as of Aug. 15, according to the Nasdaq. That means the shares had already been borrowed and sold, but not yet replaced by investors. The amount of shorted shares is relatively light--representing about 2 percent of the total number of Emulex shares that have been floated.
While short sellers who needed to replace borrowed shares could have benefited from today's plunge, there are other potential winners.
Investors who felt that the release was a fraud or who believed the reaction was overdone could have purchased Emulex shares at fire-sale prices. For example, an investor could have bought the shares at $50 in early trading and watched them double when trading reopened a couple of hours later.
The Nasdaq said all trades conducted prior to the trading halt will stand.
Losers are Emulex shareholders who felt the release was real and sold the shares as they tanked--only to watch helplessly as the hoax was discovered and the shares recovered.
SEC officials declined to comment on the specific Emulex incident.
Not an isolated case
Although releases of bogus news and information are rare, regulators and law enforcement agents have reason to be concerned about their apparent increase and the Internet's role in the crimes.
SEC spokesman Chris Ullman said the commission has seen about 130 incidents of Internet fraud during the past five years, most of which occurred in the past two years. The agency has several hundred attorneys periodically trolling the Net for evidence of fraudulent or manipulative behavior, he added.
Penalties for using the Net to manipulate stock prices aren't intrinsically any more severe than for similarly illegal offline behavior. But these penalties can be stiff: The SEC can impose financial penalties and pull a stock broker's license. Jail time is also an option.
The Net has made it easier and faster for fraud to happen--but it's also made it easier to catch some con artists, Ullman noted.
"They're easier to find when they're right out there," Ullman said. "They may try to hide behind false identities, but we have subpoena power and can root them out."
In the PairGain case, Gary Hoke was arrested after authorities scoured the network logs of several companies.
Other stock manipulation cases include Aastrom Biosciences, which saw its stock spike after an apparent hacker allegedly posted a fake announcement on the company's Web site.
But stock manipulation efforts need not be so elaborate. Internet stock chat rooms and message boards make it easy for manipulators to anonymously post fake announcements and news articles.
In today's Emulex case, Internet Wire acknowledged its involvement in hoax, the first in the company's six-year history.
"This morning ... Internet Wire published a news release regarding the company, Emulex Corporation," the company said in a statement. "We soon learned this press release was a hoax, and that Emulex did not write nor issue the press release. Upon learning of the hoax, we immediately pulled the press release from our Web site and alerted the other leading news sites on the Internet that the press release was false."
Internet Wire added that it is cooperating with authorities.
According to Internet Wire's terms-of-service agreement, subscribers posting releases must agree "that the content of the release is factually and legally accurate" and that "the release does not contain any information which is libelous or otherwise illegal."
Although the Internet has made financial information more readily available, experts urge investors to make careful decisions about their financial future.
"We try to implore investors never to rely on a single source of information in making their buying and selling decisions," Ullman said.
News.com's John Borland and Sam Ames contributed to this report.