Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

There's No Law Against Bill Ackman Talking His Book


I have got some bad news for Herbalife CEO Michael Johnson.

This news is hardly the worst Johnson has gotten lately.

Surely it was far worse for him to learn that Pershing Square's Bill Ackman was going to make an epic presentation accusing Herbalife of being "the best managed pyramid scheme in the history of the world."

And also it was worse to see that the market was reacting to the Ackman news by rapidly reducing the price for shares in Herbalife.

Here's my bad news: there is no way the Securities and Exchange Commission is going to pursue Ackman on charges of market manipulation. Because what Ackman is doing just is not illegal market manipulation. In fact, it's just about the opposite of market manipulation.

Herbalife Responds to Ackman

Let's take as our starting place the actual law banning manipulation, Section 10 (b)of the Securities Exchange Act of 1934 and the SEC's Rule 10b-5. The 1934 law declares that it is "unlawful for any person . . . to use or employ . . .any manipulative or deceptive device or contrivance in contravention of [SEC rules]." Rule 10b-5, prohibits nondisclosure, misrepresentation, and any "artifice to defraud" or any act "which operates or would operate as a fraud or deceit."

The Supreme Court has long held that Rule 10b-5 prohibits only attempts to affect a stock's price that involve deception. Think of wash trades, where a trader secretly buys and sells a stock in order to create the false impression of genuine market activity. Or a company secretly buying up its own stock to push the price higher. Or even a bear raid, in which short-sellers secretly sell shares of a stock hoping to push the price down and profit from the decline.

Ackman: Why I Am Shorting Herbalife

"The gravamen of manipulation is deception of investors into believing that prices at which they purchase and sell securities are determined by the natural interplay of supply and demand, not rigged by manipulators," the Supreme Court explained in a 1977 case.

Ackman is doing the opposite of this. He is not secretly buying or selling shares. He has declared his position outright. He is making his case in public. His hope that this will influence the price of shares in Herbalife doesn't make anything he's done illegal because he isn't practicing deception.

Thisis a good rule of thumb: if you're not keeping something secret, you aren't violating rule 10b-5.

There's just no law in the United States that says you cannot talk your book. Investors in securities are free to tout the value of those securities. Short-sellers are free to disparage their targets, even if their words help bring the stock price down and therefore contribute to making their trade profitable.

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