The Avon Hoax and what it means

Avon shares soar after fake bid

A fake filing related to a takeover of Avon has highlighted several issues for regulators.

Avon was having a perfectly normal day, trading around $6.60 at 11:35 a.m., ET, when the stock shot up to almost $6.97, triggering a volatility trading halt.

These "volatility trading halts" are single-stock circuit breakers that were created after the 2010 "flash crash" to control volatile trading in stocks. Simply put, it stops trading in a stock if it moves more than 5 percent in a five- minute period. The stock halts for five minutes everywhere (not just on the NYSE), then reopens, but if there are still huge imbalances, it can be halted for up to another five minutes.

Some firm calling itself PTG Capital had filed an offer to buy Avon for an exorbitant price. Given that it was at a 20-year low, the move immediately attracted attention.

The stock reopened, and immediately shot up to almost $8, triggering another trading halt.

By then, traders on the floor were noticing that the filing contained numerous typos, and no one had ever heard of them. There were rumors floating around that they didn't even exist.

My colleague Brian Sullivan called both the attorney's listed for the firm and the company; both went into very odd sounding voice mail.

When it reopened, the stock went in the other direction, from roughly $7.98 to $7.60, triggering a third and final trading halt.

CNBC reached out to Avon and they told us "it has not received any offer or other communication from such an entity ... and has not been able to confirm that such an entity exists."

In other words, it was a hoax.

There are two problems here:

1) how on earth did a phony filing get into the SEC's Edgar database? The trading community assumes filings made there are accurate and reliable, because—everyone assumes—they are supposed to be vetted by the SEC.

2) the NYSE (and other exchanges) should have the power to halt a stock when there is unusual and unexplainable trading activity, but it does not.

A company has the power to halt trading in its stock if it has "news pending," but that did not happen. In fact, the NYSE was unable to get in touch with the company during the halts, despite many attempts.

In the past, NYSE floor officials were able to halt stocks for an "order imbalance," that is, a huge order of buy stocks with no sell orders, or vice-versa.

That went away several years ago. Instead, the "volatility trading halts" were what stopped the trading. That's what happened—three times.

It might be easier and more logical if exchange officials merely had the power to halt stocks that are trading strangely for inexplicable reasons. This is an issue for the regulators.

At 2 p.m., ET, the stock was still trading up roughly 6 percent. Why? Because the big price moves and huge volume (more than five times normal) generated heavier than usual volume and volatility, even after everyone realized the story was a hoax.

How is that possible? Because heavy trading begets more trading. The heavy volume and higher volatility allowed traders to step in and make small amounts of money trading the stock, which corresponds to that cynical old trader saw, it doesn't matter if the story is right or wrong, as long as you're on the right side of the trade.