Cicero Policy Briefer

Issue 23, April 2008

Gossip and the City

By Laura Chisholm

One senior figure at HBOS described last week’s events as the ‘modern day version of bank robbery’. Are our modern day sheriffs up to the task? The FSA’s response was one of zero tolerance. But I doubt it had any bucket shop wideboys quaking in their Gucci loafers.

Rumours and speculation are part of what makes the City go round. Some gossip affects investors’ choices. Most, thankfully, does not.

It’s a fair bet to assume that the rumours of a stricken HBOS would not have taken hold, had it not been for Bear Stearns’ collapse just days before—shortly after its chief executive reassured the market that all was well.

The result of the rumours is well documented: the share price chart looked like a prop in an operating room drama and one speculator is rumoured to have made £100 million out of the day’s trading. HBOS’s management then bought a large chunk of shares to shore up confidence. The bank’s recovery means that their generosity will be well rewarded.

The rumours were quashed thanks to unusual denials from the Bank of England that any UK bank was seeking emergency funding. HBOS judged correctly that in the febrile atmosphere the central Bank’s denials would mean more than the reassurances of a chief executive.

Now that the crisis has passed, what will the FSA do? Perhaps it can learn something from the Security and Exchange Commission (SEC), which has announced a similar inquiry into the events surrounding Bear Stearns.

The SEC certainly has a more fearsome record. In 2005-06, the financial penalties imposed by the SEC exceeded those imposed by the FSA by 10 to one, after adjustment for differences in market capitalisation1.

The FSA has long been envious of the SEC’s powers. It was ex-CEO John Tiner’s parting request last July that the organisation “be granted formal powers to offer immunity in exchange for hard evidence”, like its American counterpart. His wish has at last been granted. The Chancellor has said he will propose legislation to give the FSA officials “special prosecutor status”. This will greatly bolster their ability to build cases that can be successfully prosecuted. One official envisages a “system of city grasses.”

What about the legal act of short-selling? Perhaps the rules around disclosure should be looked at. While the FSA says its surveillance picks up on short positions, there is no public disclosure when someone borrows shares in order to sell them, unlike when a significant amount of shares are bought in a company.

It seems unlikely that the FSA will get to the bottom of the rumours that sparked last week’s events. But to prevent the FTSE being at the mercy of Chinese whispers, regulators need to focus on deterrents and better rules of disclosure rather than public lynchings.

1. Coffee, John C., "Law and the Market: The Impact of Enforcement" ( March 7, 2007 ). Columbia Law and Economics Working Paper No. 304

Laura Chisholm can be contacted on +44 (0)20 7665 9536 or click here to email.

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