The Real Results of Stock-touting Spam
Every morning I receive 10 or 20 spam emails, unsolicited messages advertising everything from stock tips to questionable pharmaceuticals. Without a second thought I unceremoniously toss these messages in the trash. But not everyone else does so, according to Professors Laura Frieder of Purdue University and Jonathan Zittrain of the Oxford Internet Institute. In fact, according to their recent research paper entitled ‘Spam Works: Evidence from Stock Touts and Corresponding Market Activity’, many people not only read spam messages that tout stocks but actually buy the advertised stocks – enough to make real differences in the stocks’ prices. Spammers who sent out the advertisements stood to make 4.9% returns on each round of touting, and unwitting victims who bought in would have lost 5.3% on their investments each time. This discovery has implications for the micro-cap over-the-counter (OTC) stock markets, which can be easily manipulated in this Internet age, and for market regulators, who might seek to impose laws to curb this fraudulent manipulation of the market.
Stock-touting spam looks much like any other mass email advertisement. Typically the message will display the company’s name and the ticker symbol in big, bright letters, followed by any number of marketing lines, such as ‘buy this stock now!’ or ‘set to explode tomorrow morning!’ Frequently it will include some news item about the company’s recent acquisition, finalized government contract, or other event; often it is pitched as ‘insider information’ – “this news will be released tomorrow, so buy now.”
The advertised stocks are almost exclusively tiny, illiquid penny stocks sold on the OTC markets. Spammers send out millions of touting messages at a time, to uncountable addresses, often over a period of several days. Frieder and Zittrain looked at over 1.8 million spam messages and compared the stock touts with stock prices on Pink Sheets, one OTC price quotation system. They then compared the stock prices and movements of the touted stocks against other, non-touted Pink Sheets stocks, against NASDAQ stocks with low market capitalization, and against the Russell Micro-Cap Index.
The results were stunning. Touted stocks were four times more likely than non-touted stocks to have abnormally high trading volumes while they were being promoted, suggesting that the tout messages induced relatively massive amounts of trading. This finding is especially compelling given that, when they are not being touted, those same stocks chosen for touting are between four and 20 times less likely to have relatively high volumes, as compared to stocks that are never advertised. This latter result might be explained partly by the fact that, because touted stocks are heavily traded when they are touted, their ‘average’ volume is artificially high. It might also be explained, though, by the possibility that spammers like to advertise more illiquid stocks.
And the touts didn’t just result in heavier trading – the prices of touted stocks moved in exactly the way a spammer would want them to move. Prices rose quickly immediately after the touting and fell quickly afterward. A spammer who bought a stock a day before releasing the touts and sold the stock immediately thereafter stood to make a 4.9% return. The victim who bought into the advertisement (and the stock), on the other hand, would lose 5.3% of the investment after holding it for two days. And the better the spammer, the higher the return, and the harder the loss for the victim. When more touts for the same stock were sent around the same time, spammers’ returns rose to 6%, and victims’ losses became 7%.
There are two conclusions to be drawn from these results. The first is just how easily these OTC markets can be manipulated, especially with the rise of the Internet. The efficient markets hypothesis is one of the most celebrated economic theories today, but these touted stocks represent the nadir of inefficiency. Prices are set not by the company’s fundamentals or even by the market’s view of the company, but by knee-jerk reactions of spam recipients acting on imperfect – or fraudulent – information.
The correlation between intensity of touting and intensity of market reaction only underscores the explosive degree of effectiveness of touting in the Internet age. ‘Pump and dump’ schemes were not unknown before, but they involved illegitimate telephone calls, faxes, or similar old-style communications. Those schemes faced practical limitations: it was not possible to send millions of faxes, for example. But it is trivial for a spammer to send out millions of emails, and the research shows that increased magnitude does in fact increase the response. Spam is cheap, and it’s apparently profitable too.
With this surprising ability of spam to manipulate the stock market, it is reasonable to conclude next that new regulatory measures are in order, or that such measures are an inevitability. Current US policy focuses on disclosure requirements: stock advertisers must reveal their financial stake in the promoted security. For example, one stock-touting spammer, Jonathan Lebed, was prosecuted by the SEC for failing to disclose his ownership stake. Surprisingly though, many of the tout messages in fact contain disclosures and even reveal the spammer’s intent to sell immediately – and spam touts are still immensely effective.
Frieder and Zittrain suggest aggressive regulations to combat stock-touting spam. They recommend, for example, ‘additional transactional steps’ or a ‘cooling-off period’ to minimize the apparent visceral impulse of spam recipients who buy touted stocks. They also recommend rigorous enforcement of anti-spam laws to prevent these messages from being sent.
Those in the finance industry, and particularly owners of micro-cap companies or investors in micro-cap stocks, will probably object to such paternalistic regulation. Regulation constrains the liquidity of those already illiquid markets, of course. Transactional steps or waiting periods might make it difficult for small companies to attract new investors, and aggressive regulation of stock-promoting materials might create legal quandaries for companies seeking to disseminate information about their new developments.
On the other hand, there are reasons why investors and companies might favor greater protection. While stock-touting spam has currently been assumed to be a tool with which spammers can make a quick bit of money, more invidious uses are easily imagined. A corporate enemy might promulgate false negative information and drive a company to ruin. A corporate board with negative insider information might artificially pump its own company to temporarily increase liquidity so that its members can offload their holdings before a major crash. Stock-touting spam causes harm, and the current regulatory measures do not curb that impact, so it is reasonable to think that some new measures must be taken to stem the harm that stock-touting spam causes.