On Jan. 7, the stock of Pennzoil Co. took off like a loose circus balloon, its price soaring wildly from $63.37 a share to $83, creating a big windfall for stockholders and a nearly 3,000 percent profit for some speculators who had purchased options on the stock.
That balloon was filled with hot air. Pennzoil's stock was inflated by a rumor that its shareholders would soon be enriched by an offer from Texaco Inc. to buy Pennzoil, settling the two companies' multibillion-dollar legal dispute. The rumor, repeated through the financial community over a leading news wire, was specific, strategically timed -- and flat wrong. A day later, when the rumor was denied, the balloon popped and the stock price sank.
The Pennzoil episode -- now under investigation by the Securities and Exchange Commission -- is one in a growing trend of rumors that have triggered sharp, speculative swings in stock prices in the past year, particularly among companies that are targets, or likely targets, of mergers and takeovers.
Although rumors and tips are as old as the stock market itself, many experts believe professional traders increasingly are planting rumors to manipulate stock prices for profit.
"What has happened today, I feel, is that these rumors are planted deliberately," said Stephen L. Hammerman, executive vice president of Merrill Lynch & Co. and a former New York regional administrator for the SEC. "You had a situation with Texaco-Pennzoil where somebody started a rumor that there was going to be a merger. Bingo. Somebody made a buck on that.
"I think that the swings are far worse than in the past , probably because of the size of the transactions that are taking place. And I think they are more frequent over the last couple of years."
On Wednesday, leaders of the three major stock exchanges -- Wall Street arbitrageur Ivan F. Boesky, Merrill Lynch Chief Executive Officer William Schreyer, and several takeover lawyers -- will meet with SEC officials to discuss possible solutions.
One option is SEC Chairman John S. R. Shad's suggestion that the SEC might give rewards to informants who tip off investigators about illegal rumor-mongering. A few outside experts have called for grand jury inquiries and the use of sting operations and undercover agents in brokerage and investment houses.
And on a less dramatic level, the commission may consider requiring companies to provide more public information about any merger or takeover activity they are involved in, if there is unusual trading activity in their stock. It may review other aspects of its disclosure rules, according to an SEC briefing paper on the Wednesday meeting.
In a nation where freedom of speech and freedom to speculate on investments are hallowed traditions, many merger experts say it would be difficult, if not dangerous, for the SEC to try to restrict the free flow of information, including rumors.
"I don't think the problem is any worse than it has been," said Joseph Perella, a managing director of First Boston Corp. "It is just that there are more rumors today because you have a much hotter stock market. I think the rumor mill heats up when you have a hot stock market and a hot merger market."
"I think it is a perennial problem," said Guy Wyser-Pratte, head of arbitrage at Prudential Bache Securities. "I think there is some [rumor] planting, but it is difficult to pinpoint planting. There are manipulators out there. There have always been."
But enforcement officials and experts at some of the target companies say the prevalence and power of rumors could ultimately damage the credibility of the securities markets. And in individual cases, rumors can affect the control of companies involved in takeover battles by causing dramatic shifts in stock ownership, Hammerman and other experts say.
Investors need to believe that "markets are fair and have integrity," said Gary L. Lynch, the SEC's director of enforcement. "To the extent that these kinds of episodes convince some people that investing in the market is more like gambling, where the house tables are rigged, people aren't going to play."
Merrill Lynch is an example of a company whose control was jeopardized by a rumor campaign, Hammerman said -- a campaign linked to the growing furor of merger and takeover activity. "There is a recent game going on that I consider very, very disturbing," Hammerman said. "All of a sudden some professional traders decide they are going to put a stock in play."
Although managements like to see their stock price rise, they usually dread being put "in play" -- the market's term for becoming a target of takeover speculation. When this happens, individual investors seeking a profit often sell their stock. The buyers are professional investors called arbitrageurs. Thus, large amounts of stock can be concentrated among a relatively few traders who can gain a crucial influence over the company's fate.
The professionals start buying -- "then [takeover] rumors start," Hammerman said. "Something has to be in play. There is a lot of money out there and the money can't sit idle. So something has to be in play pretty much all the time."
Since the beginning of the year, Merrill Lynch has been the target of a succession of rumors, each speculating that it was soon to be taken over by a larger corporation. None of the rumors was true, said Hammerman.
"Telephone [American Telephone & Telegraph Co.] was taking them over and General Motors was taking them over; Citicorp was taking them over; Chrysler, everyone," said Donald J. Soladar, senior vice president of market surveillance for the New York Stock Exchange. Merrill Lynch and each of the companies in turn denied the rumors. "But people assumed there was truth in the rumors, and the stock went up, up, up," said Solodar.
"These things are timed," said Hammerman. "Things get done to change the rumor around. It is a game . . . Big money is made by the professionals on these things."
One senior investment banker at Salomon Brothers said the rumor problem has grown because the number of arbitrageurs investing in takeover targets has increased from about 50 to 250 in recent years.
Another new factor is the growth of trading in stock options, which permit investors and speculators to acquire the rights to buy or sell stock at costs much lower than the price of the stock itself. "It has added some fuel to the fire," says the NYSE's Solodar.
While it is difficult to trace rumors, it is easy to find companies that believe they have been abused by rumor-planters. CBS Inc. Senior Vice President William Lilley III believes much of the wild trading in CBS stock last year was driven by carefully planted false information.
"We began to really believe the stock was being victimized by rumor planting when there was all of this activity on the Chicago Options Exchange coincidental with the rumors," Lilley said. "We have been particularly concerned about rumor-manipulated trading done for the purpose of arbitrageurs' running up the price of the stock, and running down the price of the stock, and trading to their advantage on the swings."
Ultimately, the CBS rumors stopped only after the company invited New York financier Laurence Tisch to join its board of directors, increase his stake in the company and serve as a stabilizing influence on the stock.
Along with a hotter merger and takeover climate, a change in stock market regulation has affected the impact of rumors, experts note. In the past, the exchanges would routinely halt trading in a stock when price changes became too drastic, providing a cooling off period in which companies could issue clarifying statements and investors could try to separate rumor from fact.
However, the NYSE is reluctant to halt trading now because Jefferies & Co., a California-based brokerage firm that is not an NYSE member, will continue to trade the stock for interested investors -- who tend to be the professionals.
Companies also are reluctant to comment on rumors for tactical reasons. Many companies have been advised by their lawyers and bankers never to respond to questions about mergers or takeovers so that they won't have to change their response if the company does become involved in such activities.
But the stock markets often regard a "no comment" as tacit admission that a rumor may be right. As the SEC has noted, merger rumors followed by "no comment" responses have been accompanied by frenzied trading in recent months. The NYSE won't halt trading in response to a "no comment."
The SEC takes up the rumor issue with its public forum on Wednesday amid some skepticism that it can do much to counter the trend.
The SEC's Lynch said last year he would look at this area with a "fresh eye" after 20 companies became the target of takeover rumors in a two-week period. The commission, he notes, could bring cases under its general antifraud statutes against those who are suspected of spreading false statements about a company with the intent of profiting on the rumor by trading in its stock.
"To the extent that people are spreading false rumors" and capitalizing on that, "it's plain to me that's conduct that should not be condoned," said Lynch.
The SEC would love to have a front page prosecution of illegal rumor-mongering to serve as an example for the securities markets -- like the publicized insider trading case that sent former deputy Defense secretary Paul Thayer to prison. But it has none, at this point.
"I can't think of a recent case," said Lynch.
Such cases are under investigation, but the SEC will face some big hurdles, he added.
In the typical insider trading case, executives who abruptly buy a large chunk of their companies' stock just before an important news release that boosts the companies' stock prices can have a tough time justifying their conduct.
But it is a far harder to establish a guilty motive on the part of a professional trader who buys and sells thousands of shares of stock every day. "It's that much easier for them to come up with 15 reasons" to defend a suspicious transaction, said Lynch.
Another high hurdle is tracking a rumor to its source, Lynch said.
"What is a rumor?" Solodar asked. "There have always been rumors; there has always been street chatter. The definition of rumor itself is at best very cloudy."
"There are rumors to drive the price down as well as drive it up," said SEC regional administrator Ira Lee Sorkin. "It is the most difficult task we have to try to pinpoint rumors."
Technically, the stock exchanges forbid employes of member firms from spreading rumors of a sensational nature that are potent enough to influence stock prices. In reality, the rules have little, if any, impact.
Solodar, the NYSE surveillance chief, says the SEC may need more help from the exchanges and brokerage firms, which could do more in helping enforce the rules against spreading rumors. "I personally think the SEC is an effective deterrent . . . But they cannot do it alone. They have to work with the self-regulatory organizations" such as the NYSE.
But Merrill's Hammerman says a far tougher investigative campaign is necessary. "I was assistant U.S. attorney back in the '60s, and if you are ever going to crack this kind of thing, it will be through the grand jury process, where the threat of jail is [real]. . . and there are [significant penalties] for perjury," he said.
"You've got to have an enforcement philosophy directed not to the markets of the 1960s and 1970s, but to the kind of institutional, arbitrageur-oriented markets you have today," said one lawyer who represents a major corporation that has been a frequent target of rumors.
"You have to have securities enforcement more along the lines of white-collar crime enforcement," the lawyer said. The FBI could put an informant in a suspected brokerage house, or mount a sting operation, "and put people on notice that this is going to be viewed as a criminal violation," the lawyer said.
Some other stock market professionals say a campaign against rumors using grand juries and rewards for tipsters would represent a threat to free speech and civil liberties whose costs would far outweigh any benefits.
Pratte, for example, is opposed to a proposal that the SEC pay tipsters for information about rumor planting. "You then get into the realm of whether we are living in Moscow or New York," Pratte said. "That is how a police state runs society, where people live in fear of each other. I think you should make the penalty severe for perpetrators, like stiff prison sentences, rather than getting everybody looking over each other's shoulder and ratting."
Soldar thinks the SEC can do the job on rumors, leaks and insider trading. "There's no lack of will. And there's no lack of computer support to highlight activity which appears to be a problem. And I think they can keep up with it . . . I don't see it as an uphill battle," said Solodar.
The SEC's Lynch, however, is hedging his predictions on the commission's ability to crack down on market manipulation through the rumor mill. "I think it is really too early for me to say. Ask me six months from now."