Financial Regulatory and Risk Management Challenges Stemming from Firm-Specific Digital Misinformation

Event studies are the primary methodology used to test market efficiency. Researchers identify an “event” and test for stock price reaction around that event. For example, Shelor et al. [14] find that insurance company stock prices reacted positively after the 1989 Loma Prieta earthquake. The positive reaction was due to the increased demand for earthquake insurance following this event. Numerous other event studies find stock price reactions to the release of new information. These include Asquith and Mullins (dividend initiation [1]), Fields and Janjigian (Chernobyl nuclear accident [6]), Fields et al. (new regulation [7]) and countless others. Financial asset prices are so responsive to new information that one particular scam preys on this fact. The classic “pump-and-dump” scam involves the creation and spread of false firm-specific information after taking an appropriate position in the firm’s stock. For example, Scam Artist (SA) buys 1,000 shares of Company A stock. After the purchase, SA creates a “hot tip” about new information that will cause Company A’s stock to skyrocket in value. The false information pushes naïve investors to buy Company A stock and push the price higher. SA then sells his Company A stock for a profit. While this scam is illegal, it is also difficult to detect. A recent detected pump-and-dump example includes one reported by McClatchy [10] in which a man created hundreds of Internet identities to post fraudulent stock tips about 20 small-cap firms. He was convicted of fraudulently earning $870,000 in the scheme. According to Leuz et al. [9] the practice remains prevalent. Their study suggests that almost 6% of all active investors participate in “at least one ‘pumpand dump’” scheme with an average loss of 30% of invested funds. Another example is hackers creating a fake Associated Press tweet about a White House attack that injured