Consider this July 18 cnbc.com article:

“Lehman Brothers denied market rumors that it is going to take a writedown related to subprime exposure. The rumor dented stock prices and spurred buying in Treasurys, traders said.

“The rumors regarding subprime exposure are totally unfounded,” a Lehman spokeswoman said. Rumors have been circulating since mid-morning that Lehman specifically, and brokers and banks in general, will soon be revealing that they will have losses related to subprime.”

Then the article gets even more intriguing:

“The latest round of worrying and rumor mongering follows Bear Stearns disclosure last night that one if its problem hedge funds is worthless and the other is worth less than a tenth of its value.”

At this point you will have realized – if you are fully awake – that the above article is from July 2007 (not 2008).

I ask: how many Lehman investors lost money since July 2007 for not paying attention to this “totally unfounded” rumor? Is the SEC investigating that Lehman spokeswoman (possibly the ex-CFO Erin Callan)? This is clearly a case of Manipulation of Securities Prices Through Intentionally Spreading False Information (click on the link please). As I already pointed out in May, Lehman’s Enron-like disclosure practices would make an SEC probe particularly swift: all the SEC would need to do is to compare the two most recent Lehman 10Q’s and see that they are not consistent: one of them (but probably both) contains false information.

But perhaps the SEC is more interested in protecting its Wall Street investment banking cronies than investors. This would be a pity, because the SEC calls itself The Investor’s Advocate (www.sec.gov/about/whatwedo.shtml) and states that:

“The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”

Now the SEC is out to get those even hedge funds, short sellers and other locusts who, after all, where right all along in their assessment of the large American investment banks and of Fannie Mae and Freddie Mac. I put it to you that hedge fund manager David Einhorn did more to protect Lehman’s investors than the SEC: after all, he warned of the problems with Lehman stock when it was still above $30 a share (it closed yesterday at $15.27).

On July 14 the Securities and Exchange Commission “sent subpoenas to more than 50 hedge-fund advisers as part of its investigation into whether individuals spread false rumors to manipulate shares of two Wall Street firms”, as reported by the Wall Street Journal. And on July 15, the SEC announced an Emergency Order to “eliminate any possibility that naked short selling may contribute to the disruption of markets” in 17 banks plus Fannie and Freddie. That announcement opens with the following sentence:

“False rumors can lead to a loss of confidence in our markets. Such loss of confidence can lead to panic selling, which may be further exacerbated by “naked” short selling. As a result, the prices of securities may artificially and unnecessarily decline well below the price level that would have resulted from the normal price discovery process. If significant financial institutions are involved, this chain of events can threaten disruption of our markets.”

So now the SEC, which has the mission of “maintaining … efficient markets,” also takes it upon itself to determine and enforce the correct price level for certain securities. I know from John Paulson’s presentation at the GAIM International 2008 conference in Monaco that Paulson’s funds were short Fannie Mae and Freddie Mac (I don’t know if through a short sale or derivatives). Therefore, I suppose Paulson & Co. might be investigated by the SEC right now.

In his speech at the GAIM conference, Paulson presented facts and numbers showing that Fannie and Freddie were not on a solid capital base. This is also what nearly every responsible commentator has observed, despite protestations to the contrary by Treasury secretary Hank Paulson and Federal Reserve chairman Ben Bernanke. So I would like to ask the SEC: what is the rumor here? Who is spreading false information? And what is the fair price for Fannie and Freddie shares?

As of last night, I have similar questions on Merrill Lynch. A page 1 article on today’s Wall Street Journal reports:

“Merrill Lynch & Co. agreed to sell more than $30 billion in toxic mortgage-related assets at a steep loss, hoping to purge its balance sheet of problems that continue to plague the giant brokerage firm.

… Faced with another leak in its balance sheet, Merrill also announced late Monday it would sell $8.5 billion in new common stock. The sale will dilute existing Merrill shareholders by about 38% — and is additionally painful because the firm will have to make extra payments to an investor that bought shares at a much higher price in an offering last December.”

The details of this disclosure – the death-spiral provision in Temasek’s previous purchases of Merrill common stock, and the financing offered by Merrill to Lone Star to entice it to buy the $30 billion of CDOs – are important but beyond the scope of this post. What you have to realize is that such substantial disclosure only 12 days after a quarterly report, and such punitive terms for Merrill shareholders, are outrageous. Therefore I am “upgrading” Merrill’s management, and John Thain in particular, to the distinction of using Enron-like accounting and disclosure practices, a disctinction I previoulsy awarded to Lehman Brothers and its CFO.

Another point is: should the SEC or a company’s CEO be entrusted with the job of determining a stock’s true value? Should they be the judge of what is rumor and what are the facts that management decide not to disclose to the investing community?

The answer is contained in the chart below. Recall that the SEC launched its emergency attack on naked short sellers on Tuesday July 15 (http://www.sec.gov/spotlight/shortsales.htm) and that Merrill released its second-quarter 2008 results on Thursday July 17.

Despite the attempts by the SEC and company management to manipulate stock prices, the market knows better. The SEC’s actions against short sellers, and failure to act to curb faulty disclosure by company insiders, damage the credibility of the US stock market. You would expect to see such manipulation by a regulator in China, not in the US. The Economist magazine said it best in this July 17 article (emphasis added by Spencer Jakab of Dow Jones Newswire):

“Bear markets often involve bare-knuckle fights, but it is still a shock when the referee starts punching below the belt. The Securities and Exchange Commission (SEC) has intervened in the epic struggle between financial companies and the hedge funds that are short-selling their shares…The SEC’s moves deserve scrutiny. Investment banks must have a dizzying influence over the regulator to win special protection from short-selling, particularly as they act as prime brokers for almost all short-sellers…

The SEC’s initiatives are asymmetric. It has not investigated whether bullish investors and executives talked bank share prices up in the good times. Application is also inconsistent. The S&P500 companies with the biggest rises in short positions relative to their free floats in recent weeks include Sears, a retailer, and General Motors, a carmaker. Like the Treasury and the Federal Reserve, the SEC is improvising in order to try to protect banks. But when the dust settles, the incoherence of taking a wild swing may become clear for all to see.”