DD Support Board and Research Team

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Does Securities Fraud Matter Anymore?

COMMENTARY
By Howard Fischer
Dec. 2, 2021 5:00 am ET


About the author: Howard Fischer is a partner with Moses & Singer’s securities litigation and white collar practices. He was senior trial counsel at the Securities and Exchange Commission from 2010 to 2019.

As a former securities fraud prosecutor, I often wonder, based on recent events, whether fraud is needed anymore to pitch worthless stocks.

When I was a senior trial counsel at the Securities and Exchange Commission, my bread-and-butter case was of the company that tried to juice its share price through fictitious statements about its prospects and economic activity. Claims of lucrative contracts, investments and acquisitions, or of new product lines were among the most common ways to get investors excited about the company so that they would purchase shares. In fraud cases, this activity was designed to generate interest so that insiders could leverage their investment or ownership interests and sell at high valuations.

Looking at market behavior now, I wonder whether it was all in vain. We seem to be moving to a post-reality world where stock ownership is less a sign of faith in a company’s prospects than a marker of tribal affiliation. The most recent prime example of this is the proposed acquisition by Digital World Acquisition (ticker: DWAC) of former President Donald Trump’s Trump Media & Technology Group, and the resulting frenzy.

DWAC was incorporated in December 2020 as a special purpose acquisition company, or SPAC. In its May, 25, 2021 S-1 filing with the SEC, DWAC stated that had “not, nor has anyone on our behalf, initiated any substantive discussions, directly or indirectly, with any business combination target” and that its target was “middle-market emerging growth technology-focused companies in the Americas, in the [software-as-a-service] and Technology or Fintech and Financial Services sector.”

DWAC went public in September 2021. Many, if not most SPACs, take well over a year to find a target. Within a month, DWAC had a fully executed agreement in place for its target—and not one of its stated target category—announcing that it had agreed to acquire TMTG at an “initial enterprise value of $875 million, with a potential additional earnout of $825 million in additional shares (at the valuation they are granted) for a cumulative valuation of up to $1.7 billion.”

When the acquisition was announced on Oct. 20, 2021, TMTG’s company overview listed no operations, employees, or contracts, as CNBC reported. It used Trump’s Mar-a-Lago private club as its mailing address. Only hours after the announcement of a social media platform (Truth Social), hackers purported to have created a fake account in the name of the former president, with its pinned post being a picture of a defecating swine. None of that seemed to matter to investors.

On Oct. 19, DWAC’s share price was $10. Upon announcement that it would acquire TMTG, it shot up past $90 per share by Oct. 22, seeing an intraday high of $175 per share, although more recently it has traded generally around $50 and is trending lower.

Even with its downward share price trend, TMTG currently enjoys a multi-billion-dollar valuation—one in excess of the claimed value of Trump’s other possessions. DWAC has been among the most actively traded equities over the last few weeks, and has been enormously popular on the Reddit chatroom seen as largely responsible for the meme stock frenzy.

While in many ways this is an amusing commentary on the state of markets today, it is troubling for several reasons. First, we count on market mechanisms being efficient allocators of capital, with investors directing funds to companies with better prospects, and expecting riskier alternatives to provide correspondingly higher returns. When political considerations and cultural identity color investment choices, there is the risk that companies will be deprived of capital (or undeservedly be the recipient of it) for non-economic reasons.

The greater risk, however, might be that this apparently legal behavior makes the frauds I pursued as a prosecutor unnecessary. What remedies are there if people willingly and enthusiastically invest in companies with no actual operations or revenues, let alone profits? If companies no longer need to show even the illusion of good economic prospects, but only need a politically charged story, the risk increases that retail investors will ultimately bear the brunt of losses. Indeed, as retail investors piled into DWAC, the hedge funds that were early investors sold their stakes at high profits. For the retail investors who bought in to show their support of Trump, results might ultimately be far worse.

Perhaps this is only a temporary anomaly without far-reaching effects. But there is also the risk that it is a harbinger of a new means of fleecing credulous investors. Against deliberate fraud and misconduct, regulators have an arsenal of weaponry. But against willful self-delusion and disregard of market realities, they stand powerless.

https://www.barrons.com/articles/does-securities-fraud-matter-anymore-51638403696?mod=hp_LATEST