Constitutional and Regulatory
Cite as: Chelsea Peters, Whole Foods, Unwholesome Practices: Will Sock Puppeteers be Held Accountable for Pseudonymous Web Postings?, 5 Shidler J.L. Com. & Tech. 4 (Sep. 23, 2008), at http://www.lctjournal.washington.edu/Vol5/A04Peters.html.
©Chelsea Peters
The Federal Trade Commission recently exposed Whole Foods’ CEO John Mackey for having made pseudonymous posts on financial message boards for over seven years. Mackey’s practice of “sock puppeting,” or posting under a false identity to praise and build support for one’s company, is becoming more common among high-powered corporate executives who have few other outlets in which to vent their frustrations and spar with their critics. In July, the SEC began an informal investigation into Mackey’s posts. This article examines the liabilities sock puppeteers may face under current securities regulations, particularly § 10b-5 of the Securities Exchange Act of 1934 and Regulation Fair Disclosure (“FD”).
<1>For nearly eight years, John Mackey, the CEO of Whole Foods Market, used a pseudonym to make posts on Yahoo! financial message boards, promoting stock of his supermarket chain and bashing competitor Wild Oats Markets, which Whole Foods was bidding to acquire.2 Mackey’s online comments are an example of a new practice, known as “sock puppeting,” in which individuals post on message boards under false identities to praise and build support for their own companies.3 The Securities Exchange Commission (“SEC”), in order to determine whether Mackey will be held liable for his actions, is now informally investigating every word of the over 1,200 posts Mackey made from January 1999 to August 2006.4 This article will first define the practice of sock puppeting and suggest why it has recently come under scrutiny by the SEC. Next, the article will discuss possible liabilities for sock puppeteers under securities law, including possible violations of both anti-fraud and selective disclosure provisions. Finally, this article will address how the practice of sock puppeting may impact securities law in the future. These issues will be considered through the context of the recent exposure of John Mackey’s history of pseudonymous posting.
<2>“Sock puppeting” is defined by the New York Times as “the act of creating a fake online identity to praise, defend or create the illusion of support for one’s self, allies or company.”5 Based on this definition, the practice of sock puppeting appears to be an updated version of the “cybersmears” that haunted corporations throughout the 1990s.6 “Cybersmearing” has been defined as “the practice of anonymously posting messages on the Internet through the use of message boards and chat rooms, which assert disparaging, or even defamatory rumors or statements about a company, its executives, or its stock.”7 “Cybersmearing” received SEC attention when companies and investors began using it as a market manipulation device.8
<3>In recent cases, sock puppeting appears to have distinguished itself from cybersmearing by being used more as a means of bolstering one’s own company than as a method of adversely affecting another company. Although stock prices may be affected by this practice, the purpose of sock puppeting may center less on manipulation of securities and more on building support for and defending one’s company against critics.9 Regardless of the puppeteers’ precise intent, sock puppeting is becoming a pertinent concern to corporations as it becomes a more common practice among company executives.10 Paul Kedrosky, author of the blog Infectious Greed, states he is “convinced this [Mackey’s behavior] is the tip of the iceberg” when it comes to business people and sock puppeting.11
<4>While the temptation to make pseudonymous posts may be difficult for some company leaders to resist, the practice could result in severe repercussions to both the company and the individual if the sock puppeteer is exposed.12 Pseudonymous posting can create liability through allegations of fraud, deceit, and market manipulation.13 It is imperative that the SEC begins to clarify the application of securities laws, specifically §10b-5 of the Securities Exchange Act, to fraudulent practices, such as sock puppeting, that have arisen out of recent technological advances.14
<5>The SEC has clarified some of the risks of sock puppeting. Namely, if the statements made by corporate executives under pseudonyms are perceived by the public to be insider information, securities markets and stock prices could be inflated or deflated accordingly.15 Any false or misleading statements Mackey made about either Whole Foods or Wild Oats could be regarded as an attempt to manipulate either company’s stock, a clear violation of securities regulations.16 Under the relevant securities laws, false or misleading statements by pseudonymously posting CEOs could lead to financial and/or criminal liability.17 The SEC will likely be investigating Mackey’s posts for two main securities violations—statements that include false information and statements that violate selective disclosure statutes.18
<6>While many of Mackey’s posts will lead to little more than public humiliation,19 posts that could be of legal significance, however, include predictions regarding the stock performance of Whole Foods and Wild Oats.20 For example, Mackey wrote in June 2006, “So long as Whole Foods same store sales are in double digits the next 2 quarters, the stock won’t trade below $50 per share (and probably not below $60).”21 Disparaging remarks by Mackey about Wild Oats will also likely be scrutinized by the SEC, such as: “Whole Foods is systematically destroying their [Wild Oats’] viability as a business—market by market, city by city,”22 and “[Wild Oats] still stinks and remains grossly overvalued based on very weak fundamentals. The stock is up now, but if it doesn't get sold in the next year or so it is going to plummet back down. Wait and see.”23
<7>Securities law experts suggest that Mackey’s comments could violate securities laws for a number of reasons.24 These reasons fall into two major categories. First, Mackey may be liable for making statements that qualify as fraud under §10b-5 of the Securities Exchange Act of 1934.25 The concealment of a CEO’s true identity through use of a pseudonym may be an illegal misrepresentation in and of itself, or could be considered an “omission of a material fact.”26 Second, Mackey may be liable for acting in violation of Regulation FD or for other acts addressing issues of selective disclosure.27 Many securities law experts believe Mackey’s posts were a blatant attempt to manipulate stock prices.28 However, the pseudonymous nature of the posts will make it difficult to prove that others interpreted Rahodeb’s statements as credible inside information that could be used when making decisions regarding the purchase or sale of securities.29
<8>The Securities Exchange Act of 1934 (“1934 Act”) was adopted to address the problems of securities fraud and market manipulation. Various manipulative practices were prohibited by the 1934 Act, which has been reasonably successful in preventing the kind of widespread market manipulation that thrived in the 1920s.30 The antifraud provision most commonly invoked from the Act is §10b-5, which has the broadest reach.31 Section 10b-5 has been termed a “catch-all” anti-fraud provision, prohibiting all manipulative or deceptive acts or devices in connection with the sale or purchase of securities.32 Specifically, §10b-5 provides:
“It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange,
a) to employ any device, scheme, or artifice to defraud,
b) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of circumstances under which they were made, not misleading, or
c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.”33
<9>In order to be liable under §10b-5, a defendant must satisfy certain requirements. First, the Supreme Court has held that a defendant must have acted with “scienter,” or knowingly.34 In addition, under §10b-5(b), a defendant’s statement or omission must rise to the level of a “material fact.” In TSC Industries v. Northway, the Supreme Court held that, “an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.” 35 Later, in Basic Inc. v. Levinson, this standard was held to apply in §10b-5 cases as well.36
<10>The SEC will likely be looking determine whether any of Mackey’s posts contained false statements, statements contradicting previous company comments, or overly optimistic “forward-looking statements” regarding Whole Foods’ future.37 If any of Mackey’s posts contain false statements of material fact, connected to the purchase or sale of securities, he could be held liable for any effects his misstatements may have had on securities markets or investor actions. It may be difficult to prove that Mackey deliberately attempted to manipulate the stock prices of Whole Foods or a rival company.38 However, the scienter requirement of §10b-5 only necessitates a showing of recklessness, and there is likely to be sufficient evidence that Mackey acted recklessly.39 The SEC will look to §10b-5 in considering whether Mackey’s statements constituted fraud or deceit, and whether a “reasonable investor” may have relied on them in making securities decisions.40
<11>Whether or not the SEC will find Mackey liable under §10b-5(b) will depend on whether any of his statements satisfy the materiality requirement. When Mackey posted statements as Rahodeb, he omitted to state that he was the CEO of the company he was praising. It can be argued that because Mackey used a pseudonym, the market was unaware of his connection to inside information at Whole Foods, and therefore had no reason to consider his statements “material.”41 However, multiple participants on the Yahoo! message board suspected that Mackey was behind the Rahodeb posts.42 Rahodeb’s “extensive and informed opinions” caused other participants to question, “Is Rahodeb an insider?”43 Mackey’s varying responses to these inquiries could affect the SEC’s findings as well. In one of his more brazen posts, Mackey asserted, “dcc7 has claimed that my true identity is John Mackey. You can believe that one or not. Doesn't matter to me. If I really am Mackey then I'm the ultimate insider at Whole Foods and you would be well served to pay attention to what I have to say on this board.”44 Posts questioning Rahodeb’s identity, and Mackey’s response to these posts, provide support for the argument that “reasonable investors” would have looked to him for inside information that could be relied on in making decisions regarding the purchase or sale of securities.
<12>The second category of potential liability for sock puppeteers involves a violation of Regulation Fair Disclosure (“FD”), a regulation issued in 2000 to stop company executives from intentional or unintentional “selective disclosure” of information to favored shareholders or analysts.45 Regulation FD does not prohibit selective disclosure entirely, but rather requires companies that accidentally disclose material nonpublic information to selective investors to reveal this information to the entire public within twenty-four hours of the initial disclosure.46 Regulation FD states:
“Whenever an issuer, or any person acting on its behalf, discloses any material nonpublic information regarding that issuer or its securities . . . the issuer shall make public disclosure of that information:
(1) Simultaneously, in the case of an intentional disclosure; and
(2) Promptly, in the case of a non-intentional disclosure.”47
<13>It will be difficult to fit Mackey’s actions into the framework of Regulation FD, since FD was created to prohibit selective disclosure to market professionals and analysts, not message board forum investors.48 However, one class of nonpublic information recipients specified in the regulation are those that hold the issuer’s securities, “under circumstances in which it is reasonably foreseeable that the person will purchase or sell the issuer’s securities on the basis of the information.”49 It is likely that at least some of the message board investors speaking with Mackey fall into the population this section of the rule describes. As applied to Mackey, Regulation FD will require a three-part analysis. First, the SEC will need to prove that Mackey’s posts disclosed material nonpublic information.50 The SEC will look to Mackey’s over 1,200 posts to determine whether any new information was disclosed. As in the case of §10b-5, this analysis will likely hinge on the issue of “materiality,” according to the standard set forth in TSC Industries.51 Second, the Commission will need to prove that Mackey was viewed as either “an issuer” or “any person acting on [the issuer’s] behalf.”52 It is a distinct possibility that this could be shown, given Mackey’s position and forum participants’ comments regarding Rahodeb’s extensive knowledge.53 Third, to hold Mackey liable under Regulation FD, the SEC will need to prove that Whole Foods knew or learned about the selective disclosure, and subsequently failed to “promptly” disclose the information to the public.54
<14>Since Mackey used a pseudonym, it will be difficult to directly attribute the posted information to Whole Foods Market. Although Mackey, as CEO, can certainly be viewed as a spokesperson and agent of the company, violation occurs under Regulation FD only when the company itself or a person acting on its behalf selectively discloses the information or is complicit in its disclosure.55 While Mackey surely exercised poor judgment, his posts were arguably not intended to speak for the company.
<15>The above analysis assumes that Mackey’s statements on the Yahoo! message board were not public disclosures in and of themselves. However, the SEC may well find that Mackey’s Web postings meet the definition of public disclosure for purposes of satisfying Regulation FD.56 Regulation FD states that public disclosure is accomplished by either: (1) furnishing or filing a Form 8-K with the Commission; or (2) “disseminating the information through another method (or combination of methods) of disclosure that is reasonably designed to provide broad, non-exclusionary distribution of the information to the public.”57 Since the public has unrestricted access to the financial message board where Mackey posted, this method of disseminating information might be interpreted as providing “broad, non-exclusionary distribution of the information to the public” under clause (2) of the public disclosure definition set forth by Regulation FD.58
<16>Currently, the law remains somewhat unclear regarding the repercussions of sock puppeting. If Mackey is held to have violated the Securities Exchange Act or Regulation FD, 59 there may be implications for cases that arise in the future. The publicity that Mackey’s case has already generated could mean that an SEC clarification that §10b-5 is applicable to sock puppeting will effectively eliminate the practice entirely. Even in the absence of a formal condemnation of sock puppeting by the SEC, corporations are likely to amend company policies and begin holding executives accountable for this and similar practices. Although Whole Foods recently announced that it had completed its internal investigation and would continue to support Mackey,60 a change to Whole Foods’ Code of Conduct has already been made: as of November 2, 2007, executives are explicitly banned from making anonymous or pseudonymous posts.61 Whole Foods has made it clear that a violation of the amended code of conduct qualifies as grounds for dismissal.62 Other companies have recently amended their policies as well, although most of the updated codes are less strict than that of Whole Foods, the specificity of which some believe to be “an overreaction.”63 Companies like Hewlett Packard and Microsoft have kept their policies regarding blogs and online postings broad by containing only general prohibitions against posting material information that would cause financial harm to the company or violate securities laws.64 Microsoft’s trust in the judgment of its employees is revealed through the company’s code of conduct, which, according to securities analyst Josh Bernoff, can be summed up by a single sentence: “Don't be stupid.”65
<17>Sock puppeting as a practice among high-powered corporate executives is unlikely to persist unregulated much longer.66 Whether this practice will be regulated through anti-fraud provisions, selective disclosure provisions, or simply by company policy has yet to be determined. Nevertheless, the SEC has made it clear through its recent investigations that pseudonymous posters can and will be held accountable for any false comments or misstatements made in violation of securities laws.67 The illusion of the Internet as a Mecca of anonymity can be a risky belief to maintain. Sock puppeteers’ carefree posting days appear to be numbered.