FOOL PLATE SPECIAL: An Investment Opinion
Emulex Fraud Hurts All

On Friday somebody monkeyed with networking equipment company Emulex, posting a bogus press release saying the company was being investigated by the SEC, among other unpleasantries. By the time the market had absorbed it, the company had lost $2.5 billion in market value, more than 60% of its total. The stock was halted, but not before 3 million shares had been traded in a dead panic. But by the end of the day, the stock was nearly back where it started, and the search for the culprit was underway.

By Bill Mann (TMF Otter)
August 28, 2000

Friday morning, just as the trading day began, a shocking company press release from Emulex (Nasdaq: EMLX) hit the media waves. The release claimed that Emulex was suffering the corporate version of a nuclear holocaust. It stated that the most recent quarter's earnings would be revised from a $0.25 per share gain to a $0.15 loss in order to comply with Generally Accepted Accounting Principles (GAAP), and that net earnings from 1998 and 1999 would also be revised. It also said Emulex's CEO, Paul Folino, had resigned and that the company was under investigation by the Securities and Exchange Commission.

Trouble is, none of it was true.

The real trouble was that Emulex shares plummeted from their Thursday close of $113 per share to $43 -- a rapid 61% haircut that took more than $2.5 billion off of the company's hide -- before the shares were halted an hour later. The damage had been done: More than 3 million shares had traded hands at the artificially low rates. Emulex vociferously refuted the authenticity of the press release, and by the end of the day the company's shares closed within a few percentage points of where they had opened.

Some investors have been hurt badly
When the story first broke, it sounded awfully similar to the facts surrounding MicroStrategy's (Nasdaq: MSTR) March meltdown. But once the story was put in question, it became clear that a little distance and some additional facts would be helpful.

Unfortunately, conclusive facts at this point are pretty hard to come by, except for these:

• Those who panicked and sold, or those who had sell-stops, were the big losers on Friday
• Those who held were essentially unharmed
• Those who bought or closed short positions in the early trading hours made out like bandits.

And guess what? Somewhere out there -- probably among those last two groups -- is someone who is just that: a bandit. I'll deal with him in a second.

This story may be the perfect, gilt-edged example of why we counsel business-centric investing in place of market-based trading. An investor who had taken the time to familiarize herself with the business fundamentals of Emulex, the products, and the market, may have had the edge on Friday morning when panic ensued.

The company either has a viable product, or it does not. It either has a dynamic strategy for an addressable market, or it does not. The press release said nothing at all about the company's execution or market strength, so even if it HAD been true, business-centric investors would have had more information upon which to base their decisions.

It can be hard to stomach the halving of your company's shares in a morning's time. And yes, there can and will be surprises even a well-informed investor could not have foreseen. But by and large, good preparation will be the pemmican that helps Fools weather the market's short-term storms.

Stock manipulation and fraud is nothing new. But the Internet and its facility to wide dissemination of information has provided fertile ground for manipulators to prey on investors, inexperienced and seasoned alike. Instant dissemination means that those who intend to act upon said information must make snap judgments. In this case, many of those who did got hosed, and early indications from the SEC are that they intend to let the trades stand.

Why this action hurts all of us
But there is a greater evil at play here. A capital market can only work if those invested in it can reasonably trust the information coming from official sources. Those who spread false information for personal gain not only game the market to their favor, they also destabilize it.

The United States' capital markets are the largest and most trusted in the planet. Countries that lack the institutional controls available here place their domiciled companies at a competitive disadvantage for investor money. So when someone monkeys with the U.S. market system for their own gain, Fools need to stand up and take notice. This does not just hurt Emulex shareholders, it hurts all of us.

And you, the fractional human being who did this: The FBI and the SEC are looking for you. I hope you enjoy your ill-gotten gains, and I recommend that you spend them quickly. May you live in a house with 1,000 rooms, and may you have 1,000 beds in each room, and may you be lying on each of those beds, as a flesh-eating virus rends you asunder. Well, that or you get caught, prosecuted, convicted, and sued.

End of rant.

Your Turn:
Got an axe to grind? Come to the Emulex discussion board and let us know how you feel. If you want to really get your point across, make it a haiku.

Related Link:

A Postmortem on MicroStrategy, Fool on the Hill, 3/22/00