Chat 'n Chewed Up: A PairGain Parable

The case may be the clearest sign yet that the Internet's populism has turned investing into a game in which often-questionable information moves stocks.
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When money manager Charlie Smith saw the spike in

PairGain Technologies'

(PAIR)

stock, he didn't go to

Bloomberg

or

Dow Jones

in search of information. He went to

Silicon Investor

.

"I have PairGain's thread on Silicon Investor bookmarked," says Smith, who runs money for Pittsburgh-based

Fort Pitt Capital

.

It was early in the trading day on April 7.

At the other end of Pennsylvania, on the outskirts of Philadelphia, James Cooper turned on his PC shortly before trading began and visited the same SI thread for a routine check of the daily chatter. Cooper likes to comb messages for what he calls "contrarian indicators." Often, when messages grow too enthusiastic he sells.

Reading and Believing
PairGain shares' movement on April 7

Source: BigCharts

Just after trading began, Cooper spotted a link to what purported to be a

Bloomberg

story. He clicked through and found the piece.

Minutes later and more than a thousand miles away in Lawrence, Kan., George Roberts, a local landlord and sporadic online trader, was weighing a decision over his breakfast, a cup of coffee. He had seen the PairGain news during a routine morning run through the SI boards. Now, Roberts was trying to decide whether to add to his 500-share position. At first glance, he had no reason to doubt the buyout news.

Then he noticed the stock wasn't rising as quickly as one would expect on a takeover bid. He reassured himself, he says, by looking at the stock's heavy volume. "I figured with this volume, this couldn't have been just message board nonsense," he says.

Indeed, it was more than message board nonsense. It was a fake. The report that PairGain was being acquired by Israel's

ECI Telecom

(ECILF)

was fake. The purported

Bloomberg

story was fake. The site it linked to that looked like

Bloomberg's

site was fake.

On Thursday, the

FBI

arrested Gary Hoke, a 25-year-old PairGain employee in North Carolina. According to the

Justice Department

, Hoke was charged with one count of securities fraud for allegedly "disseminating false information."

The motives of Hoke, who faces up to 10 years in prison and a $1 million fine, are unclear. In an affidavit filed in the case, the FBI doesn't allege that Hoke traded PairGain stock on April 7, although he has traded online and even traded PairGain as recently as January, the Justice Department says. A PairGain official confirmed that Hoke was an employee. Hoke couldn't be reached for comment.

This ruse is so much more than another tired parable about the dubious world of online investing and the stock-touting message board denizens. It is, perhaps, the clearest sign yet that the populism of the Internet has turned investing into a game in which often-questionable information sends stocks on roller-coaster rides and involves everyone from online traders sitting at home to savvy professionals. Many of these people trade stocks, not companies, often based on innuendo, not analysis.

One Canadian investor who would disclose only his Net handle, "Peppe," bought and sold 4,000 shares into the fake reports. He turned a $3,000 profit on a 20-minute investment. And he wouldn't hesitate to do it again: "If I knew

stock news was wrong and the stock was still going up, I'd trade it."

Perhaps most important for the person behind the PairGain hoax, this cauldron offered a sort of nuclear-powered incubator for false information.

Outside Philadelphia on the morning of the hoax, Cooper read the fake

Bloomberg

story and immediately grew leery. Why were there no ticker symbols in the story? He went to the actual

Bloomberg

site and noticed that the PairGain story was missing from the top stories list.

Still, Cooper decided to climb aboard as the stock rose. "I guess I was just getting on for the ride," he says. "At that point you're not thinking hoax, you're thinking 19 bucks a share," the price he figured using the overall purported buyout price.

At 10:01 a.m. EDT, using his online-trading account with

Charles Schwab

, Cooper snapped up 1,000 shares from 9 7/16 to 9 1/2.

While reluctant to use the term "retired," Cooper two years ago closed his career as a computer-network administrator. The 46-year-old investor characterizes his personal trading as a preoccupation more than an occupation. Last year, Cooper's portfolio grew about 40%, and he's up about 10% this year. He had owned PairGain since September.

Back on Silicon Investor, Fort Pitt Capital's Smith was starting to see what all the fuss was about. Smith saw the PairGain thread was alive with new messages about a takeout bid for PairGain for $1.35 billion in cash.

As Smith read on, he found an SI message that seemed to summarize what all the fuss was about. The SI message linked to another message posted on the

Yahoo!

(YHOO)

message boards at the start of trading by a poster called "staceyITN." The Yahoo message linked to the fake

Bloomberg

page.

"The site really looked good," Smith says. But Smith's suspicions were aroused by the lack of any share price for the stock. When Smith calculated the per-share price, he saw PairGain was up only to 11 and change on "news" of what he figured would be roughly an $18-per-share buyout. "It was so far below the price, I knew it couldn't have been real," he says. "An $18 bid would take an $8 stock to $16 or $17, not $10 or $11," he notes. (PairGain hit a high of 11 7/8 on April 7, a 31% increase over its close the day before the hoax.)

It was enough to send Smith to his Rolodex. "I decided to go right to the horse," he says. After leaving two messages, he finally reached PairGain's investor relations department.

In Kansas, Roberts was still deciding what to do. "I was going to log into

Waterhouse Securities

where he has his brokerage account, and I even went to the home page, but then I didn't go through with it," he says. "Greed makes you do things without thinking." After giving the matter some more thought, Roberts decided he was content with the 500 shares he already owned.

Meanwhile, outside Philly, Cooper kept checking on his new investment. On the fake

Bloomberg

page, he began taking out letters from the page's Web address, essentially backing up. That put him at

Angelfire

, an online community managed by

Lycos

(LCOS)

that allows members to create their own Web sites.

"I realized

the PairGain story was a phony page," he says.

About the same time in Pittsburgh, Smith, who had yet to buy any PairGain shares, had the company's IR department on the line. The company representative said the news was false. Within minutes, Smith had posted the company's denial on SI.

Cooper grew more worried and decided he wanted no part of such a dicey trade. Shortly after 10 a.m., he exited the stock he had bought about 10 minutes earlier at roughly the same price. Net of commissions, Cooper figures he lost $40.

Roberts in Kansas says he was lucky. "It was an interesting day," he says. "I am really amazed there is so much power in the Internet. These sites

like SI and Yahoo! can really move stocks, and not just the penny stocks, but everything."

Do you rely on message boards for investment information?

Yes

No

Has the PairGain incident affected the extent to which you rely on message board posts for information?

Yes

No

Message board postings are ....

the truth and nothing but the truth

to be taken with a grain of salt

somewhere between the two