Napoleon Is Dead! Wait, That's a Stock-Market Scam.

The news media have been abuzz for a few weeks about the proliferation and effect of fake news. Facebook Inc. is changing how it handles news from dubious sources, while Twitter Inc. is rethinking how to respond to bots promoting fabricated articles. Alphabet Inc. (Google) has rejiggered its algorithms to fight phony stories.

All of which raises some very interesting questions for investors and traders. It's worth remembering that financial markets have been dealing with hoaxes, frauds and fake news for a long time. The wrong response can be costly.

Back in the bad old days, faxes and message boards were used to defraud investors. Recall what happened to Emulex Corp. after a news release that was sent out over a business news wire — its stock plunged 60 percent. PairGain Technologies Inc., Lucent Inc. and other companies were also victims of fake releases posted on message boards. The list goes on and on: Avon Products Inc., Rocky Mountain Chocolate Factory Inc., Tower Group International Ltd., Sina Corp., Local Corp., Javelin Pharmaceuticals Inc. and General Mills Inc. were targets of similar scams. Last year, Twitter's price spiked after an article from a hoax domain that looked like a Bloomberg News site trumpeted a phony $31 billion takeover offer.

The manipulation of stock prices with false news stories has a long and ignoble history. Consider the trial of Lord Cochrane as recounted in the "Quarterly Journal of Jurisprudence: Volumes 9-10" (Jan. 1, 1860):

About midnight, on the 21st February, 1814, a person calling himself "Colonel du Bourg, aide-de-camp to Lord Cathcart," presented himself at the ship hotel at Dover. He represented that he had just arrived from Calais by a French smack—that he was the bearer of important intelligence from Paris, to the effect that Buonaparte had been killed by the Cossacks—that the Allied armies were in full March for Paris and that immediate peace was certain.

Confederates of du Bourg "dressed as French officers distributed leaflets in London announcing that Napoleon had been killed." Rumors of Napoleon's demise had been spread before, but a willing public was easily duped when told what it wanted to hear.

Not surprisingly, as reports of Napoleon's death spread through London, British government securities on the stock exchange soared. But someone at the exchange noticed 1.1 million pounds in government-based stocks was being quietly sold. An investigation revealed that du Bourg was not a colonel — he was really one Charles Random de Berenger. He was convicted, as were other parties to the fraud. They all served jail time.

Time magazine labeled the Great Stock Exchange Fraud of 1814 one of top 10 hoaxes of all time.

All of which is a long-winded way to say that fake news has been with us for a very long time and is likely to be with us for the foreseeable future.

It doesn't require a faux colonel to move markets or stocks today. Algorithms are harvesting social media sites such as Facebook and Twitter to drive new types of hedge fund. Some are looking for changes in sentiment to make macro bets; others are looking for company-specific information. But can they continue to generate profits if fake stock news begins to compete with real? A new arms race is likely already underway between algos separating real news from fake as they trawl the social networks looking for intelligence.

If we are lucky, these quant funds might find it profitable to lease these fraud-finding algos to Facebook, Twitter and Google (unless it's more profitable for them to keep the code to themselves).

Long-term investors have a different issue with noise. It isn't the news — real or fake — that's the problem; rather, it is their reaction to it. People with long investment horizons should learn to not react to the short-term stuff. If you are truly thinking in terms of years and decades, than does the next economic-data report (or anything else) really mean much to your portfolios?

Investors need to distinguish between the empty calories — gossip, rumors, idle speculation — and instead, focus on what is genuinely useful. Fake news may be foolish, but your reaction to it doesn't have to be.

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See these additional blogs by Barry Ritholtz:

Michael Lewis' Portrait of Two Men Who Changed the World

Beware of Data Mining: Market Lessons From the Election

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