04/26/2013 06:08 EDT | Updated 06/26/2013 05:12 EDT

When Terrorism Meets Financial Fraud

This was the first chilling example as to how cyber terrorism could bring down the financial system, or specific institutions or persons. Obviously, new safeguards must be put in place by legitimate media brands, regulators, new media outlets like Twitter, markets, corporations and governments.


In the good "old" days of quality financial journalism, stories had to cite named sources and accurately unearth facts. Even then, those that would effect stock prices would be meticulously edited and "lawyered" before publication.

Some tried to get around these rules but it was impossible to plant a bogus story on the front page of an important newspaper. At the edges, there were shenanigans and one stock fraudster in the 1970s convinced a foreign newspaper to print bogus prices of Canadian stocks in order to lure investors into his fictitious companies. But the paper was inconsequential and only a feckless few were victimized.

But this week, on the heels of the Boston bombing, financial fraud and terrorism joined forces when a fake tweet from a hacked Associated Press account reported that Barack Obama had been injured due to explosions at the White House.

Within three minutes, the S&P500 collapsed by $130 billion and the Dow Jones lost 145 points. By then, the White House, Associated Press and Twitter exposed the fraud and by the end of the day markets recovered. But as the Economist wrote, "that [drop] understates the severity of the episode, since in many cases liquidity simply disappeared altogether."

It also underrates the threat in future. This was the first chilling example as to how cyber terrorism could bring down the financial system, or specific institutions or persons. Obviously, new safeguards must be put in place by legitimate media brands, regulators, new media outlets like Twitter, markets, corporations and governments.

Not coincidentally, the Twitter crash happened weeks after the Securities and Exchange Commission allowed companies to use Twitter or Facebook to report news. This, in turn, led to an announcement by Bloomberg and others it would transmit tweets to its clients. This, in hindsight, was the slippery slope.

Such permission must be reversed now because Twitter, Facebook and other social media do not validate, curate, control, lawyer or stand behind their Twitter litter. They are agnostic pipelines that are leaky, and allow anonymous sources to open accounts, post false information and hack into other accounts to do so. This is how Associated Press was violated.

This week's crash involves more than Twitter but once more illustrates a structural problem within markets. The fraud lasted only three minutes until recantations, but a future hack-attack on the Twitter accounts of two or more credible media outlets like Associated Press - that could not be recanted for hours or days -- could spark a downturn in stock, exchange or commodity markets that would cause untold damage.

The system remains vulnerable due to high frequency trading, or robots with algorithms. They scan news for words like "explosions" and act accordingly. This week's AP Tweet triggered an automatic sell-off. This would not have happened in the past because human beings, or experienced editors, in legitimate media outlets would have had time to evaluate the context or validity of the information.

Wall Street claims that the only reform necessary to avoid future Twitter crashes would be to devise more sophisticated algorithms that would look for multiple sources or confirmation. But terrorists and fraudsters will simply hack around such algorithms unless more measures are taken.

The terrorists who claimed responsibility for this - the Syrian Electronic Army - are being investigated. This unknown entity, favoring the repressive Assad regime in Damascus, also recently claimed responsibility for hacking into the BBC, NBC, CBS, NPR, Columbia University, Al Jazeera, Human Rights Watch and the head of FIFA, the world soccer organization. Its website supports for "the cause of the Syrian Arab people by armaments with science and knowledge against the campaigns led by the Arab media and Western on our Republic by broadcasting fabricated news about what is happening in Syria".

What's needed is a return to the good old days. What will speed this along would be laws that make any liable for financial damages who transmits, or loses money for others by trading without verification of information.

Another reform would be a return to the tenets of solid financial journalism from the pre-Internet days. These include a demand to provide multiple sources, curation, fact-checking and author credibility before publication anywhere.

Jacob Frenkel, former Securities and Exchange official, said on CNBC that restricting initial financial disclosures to public corporate websites and the SEC site would provide enough widespread information for investors. "A favoring of access information using various media that are available would make it fair for the SEC to retrench and back off its position [concerning allowing disclosure on Twitter or Facebook, etc.]," he said.

If that restricts the future profits of Twitter and Facebook and all the other sloppy sites so be it. Frenkel is correct. There should be one-stop shopping for credible information that affects markets directly from the sources itself, companies or governments. This means that investment information could still come via other outlets but there would be a means of double-checking information at the corporation or SEC. They would also have to erect impregnable firewalls.

Such changes will work. After all, markets were the wild west more than a generation ago and were cleaned for a while. Then, in the 1990s, a new generation of immorality swamped markets mostly due to credit default swaps that were issued without collateral and were rated questionably. This drove the world's financial system into bankruptcy in 2008.

Corrections have been made involving those practices, but the deregulation of dissemination is another mistake. Twitter and Facebook cannot curate or do what credible news organizations spend enormous amounts of money doing. To deputize them as disseminators represents the next big catastrophe waiting to unfold, aided and abetted by high frequency trading.

The dress rehearsal took place this week, thanks to terrorists, but the next one may be hackers who use corrupt multiple, credible sources with messages that create a panic among the robots who trade for financial gain or to sabotage the system.

What must be understood is what the Financial Times puts on the bottom of all its online stories to try to stop people using their content without payment: "High quality global journalism requires investment."

And the facts are that so does high quality free enterprise.

*This article originally appeared in the Financial Post.