GameStop is a struggling brick-and-mortar video game retailer which was severely affected by the COVID-19 shutdowns and the long-term decline in retail mall traffic. It all started on social media platform Reddit, where members of the wallstreetbets forum (where more than four million people discuss stocks and shares) took a stand against Wall Street. As GameStop is located in a mall, the business had been struggling owing to lockdown measures, so Wall Street hedge funds shorted GameStop stocks (betting on the stock market that it would lose a lot of value). Then wallstreetbets joined and decided to swap tips and buy shares in GameStop which resulted in a significant increase in the share price, turning mainly to commission-free trading app Robinhood.

The pandemic has seen an inordinate surge in day traders, and they’ve effectively taken on Wall Street by buying up shorted stocks. GameStop is not the only instance of this; stocks in other companies such as BlackBerry and AMC Entertainment, known as meme stocks, have also been picked up by the new wave of day traders. Since the beginning of February when the trading frenzy dried up, the stocks have suddenly seen a huge drop, triggering multiple trading halts in GameStop; the saga continues to bemuse economists, politicians, and regulators.

Is this market manipulation?

The US Securities and Exchange Commission (“SEC”) are looking into social media and message-board posts on platforms like Reddit for signs that fraud played a role in the massive stock swings for GameStop, AMC Entertainment, BlackBerry, and others. This is being conducted together with efforts to evaluate whether such posts represent a manipulative effort to drive up share prices, i.e. market manipulation. This came after suggestions were made that professional investors got involved and either took advantage of the Reddit fever, or indeed, helped hype it. Whilst the SEC has not confirmed that it took heed of those voices, the agency announced it was looking at “compliance with regulatory obligations, adequate and consistent risk disclosure, and determining if any fraudulent or manipulative behaviour has occurred.”[1]

With GameStop’s shares drastically retreating from the first week of February 2021, there is an increasing pressure on the SEC to investigate and find out what caused the unexpected surge of stock price. The US Senate and the House of Representatives have also got involved and are planning to hold hearings to look into the market frenzy, which triggered huge losses for some retail investors and prompted Robinhood Markets, whose app was used by a large proportion of the traders, to raise US$3.4bn to cover collateral demands.

The People v. Robinhood

This is not the first time Robinhood has caught the eye of politicians and regulators in the US. The SEC accused the company of misleading or failing to inform customers about how it profits from their trades. Robinhood advertises a ‘commission-free’ model, however, it is paid by trading firms in return for sending its customer orders to those firms for execution. The SEC said this practice resulted in Robinhood’s customers losing millions of dollars of profits. In December 2020, Robinhood agreed to pay a US$65m civil penalty to the SEC without admitting or denying the allegations.

Robinhood came under scrutiny in the GameStop saga for unexpectedly, and without prior communication to traders, suspending the trading of volatile stocks, such as GameStop. This came after clearing firms – which, it transpired, help resolve all transactions on Robinhood – demanded additional capital to help offset the high volume of transactions being processed.

Whilst we will have to await the verdicts of regulators and possibly courts on the legality of this conduct, it may be that what we are witnessing in the GameStop situation is not fraud or market manipulation. Instead, it could be seen as a new, not yet defined, branch of influencing the stock market and stock traders’ behaviour through something more akin to a viral movement on social platforms. The Meme stocks were arguably triggered more by decentralised chatter and ideas than coordinated actions or disseminated false and misleading information.

What does the crisis mean for future regulation?

Perhaps the most interesting and peculiar aspect of the whole saga is that it did not start out with a collective goal; some people’s trading was recreational, and others potentially to ‘get back’ at Wall Street for the 2008 financial crisis, and their legacy of dominating the markets. We are, however, likely to see some consequences of the GameStop saga, in terms of regulation – US politicians and high-profile businesspeople joined the conversation with their own analyses of the trend, triggering a need to evaluate what mechanisms are in place to supervise the exercise of this type of influence upon the stock market.

The SEC does not currently regulate social media or message boards, however, the agency has brought cases against individuals accused of making false claims about stocks online. In 2000, a teenager paid the SEC more than US$27,000 in profit to resolve allegations of buying microcap stocks, hyping the shares and then quickly selling them for profit.[2] More recently, in December 2020, the SEC sued a day trader for planting false rumours about companies.[3]

Shorting stocks is one of the ways for investment funds to make money and involves borrowing shares from another investor, betting that a company’s share price will fall and making a profit from the difference when it does. Unsurprisingly, due to the economic effects of COVID-19, malls and businesses have found their stocks shorted following a drop in share price as their businesses rely on customers visiting to profit. In the UK, the Financial Conduct Authority (“FCA”) posted its latest short positions (i.e. the companies that are most seeing their stocks targeted for shorting), among which are Sainsbury’s, struggling mall group Hammerson, and film theatre chain Cineworld.

Robinhood CEO Vlad Tenev and Reddit CEO Steve Huffman will testify before the US financial committee on 18 February 2018 with the title, “Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide.” They will be joined by two of Wall Street’s leading hedge fund managers, Citadel’s Ken Griffin and Melvin Capital’s Gabe Plotkin. The committee announced that Keith Gill, a trader known as “Roaring Kitty” who emerged as a key player in the GameStop rally, would also appear. Despite the fact that trading in GameStop has now stabilised, legislators and regulators are still interested in finding out whether the incident was caused by market manipulation or other systemic problems in the financial system.

As investigations are invariably long, drawn-out processes, it may be months – or even years – after the GameStop commotion has passed before there is a conclusion upon the legal and regulatory position in relation to the conduct under the spotlight. The episode will undoubtedly have broader implications for the retail market and may lead to changes in legislation and regulations to cover short-selling, trade settlement, investor protection, fair and efficient markets, online apps, and disclosure rules.

With a number of material developments (including the anticipated hearing of Vlad Tenev; the SEC investigation; and meetings of the US Treasury Secretary Janet Yellen with the SEC, the Federal Reserve Board, and the US Congress) scheduled over the coming weeks, a major legislative response is expected. They will have to consider, amongst other things, how the conduct which creates meme stocks fits within the current legislation, whether new regulations are necessary to cover them, and whether the recent activities are consistent with the need for investor protection, and the maintenance of fair and efficient markets. Indeed, the chain reaction ignited by the GameStop saga has the potential to change the landscape of the financial markets around the world.

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