U.S. regulators will likely examine GameStop Corp.’s quadruple stock over the past two weeks, a breathtaking buying spree supercharged by bullish dealers about the video game retailer on Reddit and other online forums. .
Yet for the Securities and Exchange Commission to fight online comments that hypes stocks are an uphill struggle, mainly because it is difficult to prove that these posts are part of an illicit scheme to manipulate the market. On the contrary, successful enforcement cases usually depend on the SEC showing that investors are knowingly spreading false information to trick other traders into buying or selling a stock.
“It’s an enforcement nightmare for the SEC,” said James Cox, a professor at Duke University School of Law who focuses on securities regulation. “The question is: where does manipulation start and when does it start to negotiate according to your own hunches and make your hunches known?”
As of now, GameStop has been a hit in the market, with its main victims being professional speculators like hedge funds who short-circuited its stocks. But the SEC has been sensitive in the past to the risk that mom-and-pop investors could get caught up in frantic buying that ends in big losses if the market turns around.
Anticipating this threat is a first test for Gary Gensler, President Joe Biden’s choice to lead the SEC. The former chairman of the Commodity Futures Trading Commission is seen as a tough watchdog and with everything from PSPCs to booming penny stocks, responding to bubbles could be a defining theme of his tenure.
While it started on obscure websites, the story of GameStop is now known to everyone on Wall Street. The 37-year-old video game retailer, his brick-and-mortar business model presumed dead amid years of declining profits, has become an obsession with amateur jocks on Reddit’s WallStreetBets forum, whose value thesis deep has turned into a craze that tests the courage of short sellers. While no regulator has weighed in on the chat campaign, its concerted nature is uncomfortable next to a title where 50% swings are now a daily feature.
For the SEC, it is not a fraud when someone claims that a stock is undervalued, even though such arguments are broadcast to millions of people via social media. What becomes problematic is if investors publish specific claims that are not opinions, such as claiming that a company is considering filing for bankruptcy. But focusing on such comments, figuring out who is behind it and what their motives are can be difficult for government agencies with limited resources like the SEC.
“If you can actually catch people knowingly transmitting fraudulent information, then it’s clearly illegal,” said James Angel, professor of finance at Georgetown University. “If all they do is say, ‘I think this business is a good buy,’ there’s not much nobody can do about it.”
SEC spokesman Kevin Callahan declined to comment.
One thing that can’t be said about GameStop’s chat room boosters is that they’ve been wrong so far. While people might disagree that the action has never been cheap, the past few days provide strong evidence that GameStop was vulnerable to short squeeze, with bearish bets totaling over 100% of its outstanding shares. Another strategy promoted on Reddit – calling brokers and insisting that they don’t lend shares short – is a standard client right.
Reddit is also commonly used to jack up captions which, unlike GameStop, have stopped posting financial results and are not trading on regulated exchanges. In such cases, the SEC often punishes not by preying on those who tout the stocks, but by suspending trading of the missing companies or revoking their registrations, preventing brokers from executing trades.
Such market momentum is an issue the SEC will increasingly face as Twitter and online message boards allow armchair stock analysts to broadcast their opinions like never before. There is no doubt that such opinions are being eaten up, in many cases by the army of investors who have been day trading during the coronavirus pandemic.
The SEC has shown that it is eager to tackle fraud involving the promotion of stocks, especially in cases of promoters touting stocks without revealing that they are paid by companies. Actor Steven Seagal and boxer Floyd Mayweather are among those the agency has accused of misconduct in recent years, both of whom have recommended initial coin offers. If the SEC found out that the posters on Reddit recommended action without disclosing compensation, then it could potentially lead to similar cases.
Moreover, law enforcement is not the SEC’s only tool to temper some of the mania that has gripped the markets over the past year. Last June, the SEC blocked Hertz Global Holdings Inc. from selling new shares that the bankrupt car rental company described as potentially “worthless.” Hertz was looking to profit from a nearly tenfold increase in its shares and investors were eager to buy back the shares before the SEC intervened.
The challenge for the SEC is that Hertz and other companies are quite receptive to their regulator’s demands. The same can’t necessarily be said of traders posting comments on the Reddit and Twitter discussion forums.