Gary Gensler hasn’t even been confirmed yet, but President Joe Biden’s pick to lead the Securities and Exchange Commission will take the helm amidst a growing tempest that threatens to swamp small investors.
The retail investor mania for GameStop and a handful of other struggling companies continued unabated into its second week, facilitated by online trading tools that let unsophisticated investors place complex, leveraged bets and egged on by an ostensibly grassroots network of day traders.
The SEC said in a statement issued Friday that it was “closely monitoring and evaluating the extreme price volatility of certain stocks’ trading prices,” adding that volatility can expose investors to losses and erode market confidence. “We will act to protect retail investors when the facts demonstrate abusive or manipulative trading activity,” the agency pledged.
There is a sort of general agreement among lawmakers and market observers that “someone” should do “something,” but little consensus on what or who — or even if any laws were broken over the course of a volatile week for equities. While some suggested that other financial rulemaking authorities such as the Consumer Financial Protection Bureau could potentially become involved, there remained a sense that institutions like the Treasury and Federal Reserve remained above the fray.
Ben Koltun, director of research at policy research consulting firm Beacon Policy Advisors, expressed doubt that Biden’s newly confirmed Treasury Secretary Janet Yellen would weigh in on the situation — at least in its current size and scope. “I don’t think it’s risen to the systemic level that would involve Yellen’s active participation,” he said. “As long as this remains a little more siloed, I think Yellen’s attention will remain elsewhere,” Koltun said.
“What we have right now is a limited group of companies experiencing this unusual trading. If it starts to expand beyond that, you might start seeing the Treasury get into it … but they’re looking more at the larger economic picture,” said Matthew Nielsen, a partner at the law firm of Bracewell LLP. “The SEC is limited on what it can do… even when trading seemingly results in an unrealistic stock price,” he said.
“I think it’s noteworthy that the SEC has not suspended trading in GME [GameStop] or any other of the affected tickers to date,” said Philip Moustakis, counsel at Seward & Kissel LLP and former senior counsel in the SEC’s Division of Enforcement. “It’s not in the SEC’s DNA to suspend trading short of some indication of wrongdoing,” he said — although he added that it would be reasonable to assume the agency’s enforcement division is investigating the goings-on of the past several days.
“The prices we’re seeing for all types of assets — not just those in public equities — seem to have a very loose relationship with what anyone might reasonably call a fundamental value. But are prices being manipulated?” said Tyler Gellasch, executive director of Healthy Markets Association, an investor advocacy group.
Gellasch said there are “weaknesses in regulation that have been exposed by these events,” such as a lack of clarity around how market players are incentivized and compensated. He also said the SEC should review capital and settling requirements for trading institutions, and consider revisiting or strengthening the guardrails intended to protect retail investors.
Many market experts blamed the proliferation of commission-free, app-based platforms that offer complex financial instruments to investors regardless of their level of experience.
Many blamed the proliferation of commission-free, app-based platforms that offer complex financial instruments to investors regardless of their level of experience. Barbara Roper, investor protection director for the Consumer Federation of America, said she hoped the SEC would examine “the excessive ease with which individuals are able to engage in risky options trading, and whether we need to restore a little friction to the system.”
“There’s a gamification that occurs on Robinhood that really invites a lot of volatility,” said Mazi Bahadori, chief compliance officer and vice president of securities at Altruist, a technology platform for financial advisers.
Two areas of potential interest for securities regulators could be the role that social media plays in amplifying and distorting market information, along with the compensation structure of online brokerages like Robinhood. “The SEC is all about protecting retail investors,” Koltun said, saying this could manifest as “better disclosure requirements for groups like Robinhood.”
Robinhood, which doesn’t charge commissions for trades, makes its money via payment for order flow, a term that refers to funneling trades to a larger financial entity to execute, in exchange for a tiny payment per trade. Consumer advocates have raised questions about whether or not commission-free platforms who make money this way are sufficiently transparent about the process.
A business model relying on this revenue stream also incentivizes those platforms to encourage customers to trade frequently. “It’s not a buy-and-hold [model],” Bahadori said. “They make money selling order flow, so it’s very much in Robinhood’s best interest for its customers to be trading frequently.”
“It’s very much in Robinhood’s best interest for its customers to be trading frequently.”
Legal experts said the SEC would probably seek to investigate who or what triggered the sharp escalation in GameStop’s stock price, and who reaped a windfall from that spike, predicting that regulatory enforcers will look for evidence of coordination between some of the louder voices on social media urging investors to pile into GameStop, and examine whether or not these de facto investor influencers deliberately spread misinformation.
“Is this really the result of a bunch of individuals getting together and groupthink, or was the spark for that occurring someone looking to manipulate the stock?… It’s not hard to believe that someone lit the fire there that stood to benefit from trading in a stock that doesn’t really seem to be supported by the fundamentals of the company,” Nielsen said.
“If this really is the mania of the crowds, then it’s difficult to see what theory of market manipulation would be available to the enforcement staff,” Moustakis said. “On the other hand, the price of GME stock seems completely divorced from any reasonable measure of corporate value.”
Michael Munger, a professor of political science at Duke University, argued that the runup of GameStop stock, unmoored from any fundamentals of valuation and driven by an assertively vocal subset of social media users, was market manipulation similar to the tactics employed in “pump and dump” schemes and should be pursued as such.
“There are plenty of people who openly advocated for others to buy the stock, for the explicit purpose of raising the price through collusive action. That’s illegal, full stop,” he said. “The symbolism of prosecuting some ringleaders will be sufficient to discipline future groups from doing this.”
Munger drew a parallel between the Reddit-fueled pursuit of revenge against hedge funds and the populist, anti-government sentiments that fomenting the insurrection in the nation’s capital on Jan. 6. “In a way, this is like the Capitol riot attack — a populist group takes on elite institutions,” he said. “You can say it was a protest, or something about little guys versus big guys, [but] this is illegal, and always has been, if you strip away the populist and symbolic trappings.”