‘GameStop’, a well-known retail company active in the field of electronics and games, has been dragging its feet for the last few years. After shutting down hundreds of shops globally, it’s stock on the NYSE has been flat for the last couple of years ranging well below $10. However, January 11th marked the commencement of an unprecedented stock rally which skyrocketed the company’s shares over a period of three weeks, peaking at $492 in the afternoon of January 28th.
The story has already hit the front pages globally. In short, wave after wave, thousands of ‘Discord’ or ‘Reddit’ users (subscribers to the ‘WallStreetBets’ sub-forum of the latter) were urged or convinced by the respective forum’s moderators or other ‘experienced’ users to purchase GameStop options enjoying their user-friendly, no-fee access to mainstream stock trading apps/platforms such as ‘Robinhood’. In response, short-sellers and institutional investors such as hedge funds (which had placed a bet that the particular stock is going to plummet) started purchasing actual GameStop shares en masse to make up for their losses. The result? Multiple back-to-back jumps to GameStop’s share value with no visible ceiling. In other words: a looming bubble. A similar pattern was observed with other shares listed on the NYSE (e.g. AMC Theatres or BlackBerry).
Stock bubbles are not new. However, the GameStop phenomenon rang several bells in Wall Street with institutional investors calling for enhanced regulation or even a restructuring of the stock market to deal with what they perceive as market manipulation. In their view, ‘Reddit’ & ‘Discord’ users conspired to force an increase on the share’s value. From their part, several of the platforms’ users comment that they acted legally by taking an informed decision to invest in the particular stock and that institutional investors, who (in their view) have been manipulating the stock market for years at the expense of the average investors and their target’s employees, are not entitled to complain.
The question is then raised: Have the thousands of aspiring investors manipulated the stock market? The answer is far from clear and there is a very fine line to draw.
Section 9(a)(2) of the USA Securities Exchange Act of 1934 prohibits effecting “a series of transactions” in a security (i) that “create actual or apparent active trading” or affect its price, (ii) “for the purpose of inducing the purchase or sale of such security by others.” The purchase or sale of a security (e.g. a share of a listed company) inherently involves the act of trading which frequently affects the security’s value in an open and free market. So, in the absence of an actual definition of ‘manipulation’ in this statute, under the US Federal Law, ‘purpose’ is what defines an act as manipulating and consequently fraudulent. What constitutes a ‘purpose’ to manipulate or commit fraud in the stock market, is a question that keeps academics and lawyers in the US busy for many decades. Distinguishing between a sincere belief in a share’s potential as opposed to an attempt to manipulate the market is not easy and it seems that, as in many other legal questions, the answer depends on the facts and the merits of each individual case.
On the one hand, one could argue that the 2021 stock market has nothing to do with the pre-2008 era. There is a multitude of individual investors and a wide range of ‘free’ trading platforms. At the same time, social media and online fora enable the average or aspiring investor to learn and exchange ideas or investing strategies with other more experienced, non-institutional investors. This is the so called ‘democratisation’ of investing, driven by the technological developments of our times. In this context, anyone is free to make an informed or even an irrational and rushed decision to invest in a stock, an option, cryptocurrency or commodity and assume the relevant risk while ignoring the investing guides and recommendations circulated in the mainstream financial media. Under these circumstances, expressing your opinion, exchanging ideas or even urging thousands of people online to buy or sell a security is not necessarily an attempt to manipulate the stock market. It’s just a matter of free speech.
On the other hand, institutional investors argue that the aspiring investors, whether encouraged by Reddit’s moderators, their greed, their playfulness or simply their ignorance, acted in co-ordination; in other words, as a single group (or ‘herd’) with the sole purpose of manipulating the stock’s price in order to punish Wall Street’s hawks while waving their anti-establishment flags on the web and bragging about their cash-outs on their social media profiles.
Under the US law, the regulatory authorities and prosecutors who wish to prove that the investors’ conduct has been fraudulent and manipulative, have to show that the said conduct involved false statements or omissions of important facts and that the person(s) making those statements as aware that they were untrue, thus misleading a “reasonable” investor who, in turn, suffered losses. This seems to be a very high standard and would be extremely difficult to prove when you are targeting a large group consisting of thousands of inexperienced investors and users of online fora. It could be argued that at least some of the users (e.g. the forum’s moderators) were engaged in manipulative behaviour by urging the other users to buy options. However, if no untrue statements were made and no important information was omitted, the mere urge to buy does not seem to fall within the scope of the US legislation and does not suffice to establish purpose to manipulate or commit fraud. The purpose of getting a share’s price up, is not manipulative or fraudulent per se; it’s the ultimate goal of any investor who is hoping that at some point in the future will be able to sell that share and yield the profit. This is the very essence of investing.
By the time this commentary was being published, GameStop’s share value had collapsed to $197. The 3-week-long online bras de fer, proved that the legal questions raised above are not easy to answer. It is highly probable that the US Securities and Exchange Commission will look into the matter, but it is uncertain whether it will cross the fine line of labelling the investors’ conduct as manipulative. ‘Robinhood’ has already shut down the trading of GameStop’s stock on its platform while members of US Congress are now siding with the users, accusing the platform of blocking the investors’ ability to trade and protecting Wall Street’s hedge funds. The GameStop saga, has disrupted Wall Street’s usual game. It remains to be seen whether it will redefine the traditional legal perception of investing behaviours and trends.
Avgerinos Hartsiotis
Partner
Note: In Cyprus, Section 9(2)(a) – (d) of Law 136(I)/2016 regarding Criminal Sanctions for Market Abuse expressly labels certain behaviours as ‘market manipulation’. Over the years, CySEC (the national Securities and Exchange Commission) has released Directives with non-exhaustive lists of particular behaviours that constitute ‘market manipulation’.