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GameStop’s share price began to rise when retail investors spread the news on WallStreetBets that GameStop shares had been widely shorted. Posts noted that if the price did not fall as anticipated, short sellers would make a loss. With that knowledge, many WallStreetBets users chose to purchase GameStop shares. This forced short sellers to purchase GameStop shares to cover the shorts amid the rising price, causing a ‘short squeeze’.
Amid the price volatility, both the U.S. Securities and Exchange Commission (SEC) and the U.K. Financial Conduct Authority (FCA) issued warnings to investors.
The SEC stated that it would “act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws.”
The FCA warned that firms and individuals “should ensure they are familiar with, and abiding by, all regulations including the market abuse and short selling regimes in the jurisdiction they are trading in.”
The Market Abuse Regulation (MAR)1 applies to all UK and EU listed financial instruments. This means that all investors in UK or EU listed shares must comply with MAR rules, including retail investors who give or receive trading advice on WallStreetBets.
Although GameStop is a NYSE listed company (so not subject to MAR), users of WallStreetBets also post about UK and EU listed shares. When doing so, posters must comply with MAR. In particular, investors must not disseminate false or misleading information, where they know or ought to know that the information was false or misleading. They should also not engage in behaviour with the purpose of positioning prices at distorted levels.
The most influential information that was shared on WallStreetBets was true and publicly available: GameStop shares were being widely shorted. While sharing that information does not fall foul of MAR, there are many other posts on WallStreetBets that may be inaccurate or misleading.
It would be a major endeavour for a prosecutor to trawl through posts on WallStreetBets searching for misinformation. However, this kind of investigation is not impossible, particularly if it transpires that WallStreetBets has been used to operate a “pump and dump” scheme, i.e. users have bought shares, spread misinformation to encourage others to buy the same shares, then sold when the share price has been pushed up. It remains to be seen whether WallStreetBets has been (or will be) used in this way.
Regulators and prosecutors are generally more focussed on financial institutions than amateur investors. This is because, traditionally, institutions’ conduct is more likely to impact market integrity, due to their greater buying and selling power.
Regulators are likely to scrutinise how institutions behave at times of market volatility, including when this is caused by online collaboration by retail investors. Instituitions should therefore consider the legal and regulatory obligations that become relevant in these circumstances.
Some investors have made exponential gains on their GameStop share purchases but many stand to make substantial losses. Many of those who lose out will be inexperienced investors. They may have bought GameStop shares at their peak, in order to be part of the online phenomenon. Some may not have understood the risks involved.
The FCA handbook requires regulated firms to pay due regard to the interests of their customers and treat them fairly. Retail investment platforms will already take steps to warn their customers about the risks of trading. To ensure that they are complying with their duty to protect customers’ interests, platforms should consider the effectiveness of the warnings that they are providing and whether these warnings need to go further.
Blocking trading
As the price of GameStop shares rocketed, the trading platform Robinhood controversially suspended trading in GameStop shares. This attracted the ire of many investors and commentators who argued that Robinhood had unfairly blocked retail investors from trading, while institutional investors could continue to trade. Robinhood has since stated that it suspended trading in GameStop shares only to ensure it could meet its capital requirements. Like other trading platforms, Robinhood uses clearing houses to clear and settle its trades. These clearing houses can require higher margin to be held in times of market volatility, which can cause liquidity issues in meeting fluctuating margin calls.
Robinhood’s situation illustrates the difficulty that firms can face in balancing customer interests against other requirements. In order to be sure that they are treating their customers fairly, FCA regulated platforms should clearly warn customers in their terms and conditions that the platform has the discretion to block trading. While many firms already do this, they should consider also clearly explaining to customers the reasons that trading has been suspended, at times when this becomes necessary.
Regulatory filings
Market volatility and uncertainty can create opportunities for financial crime. Firms should be conscious of their duty to make regulatory filings in relation to suspicious activity. In the UK, this includes reporting any knowledge or suspicion of criminal activity to the National Crime Agency (via a Suspicious Activity Report) and any suspicions of market abuse to the FCA (via a Suspicious Transaction and Order Report).
Regulators might try to regulate differently the kind of activity that was recently demonstrated using WallStreetBets. They could perhaps do this by imposing stricter restrictions on trading platforms that enable retail investors, like Robinhood. They might also impose new regulations on online platforms, like Reddit. Regulating conduct on the internet is famously difficult, so an innovative approach may be required if this is to be successful.
17 February 2021
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