US regulators and the White House are meeting this week to examine whether action should be taken about the retail tidal wave of trading inspired by Reddit’s WallStreetBets in stock such as GameStop Corp (NYSE:GME) and AMC Entertainment Holdings Inc (NYSE:AMC).
However, many financial experts agree there is no law against people encouraging each other to invest.
New Treasury Secretary Janet Yellen will hold a meeting with the heads of the Securities and Exchange Commission, the Federal Reserve, the Federal Reserve Bank of New York and the Commodity Futures Trading Commission, the Treasury confirmed overnight.
This follows the breakneck rise in the shares of GameStop last month after users of the WallStreetBets (WSB) forum on Reddit noticing that the games retailer was being targeted by hedge funds with huge levels of shorting in anticipation that the price would continue to fall.
At the start of the year, short interest in GME was reportedly around 148%, meaning more shares had been sold short than existed in circulation, as some shares had been borrowed and sold more than once, with hedge funds having also bought a large number of put options in the stock, meaning they held options that would make money if the stock fell.
However, seeing this stock was massively over-shorted, the users of the WSB subreddit, an online forum designed for amateur retail investors and traders, decided to buy the stock en masse.
This was either a push-back or slap in the face for the Wall Street professionals or because the huge levels of shorting would mean that the hedge funds would have to cover their short positions and this would catapult the stock even higher.
“This isn’t market manipulation – you’re allowed to encourage other people to buy a stock, and if lots of them go along with you, then there’s no issue,” said market analyst Marshall Gittler at BDSwiss.
Back in the Russ Mould at AJ Bell, agreed that “there is no law against what has happened”.
However, he said the co-ordinated nature of the buying via social media “could be seen in a worst case as intentional market manipulation” and this is what the SEC and Yellen are likely to be investigating.
Neil Wilson, chief market analyst at Markets.com, said “this was pump and dump so it should be treated as such – the market manipulation was by the Reddit lot as far as I’m concerned”.
Pumping-and-dumping, involving pumping out exaggerated claims, false rumours and speculation designed to act as a catalyst for the stock to rise, with the pumper then dumping the stock once the price is higher, is illegal.
But forms of this, heavy on the enthusiasm and with a dollop of bias but without necessarily plying any untruths, has been a mainstay of many financial bulletin boards and on social media for years.
It has also been argued that many of the practices of the algorithmic or high-frequency traders are treading a fine line with market manipulation.
Yellen, a Treasury spokesperson told Reuters, “believes the integrity of markets is important and has asked for a discussion of recent volatility in financial markets and whether recent activities are consistent with investor protection and fair and efficient markets”.
But as the UK financial watchdog, the FCA, said, broking firms are not obliged to offer trading facilities to clients.
“They may withdraw their services, in line with customer terms and conditions if, for instance, they consider it necessary or prudent to do so. Firms are exposed to greater risk and therefore more likely to need to take such action during periods of abnormally high transaction volumes and price volatility.”
Also, while much of this activity has been attributed to retail traders and the YOLO traders convening on Reddit and social media, some market participants say that in fact hedge funds have been front-running the retail traders.
Some hedge funds have reportedly been using computers to follow the chatter on these discussion boards and trade on it, according to claim made to Bloomberg.
“Given that these funds operate at the nanosecond pace while many retail traders are buying the wrong GME (there’s a stock with a similar ticker listed in Australia that saw its stock price nearly double on Jan. 29th due to mistaken purchases), it’s not obvious who’s made money here and who’s lost money,” said Gittler.
With the White House’s involvement, the issue has undeniably morphed into a semi-political argument about one rule for the big players and another for the little guys.
“I think there is risk this gets politicised and we get a load ill-thought-out regulation,” said Wilson.
He said the reason the rules are different for private traders using the RobinHood (RH) app is that “they are not paying therefore they are not ‘customers’, they are getting a platform for free and so ought to accept that things might be geared entirely for their benefit”.
“The RH’ers don’t understand things like counterparty risk or the fact it takes two days to settle a trade after execution – they are not being obstructed from trading they are just having to play by the rules.”
Controls on the amount of stock that can be out on loan could be a more sensible option, Wilson said.
“Distinguishing what is a sincerely held belief as opposed to an attempt to manipulate the market is…an extraordinarily fuzzy area,” lawyer Anthony Sabino and business law professor told MarketWatch.
Lawyer Chris Sunstrum of Goodmans LLP agreed that the trading action stemming from the Reddit forums was a regulatory grey area.
“Does this constitute market manipulation? … I think what the regulators are trying to figure out is, have they crossed that line,” he told Reuters.
“Your typical retail investor just going on a chat board and giving their opinion, or helping rally the troops behind buying GameStop, is probably not going to be offside.”