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In GameStop saga, U.S. regulator examining all aspects and parties: sources

WASHINGTON (Reuters) - The U.S. Securities and Exchange Commission (SEC) is looking at every aspect of and parties involved in the “Reddit rally” of GameStop Corp and other stocks, said two people familiar with the matter, suggesting a swath of industry participants may be swept up in the regulator’s review of the trading frenzy.

FILE PHOTO: A person walks past a GameStop store in the Manhattan borough of New York City, New York, U.S., January 29, 2021. REUTERS/Carlo Allegri

The people added that the furious surge in shares of GameStop, AMC Entertainment Holdings and other stocks contained familiar patterns, in that it involves users of online platforms hyping up stocks – something seen in the past on bulletin boards and social media platforms.

However, manipulation cases can be complex and may rely on more than simply language posted on a message board, they said.

Thousands of Reddit users trading on low-cost retail platforms including Robinhood banded together to drive up the prices of GameStop and other “meme” stocks, squeezing hedge funds that had taken short positions, or bets against those shares.

The resulting volatility triggered massive margin calls from post-trade “clearing” houses that guarantee stock trades, prompting several retail brokers to suspend buying in the affected securities. The Reddit effect then appeared to spread into the silver market last week.

Several U.S. lawmakers expressed outrage at trading limits on individual investors, and Treasury Secretary Janet Yellen convened a meeting of market regulators.

On Monday, acting SEC chair Allison Herren Lee told National Public Radio the agency was examining the conduct of retail brokers, potential market manipulation, the role of hedge funds that bet against the companies, and whether the companies tried to exploit the rally by raising money.

In recent days, questions have grown around the arrangements retail brokers have with market making firms to which they route orders; the role of the clearing houses; and whether some hedge funds jumped on the Reddit bandwagon and bought up GameStop to amplify their rivals’ pain.

GameStop and other Reddit rally stocks have since dropped sharply, with GameStop down 38% on Thursday.

BEYOND THE HYPE

Proving manipulation may be tough due to ambiguous U.S. securities laws, said Joseph Grundfest, a professor at Stanford Law and a former SEC commissioner.

“The law governing market manipulation is almost as chaotic as the trading in GameStop shares,” he said.

Still, the episode is not entirely novel territory. In 2000, the SEC charged individuals in two separate “pump-and-dump” schemes that used internet message boards to drive up stocks. In December, it sued a former day trader who profited from spreading false rumors about public companies in online forums.

The SEC would look beyond generalized hype for users who disseminated false or misleading information about material company issues, such as revenues and products, or coordinated efforts to force buying or selling, said lawyers.

“I think the existing SEC playbook still functions fairly well,” said Philip Moustakis, counsel at Seward & Kissel and a former SEC senior enforcement counsel. If the trading was driven by a decentralized crowd with no organizers, that could pose challenges, he continued. “They might have to rely on a more novel theory of market manipulation.”

The SEC will likely also probe whether hedge funds properly disclosed risky bets to clients and allowed some clients to cash out before others, said Ken C. Joseph, a managing director at Duff & Phelps LLC and former SEC official.

Broker trading restrictions will also raise questions over fair access to markets, said Robert Frenchman, an attorney with Mukasey Frenchman & Sklaroff.

“Fair access to markets has long been a regulatory priority,” he added.

Robinhood has said its decision to suspend trading in some shares was purely a risk management decision and that it is committed to its customers.

Reporting by Chris Prentice and Pete Schroeder; Editing by Michelle Price and David Gregorio

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