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SEC Likely to Probe GameStop Trading Surge, but What Will It Find?

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Attorneys who represent advisors and broker-dealers anticipate a probe by the Securities and Exchange Commission of the recent dramatic price run-ups and high trading volumes in heavily shorted stocks including the retailer GameStop and others promoted by a group on Reddit’s WallStreetBets board.

Over the past week, a wave of trading fueled by members of the Reddit group WallStreetBets pushed up the stock of video game retailer GameStop — a wave that has since spread to other stocks heavily shorted by hedge funds, including movie chain AMC and phonemaker BlackBerry.

The volume of GameStop shares surged to over 177 million on Monday and Tuesday, dropping to a still-high 91 million on Wednesday. Meanwhile, its stock has risen about 350% from late Friday, when it traded at about $65 per share, to $292 per share in after-hours trading Wednesday.

“The political pressure to investigate is intense, so I suspect an investigation is already under way,” Nicolas Morgan, a partner at the global legal defense firm Paul Hastings, told ThinkAdvisor on Wednesday in an email.

“However, identifying a violation of the federal securities laws will be challenging,” said Morgan, a former senior trial counsel in the SEC’s Enforcement Division.

Acting SEC Chair Allison Herren Lee said, in a joint statement released Wednesday afternoon with the head of the exam division and the acting director of trading and markets, that the securities regulator is ”aware of and actively monitoring the on-going market volatility in the options and equities markets and, consistent with our mission to protect investors and maintain fair, orderly, and efficient markets.”

The SEC, the statement said, is “working with our fellow regulators to assess the situation and review the activities of regulated entities, financial intermediaries, and other market participants.”

Jim Lundy, partner in Faegre Drinker’s Chicago office, said his law firm has “relayed information to several points of contact at the SEC” in the Washington headquarters and in a regional office “anonymously on behalf of clients.”

Said Lundy, who was a senior trial counsel and a branch chief for nine years in the SEC’s enforcement division: “My understanding is that certain other law firms around the country have done the same. The responses that we have received from the SEC in response to our submissions have been brief, non-committal, and indicated no direction one way or the other in terms of what, if any, next steps that they may take. That’s fairly typical.”

Still, Lundy explained that “due to the nature of the issues and multiple law firms who practice in this space submitting concerns on behalf of clients anonymously around the country … the enforcement staff should be amenable to investigating.”

What would the SEC be looking for?

“False, material statements by anyone: the small retail traders, the short sellers, and obviously the company,” Morgan relayed. “I haven’t looked, but there are probably many inaccuracies being posted or circulated among the small retail traders, but establishing the materiality of any such false statements would be difficult to prove, particularly in light of the price volatility.

“I haven’t seen any reports of false statements by the company or by short sellers, but if any such false statements existed, the SEC would obviously take a keen interest,” he said.

The SEC “might look for evidence of manipulation, but proving that, for example, any particular small retail trader (or even a bunch them in concert) had an intent to create misleading price or volume (and actually succeeded!), will be very tough to establish,” Morgan added.

“Short of identifying false, material statements, the SEC is unlikely to bring an enforcement action in response to the recent market activity,” according to the attorney.