SEC Needs to Act on GameStop: Valliere

What’s Next?

While we aren’t at the level of distress we saw during the 2008 financial crisis, the current turmoil “could end badly for small investors and hedge funds; meanwhile, ordinary investors could become apprehensive,” he says. “The SEC needs to cool this crisis, but how?”

The SEC would need to prove criminality, which means officials have to show “an organized effort to manipulate stocks up or down,” Valliere said. “A key issue: is this just a populist Reddit revolt against hedge funds or a ‘pump and dump’ get-rich-quick scheme?”

Proving market manipulation will be “extremely difficult, unless the agency can prove that the traders had the required level of intent, and/or engaged in an illegal pump and dump scheme that involved false or misleading statements,” Ken Joseph, head of the disputes practice at the law firm Duff & Phelps said Thursday.

“Merely buying stock to squeeze short sellers is not illegal,” Joseph added. And actions against Reddit users “will be equally difficult” for the reasons he explained earlier. “Among other things, these posters may qualify for protection under the First Amendment to the extent they are expressing opinions about the stocks involved.”

So far, hedge funds have likely lost about $24 billion in their short positions in GameStop, Valliere points out. “They can unwind the holdings, but they’ll also require “even more cash infusions from solvent firms.”

As for the Washington angle, it’s “virtually certain that [Massachusetts] Sen. Elizabeth Warren and other industry critics will demand SEC prosecution which — Warren hopes — would result in steep fines and disgorgement of profits,” according to the political expert.

“For years, the same hedge funds, private equity firms, and wealthy investors dismayed by the GameStop trades have treated the stock market like their own personal casino while everyone else pays the price,” Warren said Wednesday. “It’s long past time for the SEC and other financial regulators to wake up and do their jobs — and with a new administration and Democrats running Congress, I intend to make sure they do.”

On Thursday, Sen. Sherrod Brown (D.-Ohio), the incoming Senate Banking Chairman, said he intends to hold a hearing on the “current state of the stock market,” referring to the intense trading of GameStop and other firms: “It’s time for the SEC and Congress to make the economy work for everyone not just Wall Street.”

In general, the trading frenzy likely won’t end well for speculators, “but the economic fundamentals still look solid,” Valliere said, adding that he doesn’t think the trading situation will spill over to broader market and economy (as it did in 2008).

“But the SEC will have to get involved,” he concluded. “It will have no choice but to send a signal to speculators.”

— Related on ThinkAdvisor:

• Huge GameStop Position Lurking in Some ETFs
• Schwab, TD Ameritrade Put Brakes on Some GameStop Trading