The calls for regulatory action to address the GameStop stock trading frenzy have been as vague as they have been vocal.
If it turns out that the stock price and volume volatility was nothing more than what has been described as “crowdsourced lulz,” the Securities and Exchange Commission doesn’t have tools to address the issue in the absence of material misrepresentations or deceptive conduct.
And in the absence of deception, the SEC would be justified in bringing no GameStop mania enforcement actions.
What appears to have happened over the last couple of weeks is an accelerating number of long purchases by members of the Reddit group WallStreetBets, which has caused GameStop’s stock price to swing wildly in a sharp upward trajectory at enormous volumes.
The price surge has cost money for holders of short positions, which may have been the intent of some of the WallStreetBets purchasers. More recently, some online brokerages have restricted their members’ ability to trade the stock, and this, among other factors, has tamed the GameStop stock price increases a bit.
The SEC’s go-to tool here will be the antifraud provisions of the federal securities laws, prohibiting material, false statements made with fraudulent intent.
Three tactics that would be low-hanging fruit for the SEC would be: false material statements about GameStop, false material statements about a trader’s own intention to buy GameStop shares, and transactions that give the materially false impression of market demand for GameStop shares.
‘PennyStock Pumper’ Case
So, for example, last year when an individual investor in a small biotechnology company anonymously posted messages on Investors Hub using the name PennyStock Alert — let’s call him the PennyStock pumper — falsely and repeatedly claiming, among other things, that the company had received FDA approval for a COVID-19 test (and then selling his shares after the stock price rose), the SEC had no problem bringing a so-called “pump and dump” fraud case.
But to allege fraud, the SEC had to conclude that the shareholder knew or was reckless in not knowing that the FDA approval statements were false, and that such statements were material to the market.
If the SEC identifies someone who made false statements about GameStop knowing or reckless in not knowing that those statements were false, and if the SEC can prove those false statements were material because, for example, the statements caused the GameStop stock price to move, then bringing a pump and dump case would be a layup for the SEC.
In the PennyStock pumper case, the SEC also alleged that the shareholder “posted numerous messages on Investors Hub touting his purchases, or intent to purchase” the biotech company’s stock “in an effort to entice other investors to do the same. However, unbeknownst to other investors, [the PennyStock pumper] quietly sold the stock when its share price increased.”
During the week when the PennyStock pumper was encouraging others to buy, he executed only one purchase order for 5,000 shares but executed 90 transactions selling over 2.5 million shares. In the SEC’s view, the PennyStock pumper’s failure to disclose his plan to sell shares “at the same time he was recommending buying it to others” constituted fraud.