On January 28, 2021, and possibly before, members of the Reddit group r/WallStreetBets sent the market (and, apparently Hollywood box office executives) into a frenzy. Rogue day-traders noticed that several institutional investors were shorting the stock of companies like GameStop, a publicly traded video game retailer. Members of r/WallStreetBets—in an allegedly coordinated effort—began discussing how they, and other retail investors, could “beat” the institutional investors who had shorted (i.e., bet against) GameStop. The group settled on a plan to inflate GameStop’s stock price by going long on GameStop. Undoubtedly, some of these retail investors honestly believed in the fundamentals of the stock and the long-term value of GameStop. Others believed the company’s value was higher than its 2020 price reflected, but really just wanted to drive the stock price up to force institutional investors to cover their short positions at a significant loss—i.e., to engage in a “short squeeze.” This was no secret; these certain investors made their goals known to broad swaths of the investing community.
In 2020, GameStop’s stock price hovered below $20 per share, with a 52-week low of $2.57. The stock price increased drastically in January 2021 when retail investors began buying the stock and buying long options. It spent most of January under $100 until January 26 when it closed at $146. Then, on January 28, GameStop’s stock price hit an eyepopping high of $483 per share. Retail investors took to the internet to rejoice. During this stock surge, various trading platforms used by retail investors decided to block customers from purchasing additional shares in GameStop (and other companies experiencing similar stock price surges) for part of the day. While many retail investors were effectively prevented from buying more GameStop shares, institutional investors continued to trade, and the stock price fell almost immediately, closing the day at $347.51.
The expansive media coverage, and the Securities and Exchange Commission’s deafening silence, left many people asking: what securities laws and regulations apply to this strikingly odd situation and would the SEC (or worse, the Department of Justice) bring enforcement actions against members of r/WallStreetBets, the online brokerages that facilitated some of the trading, or others?
Frequently, the SEC will charge a so-called “pump and dump” scheme under the antifraud provisions of the ‘33 Act, the ‘34 Act, and/or under SEC Rule 10b-5. However, this situation does not neatly fit into the antifraud box. What were the material misstatements? Were they protected speech? Was there even actual fraud or deceit? Or were the retail investors honestly buying stock to tank the institutional short positions? Two other possibilities:
- Section 9(a)(2) of the ‘34 Act prohibits any seller of stocks from (1) creating actual or apparent active trading in a stock; or (2) raising or depressing the price of a stock, for the purpose of inducing others to purchase or sell that stock.
- Section 17(a) of the ‘33 Act prohibits any seller of stocks from directly or indirectly (1) employing a device, scheme or artifice to defraud another; (2) obtaining money or property by means of a false statement (or omission) of material fact; or (3) engaging in any transaction, practice, or course of business which operates as fraud or deceit upon the purchaser. (Emphasis supplied.)
Like you, we will be watching curiously to see what enforcers do next. This does not look like a clean kill. But can the SEC be still when investors apparently scheme to inflate stock prices based on things other than company fundamentals? We’ll get back to you on this.