GameStop Stock Trading Poses ‘Manipulation’ Challenge for Regulators

Sudden surges in the share prices of GameStop Corp., which has led to multiple NYSE trading halts in the past few days on the stock, have gotten the media’s attention. Questions are being raised about the role of online chatrooms in the quick price increases in GameStop and whether regulatory investigations are appropriate.

Though matters like this are likely to give rise to scrutiny by the Securities and Exchange Commission or other regulators, these issues are challenging to enforce.

In order to show a violation of federal securities laws in these actions, the SEC must demonstrate that defendants had an intent to manipulate, deceive, or defraud through false and material statements or omissions of a material fact, and demonstrated an intent to set a misleading share price. That may be difficult in this instance, and it is unclear to what degree regulators can and should intervene.

A Stunning Run Up in Share Price

As background, GameStop’s shares rose over 800% in the past month—a seemingly unusual occurrence given the dying breed of shopping mall video-game retailers in the era of e-commerce—following extensive discussions of the stock in Reddit chatrooms.

GameStop’s net income has seen a sharp decline in recent years—from earning $408 million on $9.5 billion in revenue in 2011 to seeing a net loss of $275 million on $5.2 billion in revenue in the past year.

But this month, traders have flocked to r/wallstreetbets, a popular Reddit forum for day traders with over two million subscribers, to discuss their interest in buying GameStop stock.

Large purchases of GameStop options prompted by the Reddit frenzy have forced big Wall Street players who shorted GameStop stock—assuming the price would go down—to purchase more GameStop stock to cover the short positions or hedge against further massive losses, driving up the share price even more.

This contest between WallStreetBets forum members and institutional Wall Street players has continued, resulting in an unprecedented week for GameStop stock.

But Is It Manipulation?

There are now public calls for investigations by the SEC and other regulators as to whether this internet chatter led to a market manipulation—a potential pump-and-dump scheme of sorts.

Pump-and-dump schemes have long existed in the markets. These matters generally involve a party or entity acquiring a position in a financial instrument, like a stock, then artificially inflating the stock through fraudulent promotion before selling its position at an inflated price, which generally crashes after the sale. As the SEC describes, “promoters ‘pump’ up the stock price by spreading positive rumors that incite a buying frenzy and they quickly ‘dump’ their own shares before the hype ends.”

To successfully show a violation of federal securities laws in these actions, the SEC must demonstrate that a defendant had not only the intent to manipulate, deceive, or defraud, but also that the defendant did this through statements that were both false and material (or omitting a material fact). In these schemes, regulators must be able to demonstrate an intent to set a misleading share price.

The SEC frequently investigates and brings enforcement actions in alleged pump-and-dump cases, as do other regulators. Of course, investigations by the SEC, the Commodity Futures Trading Commission, the Financial Industry Regulatory Authority, and state regulators are likely here, particularly when the activity has led to halts in market trading and “trials” have already begun in the court of public opinion. On the night of Jan. 27, the SEC and the White House unsurprisingly announced that they are “monitoring” the ongoing market volatility here.

However, the degree to which the regulators can and should intervene is unclear. We have already seen trading on GameStop halted at times and restricted on various platforms, including Robinhood and TD Ameritrade. While trading suspensions are also possible (the SEC can stop trading in any publicly traded stock), the SEC is likely hesitant to take such drastic measures where it is not clear that any violation of securities laws took (or is taking) place.

There is nothing that says that the company or some other entity is intentionally spreading material misinformation. Suspending trading based on a hunch is basically unprecedented.

Enforcement Action Challenges

Any enforcement action will also face its own challenges. It is not a per se violation to merely chat about a stock or an intent to purchase a stock in an internet chatroom—or even for a group of individuals to decide to purchase a stock at the same time.

The regulators would have to establish that Reddit posts by seemingly ordinary investors were part of some illicit scheme to manipulate the market—to set a misleading price or volume. Sharing market views and market color is not a violation.

Further, it will be difficult to determine when any purported manipulation started, versus whether individuals were just discussing their own market views in online forums and making their own trading bets in a volatile market.

There will be significant questions regarding whether any online statements were false (or intended to be false) or material. Proving that there was an intent to create a misleading price will be difficult and not easily resolved.

In essence, what seems to have happened here is a perfect storm of events. With the increase in free or low-cost platforms such as RobinHood for ordinary individuals to easily trade, more individuals using these platforms to trade at home during the Covid-19 pandemic, and a volatile market, internet chatter led to this GameStop phenomenon. That does not mean that there is an “open and shut” case for market manipulation.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

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Author Information

Kenneth Breen is a partner in the Litigation Department of Paul Hastings and serves as head the New York White Collar Defense practice. He is a former federal prosecutor in the U.S. Attorney’s Office for the Eastern District of New York and the Justice Department’s Tax Division.

Phara Guberman is a partner in the Litigation Department of Paul Hastings, defending clients in high-stakes and sensitive regulatory enforcement and white collar criminal investigations.