As a former senior trial counsel with the Securities and Exchange Commission, I prosecuted multiple microcap pump-and-dump schemes. Each shared several essential characteristics: a guiding hand—usually a group of conspirators working in concert— obtain a sizeable amount of shares in a public issuer, usually a microcap company. They then conduct a campaign of publicity or engage in sham transactions designed to promote the company’s prospects or to create the illusion of economic activity and a vibrant and promising business.
Frequently, social media posts are used to promote the stock and to get investors excited about its prospects and potential return. Often, the conspirators buy and sell shares to each other at inflated prices to both create the illusion of a thriving market in the shares, as well as to pump up the price.
The organizers try to keep the pump going by urging investors to hold the shares. Then, ultimately the organizers—after seeing the value of their shares rise—sell at the inflated valuations, or sell their shares directly to the new investors, and the stock prices ultimately collapse.
Resembles Standard Pump-and-Dump Scheme
Recollections of my former caseload were rekindled by the explosion of GameStop (GME) shares though trading promoted on the subreddit r/WallStreetBets and using the Robinhood platform, along with shares of AMC, Blackberry, and other “meme stocks” targeted by retail investors on that subreddit.
To a former SEC enforcement attorney, the similarities with a standard pump-and-dump scheme were apparent. There was a coordinated campaign, conducted over the internet and on social media platforms; a central figure, with an unprintable Reddit handle and an incredible upsurge in the share prices of meme stocks.
While the story’s end has yet to be written, it looks like GME’s share price is currently in a downward spiral. So where are the SEC enforcement cases?
What Was the Intent?
The SEC usually charges pump-and-dump schemes under the anti-fraud sections of the Securities Act and Securities Exchange Act. Yet one difficulty with the meme stock frenzy is identifying who the defendant(s) would be.
But if there is no intent to deceive, and if there are no misrepresentations, no misstatements of fact about company performance or prospects, where is the fraud? If the intent is simply to create chaos, or make a political statement about short-sellers, or to promote the centrality of the retail investor in equities markets, is that fraud?
It certainly falls outside the parameters of what the SEC has traditionally seen as fraud, if the meme stock frenzy is simply an autonomous, viral trend, albeit one with a multi-billion dollar impact.
But is it? Recent coverage has focused on the role of Keith Gill, GameStop’s chief online cheerleader. Gill, a registered securities broker who used to work at MassMutual, had purportedly driven his investment in Gamestop, originally valued at approximately $50,000 to almost $50 million, according to his Reddit posts. Ultimately, regulators will have to determine the propriety of Gill’s intent and whether it was a clever update on the traditional pump and dump?
Perhaps focusing on the GME frenzy is missing the real risk here, which is that the formula to manipulate widely traded stocks has been discovered. Unlike thinly traded microcaps, where a few well-placed reports and website posts could cause substantial price movement, especially if insiders control a large amount of the public float, it had been thought that it was far more difficult to conduct a similar manipulation scheme with more liquid exchange-traded equities.
But we are living in an era where viral campaigns can sway tens of millions, where absurd beliefs propagate widely on Facebook and other social media platforms,and are embraced by millions of fervid believers. Could a sham viral campaign be conducted covertly, with its mastermind shielded from public scrutiny?
Perhaps an issuer with a lagging security price might foster such a campaign and convince investors to buy and hold. Or persuade holders of its convertible debt to exercise conversion rights, and thus reduce indebtedness. Or use the opportunity to raise additional funds through public offerings.
Among other unusual aspects of the meme stock run-up is the lauding of “diamond hands” on social media—the retention of a position regardless of the losses incurred, as a way to earn social media esteem.
Having reviewed tens of thousands of emails and texts between pump-and-dump participants, I can attest that one of the main concerns of conspirators is keeping the scam going by persuading investors to hold their shares (at least long enough for the wrongdoers to sell theirs). Some of the defendants I prosecuted would have been ecstatic to have developed a regulating mechanism such as “diamond hands” to achieve that goal.
We may have moved, without being fully cognizant of it, into a new era of fraud—especially as retail traders make up an ever larger portion of trading volume in equities. Have fraudsters developed a road map for transposing pump-and-dump schemes to more widely traded securities? And if they have, is the SEC, along with other regulators, prepared to follow them down that road? Or have they already lost the way?
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Howard Fischer is a partner in the litigation and white collar departments of Moses & Singer LLP. As a former senior trial counsel at the SEC, he was lead counsel in the litigation against Wing Chau and Harding Advisory LLC (relating to CDO asset selection in the run-up to the financial crisis) resulting in a major victory against one of the characters lampooned in the film “The Big Short.” He also led the SEC litigation involving the infamous London Whale, arising from JPMorgan Chase trader Bruno Iksil’s multi-billion dollar loss in its credit derivatives book.