Wall Street has been in a state of disorder in recent weeks as the share price of brick and mortar retailer GameStop Corp. (“GameStop”) continues to fluctuate. GameStop's share price increased in value from under USD $20 on January 12, 2021 to a 52-week high of approximately USD $483. This time last year, the share's price was hovering around USD $4.00.
The extreme volatility of share price these last few weeks is the fallout from trading by retail investors, portrayed by the media as being pitted against Wall Street hedge funds with a short position in the stock. Reportedly in response to an initial attempt by Wall Street hedge funds to short GameStop's stock, day traders and other individuals apparently used new platforms such as Reddit and Robinhood to promote and complete trades of the company's stock.
The ordeal has raised daunting questions for securities regulators and other policy makers, including role of regulatory intervention, the scope of what constitutes manipulation, and how to regulate capital markets with increasing retail investor participation. Already, the United States Securities and Exchange Commission (the “SEC”), the Canadian Securities Administrators (the “CSA”), and the Investment Industry Regulatory Organization of Canada (“IIROC”) have each informed the public they will be monitoring the situation closely and investigating any potential wrongdoing. Notably, these organizations specifically warned investors (including retail investors) that engaging in abusive or manipulative trading activity violates securities laws.
These warnings raise several interesting regulatory, legal, and policy issues for regulators – and the political entities to whom they report – around the world to consider when evaluating their potential risk exposure:
Market manipulation or free speech: Non-traditional market participants in a social media world
The GameStop saga will force regulators to grapple with how existing securities legislation – which was designed to regulate the actions of traditional market participants – applies to an evolving market in which new platforms facilitate increased trading by laypersons and in which information posted on social media can significantly influence market valuations.
Among other things, regulators will need to grapple with the issue of what constitutes market manipulation. In Canada, Part 3 of National Instrument 23-101 – Trading Rules expressly prohibits investors from directly or indirectly engaging in or participating in transactions relating to a trade in securities if the investor knows, or ought reasonably to know, that the transaction will result or contribute to a misleading appearance of trading activity or an artificial price for a security. The securities acts of British Columbia, Alberta, Ontario, Quebec, and Saskatchewan contain substantially similar versions of this prohibition.
There is little doubt that GameStop, which lost hundreds of millions of dollars in 2019, has been trading at an inflated price. Further, statements from regulators throughout North America make it clear that the actions of retail investors, in appropriate circumstances, are subject to prohibitions against market manipulation.
It is unclear, however, whether and in what circumstances the “viral” spread of information about individual stocks may constitute manipulation within the meaning of existing securities rules and regulations. In addition, securities regulators will face enforcement challenges against even well-coordinated online communities, raising serious questions as to what steps can or ought to be taken by regulators to control these trades or the dissemination of information in these circumstances.
GameStop's rally also raises novel issues relating to the dissemination of information about publicly traded securities in online forums such as Reddit. Typically, regulators closely monitor the information and advice being disseminated about publicly traded companies and there are stiff consequences for disseminating false or misleading information. Whether and how to regulate statements about securities on such forums – which offer the opportunity to cloak information with anonymity, and on which users may not fall within the definition of “Promoter” or “Influential Person” under relevant securities legislation – presents novel legal and enforcement challenges for regulators. Similar issues have been raised by the CSA in Consultation Paper 25-403, Activist Short Shelling [PDF] as well as in the Final Report [PDF] written by Ontario's Capital Markets Modernization Task Force. For now, the CSA and IIROC have issued warnings to the public that online chatrooms are unregulated, and that investors should check the registration of any person or business trying to sell them an investment or give them investment advice.
Notably, the activities on Wall Street in the last few weeks have garnered attention so far beyond traditional capital market players, that regulators and politicians such as Elizabeth Warren (the former head of the Consumer Protection Agency) have waded into the discussion. Reports also state that financial sector overseers and policy makers like Treasury Secretary Janet Yellen have engaged with the Federal Reserve and other institutions to discuss the impact of retail activism.
GameStop's volatility – and the market behaviour that spurred it – is forcing the SEC and its Canadian counterparts to rethink existing enforcement mechanisms. These regulators have suddenly been forced into the spotlight while they carefully consider the evolving market, its new participants, and how best to regulate them. Their greatest challenge will be balancing competing interests: the need to protect new market participants (including retail investors) from market volatility while also ensuring these new players comply with applicable securities laws and regulations.
GameStop's rally once again illustrates the fast pace at which innovators in information and technology can influence capital markets. While increasing access to capital market investing is a positive development, it is not without challenges for market regulators.
Originally Published by Osler Hoskin, February 2021
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