Reddit revolution may give Canadian watchdogs an edge
Regulators around the world have been scrutinizing the recent social-media-driven surges in the stock prices of companies such as GameStop and AMC, but some securities industry veterans say there may be little they can do because the traditional rules of market oversight don’t apply.
That’s because the activity appears to have been inspired and led by voluntary groups of retail investors — empowered by new technologies that have expanded access to markets and emboldened by posts on social media sites such as Reddit — and not registered professionals.
“Registration is what brings traders into the regulatory system,” Maureen Jensen, former chair of the Ontario Securities Commission, told Postmedia Tuesday.
“The old rules for market professionals and regulator oversight of markets now (don’t) work since these new traders are outside this ambit,” she said. “There is no closed market system anymore and that means we have to rethink the system.”
While some have pointed to the incredible surge in value of some of the stocks — GameStop, a U.S.-based video game retailer saw its stock surge nearly 20-fold in a matter of weeks — as a sure sign of manipulation, others have warned that it’s not so easy to draw a line.
“GameStop is the focus of current commentary because the fundamentals don’t make sense in relation to the stock price. But some would say the same of Tesla, and who gets to decide?” said Robert Staley, vice chair and partner at law firm Bennett Jones LLP in Toronto.
“It is hard to see ready regulatory solutions … when what’s happening is an aggregation of individual actions on social media.”
Still, in a joint statement late Monday, Canada’s provincial securities watchdogs and the national investment industry regulator said they are closely monitoring the situation, and pledged to take “appropriate regulatory action to protect investors” if “abusive or manipulative trading activity” is found.
If regulators were to take this on as a market manipulation case, they would have to prove intent to artificially affect the supply, demand, or price of a security. Such cases have a notoriously high burden of proof, securities lawyers and regulators say.
Despite repeated calls on regulators to step in and stop short-selling, where investors routinely talk down stocks, even publicly on social media platforms, short sellers have seldom been reined in by regulators. In both cases, investors are entitled to their opinions, and regulators must demonstrate intent to manipulate.
Staley cautioned that regulatory intervention at this point could have a detrimental effect on already volatile markets.
“You have a bunch of people riding with the herd,” he said. “You know someone is going to get hurt eventually, but a lot of money is being made on the way up, and regulatory intervention in itself could cause the market to crash.”
A key question should regulators decide to take aim at the Reddit phenomenon is who to go after?
One securities lawyer joked that the first problem would be where to begin when there may be millions of individual investors involved in the largely retail-investor-driven stock frenzy.
“If regulators wish to go after anyone in this context, it is not practical to go after retail traders,” said Jon Levin, a partner at Fasken Martineau DuMoulin LLP.
“Rather, it would seem to be appropriate to go after the dealers who are processing the trades on behalf of those retail players.”
Canadian regulators have placed increased scrutiny in recent years on the role and obligations of professionals such as brokers and accountants when it comes to maintaining the fairness and integrity of the capital markets.
“One of the biggest concerns from a public policy perspective has to be that (these) retail players do not understand the risks they are assuming, particularly the potential downside that they may suffer,” Levin said.
“There cannot help but be concern that most of the retail participants in the current market activity have never seen a bear market and do not understand how devastating a sudden turn in the market might be.”
However, attempts to shut down discount brokerages or online forums that are part of the latest market phenomenon are fraught due to concerns over restricting trading in already volatile markets and curtailing freedom of expression.
“Any country that embraces free speech cannot have its securities regulator restricting the right of expression,” said Jacob Frenkel, a former senior enforcement lawyer at the U.S. Securities and Exchange Commission now in private practice in Washington, D.C.
“Nevertheless,” he said, “the use of social media for fraudulent purposes, that is to manipulate stocks, or to circumvent strict disclosure and investor communications rules, should be enforced strictly.”
Staley, the Bennett Jones lawyer, urged regulators to be cautious, particularly because the phenomenon could turn out to be “a herd effect and not manipulation or misrepresentation by people seeking to make a buck.”
He warned that “ad hoc solutions may cause more harm than they solve” in terms of systemic risk.
“This (phenomenon) is in considerable measure a reaction to large short positions, where people can make money squeezing the shorts if enough people jump in,” Staley said. “There’s no easy solution, especially as shorting serves a valuable commercial purpose.”
Jensen said her view is that neither investors nor the trading platforms appear to be doing anything illegal or wrong.
“But they are taking large risks, some of (them) don’t understand that they are,” the former regulator said.
“The issue is the huge momentum with little knowledge,” she added. “I am most worried about people using (sophisticated investing strategies involving) options and margin when they don’t understand it.”