Through the social networking platform Reddit, a community of investors or speculators co-ordinated support and encouraged the buying of select US listed shares, resulting in the share price of companies such as GameStop to increase by around 230% last week.
This community are said to be targeting companies such as GameStop in response to certain institutional investors short selling these companies and seeking to profit from a decline in their share price.
Despite many retail investors profiting from the share price rise of GameStop and other companies last week, others were left frustrated with brokerage firms who restricted and/or suspended trading in these stocks. The risks involved in speculation and the ability of social media to affect prices have never been greater. So, what have the regulators had to say?
The Securities and Exchange Commission’s (SEC) view
In a statement on Friday the SEC, the US financial regulator, said it was “closely monitoring and evaluating the extreme price volatility of certain stocks’ trading prices over the past several days” and that they will “act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws. Market participants should be careful to avoid such activity. Likewise, issuers must ensure compliance with the federal securities laws for any contemplated offers or sales of their own securities.”
The statement therefore was a warning to all market participants on both sides. We have considered the regulatory impacts for both below:
There are different ways for individual investors to gain exposure to stocks and shares. The securities themselves can be traded on regulated exchanges and other types of trading venues, primarily through interdealer brokers. Part of the regulatory scrutiny in the US relates to the relationships between interdealer brokers and executing brokers causing potential conflicts of interests to the detriment of retail investors.
A common alternative method for retail investors to gain exposure to global stock markets is through other financial instruments such as contracts for difference (CFDs), in which the investor does not own the underlying stock. In the UK and EU, brokers offering CFDs (including CFDs of US stocks) are subject to the requirements of MiFID II. Because CFDs are traded over-the-counter and not on a trading venue, the brokers themselves are the market maker and reserve the right to restrict or suspend trading for one of a number of reasons, and this is typically explained in client agreements. This was also validated in a statement published on Friday by the Financial Conduct Authority (FCA), the UK financial regulator, which stated “Broking firms are not obliged to offer trading facilities to clients. They may withdraw their services, in line with customer terms and conditions if, for instance, they consider it necessary or prudent to do so.”
Having said this, last week’s events may prompt FCA scrutiny in other areas, for example ensuring that if certain products and services were suspended or restricted, firms adhered to the high-level FCA requirements around treating customers fairly which includes the provision of clear, fair and not misleading information to clients.
Investors or speculators
On the flipside, the SEC hinted it may look for links towards the social media activity and influence on stocks such as GameStop from a market abuse and price manipulation perspective. This in turn may prompt a review of FCA regulation and UK legislation in respect of market abuse, as indicated in the aforementioned FCA statement which said it will “take appropriate action wherever [the FCA] see evidence of firms or individuals causing harm to consumers or markets”.
The FCA also warned UK retail investors to use “extreme caution” in relation to these US listed shares and that “volatile markets are unpredictable and mean [investors] can quickly lose money. Losses are unlikely to be covered by the Financial Services Compensation Scheme”.
No doubt there will be some big losers (likely the public) from this recent explosion in activity and the regulators will be under further scrutiny.
Our Financial Services Advisory team will be monitoring the situation for further developments.