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A collection of Reddit users have gotten a lot of press lately for organizing and pushing back against corporate hedge funds. For those who haven’t followed the story, here’s the simplified version:

This ride is going to have some twists and turns.

Institutional investors saw the opportunity to make a profit from companies like GameStop, which have been struggling during the pandemic. Through a process called short selling, hedge funds can make money by betting against a company’s success. A stock trader engaged in short selling wants the price to go down. That is how he makes money on the deal. If the price goes up, he loses.

The problem for the institutional investors started when some amateur investors (sometimes called retail investors) on Reddit saw the opportunity for a short squeeze. Using the internet and social media for cooperative purposes, the Redditors drove the share price of GameStop through the roof and up past the clouds. This caused problems for the short sellers.

As more and more people bought the stock, it forced some of the short sellers to buy shares themselves to protect against more losses. This created a sort of snowball effect as more and more people bought in, continually driving the price higher and higher.

As the days passed, it became clear that the snowball was on a rollercoaster. GameStop’s share price rose from about $17 in early January all the way up to $483 at the end of the month. A week later, it was back down to $50.

Much has been made in the media of the role played by the hedge funds or trading sites like Robinhood. But what about the Redditors who openly coordinated to drive up the price of GameStop’s shares? Could they be on the hook for market manipulation?

Federal investigators are reportedly looking into that very question. People on the Wall Street Bets subreddit urged others to buy shares and hold onto them. Was this illegitimate? Because of its popularity with the amateur investors, Robinhood has received subpoenas regarding the flurry of trading activity. The U.S. Justice Department, Commodity Futures Trading Commission, and Securities and Exchange Commission are all investigating. 

To make the case for market manipulation, the investigators would need to prove that the Redditors used online forums to disseminate incorrect information and lift shares to an artificially inflated price. It would also be helpful if the “army of bullish individual traders” could be narrowed to “a few key individuals” who were behind the sudden rise in stock value.

The U.S. Code protects against manipulative and deceptive devices when dealing with the markets. It does not, however, protect against enthusiasm. According to the former Chief of the Office of Internet Enforcement at the SEC, unless some sort of deception or misrepresentation is involved, it’s not against the law to “generate excitement about an investment.”

The SEC can investigate for a number of reasons, but it’s more likely to prioritize a matter that:

  • Requires immediate action to protect investors;
  • Relates to conduct that may threaten the fairness or liquidity of the securities markets; or
  • Concerns an industry practice that may be widespread and should be addressed.

The still-evolving story of GameStop and other struggling companies raises some thorny questions. What about the people who bought in but didn’t get out in time? Are the investigators looking out for the little guys? Or does fairness mean whatever the hedge funds say it means?

It will be interesting to see in the coming months what other weaknesses or vulnerabilities in the stock markets might be exposed. Information is more valuable than it’s ever been, and the Marc Lopez Law Firm is here to help. Give us a call at 317-632-3642, and remember—always plead the 5th!