SEC vows to act on potential manipulation during trading surge

Market volatility related to a surge in trading of shorted stocks has drawn the attention of regulators and lawmakers. But it’s not clear whether there's a role for them to play.

The Securities and Exchange Commission said Friday the market has held up well amid a surge in trading of GameStop Corp. and other shorted stocks, but promised to act if it finds manipulation.

The volatility also has drawn the attention of lawmakers. But it’s not yet clear whether there has been any malfeasance related to the wild market ride, experts said.

“Our core market infrastructure has proven resilient under the weight of this week’s extraordinary trading volumes,” Acting SEC Chair Allison Herren Lee said in a joint statement with SEC members Caroline Crenshaw, Hester Peirce and Elad Roisman. “Nevertheless, extreme stock price volatility has the potential to expose investors to rapid and severe losses and undermine market confidence.”

The commissioners said they are monitoring the markets and will respond if investors are being harmed. “The Commission will closely review actions taken by regulated entities that may disadvantage investors or otherwise unduly inhibit their ability to trade certain securities. In addition, we will act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws.”

The statement elaborates on a similar message sent by SEC officials earlier in the week in response to the bizarre runup in options and shares of GameStop, a video game and consumer electronics retailer, and other companies that have faltered in the economic slowdown, such as AMC Entertainment Holdings Inc. and Bed Bath & Beyond Inc. The trading activity has been spurred by investors on the online forum Reddit who are taking long positions on stocks that have been shorted by hedge funds.

The market gyrations and related halt of trading by brokerage platforms also has drawn a response from lawmakers.

The incoming chairman of the Senate Banking Committee, Sen. Sherrod Brown, D-Ohio, and the chairwoman of the House Financial Services Committee, Rep. Maxine Waters, D-Calif., both announced they would hold hearings on the stock market volatility.

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In a letter to the SEC on Friday, Sen. Elizabeth Warren, D-Mass. and a member of the Senate Banking Committee, pressed the agency on how it intends to respond to potential market manipulation.

“These wild fluctuations are just the latest indication that many private equity firms, hedge funds, and other investors, big and small, are treating the stock market like a casino, giving little consideration to the companies, communities, workers, and consumers that may be affected by these risky bets,” Warren wrote.

It’s too early to tell whether there’s a role for regulators or Congress to play in responding to the trading surge, said Ken Joseph, head of compliance and regulatory consulting for the Americas at Duff & Phelps. “We don’t know what, if anything, failed,” said Joseph, a former supervisor in the SEC Division of Enforcement’s Asset Management Unit.

What’s unique about the trading surrounding GameStop and other companies is that it is not so much geared toward making a profit as sending a social message by individual investors against hedge funds, Joseph said. That has combined with low-cost trading on many brokerage platforms and a large pool of day traders who have time on their hands thanks to the coronavirus pandemic.

“That dynamic is not something that our securities regulations as currently written anticipated,” Joseph said.

The SEC should proceed cautiously before bringing enforcement actions because courts normally reject claims of manipulation in situations where the purchaser has a legitimate reason for buying a stock, said Nick Morgan, a partner at the law firm Paul Hastings.

“Here, the WallStreetBets Reddit members appear motivated by profit and amusement — weak foundations for enforcement action,” Morgan, a former senior trial counsel in the SEC’s Division of Enforcement, said in a statement. “Moving with too heavy a regulatory hand in an attempt to prevent open market manipulation may chill perfectly legitimate open market transactions.”

The SEC likely will assess whether there were structural market problems, examine disclosure, liquidity and solvency of funds involved in the volatility and review how brokerages managed trading on their platforms, Joseph said.