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David vs. Goliath or market abuse? The regulatory challenge posed by Gamestop

Written by Ben Parker

David vs. Goliath or market abuse? The regulatory challenge posed by Gamestop

A New Regulatory Challenge

Global financial regulators are eyeing up new controls on market manipulation following the widely reported GameStop (NYSE:GME) debacle.

With social media ‘hot tips’ driving retail investors to the markets in greater numbers than previously seen, it seems inevitable that new guidelines (and perhaps even tightened rules) will follow. This goes to show that the regulatory environment is constantly evolving, and as legislators scramble to keep up with the financial reality of an ever-changing investment market, firms are left with an increasingly complex compliance burden.

Here we look at what happened with the GameStop investment frenzy, and consider the potential regulatory fallout for financial firms.

What happened with GameStop?

In January 2021, GameStop became the subject of what some publications pitched as a ‘David and Goliath’ battle between retail investors and hedge funds.

The ailing American video game retailer had seen its share price steadily tumble following years of declining physical retail sales, prompting hedge funds to bet against its continued devaluation by short-selling. By ‘borrowing’ shares of GME and immediately selling them, the funds could profit by then repurchasing the stock to at a lower cost as the price dropped further.

This is a fairly common (and legal) practice that has been conducted by funds for years. It was only when a forum on the social media site Reddit took an interest in short selling that the financial battle commenced. Guided by posts on the ‘WallStreetBets’ forum, retail investors began purchasing GameStop stocks, causing the share price to skyrocket. In just 16 days, the value of GME stocks rose by nearly 1600% before dropping by 50% and falling into continuous decline.

The event caused short sellers to lose an estimated $13 billion on GameStop stocks alone, with the battle continuing to rage as the social media retail investment groups turn their sights onto the likes of AMC, BlackBerry, and Cineworld. Naturally, considerable market volatility has followed.

How have regulators responded?

The rise of the activist ‘retail investor’ has prompted concern from global financial regulators. This is not because of the losses incurred by hedge funds – it is a free market after all – but rather that such volatility presents a real risk to retail investors and brings into question the role of regulatory bodies.

In the UK, the FCA commented that: “UK investors should take care when trading shares in highly volatile market conditions that they fully understand the risks they are taking. This applies to UK investors trading both US and UK stocks. Firms and individuals should also ensure they are familiar with, and abiding by, all regulations including the market abuse and short selling regimes in the jurisdiction they are trading in."

Beyond this, concerns have also been expressed that the artificial inflation of stock values through coordinated investment efforts could cross over into the realms of market manipulation. In the US, the Securities and Exchange Commission (SEC) reaffirmed their commitment to ensuring that “regulated entities uphold their obligations to protect investors and to identify and pursue potential wrongdoing”, and noted that they would act to protect retail investors “when the facts demonstrate abusive or manipulative trading activity”.

What could the regulatory implications be?

Looking to the future, the increased popularity of social media investment content could force the hand of regulators. Reports now suggest that one in ten investors are using social media to inform their investing strategy, and it’s not inconceivable that the FCA could take the lead of the Advertising Standards Agency by introducing rules that limit the proliferation of unqualified investment advice while encouraging more transparent online practices. In plain terms, we can expect financial content to be accompanied by warnings and a crackdown on creators whose musings stray into the territory of unauthorised financial advice could follow.

A stronger stance has been taken by the likes of Hong Kong’s Securities and Futures Commission, and brokers there are now subject to enhanced reporting obligations. These rules specifically relate to any instructions received in respect of specified trading accounts that are suspected to be involved in market manipulation, and it follows that similar measures could be adopted by other international regulatory bodies as they act to curb so-called ‘pump-and-dump’ scams.

For institutional investors and financial firms, the future is as yet unknown. How regulators in the UK and EU will react is likely to depend on the results of their continued monitoring of market volatility over the coming weeks and months. Outside of retail trade chat forums, their focus is on the practice of short selling and whether there is a need to shield the equities market from volatility. It was only in March 2020 that regulatory action was taken to temporarily halt short selling in Austria, Belgium, France, and Greece amongst other jurisdictions – and such action has once again been mooted following the run on GameStop.

Even if the FCA does not take a similar line, we could at the very least see lower thresholds for the reporting of short positions and enhanced trade surveillance rules.

Regulatory compliance made easy

All of this makes for a complex and constantly shifting regulatory compliance burden. With no steer as to how the regulators will ultimately act, firms have been left to continue with their usual compliance and reporting obligations all whilst wondering when new rules will be applied.

Compliance can be challenging for listed companies and financial services providers, and this is especially true now that the spotlight is firmly pointed at share dealing. The growth of the retail investment market is only likely to complicate the approach taken by regulators, and it has never been more important to stay abreast of reporting requirements.

For firms that are set on taking their regulatory compliance duties seriously, eflow’s TZ platform provides a one-stop solution for trade surveillance, transaction reporting, and a range of other essential legal responsibilities.

To find out more about keeping your business on the right side of the regulators, book a demo below or contact eflow today.