IVAN SMERZNAK—The trading value of several stocks, most notably GameStop, has skyrocketed in recent months after members of a Reddit discussion board actively encouraged users to buy the stock to push prices higher. However, as investors rushed to participate in this upward trend, some trading platforms including Robinhood, Investment Brokers, and Charles Schwab temporarily restricted or even suspended trading of GameStop and other popular stocks by private investors. Many lawmakers on both sides of the aisle have criticized this decision as supporting Wall Street elitists to the detriment of middle-class Americans. Representative Alexandria Ocasio-Cortez stated on Twitter that an investigation into Robinhood was necessary and Senator Ted Cruz replied that he fully agreed. The SEC has acknowledged the recent market volatility and warned that they would “act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws.”
These recent events have raised questions both with respect to the activity of members of Reddit in driving up the price of particular stocks and the actions that trading platforms such as Robinhood took in response to the increase in trade volumes. First, did either the open cooperation of Reddit traders or the actions of trading platforms such as Robinhood in response constitute market manipulation? Second, should the Securities Exchange Commission adopt a more nuanced approach to securities oversight given modern investment platforms and means of communication?
The SEC defines market manipulation as occurring when someone “artificially affects the supply or demand for a security.” Based on the plain language alone, it would seem that both users of Reddit and the trading platforms themselves could potentially face liability.
With respect to the members of Reddit, in theory, a plaintiff could bring an action under Section 9 of the Securities Exchange Act of 1934 for manipulation of securities prices. Section 9(2) of the Act forbids “effect[ing] alone or with 1 or more other persons . . . transactions in . . . any security . . . creating actual or apparent active trading . . . or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such a security by others.” Finding the individual Reddit traders directly responsible would be difficult, however, because as Professor John Coffee of Columbia Law School believes, successfully bringing manipulation claims against the Reddit group would be like attempting to find “the evil needle in the huge haystack of uninformed deluded fools.” Similarly, Andrew Vollmer, Professor at George Mason School of Law, also points out that as long as there is market risk (risk that the buyer will make or lose money) one cannot be considered to have manipulated the market. Thus, even if users of Reddit had an evil intent for the price of GameStop shares to rise, such intent is legally indistinguishable from a natural desire for stock prices to rise.
Lawsuits by private investors against trading platforms such as Robinhood may be equally unsuccessful because of the terms which users agree to when they use the platform. Robinhood’s user agreement in particular contains an arbitration clause which states that by using their service all parties give up the right to sue in court. Instead, disputes must be resolved through arbitration. Several lawsuits have been filed including one class action in the Southern District of New York which has alleged that Robinhood purposefully manipulated the market in favor of hedge fund institutions under the legal theories of breach of contract, unfair dealing, and negligence. Nevertheless, the arbitration clause will likely keep lawsuits against Robinhood from getting very far.
Even assuming these suits reached courts, Robinhood may escape liability under Section 9 of the Securities Exchange Act because there may be a perfectly legitimate reason for its actions: current SEC regulations require brokers to have a certain amount of cash on hand to insure against potential losses. When GameStop stock spiked, Robinhood may have had to restrict sales to maintain sufficient cash reserves.
Perhaps most interesting is the question of what course of action, if any, the SEC should take moving forward? Do these events call for increased regulation? Professor Vollmer believes that these events do not constitute the “sustained social harm of the kind that would possibly justify new regulatory action.” Regardless of the proper course of action in response to these particular events, it is undeniable that the modern era has created novel means for dissemination of information about publicly traded securities, which are much more difficult to control. Social media and online forums allow for users to anonymously disseminate information, which makes it much more difficult for law enforcement to identify potential market manipulators. Thus, it has become increasingly difficult for the current SEC regulatory scheme to identify violators and assign liability. Time will tell how these events will change the course of security trading and its regulation in the future.