By Jack Kelly
It’s telling that regulators aren’t asking why high-end hedge funds were allowed to target vulnerable corporations, such as GameStop, in an alleged short-selling scheme to drive their victims into bankruptcy. As the stock price of their prey goes to nearly zero, the hedge fund honchos could earn multimillions—or billions of dollars–in profits off of the companies closing their doors and laying off thousands of employees into the worst job market in modern history.
Instead, according to the Wall Street Journal, the Securities and Exchange Commission (SEC) is looking into the young, goofy, fun-loving, scrappy and foul-mouthed novice investors on the r/wallstreetbets subreddit of Reddit. There is the feel of an institutional knee-jerk reaction to accept activities from established Wall Street professionals (no matter how odious it seems), while shining a harsh light on new—mostly naive—entrants into the financial community.
The storyline against the loosely knit confederation of emerging investors, who are still fuming over the 2008 financial crisis that bailed out the banks, but put their parents out of work and wiped out their savings, are on a mission. It’s the “little guy” against the wealthy hedge fund elite.
Now, the young adults are relatively new day traders. They’ve rallied together to buy shares of GameStop and other heavily shorted stocks. Spurred on by discussion on Reddit and other social media sites, large numbers of small investors fell in love with companies and invested in them by buying their stock and speculating in options.
Some institutional-type folks are claiming foul on the Wallstreetbets crowd. Daniel Hawke, a partner at Arnold & Porter Kaye Scholer, in a Wall Street Journal piece, said about the Gen-Z and Millennial investors, “If they are all egging each other on using a social-media platform, they are effectively engaged in a crowdsourced pump-and-dump scheme.” He added that the day traders “are making no effort to conceal their apparent intent to manipulate the price of the stock.” Hawke was a former chief of the Securities and Exchange Commission’s market abuse unit.
According to the Wall Street Journal, “Securities lawyers expect the SEC to probe the trading.” The SEC said it is monitoring the “volatility in the options and equities markets” and “working with our fellow regulators to assess the situation.” It’s reported that some people have turned on the rag-tag group of small-lot traders, as “tipsters have urged the regulator in recent weeks to review statements made on Reddit and other websites, and determine whether any of them constituted fraud.”
There are roughly three million members of the Wallstreetbets group and lots more who share the same interests on social media. The volume of trading and number of people involved is enormous. Any investigations would take a considerable amount of time and effort to look into the trading, especially since most of the people involved make small dollar amounts of trading and don’t use their real names online. There may be, however, some scapegoating for the regulators to show that they’re on top of the situation.
Detractors of the enthusiastic investors claim they were engaged in a “pump-and-dump” scheme. This is when a group bands together to drive a stock higher through any means possible, then sell and pocket the profits. Unsuspecting people who purchased the same stocks later in the game, at a high point, end up holding the bag and losing money.
The young novice investors say they aren’t engaged in manipulation. They contend that they support the companies and show it by investing in them. The traders also claim that they are on a mission to level the playing field against the entrenched Wall Street infrastructure.
This matter quickly captured the nation and world’s attention. People who’ve never been interested in Wall Street or investing became transfixed by this story. It opened their eyes to how the financial markets seem unfair and unbalanced—in favor of the rich and powerful. This feeling escalated after Robinhood—the go-to trading app—denied customers the opportunity to buy their favorite stocks. Meanwhile, hedge funds were free to trade. There were claims that this action seemed purposeful to thwart the growing movement and momentum of investing by the masses.
One of the results may be positive. Only a relatively small amount of Americans invest in stocks, bonds, ETFs and mutual funds. As you’ve seen over the pandemic, with the stock market hitting one record high after another, investing is a meaningful way to build net worth. This is one of the ways the rich get richer. The wild story may spur more people to get involved, start to invest and create long-term wealth for themselves.
Another outcome will be more regulations and greater oversight. Former President Donald Trump was open about his disdain for regulations. He believed it was an anathema to business growth. As a signal of his distaste for rules, Trump gave an edict that for every new proposed regulation, two would have to be ripped up.
After four years of relatively little regulation, it’s highly likely the next four years will change this trend. President Joe Biden picked two smart, aggressive and experienced Wall Street and compliance experts to head two powerful regulatory agencies—the SEC and the Consumer Financial Protection Bureau.
There will be intense pressure on regulatory agencies to find out exactly what happened. They’ll have to examine hedge funds, online brokerage firms (like Robinhood), chat boards and the new trend of banding together to jump onto a beloved stock.
According to the Washington Times, “House Financial Services Committee Chair Maxine Waters said Thursday her committee would dig into the conduct of hedge funds and private funds, in the aftermath of market volatility surrounding Robinhood’s decision to prevent its users from buying certain stocks.”
This may be merely skimming the surface. It’s reasonable to conclude that the Biden administration, with newly appointed heads of the top regulators, would embark upon an aggressive program to find out what other issues have been festering for years on Wall Street. It’s also likely that the same scrutiny will be applied to other sectors across the board as well.