10 December 2021 – As 2021 comes to a close we review a prominent incident in January 2021 involving Reddit users and GameStop Corporation (NYSE: GME), a company with its common stock traded on NYSE. A quick summary according to publicly available reports is as follows: GameStop is seen as a struggling video game retailer and is targeted by some institutional investors as being overvalued and take up short positions. If you do not already know what is a short position, it is when an investor sells shares of a company it does not have at a higher price, hoping to buy it at a future time, hence profiting from the difference. A Reddit community r/WallStreetBets sought to push up GameStop’s share price. This is apparently motivated by several factors, one of which is the fight against the large investors of Wall Street making money at the expense of the individuals. The backdrop of this train of thought is portrayed popularly by the movie The Big Short that chronicled the trades of synthetic collateralised debt obligations and the bailout of US banks.
Short sellers v. Short squeeze
In the case of GameStop, it was reported that institutions had taken short positions in GameStop. The populist opinion was that this behaviour ruins the livelihoods of honest individual investors who had bought into the stock. Based on publicly available information, discussions in the community reported that the company was significantly undervalued and considering the volume of stock shorted a relatively small intervention could force its price to a point short sellers are forced to cover their positions and in turn cause a short squeeze. A “short squeeze” market condition occurs where there is a large volume of short-sold stock, and prices rise such that some short sellers start to buy shares to close their positions and cover their losses (and this under normal conditions would cause a downward pressure in stock price). However, where a large enough volume of short-sold stock is covered, the stock price will instead further increase, causing a positive feedback loop to cause more and more short sellers to cover their position.
In this particular case, there are reports that the rise in price apparently initiated by r/WallStreetBets community precipitated the occurrence of a short squeeze and it was widely acknowledged that this market condition caused the wild fluctuations during the relevant days for GameStop, going from about $17 at the start of the year to $483 and down to $90 within a couple days. Since then the counter has closed as low as $40.59 on 19/2/2021 and as high as $302.56 on 9/6/2021.
Reactions were understandably varied, ranging from “insane”, “it has become political”, “Ponzi Scheme”, “market manipulation” and “mass psychosis”. This article is a brief study into the law and limits of market manipulation.
Free and fair operation of the market
Market manipulation is one category of market abuse where the free and fair operation of the market is deliberately interfered with. A subcategory involves the creation of a false or misleading appearance of the price or market for securities. Market manipulation is regulated in many jurisdictions, including the US under the Securities Exchange Act*, the EU under the Market Abuse Regulation*, in Australia under the Corporations Act*. In Singapore it is prohibited under the Securities and Futures Act*. Market manipulation takes different definitions over different jurisdictions. A limited comparative study reveals the following as key prerequisites to conduct regulated by authorities:
- Definition of genuine market forces being disrupted.
- A wrongdoer having market dominance.
- False and misleading market being created. It is common to define this with criteria such as:
- increase in market volume, by exchanging trades with no change in beneficial ownership,
- Increase in demand or supply, by making trades to influence the price of securities upwards or downwards.
- Artificial price being maintained.
- False and misleading information being disseminated. Some versions of this include:
- Creating a false or misleading signal about the supply, demand or price of securities, like influencing the opening or closing price of securities
- Element of deception, culpability, collusion attributable to the conduct. This could be defined by use of a fictitious device, deception, or contrivance to affect the price of securities.
- The use of methods, legal constructs, or technological devices to cloak the actual intentions of a wrongdoer, as such as the following:
- The use of nominee companies to hide beneficial ownership while trading up or down a stock, or increasing trading volume,
- Using high speed trading platforms to placing orders, modifying orders, and cancelling orders thereby making it difficult for others to identify genuine orders,
- Use of electronic media to voice opinions to profit from the impact of opinions not having disclosed one’s conflict of interest.
As already mentioned the above is not exhaustive and each jurisdiction defines the above concepts with different nuances. For example, regulated market participants like brokers, dealers, banks and institutional traders are generally held to higher standards as having size, influence, dominance, and the high possibility of being in a position of conflict.
False and misleading; deception; contrivance
An interesting area of note is the varying degree to which different jurisdictions treat dishonest intent (or an equivalent concept) as being relevant in defining illegal conduct.
The EU Market Abuse Regulation broadly categorises illegal conduct as including:
- Giving false and misleading signals as to price, supply, or demand.
- The use of a fictitious device, deception or contrivance.
- Disseminating information that is false or misleading.
Section 2 of Article 12 sets out one particular example of note to us:
“… taking advantage of occasional or regular access to the traditional or electronic media by voicing an opinion about a financial instrument… (or indirectly about its issuer) while having previously taken positions on that financial instrument… and profiting subsequently from the impact of the opinions voiced on the price of that instrument…, without having simultaneously disclosed that conflict of interest to the public in a proper and effective way”
The US Securities Exchange Act includes the following categorises as illegal conduct:
- Creating false or misleading appearance of active trading or market.
- A regulated person (including dealers and brokers) disseminating information to raise or depress price of securities, or is otherwise false or misleading.
- Any person working together with a regulated person (as mentioned above) to disseminate information to raise or depress the price of securities.
Artificial price
In contrast, the Australian Corporations Act (“CA”) and Singapore Securities and Futures Act (“SFA”) both seem to have a more obvious dichotomy between illegal conduct that does not involve dishonest intent and that which does. These sections of the Singapore Securities and Futures Act bears similarities to the Australian Corporations Act as certain portions were developed having regard to the Australian Corporations Act at the time it was enacted in 2001. The relevant provisions are as follows:
- Sections 1041A CA / Section 198, SFA: taking part in transactions that create an artificial price.
- Sections 1041B CA / Section 199, SFA: taking part in acts that create a false and misleading appearance as to price, or trading activity.
It is pertinent to note that the definition of “artificial price” need not be false and misleading. A judgment of the High Court of Australia reported in 2012 held that “artificial price” is one reflecting forces of genuine supply and demand “created in a market of buyers whose purpose is to acquire at the lowest available price and sellers who purpose is to sell at the highest realisable price” and includes to intentional conduct resulting in a price that did not reflect such forces of demand. It described the way for which the artificial price was achieved as by way of “cornering” or “squeezing” such that genuine forces of supply and demand did not operate. It additionally held that it is not relevant whether the artificial price was in fact fixed, or that the artificial price was maintained by market dominance.
Best intentions
I find it interesting that market manipulation in the absence of the use of false or misleading information may not constitute illegal conduct in certain jurisdictions. The relevant example here is the use of an electronic media community to initiate participates to create market conditions akin to cornering or squeezing. My quick review seems to show that for some laws only market manipulation accompanied by some degree of dishonesty would constitute illegal conduct. The problem with this is it is like saying market manipulation with the best intentions is ok. I think one should be reminded that the rules of capital market are created to protect the people-at-large, not a single activist. What if it were not a single activist, but a thousand, or perhaps 100,000? It remains to be seen how a test case in such jurisdictions would resolve.
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Flint & Battery LLC is an international law practice licensed by and registered with the Legal Services Regulatory Authority, and is the Singapore office of the Cicero international law firms. Winston WONG is a Director of the Corporate and Commercial Practice of Flint & Battery LLC.