How will Wall Road regulators deal with GameStop?

More than a decade later, industry opposition and bureaucratic problems have conspired to leave this database – known as the Consolidated Audit Trail – years behind schedule and form a shell of what regulators originally intended, proponents of stronger financial oversight say .

Now the constraints of the system will make it harder for Wall Street’s Washington thinkers to quickly get a glimpse of the turmoil that is still shaking the markets. Amid the GameStop turmoil, regulators are faced with a growing list of questions about using social media to manipulate stock trading. the adequacy of online brokers’ capital reserves; and the need for hedge funds to disclose more about their holdings.

“It will be very difficult to understand the sequence of events and it would have been relatively easy if the CAT [consolidated audit trail] was up and running, ”said Tyler Gellasch, founder of the nonprofit Healthy Markets Association and former attorney for the Securities and Exchange Commission. He said it highlights the agency’s disappointing track record. “The wise bet on the SEC was in the past, name the problem and the response will be muted.”

The SEC declined to comment. A spokesman for the CAT operations committee said it was “not a shell and it will be built exactly to SEC specifications without reducing the size. It is currently being built and will not contain all customer data until July 2022. “

Regulators aren’t waiting for an authoritative timeline for the hype, which appears to have been initiated by amateur traders organizing on Reddit forum r / WallStreetBets. As early as Thursday, Treasury Secretary Janet Yellen convened the heads of state and government of the SEC, the Federal Reserve, the Federal Reserve Bank of New York and the Commodity Futures Trading Commission to investigate the matter.

Yellen called for a “discussion of the recent volatility in financial markets and whether the recent activities are compatible with investor protection and fair and efficient markets,” Treasury Department spokeswoman Alexandra LaManna said in a statement.

The regulatory authorities are faced with the question of whether the activities of the apparently amateur traders amounted to illegal market manipulation – and whether highly developed professionals used the cloak of online anonymity to fuel the intoxication. According to Bloomberg News, the SEC is already searching social media and message boards for evidence of such efforts.

But those who set and enforce market rules don’t just look at malefactors, they look at a myriad of issues raised as a powerful force by the advent of retailers. Possible answers range from the practical – aside from online brokers selling their clients’ orders to huge Wall Street firms – to the philosophical. Some are calling for a major rethinking of what they say works more like a casino than an efficient capital redistribution machine.

“The best mathematicians in America are trying to beat the other best mathematicians by a millionth of a second,” said Rep. Brad Sherman, D-Calif., Chairman of the Subcommittee on Investor Protection and Entrepreneurship for House Financial Services and Capital Markets. “I would like to see our capital markets be a place to invest because you believe a company will do well and companies can raise the capital they need to create jobs. Instead, you have high frequency trading, the social benefits of which are difficult to identify and which consume enormous intellectual resources, and I don’t know for what purpose. “

The entire House Committee will consider the matter at a hearing on February 18. House Financial Services Committee Chair Maxine Waters, D-Calif., Said she was finalizing the list of witnesses for the hearing and aimed to “shed light on exactly what happened.” She said she’d like to hear from Reddit, Robinhood, GameStop and “some of the hedge funds”. She said a legislative response was not imminent. “I think we still have a long way to go.”

The Senate Banking Committee has announced its own hearing, although a date has not yet been set. And his unplanned hearing to confirm Gary Gensler, President Biden’s election as head of the SEC, will focus at least in part on how he plans to approach the matter.

Allison Messrs. Lee, the agency’s acting chairman, said her first priority is investigating the decisions made by Robinhood and other online trading platforms that caused a turmoil last week as they started trading GameStop and other stocks that soared private investors had driven, restricted. In an interview with NPR on Monday, Lee said the SEC wanted to ensure that these decisions are “in compliance with regulations, transparent to their customers, and that they are applied consistently and fairly.”

Hedge funds, some of which have suffered billions in losses from taking short positions on stocks that retailers bought out, are also being scrutinized. Waters said in a statement that their “unethical behavior directly led to recent market volatility”. Sherman and others called for more disclosure from hedge funds, including their short positions, and possibly higher capital requirements.

The industry is ready to fight back. “Short sellers conduct in-depth research and analysis that can uncover financial fraud and corruption,” said Bryan Corbett, director of the Managed Funds Association, the industry lobby group. “This is a highly regulated activity by both the SEC and the SEC [the Commodity Futures Trading Commission]and existing framework conditions offer ample protection for the markets and all investors. “

The GameStop mania isn’t the first time the SEC has investigated the connection between the Internet and securities fraud. However, according to Joshua Mitts, an associate professor at Columbia Law School, the market observer has not adequately monitored the use of social media and other emerging technologies in financial markets. This deficiency could hamper efforts to investigate the GameStop episode.

“You are really around the corner,” said Mitts. “The SEC doesn’t really step in, saying, ‘These are the rules of the street on social media.'”

The Commission has made increased use of advanced data analysis in recent years to uncover insider trading and accounting and disclosure violations. However, the SEC’s enforcement division is still heavily populated by securities law experts and lacks the data science specialists needed to combat market manipulation cases over social media, Mitts said.

“The average person who runs the SEC is an attorney who probably hasn’t done a lot with data,” Mitts said. “You need data scientists.”

More than two decades ago, as the tech bubble ended in the 1990s, the Commission followed up several cases of alleged securities fraud involving digital tools.

Any GameStop investigation is likely to have similarities to previous cases from the Internet era, according to John Stark, first director of the SEC’s Internet Enforcement Office. Many fraudsters involved post false or misleading information on websites in order to increase the price of selected stocks.

In the GameStop case, where an army of retail investors posted enthusiastically about the video game company’s stock, people who were paid to post the stock and hadn’t disclosed that fact could be vulnerable to tampering fees, Stark said. However, given the volume of posts on r / WallStreetBets of 8.4 million members, sifting through the evidence will be a daunting task.

In addition to countless Reddit postings, investigators will also face a potential avalanche of tips filed by members of the public via an online SEC form.

“I am confident that SEC staff will get to the bottom of any manipulation. But it will be difficult to prove it, ”said Stark.

After the tech bubble burst in 2000 and the Nasdaq index lost more than half of its value, SEC officials tracked a series of fraud cases that used the Internet to give stock prices the creeps.

In 2002, the SEC reached a civil lawsuit settlement with Cole Bartiromo, a student who had participated in a “pump-and-dump” system on the Internet. Bartiromo, then 17, manipulated the stock prices of 15 companies by buying large numbers of stocks and then posting “false and misleading information” about them on Yahoo! Finance and Raging Bull Message Boards, the commission claimed.

In less than two months, Bartiromo posted more than 6,000 messages informing him of an upcoming merger or acquisition that he incorrectly attributed to sources such as Bloomberg and JP Morgan. In the case of an over-the-counter stock that Bartiromo claimed had risen to $ 10 a share, he sold his entire stake for less than 25 cents, the SEC told a federal district judge in Manhattan.

The settlement required Bartiromo to distribute illegal profits and interest of $ 93,731.

Two years earlier, the commission had settled civil fraud charges against an even more recent Internet advertisement. Jonathan Lebed, a 15-year-old high school student, agreed to pay the government $ 285,000 in illicit profits and interest without admitting or denying the charges.

On eleven occasions, Lebed bought shares of thinly traded small companies and then used several false names to “publish unfounded price predictions and other false and / or misleading statements,” the SEC said.

Lebed made claims that a $ 2 stock would soon be trading for $ 20, or that one stock would be the next “up 1000 percent,” the commission said. He often placed automatic sell orders with his broker to “make sure he didn’t miss the stock price hike while he was at school the next day,” the commission said.

“I ask investors to be extremely skeptical of any advice they receive from the Internet. People should do a thorough research before making any investment decision and review any information before reacting, ”said Ronald C. Long, administrator of the SEC’s Philadelphia regional office who led the investigation.

In 1999 the SEC filed a civil lawsuit alleging four men from Southern California had joined a scheme to manipulate the existence of a bankrupt commercial printing company by spreading false takeover rumors on the Internet.

On a November weekend in a University of California library in Los Angeles, the three created numerous Internet message board accounts and posted messages falsely claiming that NEI Webworld would be acquired by LGC Wireless, a privately held telecommunications company.

The rumors that were fabricated drove NEIP’s share price from 13 cents on a Friday to over $ 15 the following Monday, according to the SEC complaint, bringing the men about $ 364,000 in profit.

Two of the men, who did the same thing to several other thinly traded stocks, pleaded guilty to security fraud charges and received short sentences. The courts eventually ordered the four men to pay approximately $ 1 million in distributed profits and fines.

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