Thanks to Blaine for not only attending this panel session, but for summarizing it for us! – Alan 

Recently, the Roaring Kitty (aka Keith Gill) and his brethren made headlines with their trading (most notably in GameStop) and the impact it had on certain hedge funds and banks.  The interest on this saga seems to be universal with folks wanting to know whether or not these trader/customers were doing anything wrong and if there were any possible ramifications.  Thus, it seemed particularly timely when the Chicago Bar Association announced that it would be hosting a panel made up of SEC and FINRA personnel to discuss the topic of market manipulation (which was one of the theoretical transgressions of the traders that has been bandied about).  Before you get too excited, however, the regulators prefaced their comments by indicating they would not be discussing any current trading activity or active investigations, which would almost certainly cover GameStop, etc.  Still, as always, it is nice to learn what regulators are thinking before you end up sitting across the table from them trying to explain away your own actions.  With that in mind, here are the highlights of the discussion.

The regulators generally described manipulation as an action taken to interfere with the market in its natural state, which frequently means an act that artificially changes the price of a security or product.  Sounds amorphous, right?  Luckily, one of the regulators from the SEC outlined some of the things he looks for:

1) The trading makes no sense – e.g. orders on both sides of the market or other circumstances where even the traders themselves have no bona fide explanation for the purchases and sales.

2) Notice of illegality or rules violations – this does not necessarily mean that the SEC or FINRA are knocking on your door, it could be the BD telling the trader to stop a certain type of trade, shutting down accounts because of the trading activity or, simply, questioning the trading.  In other words, if the trader’s broker-dealer has been sniffing around, regulators are probably going to assume the trader was on notice that something might be afoot and will not look kindly upon an ignorance plea.  In theory, this should help weed out any type of mistaken or innocent acts.

3)  Hiding actions – this one seems obvious and includes opening up accounts in the names of friends, family and other entities to disperse trades and other furtive activity that indicate the trader knew or at least had reason to believe his or her actions might be wrong.

So how do these bad acts manifest themselves in the everyday market? The regulators mentioned a host of illicit activities including but not limited to spoofing, wash trades, banging the close and a healthy discussion of “pump and dumps.” A pump and dump classically occurs when a person or group of persons obtains control over a company that has a low value (sometimes known as a penny stock company).  That person might hide their control by putting their shares in the name of family members and or other entities (which would hit on Regulator’s #3, above).  After that they promote the company, either doing it themselves or by paying others to do so in chat rooms or other mediums, using false information about the future prospects of the company.  After innocent investors purchase the stock, and drive its price up, the owner dumps his or her shares and the innocent investors are left holding the bag.

These types of schemes were of particular concern last year when different companies marketed potential “miracle” cures for COVID that unsuspecting investors might have tried to jump on to make a quick dollar.  These schemes are often found in companies doing business in whatever is the fad of the day (COVID, Marijuana, etc.).  As the moderator pointed out, this fact pattern is basically the plot to the industry favorite film Boiler Room, which is worth a watch for industry wonks.

As mentioned above, the regulators promised to avoid current events (read GameStop) in favor of resolved matters. Still, it creeped into the conversation, at least tangentially.  The moderator, while not mentioning Game Stop, asked why the public should care if investors are doing something (whether manipulation or not) that ends up harming a Wall Street bank.  Notably, the question is not if there is some type of violation, but, instead, why people should care.  The answer was that it does not only impact those banks or hedge funds but interferes with market liquidity and, potentially, the average investor (especially older ones) if one of the securities at issue happens to be in average Joe’s 401K or his personal trading account.  Theoretically, that makes perfect sense, but if the average investor saw his stock in GameStop temporarily rise and then fall back down, he might not have suffered too much harm.  The real damages was done to those shorting stocks, but it is, of course, not clear how many 401Ks or elderly investors are shorting companies on a regular basis.  It will be interesting to see where the regulators, ultimately, shake out on the issue.

Again, while not mentioning GameStop, there was talk about how broker-dealers can protect themselves if, by chance, their customers are engaged in some type of market manipulation.  According to the FINRA representative, foreign nationals going through broker-dealers (especially those who offer direct to market access) have been an ongoing problem.  While FINRA, at least, would not be able to touch those unregistered foreign individuals (true of unregistered domestic individuals, as well),[1] the broker-dealer could find itself with a failure to supervise case pending against it.  The lesson is that broker-dealers need to be vigilant in ensuring (or at least taking reasonable steps to try to ensure) that its customers are not manipulating the market and to make sure they are keeping accurate tabs on who exactly is opening accounts with the firm.  In other words, and as always, vigilance is the key to avoiding entanglements with regulators whether pertaining to manipulation or any other issues that broker-dealer personnel face.


[1] The Roaring Kitty, of course, presents a different circumstance since he is currently registered.