{"id":3589,"date":"2021-02-02T08:00:21","date_gmt":"2021-02-02T14:00:21","guid":{"rendered":"http:\/\/blogs.luc.edu\/compliance\/?p=3589"},"modified":"2021-02-02T08:00:21","modified_gmt":"2021-02-02T14:00:21","slug":"bitcoin-tesla-and-gamestop-regulatory-challenges-posed-by-the-new-retail-investor","status":"publish","type":"post","link":"https:\/\/blogs.luc.edu\/compliance\/?p=3589","title":{"rendered":"Bitcoin, Tesla, and GameStop: Regulatory Challenges Posed by the New Retail Investor"},"content":{"rendered":"

Patrick Gilsenan<\/em><\/span>
\nAssociate Editor<\/em><\/span>
\nLoyola University Chicago School of Law, Weekend JD 2023<\/em><\/span>
\n\u00a0<\/em><\/span>
\nGameStop started 2021 with a stock price below $20 but saw its stock price skyrocket to well above $300 a share towards the end of January.\u00a0 The rally would be hard to explain by solely relying on the company\u2019s financial reports or underlying fundamentals.\u00a0 Instead, the rally has to be explained through a combination of external factors involving a popular fintech company\u2019s app, manic speculation by retail investors, and Reddit.\u00a0 Although at first glance this may seem like a new phenomenon, the same factors have been at play for years with a huge interest in Tesla and Bitcoin \u2013 and they pose a risk to the markets that regulators and Wall Street together can\u2019t ignore.<\/span><\/p>\n

<\/span><\/p>\n

The massively multiplayer online investment war <\/strong><\/span><\/p>\n

Towards the end of 2020, activist investor and co-founder of Chewy Ryan Cohen<\/a> had invested in GameStop, calling for a strategic review of the company to revamp the slogging retailer\u2019s outlook.\u00a0 That investment, which caused a modest increase in GameStop\u2019s stock, was met by big bets against<\/a> the company by a pair of large investment firms, Citron Research and Melvin Capital.\u00a0 The rest is history \u2013 a Reddit fueled rally from subreddit r\/WallStreetBets<\/a> brought in hordes of retail investors and caused shares to surge, with momentum maintained by tweets by billionaires Chamath Palihapitiya and Elon Musk, trapping the investment firms in a short squeeze.\u00a0 Estimated losses experienced by the investment firms and other short sellers run as high as $19 billion<\/a> as of January 29, 2021.<\/span><\/p>\n

The tug of war between retail investors and large investment firms is unprecedented and has left many looking for answers as to how it happened.\u00a0 Important to the story is the online brokerage Robinhood, a Silicon Valley based fintech company that offers commission free trading on an app.\u00a0 Robinhood has amassed over 13 million users<\/a>, many of whom are young amateur stock traders.\u00a0 In the chaos of the GameStop saga, Robinhood fell under significant pressure due to the volatility and its regulatory obligations, leading the firm to tap credit lines from banks and raise over a billion dollars<\/a> from its existing investors.\u00a0 Robinhood also controversially halted trading<\/a> on GameStop and other related stocks such as the movie theater chain AMC, leading to accusations that Robinhood sought to protect Wall Street.\u00a0 Additionally, Congress is calling for hearings over the halted trading, and at least one class-action<\/a> lawsuit has been filed.\u00a0 Robinhood, like most brokerage firms, has an arbitration clause<\/a> in their customer agreement that prevents customers from suing them in court.\u00a0 Still, even if the courts don\u2019t hear the case, the reputational damage suffered by Robinhood appears substantial.<\/span><\/p>\n

Market manipulation, suitability rules, and disclosure requirements<\/strong><\/span><\/p>\n

Accusations of illegal conduct are flying on all sides, with many pundits calling the actions of retail investors inspired by reddit memes market manipulation<\/a>, while others levy similar accusations<\/a> on Robinhood and other brokerages that halted trading.\u00a0 Market manipulation is difficult to prove, however, and there is uncertainty around its very definition.\u00a0 The Securities Exchange Act<\/a> defines market manipulation as \u201ctransactions which create an artificial price or maintain an artificial price for a tradable security,\u201d but as Sen. Elizabeth Warren<\/a> noted, the Securities Exchange Commission (\u201cSEC\u201d) has failed to provide guidance or rules as to what that means.\u00a0 Additionally, according to James Cox<\/a>, a professor at Duke University School of Law specializing in securities regulation, it\u2019s difficult to determine where \u201cmanipulation start[s] and when does trading on your own hunches and publicizing your hunches start?\u201d<\/span><\/p>\n

Beyond their alleged market manipulation, regulators and market participants ought to consider the obligations that Robinhood and other brokers have regarding disclosures and how suitable the financial products that their customers are trading.\u00a0 In addition to the SEC, brokerage firms are regulated by the Financial Industry Regulatory Authority (\u201cFINRA\u201d) and are subject to the FINRA\u2019s suitability rule<\/a>, which requires that firms must have a reasonable basis to believe that a recommended transaction or investment strategy is suitable for a customer, based on a number of factors including a customer\u2019s investment experience and risk tolerance.\u00a0 Additionally, the SEC has adopted Regulation Best Interest (“Reg BI”)<\/a> to clarify firms\u2019 responsibilities to their customers to provide transparency to their customers, especially as related to conflicts of interest.\u00a0 Based on these rules, brokerage firms are generally required to approve<\/a> customers\u2019 trading accounts for higher risk products, such as the options and margin accounts that have been so prevalent in recent stock rallies.\u00a0 In practice, however, retail brokerage firms rely on customers self-attesting to their investment experience and risk tolerance.\u00a0 And while the firms tend to require an application<\/a> for customers to access riskier products like options trading and margin, some firms make it easy for customers to adjust settings<\/a> on their platforms on their profiles to gain access to the products they want to trade.<\/span><\/p>\n

Reg BI and FINRA\u2019s suitability rule are not equivalent to a fiduciary standard, but some state securities regulators do impose a fiduciary standard on brokerage firms.\u00a0 Massachusetts\u2019 securities regulator<\/a> is currently suing Robinhood for aggressively marketing to inexperienced investors and failing to protect customers and their assets, breaching the state\u2019s higher fiduciary standard.\u00a0 The state alleges that Robinhood utilizes gamification<\/a> techniques that encourage users to trade stocks and options incessantly \u2013 nearly 100 times per day on average in at least one case.\u00a0 The case was filed prior to the GameStop events, but recent events are sure to be relevant- especially when considering the amount of Robinhood customers with access to margin trading and options trading, with novice customers encouraged to update their profile<\/a> after making some trades to access the riskier products in their app.\u00a0<\/span><\/p>\n

Meme stocks, cryptocurrencies, and fears of the bubble bursting<\/strong><\/span><\/p>\n

Many pundits and politicians have referred to the recent activity in the stock market as a casino<\/a>, which is not an unfair observation to make given the circumstances.\u00a0 There has already been substantial concern that the market has kept growing rapidly through the pandemic, seemingly detached from the harsh realities faced by the economy.\u00a0 But while there are fears of a bubble arising out of GameStop\u2019s $23 billion market value<\/a> being inflated, other companies with popular internet followings like Tesla have reached market caps as high as $820 billion<\/a>.\u00a0 Unlike GameStop, Tesla\u2019s prospects are reasonably more optimistic, with new technology that could prove lucrative.\u00a0 Nonetheless, numerous analysts have considered Tesla dramatically overvalued<\/a>, pointing out that the stock price appears to be driven more by speculative fervor than the company\u2019s recent performance.\u00a0 Specifically, Tesla founder and CEO Elon Musk maintains a cult-like following on Reddit<\/a> of his own.\u00a0 These phenomena have been referred to \u2013 whether it be Tesla or GameStop \u2013 as meme stocks<\/a>, due to their value being linked to internet culture.\u00a0 As Elon Musk himself has tweeted<\/a>, \u201cWho controls the memes, controls the Universe.\u201d<\/span><\/p>\n

Much of the same criticism can just as easily be applied to cryptocurrencies.\u00a0 Unlike securities, cryptocurrencies are not inherently valuable<\/a> outside of their use as an alternate form of currency, with some raising concerns that the unjustifiable gains seen from these meme stocks also apply to them.\u00a0 Bitcoin, the most popular cryptocurrency, has a market cap of over $600 billion<\/a>, but is notoriously volatile \u2013 and Reddit-fueled rallies of a dog themed competitor to Bitcoin, Dogecoin, also occurred this month, increasing the value 600%<\/a> in 24 hours to a market cap of over $9 billion.\u00a0 The frenzy around cryptocurrency is less new than the meme stocks, however- in December 2017, Bitcoin reached almost $20,000 per Bitcoin and was predicted to reach $142,000<\/a>\u00a0before it crashed<\/a> and hit a bottom of $6,200.<\/span><\/p>\n

The simultaneous rallies around cryptocurrencies and meme stocks should have market analysts, market regulators, and Wall Street itself concerned about the health of the market as a whole.\u00a0 In the middle of a devastating pandemic, where unemployment<\/a> peaked at 14.8% and was still elevated as of December, a market correction could hurt not only Wall Street, but Main Street.\u00a0 Given the huge speculation in simultaneous potential bubbles<\/a>, there is a real risk of a market panic.\u00a0 Wall Street<\/a> appears to be banking on either the retail investors losing steam or market regulators intervening to return conditions to normal, but the retail investors appear here to stay, at least as long as apps like Robinhood exist.\u00a0 In order to properly control the risks posed by large amounts of retail investors creating bubbles based off of social media activity, brokers should be doing more due diligence into the sophistication of their customers, and regulators should be more adamant on enforcing the rules.\u00a0 \u00a0<\/span><\/p>\n

The views expressed in this blog are those only of the author and not that of any employer.<\/span><\/em><\/p>\n","protected":false},"excerpt":{"rendered":"

GameStop started 2021 with a stock price below $20 but saw its stock price skyrocket to well above $300 a share towards the end of January.\u00a0 The rally would be hard to explain by solely relying on the company\u2019s financial reports or underlying fundamentals.\u00a0 Instead, the rally has to be explained through a combination of external factors involving a popular fintech company\u2019s app, manic speculation by retail investors, and Reddit.\u00a0 Although at first glance this may seem like a new phenomenon, the same factors have been at play for years with a huge interest in Tesla and Bitcoin \u2013 and they pose a risk to the markets that regulators and Wall Street together can\u2019t ignore.<\/p>\n","protected":false},"author":65,"featured_media":0,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[26],"tags":[296,930,1205,1690,1735,1788,1896,1967],"class_list":["post-3589","post","type-post","status-publish","format-standard","hentry","category-finance-banking","tag-bitcoin","tag-gamestop","tag-journal-of-regulatory-compliance","tag-regulation","tag-robinhood","tag-sec","tag-stock-market","tag-tesla"],"_links":{"self":[{"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=\/wp\/v2\/posts\/3589","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=\/wp\/v2\/users\/65"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=3589"}],"version-history":[{"count":0,"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=\/wp\/v2\/posts\/3589\/revisions"}],"wp:attachment":[{"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=3589"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=3589"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.luc.edu\/compliance\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=3589"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}