The Reddit-fueled buying spree of GameStop stocks may be winding down, but regulators are just beginning the process of understanding its legal implications and whether new rules are required to stop future smash-and-grab investing by online traders.
The U.S. Securities and Exchange Commission issued a statement on Friday stating that it was "closely monitoring" the situation and would work to "maintain fair, orderly, and efficient markets."
"In addition, we will act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws," it continued, though the agency avoided pointing fingers at who exactly manipulated the market in this case.
Some have argued that members of the subreddit community r/WallStreetBets engaged in market manipulation when they urged other retail investors to buy GameStop stocks in order to put pressure on hedge funds with large short positions.
Gabriel Rauterberg, a professor and expert in securities law at the University of Michigan Law School, said he's skeptical this kind of argument would hold up in court.
He pointed to Section 10(b) of the Securities and Exchange Act as the "workhorse provision" that would likely be invoked in any market manipulation case. The law forbids fraud in trading activity, but there is significant disagreement about what exactly that means.
"The core thing that they have to show is that the defendant intentionally committed a manipulative act, and the federal courts actually disagree a lot about what constitutes a manipulative act," he said.
One point of agreement in the case law is that a false price signal must be sent to constitute manipulation. In the case of GameStop, Rauterberg explained, that would mean members of r/WallStreetBets would have had to provide verifiably false information about GameStop and then urge trading activity based on that claim.
With many retail investors buying the stock because it had momentum and the price was shooting up, this kind of direct manipulation could be hard to prove.
"I think a lot of these people are acting in good faith," Rauterberg said. "They just think 'the stock is worth a ton of money and I should buy it,' even if by any reasonable consensus the value is completely disproportionate."
As for simply promoting a stock despite its fundamentals — such as earnings or growth prospects — he said that's a "super weird, hard-to-win, unusual manipulation case."
"Manipulation law doesn't make it illegal for you to cause a stock price to deviate from its fundamental value," he said. "That's just not something it does."