The GameStop short squeeze, with its massive price runup and subsequent price drop, invited critical commentary from Sen. Elizabeth Warren, D-Mass., who suggested on CNBC that market manipulation was at work. In this article, Stuart Kaswell, longtime financial services attorney, now retired, dissects Sen. Warren's comments. Mr. Kaswell explores price manipulation in the context of her statements, which he characterizes as "inaccurate and misleading."
Senator Elizabeth Warren’s comment to CNBC on January 28, 2021 were very troubling, but not for the reasons she suggested. Her comments are inaccurate and misleading
Market manipulation is illegal, regardless of who is the manipulator, whether on the long or the short side. I respect those who invest for the long haul and short sellers who check “irrational exuberance.” Legal short sellers are economic whistle blowers.
Day traders who buy shares without any understanding of what they are doing probably are going to get hurt. They may find that buying shares and selling them to the next “greater fool” does not work out well. In all likelihood, they will discover that they are the greatest fools of all.
Senator Warren’s Comments
Senator Warren commented on the GameStop trading on January 28, 2021. Her comments on CNBC included the following:
For a long time now, the SEC has pulled back and not made sure that we have an honest market, *** All of a sudden, the billionaires and some hedge funds are yelling because they’re not the ones, the only ones, who make money when the manipulation works. But remember the other half of this: There are gonna be a lot of people who are gonna lose money around this, a lot of money that they can’t afford to lose. This is why we need an SEC that has clear rules about market manipulation and then has the backbone to go in and enforce those rules.
Analysis of Comments
The Senator’s comments simply don’t add up.
- – “We need clear rules about market manipulation.” Congress enacted the Securities Exchange Act of 1934 (the Exchange Act) because of its concerns about the manipulation that was prevalent on Wall Street. The legislative history is replete with congressional concerns about market manipulation. Sections 9 and 10 of the Exchange Act empower the SEC to prohibit long and short sales that are manipulative.
The SEC has adopted a number of rules to prohibit manipulative behavior. Some rules are specific and others are general. For example, Regulation M prohibits most short selling in conjunction with a distribution. Regulation SHO includes a “circuit breaker” to slow cascading short selling. It also prohibits “naked shorting.”
In addition to these very specific rules, the SEC had adopted generalized antifraud rules. Rule 10b-5 is the SEC’s broadest possible assertion of its antifraud authority. It prohibits activity of every stripe, regardless of the means by which a fraudster seeks to harm investors.
The genius of the antifraud prohibitions is that they are broad and not specific. Antifraud rules that are too specific invite crooks to circumvent them. Section 10(b) and Rule 10b-5 prohibit securities fraud, whether the crook is engaging in fraud by means of a telegraph, a rotary dial telephone, or crypto currency. The law is clear, but not overly specific.
Senator Warren also asserts that the SEC has “pulled back” and is not enforcing the law. On what basis? Does she have data about the numbers of times that the SEC chose not to pursue an allegation of market manipulation?
Based on public sources, the SEC has a vigorous enforcement program that includes bringing market manipulation cases. Further, Jay Clayton, who recently stepped down as chairman, successfully urged Congress to expand the SEC’s authority to seek equitable remedies in enforcement cases. Accordingly, based on publicly available information, I see no basis for the Senator’s suggestions that no one is enforcing the law.
- “All of a sudden, the billionaires and some hedge funds are yelling because they’re not the ones, the only ones, who make money when the manipulation works….” This statement is breathtaking in its defamatory nature and its implications.
If billionaires and hedge funds manipulate the securities markets, they are breaking the law. Manipulation doesn’t “work” for them or any one else as a business model. To suggest otherwise ignores the legal framework discussed above. It is difficult to comprehend the idea that hedge funds and billionaires are routinely engaged in market manipulation and that neither the SEC nor any US Attorneys are doing anything about it. Such a conclusion only would mean that there is some conspiracy among the billionaires, hedge funds, and regulators to ignore widespread wrong doing. I am not aware of any such conspiracy.
The second portion of the Senator’s comments are equally perplexing, when she says that “they’re not the ones, the only ones, who make money when the manipulation works….” Is she suggesting that the markets are unfair because only the big guys can engage in manipulation and that the little guys should be able to manipulate like the big guys? Is she saying the federal securities laws should allow for market manipulation provided only the “little guys” are the ones engaged in manipulating stock prices so that they may make money at the expense of others?
Senator Warren’s comments may attract lots of attention, but they don’t withstand thoughtful scrutiny. Market manipulation is illegal, whether on the short or the long side. Short selling is as legitimate an economic activity as “going long.”
If anyone, billionaire, hedge fund, or little guy, is engaging in market manipulation, the SEC should investigate fully and hold wrongdoers accountable. Misstating the situation helps no one.
• • •
Stuart J. Kaswell is an internationally-known attorney with over 40 years of experience in the regulation of securities markets. He began his career at the U.S. Securities and Exchange Commission, was Republican Securities Counsel for the Committee on Energy & Commerce of the US House of Representatives (when that committee had jurisdiction over the federal securities laws), was the general counsel of the Securities Industry Association, the predecessor of SIFMA, and the Managed Funds Association. He was a partner at two law firms. Stuart has worked on financial services legislation and regulation in the US, EU, and elsewhere.