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Will the SEC sue GameStop traders? The case could pose a 'super weird' challenge

Traders who gobbled up GameStop (GME) stock in the Reddit-user-fueled push to squeeze short sellers could end up on the defending side of enforcement action if officials can find out who they are and show they tried to manipulate or deceive the markets.

Indeed, Fox Business Network’s Charlie Gasparino tweeted on Thursday that regulatory sources were telling him they would be looking at a market manipulation case related to GameStop trading.

However, a successful case against those who caused the spikes is no slam dunk. That’s partly because it could be hard for regulators to show that traders intentionally deceived market participants into thinking that GameStop’s fundamentals were healthier than they actually were.

“GameStop is super weird, because at least at this point it’s all over the news. People kind of know that this strange and artificial thing is happening — that the company's price is much higher than its fundamentals,” University of Michigan School of Law assistant professor, Gabriel Rauterberg, told Yahoo Finance, noting that it could be tough for regulators to show the traders, whose efforts appear to have been out in the open, sent false price signals. Regulators may have more success targeting the buying behavior that took place at the very beginning of the effort, he said.

A Fedex deliveryman prepares a package for a GameStop store amid the coronavirus disease (COVID-19) pandemic in the Manhattan borough of New York City, New York, U.S., January 27, 2021. REUTERS/Carlo Allegri
A Fedex deliveryman prepares a package for a GameStop store amid the coronavirus disease (COVID-19) pandemic in the Manhattan borough of New York City, New York, U.S., January 27, 2021. REUTERS/Carlo Allegri

Those traders pushed GameStop’s stock price from $96.73 a share at the market open on Monday to $347.51 at the market close on Wednesday, prompting the New York Stock Exchange to halt trading multiple times. On Thursday, the popular trading platform Robinhood halted buying of the stock, along with other hot stocks including AMC (AMC), BlackBerry (BB), Bed Bath and Beyond (BBBY). GameStop stock was down 27% just after 1:30 p.m. EST on Thursday.

These stocks, which short sellers have bet against, have shot up wildly in recent days as day traders, particularly those on the Reddit group WallStreetBets, have dove headlong into the stocks. That buying frenzy, in turn, has spurred short sellers to buy the stock to cover their losses — driving up prices even more. Can the traders behind this short squeeze be accused of market manipulation?

“What matters the most, legally, is what can be proven about the intent of the trader when he or she placed the order,” futures and securities litigation attorney Andrew Lourie, who specializes in disputes alleging market manipulation, told Yahoo Finance.

‘Always potential’ for legal action

Traders who knowingly worked in concert to purchase the stock for reasons aside from its market fundamentals could face legal action from regulators, according to Lourie. That action would most likely be a civil suit from the Securities and Exchange Commission (SEC), due to a vaguely worded statute that gives it wide latitude to file litigation over market scenarios they view as undesirable.

“When it comes to manipulation there's always potential [for legal action] merely because there's no clear statutory definition for manipulation, especially with futures,” Lourie said. “The definition is largely case-law created, and can evolve in response to new interpretations regulators ask the court to adopt, via an enforcement action.”

The Securities Exchange Act prohibits very specific kinds of conduct, and otherwise relies on general fraud provisions, which prohibit using a “fraudulent, deceptive or manipulative device,” Lourie noted.

Manipulation law is ‘always a mess’

Rauterberg, of the University of Michigan Law School, said he wouldn’t be surprised if the SEC sued GameStop traders, based on the agency’s affinity for high-profile cases and aggressive pursuit of market manipulation. But it could be tough to prove the case.

For one, GameStop’s stock volatility, in his view, doesn’t appear to involve securities fraud, which means regulators would rely on case law that poorly defines market manipulation and deception.

“The really striking thing about manipulation law is that 85 years after the securities laws were adopted, the federal courts still disagree about what it means. So manipulation law is always a mess,” Rauterberg said.

Under the law, one way regulators can attack what they deem to be a “manipulative device” is by proving a group of people agreed to take collective action to buy, sell, or otherwise contract for a stock based on motivation unrelated to a company’s fundamentals — in essence, buying or selling collectively in order to move price, rather than based solely on perceived market value, or speculation as to future value.

That claim could unravel, though, because GameStop traders’ appear to have acted openly, Rauterberg said.

SEC reviewing GameStop activities, working with fellow regulators

Investors pressed to cover short positions have argued that Reddit group participants artificially drove up the price of GameStop’s stock. Reddit participants, on the other hand, have argued that their tactics were fair game, and merely took advantage of greedy Wall Street players who first exploited the system by over-shorting the stock to artificially drive down the company’s stock price.

SEC officials, for their part, issued a joint statement Wednesday noting that they were “monitoring the ongoing market volatility,” though they did not mention GameStop by name.

In addition to making their legal arguments, regulators would first need to identify the relevant purchasers and connect them to the trades — which could be challenging. The hurdles shouldn’t be expected to stop the SEC from trying, the legal experts said.

“Once you get into these unusual price spikes, like you have with GameStop,” Lourie said, “you're going to draw the attention of the regulators.”

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Alexis Keenan is a legal reporter for Yahoo Finance and former litigation attorney.

Follow Alexis Keenan on Twitter @alexiskweed.

Follow Yahoo Finance on Twitter, Facebook, Instagram, Flipboard, SmartNews, LinkedIn, YouTube, and reddit.

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