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GameStop mania continues as SEC warns against market manipulation

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Yahoo Finance’s Julie Hyman, Myles Udland, and Brian Sozzi speak with Former SEC Chief Economist and Carnegie Mellon Professor of Finance, Chester Spatt, about the Gamestop frenzy and outlook for Robinhood.

Video Transcript

JULIE HYMAN: Something else I just wanted to mention as you talk about Robinhood and some of these other trading platforms is the latest status on the restrictions on these platforms. This morning, reportedly coming into the session, eight stocks, eight companies have restricted trading on Robinhood. That's down from about 50 at the peak. And when we talk about restrictions, it differs depending on the stock, but it means some restrictions on taking new positions in these companies.

We should also mention that Vlad Tenev, who was on our air on Friday, was on "Clubhouse," which is a new hot sort of audio/podcast/social app. He was on it with Elon Musk, and they had a conversation about all of this. And Tenev said that-- he sort of explained more about why they had to restrict trading and the sort of capital position that the company was put in that led it to take those decisions. So kind of interesting that he has had-- he's been very visible through all of this, trying to do some damage control as the so-called-- you know, the Redditors that sort of turned against him.

MYLES UDLAND: And, you know, I think also-- I'm surprised at how much-- our producer Val just pointed this out. I'm surprised at how much he keeps talking. I'm surprised that Robinhood feels that the right move here is to put their CEO out in extremely public places for five straight days. And to continue-- and I know it's been explained by Vlad and by-- you know, CEO of Webull was on our air, I think Wednesday or Thursday? Probably had the best explanation of it.

And that was before everyone all of a sudden became a DTCC expert, saying that they didn't decide that they couldn't allow trading in these names. They were told that they couldn't allow trading in these names. I think it's very interesting. And again, none of us are PR experts. It's interesting as a PR strategy for Robinhood to continue to try to spin the story like they are actually on the side of investors, when they're not on any side, Sozzi.

They're just being told what capital they need and what capital they don't have. And it appears-- for other people who might have an agenda about what the company does-- that they're coming down on a side of hedge funds or the government, whatever it is. I mean, that's just all misinformation at this point. They're just told to follow rules that are put in place on how much capital is required to clear certain trades. And that's the mechanism here.

And so again, it's very interesting that the company continues put its CEO out there and he continues to say this line like their mission hasn't changed. And their mission is fine, but right now, I mean, this is a capital crunch. This isn't time for a mission; this is time to survive as a business.

BRIAN SOZZI: Myles, I would say this strategy, this PR strategy, or the comm strategy for Robinhood, it really falls in the category of "can't lose" strategy. First of all, Robinhood-- it's not public; a non-public company. They have already proven throughout, I would say, their own crisis of the past week and a half, the ability to raise capital. And you have a company that-- whatever-- they're going to get attacked anyway on social media, so why not put the CEO out there in the hopes of maybe getting a little bit of sympathy?

But again, you're seeing really-- I think really the benefit here of not being a public company and why, again, I think Robinhood may not ever be a public company. It should just be a division of a larger bank.

JULIE HYMAN: And by the way the, Robinhood app is still the most downloaded on-- I think both on iOS and on Android still, at this point. So it hasn't slowed down demand for the app as all of this has been going on.

Let's talk about the regulatory framework and role in all of this. We are joined now by Chester Spatt. He is the former SEC chief economist. He's now professor of finance at the Tepper School of Business at Carnegie Mellon University.

Thank you so much for being here. This is a piece that we haven't yet talked about this morning, the whole regulatory piece. And there's been a lot of talk in Congress about what role regulators should be taking in all of this. On the part of the Redditors, of course, as always, there's some conspiracy theories about the SEC's role in all of this. What do you think the SEC should be doing, if anything, in this situation?

CHESTER SPATT: Well, the SEC indicated late last week that it's monitoring developments, and I think that's extremely important in the current situation. Some of the issues that you were just chatting about, namely the capital needs of Robinhood and the necessity-- and the possible necessity of the trading limits that they imposed, are certainly something the commission staff ought to be getting a handle on understanding.

You know, what was the nature of the capital before this happened of Robinhood? Was it inadequately capitalized? What do the restrictions that they've imposed mean? For example, restricting-- I'm not sure if I understand it, but restricting the gaming stock to one share. What sort of brings about that particular restriction? I think these are all important to understand.

And the regulator, at the same time, may be interested in understanding whether the Redditors manipulated the markets to produce an artificial price. It seems to me all issues are on the table. But these are issues for the staff, for them to explore. At this point, they don't seem to me to rise to the level of lawmakers already trying to do an autopsy. I think first we have to let the SEC staff do an autopsy, and only later should lawmakers be debating possible changes in the regulatory framework.

First let's see what our regulatory framework did. And why did it do that? And to what extent were the actions of the market participants appropriate?

MYLES UDLAND: And Chester, you brought up the issue of market manipulation. I'd love it if you could maybe briefly outline how the SEC goes about trying to define when a security has been manipulated. Because I think there's perhaps a popular misunderstanding that discussing a specific stock constitutes manipulation of that stock.

CHESTER SPATT: Well, I certainly wouldn't think that discussing a particular stock would be manipulation. It's been a hard-- it's been a difficult issue for the commission to define. I think of manipulation in terms of attempts to create an artificial price. But I don't think just communication, for example, that this stock is undervalued because there's a potential for doing a short squeeze, that [? one ?] in and of itself, it would not seem to me to constitute manipulation. But what the nature of the communications were, this is something also that the staff might be interested in understanding.

You know, so here we have an interesting situation. We have two forces knocking heads against each other. On the one hand, we have short sellers who felt that the earlier prices of some of these stocks were of-- and especially GameStop-- was artificially high. On the other hand, the Redditors saw that there was potentially vulnerability here to a short squeeze and felt that the actions of the shorts were not justified. And so they pushed back.

And so you have these two very strong forces. The shorts to some extent can be broken by a squeeze, and indeed I think here they have been broken, but also potentially aspects of the risk management framework and perhaps broader kind of issues of market rationality may also ultimately put a stop to what the short squeezers try to do. Ultimately a short squeeze is [? end. ?] You know, sometimes they end, of course, in great success. So here you have these two opposing forces really coming to loggerheads.

BRIAN SOZZI: Chester, if you could put your broader business hat on now, what should the CEOs of a GameStop and a BlackBerry-- these heavily shorted stocks-- what should these executives be doing? GameStop's CEO is now worth $1 billion because he owns 4% stake in the company. But should they come out and say, hey, you know what? Yeah, I get the trading activity, but man, our businesses don't match up with this.

CHESTER SPATT: Well, I might want to confer with a good securities attorney and decide if I could sell into-- and decide if I can sell my stock into this so I could liquefy my billion dollars. But in all seriousness, though, these are issues. Should they put out-- I don't know, do they have an obligation to put out an announcement? It's not clear to me that in terms of running their business, that they necessarily need to.

Now, we had a kind of a somewhat analogous situation last year that I thought was quite interesting. We had a situation involved-- and maybe a little cleaner situation, involved Hertz. Hertz was in bankruptcy. And the bankruptcy attorneys for Hertz got the judge to agree that Hertz could issue new shares. Hertz was still selling for several dollars in bankruptcy-- the equity was selling for several dollars-- even though the value of the debt was only about $0.40 on the dollar.

So basically, the capital markets were saying-- at least through-- as it priced the debt, that these securities-- that the equity was likely to have little, if any, value because of the absolute priority rules that are used in bankruptcy. And so the Hertz attorneys went to the bankruptcy judge and said, oh, we want to issue more equity. And the judge said, OK, go ahead and issue more equity. And they were playing an equity offering of about half a billion dollars.

And then the chair of the SEC, during a broad-ranging interview on one of the cable networks, said that he had serious disclosure concerns. And within a few hours-- about the Hertz offering. And within a few hours, basically the SEC and Hertz met, and within a day or so, the offering was withdrawn. And the concerns basically that the SEC had were that the offering was going to be a violation of investor protection.

But still this raises a broader point about what executives whose companies are inflated up in the context of a short squeeze might consider doing. And one thing they might consider doing is, if the security attorneys opine that it's OK, to consider the possibility of doing an equity offering. You know, I understand that there was some discussion by one of the major airlines at the end of last week to possibly view this as an opportunity, for example, to do an equity offering.

JULIE HYMAN: Yes, I believe it was American Airlines. And AMC definitely did an offering as well, which raises the question throughout this of how much you need to protect investors from themselves. We've got to leave it there, Chester. Thank you so much for your time this morning. Chester Spatt is former SEC chief economist and professor of finance at the Tepper School of Business. Thank you very much.

CHESTER SPATT: Thanks. Thank you.