GameStop and Compliance: Part 4 – The Regulatory Response

Thomas Fox
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Compliance Evangelist

I  think the GameStop phenomenon portends a seismic shift in many areas. It may well be a turning point in markets and investments. Where it will be going, I do not think anyone knows right now but everyone needs to be watching and, more importantly, every Chief Compliance Officers (CCOs) and compliance professional needs to be paying attention. Today I want to look at some possible regulatory responses and the one regulatory response which stopped the Robinhood trading platform for one day.

The DTCC

According to Investopedia, the “Depository Trust and Clearing Corporation (DTCC) is an American financial services company founded in 1999 that provides clearing and settlement services for the financial markets.” Established in 1999, it combined the functions of the Depository Trust Company (DTC) and the National Securities Clearing Corporation (NSCC), which is a subsidiary of the DTCC. The “DTCC settles transactions between buyers and sellers of securities and plays a critical role in automating, centralizing, standardizing, and streamlining the world’s financial markets. When an investor places an order through their broker—and the trade is made between that broker and another broker or similar financial professional—information about that trade is sent to the NSCC (or an equivalent clearinghouse) for clearinghouse services.”

Jeff John Roberts, writing in Fortune discussed this role, where the DTCC serves to centralize the settlement operations of all stocks and bonds, and is funded by banks and brokerages, including Robinhood. While the DTCC’s activities are an integral element of financial markets, the process by which it assesses risk is not transparent. For instance, executives at Robinhood were greeted at 4 AM on January 28th with a demand for an additional $3 billion in capital based upon the trading volume.

The reason for the dramatic increase in collateral was  the soaring price of GameStop “created fears the clearinghouse could be left in the lurch if prices suddenly cratered. Specifically, brokerages like Robinhood might not have the capital to cover a potential collapse in prices between when shares were purchased on Wednesday and when they cleared two days later. In the same way a brokerage can ask an individual investor to pony up more cash to cover a margin call, the NSCC wanted Robinhood to plunk down more money to avert risk.”

The SEC

 A.     Robinhood

Many have been asking where the SEC has been in all of this. John Reed Stark, a former Chief of the Office of Internet Enforcement at the U.S. Securities and Exchange Commission (SEC),, writing in LinkedInbelieves the SEC has been quite busy. He opined that the SEC may well have “initiated a dual track assault upon Robinhood: an investigation conducted by the SEC Enforcement Division and a “for cause” examination conducted by the SEC Examinations Division.”

Further, Stark believes “the SEC has probably already dispatched an examination team to Robinhood” and has asked for or already “obtained a formal order of investigation, which activates certain added powers for SEC staff; Issued subpoenas for testimony, documents and other information requests to Robinhood; Begun coordinating efforts with the Financial Industry Regulatory Authority (FINRA) and other state and federal regulators and self-regulatory organizations, sharing intelligence, analysis and data; and Started reviewing the thousands of complaints that are pouring to its online tip center, interviewing anyone who requires further inquiry and seeking documents from any tipsters as well.

He dryly concluded, “This is a hideous regulatory morass for Robinhood, which will incur tens of millions of dollars in legal fees merely to respond to SEC requests, let alone defend themselves later against any accusations of wrongdoing.”

B.     Reddit

What about the platform where all the touting of squeezing the shorts and highlighting the underappreciated value of GameStop occurred? The SEC said in a statement “[W]e will act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws. Market participants should be careful to avoid such activity.”

Reed interpreted this statement to mean “SEC enforcement staff have begun gathering all of the Reddit and other relevant online posts, and dumping them all into an e-discovery database for searching, preserving, organizing, etc. The SEC staff are at this minute likely pouring over the data, searching for indications of wrongdoing, and seeking from Reddit any subscriber information maintained by Reddit that the SEC has the authority to request.”

C.    Reddit Users

What about the user of Reddit who touted the stock and created the herd mentality which drove the purchases of GameStop? Typically, if there is no deception, creating a herd to generate excitement about buy a stock and being transparent about your objectives, is not fraud in connection with the purchase or sale of a security and would not be investigated by the SEC. Yet as Stark noted, “The only possible exception being Reddit users who are also registered with the SEC as investment professionals or who run stock-picking newsletters. In such instances, those individuals, because of their special relationship with their customers and clients, arguably must meet a higher fiduciary standard.”

Roaring Kitty is one of the most well-known Reddit users who touted all things GameStop.  The New York Times reported that what was less well-known about his is that he is a registered securities broker. Further, until January 21, his day job was as a financial wellness education director at “MassMutual, officially known as Massachusetts Mutual Life Insurance Company, also informed regulators that Mr. Gill gave his notice on Jan. 21 but was technically still an employee of the firm and its securities and investment advisory arm, MML Investors Services, through Jan. 28 — the week when GameStop shares surged the most.”

These are simply some of the regulatory responses which are or may not be in play. There are already 30 civil lawsuits filed against Robinhood. Who knows maybe the hedge funds which got caught in the squeeze may file suit against Roaring Kitty or others for their intemperate attacks on their business model? Given the venom which came from the Hedge Funds who lost shorting GameStop, anything may be possible.

Join us tomorrow where conclude with lessons for the compliance professional and final thoughts.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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