GameStop and Compliance: Part 5 – Lessons Learned

Thomas Fox

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 Officer (CCO) and compliance professional needs to be paying attention. Yet even as I write this GameStop which began as five-part series on Monday at $328.59, closed at $53.50 at the bell on Thursday as I write this post on lessons learned. Perhaps the first, most important and everlasting lesson of all time is that all market bubbles burst at some point.

All this week, I have been citing to Jed Gardner, Senior Vice President at Linedata Technology Services, who said about the Coronavirus health crisis and its impact on business, “we have moved from disaster recovery to business continuity to business as usual during the time of Coronavirus. He explained that “risk managers, compliance professionals and business executives now have to plan for the unknown unknowns in their business plans and risk management strategies.” I decided to ring up Jed in the UK and ask him about the entire GameStop matter and what it means for compliance professionals.

Gardner said that one of most important points was “can you move quickly enough to control events?” He began talking about GameStop, the company, Robinhood, the trading platform and the institutional investors, particularly the shorts, many of whom paid dearly for their short positions in GameStop. He said that Robinhood was clearly not ready for the type of transaction volume generated which led to a trading suspension on Thursday, January 28 because the Depository Trust and Clearing Corporation (DTCC) demanded a cash infusion of $3 billion to clear Robinhood’s trades. (This amount was later reduced to $1 billion.) This not only stopped the traders in their tracks but enraged many Robinhood customers who were blissfully unaware of the terms under which they traded on the platform.

While Robinhood may have had the legal right to suspend its users from trading in Robinhood, it was their ham-handed approach (with apologies to any hams out there). Mengqi Sun, writing in the Wall Street Journal(WSJ), said, the company “is facing more than 30 civil lawsuits in relation to trading restrictions imposed by the online brokerage that temporarily limited purchases of certain securities last week”. Many of these claims are based on state security laws which Robinhood may be woefully unaware of. In part of its disastrous response, Robinhood “said the restrictions stemmed from regulatory requirements and risk management considerations as a brokerage firm. That includes net capital obligations required by the Securities and Exchange Commission and deposits requirements from its clearinghouses, which process the securities on the back end after a user executes a trade with their brokerage.” Of course, this statement only came after it suspended trading on the 28th, when “the amount required by clearinghouses to cover the settlement period of some securities rose tremendously”.

But Gardner said it is more than trading companies, financial institutions, hedge funds and social media platforms who need to study the past few weeks for lessons. It is literally every industry which needs to be aware of this matter. You need to understand what is being said about you, your industry, where and how you do business so you can be prepared if it all blows up. The GameStop phenomenon did not appear overnight. It had been building for months. In the Reddit chatroom at the center of the trader’s world, r/WallStreetBets, traders like Roaring Kitty had been touting GameStop stock since at least September 2020. Many had done this based upon market research and positions taken by the Shorts. But the more interesting part was that later traders made their decisions to purchase GameStop solely based on the moves of people like Roaring Kitty. Robinhood apparently allows you to follow your favorite traders and many purchasers of GameStop did so and bought simply because he did.

In other words, follow a key player, do what they do and you will be rewarded like they are. That is about as close to location, location, location as you can get in the trading world. This is not entirely new as some investors purchase stock after people like Warren Buffet does but Robinhood seems to drive this sort of herd behavior in a way not previously seen.

Now take that same herd mentality and apply it to a social media cause such as modern slavery or responsible sourcing. What if there is a significant discussion going on in any Reddit chat room so dedicated to that topic? It could go on for months and then some spark could ignite it for all the world to see. What if your company was named? What if a key supplier was named? Would you be ready to respond? Would your compliance program be ready to respond in a documented manner which could refute any such allegations?

What about your own employees? What if they are a part of those discussions? Is that activity protected under the National Labor Relations Act? Is it free speech? What about Mass Mutual and its former employee, Roaring Kitty? The New York Times (NYT) reported 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.”

Do you think there was any conflict-of-interest present? What if Mass Mutual invested in GameStop? Apparently, “MassMutual, has told securities regulators in Massachusetts that it was unaware that Mr. Gill had spent more than a year posting about GameStop. The insurer also told regulators that had it known about Mr. Gill’s outside activities, it would have asked him to stop or possibly fired him.” But it is not as if Roaring Kitty was hiding in the shadows or even hiding in plain sight, as he was (and still is) on social media, online message boards and YouTube.

Finally, what does all this mean for zeitgeist? Gregg Greenberg, General Manager & Host, C-Suite TV, observed the following, “The battle over GameStop has very little, if anything, to do with GameStop. It has to do with supply, demand and a bunch of hedge funds that were far too confident in their thinking. It was nice to see so-called Main Street Investors rise up and stick it to the so-called Masters of the Universe. The result will be a far more efficient market and the prevention of collapses like we saw during the mortgage and Long Term Capital crises where Uncle Sam bailed out the financial elites. Hats off to all those folks in their parents’ basements sticking it to all those folks in their Greenwich and Hamptons mansions.”

This is a sentiment that was expressed by both Occupy Wall Street and some Tea Party members after the 2008 financial crisis, where Wall Street was bailed out with no legal consequences for tanking the economy. Joan Donovan, writing in Politico, found those “folks in their parents’ basements” as direct descendants of the Occupy movement. She wrote about protestors in Zuccotti Park in Manhattan’s financial district, “there to protest limits imposed on “the little guy”.”  She drew a direct line from the Occupy protesters whose home base was that same Zuccotti Park to those of today, the “retail stock traders who had found a way to make money by banding together on the Robinhood trading app to move the markets.”

But if you go back to the original Tea Party (before the GOP Co-opted it into a racist throng); there was a small group focused on the economic inequality emanating from the Wall Street elite. The point of both is that there is a large group of folks who are ready, willing and now able to stick it to the man. If they focus their collective ire on your organization, will you be ready?

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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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