Takeaways:

• Stock promoters have moved from boiler rooms and stock newsletters to social media services.
• The COVID-19 pandemic and the “meme stock” mania that accompanied it brought an influx of retail traders to public markets.
• Those retail investors have proven to be prime fodder for social media stock promoters.
• Recent enforcement actions show that the Securities and Exchange Commission and Department of Justice are clamping down on social media stock promoters.

Recent enforcement actions show that the federal government is once again clamping down on online boiler rooms.  Last year, the Securities and Exchange Commission filed a civil complaint against Steven Gallagher, with the Department of Justice lodging parallel criminal charges against Gallagher.[1]  Gallagher allegedly used the Twitter handle @AlexDelarge6553, a nod to a character from A Clockwork Orange.  The government claims he used his social media feed to promote shares in public companies that he had already taken a position in and then sold his equity shortly thereafter at a profit.  In February, Gallagher pled guilty to securities fraud.  He faces up to twenty years in prison.  Gallagher has not resolved the SEC’s more expansive civil enforcement action, which remains pending.

The SEC then filed a complaint against Michael Beck earlier this year.[2]  Beck allegedly used the Twitter handle @BigMoneyMike6 to tout shares in issuers that he had purchased and then quietly sold his shares after his followers purchased stock and caused spikes in the share price.  The Department of Justice filed a narrower criminal case against Beck as well.[3]  Both the civil and criminal cases are pending.

The Gallagher and Beck cases are strikingly similar and primarily revolve around so-called “scalping” schemes, a variation on classic pump and dump tactics.  In a social media scalping scheme, a stock promoter initiates a position in a public company.  This is typically a thinly traded, low float microcap or small cap company.  Such companies are targeted because, by virtue of their low float and thin trading volume, a successful promotional campaign can cause massive spikes in the share price.  After quietly amassing shares in the issuer (“frontloading”), the promoter aggressively touts the issuer on social media: asserting that the share price will rise sharply (e.g., providing fanciful price targets and price predictions), that a short squeeze is imminent, that the stock is undervalued, and so on.  This is often effectuated through Twitter, Discord, or Reddit (or some combination thereof).

As the promoter’s followers pile into the thinly traded stock, the share price and volume rise – at least temporarily.  The promoter’s efforts to “pump” the issuer’s stock eventually peter out as the number of susceptible investors inevitably dwindles.  There are, after all, only so many “marks” to push up and support the share price, and so every rocket runs out of fuel.  At that point, the promoter, without warning, unloads his or her position, with his or her followers providing liquidity for a clean exit.  Once the promotional campaign ends, the buying mania subsides.  The share price and volume in the issuer plummet as investors realize that the promise of “getting rich quick” has become “getting poor quicker.”  

The government considers these practices to be fraudulent in that the promoter touts the stock in order to secretly sell his or her shares days or hours after (or even while still) promoting shares in the issuer.  The promoter’s continued support and holding of the issuer’s shares, and decision when to sell those shares, indeed appears to be a material consideration for investors.  The remarkable correlation between the promotional campaign and the price and volume action in the issuer’s stock leaves little room for argument.  The share price and volume skyrocket in tandem with the promotional campaign and just as quickly drop once the promoter’s support fades and it starts to become clear that the promoter has exited the stock.  The fact that stock promoters are not in the habit of previewing or posting their exits suggests that they too are aware of these dynamics.

Before the age of social media, a stock promoter would generally need to hire a small army to man the phone lines in a boiler room or issue a newsletter to pull off such a scheme.  But social media provides a far more effective method to tout equities to naïve investors, costing nothing while providing virtually unlimited reach and maximal anonymity.  Decades ago, the notion that investors would take financial cues from often pseudonymous social media users would have seemed farfetched, but that is no longer the case.  In fact, many stock promoters on Twitter boast hundreds of thousands of followers.  Those individuals have a greater audience than most traditional financial analysts, even if their audience is retail investors, as opposed to more sophisticated market participants.

Buying manias caused by social media scalping schemes have skyrocketed in recent years.  The COVID-19 pandemic, and the meme stock mania that accompanied it, brought an untold number of new retail investors to public markets.  Lured by the spectacular gains in GameStop and similarly volatile meme stocks, these traders flooded Twitter, Discord, and Reddit looking for the next diamond in the rough.  These investors became prime fodder for scalpers who exploited their naivety for their own financial gain.

As venture capitalist Josh Wolfe aptly described the manias in meme stocks: “‘To the Moon’ is not fundamental analysis.  It is an inducement.  It is an encouragement of belief.  And the only thing that is fueling that rocket ship ‘To the Moon’ is the credulity of others.”  That sentiment holds equally true in the context of social media scalpers, where a promoter suggests “easy money” gains in order to lure gullible followers into the shares he or she has frontloaded.  Once the rocket begins to slow down, or reverse course, the promoter is quick to jump ship.  His or her followers, meanwhile, ride the rocket as it crashes back to Earth.

History may not repeat itself, but it often rhymes.  The boiler rooms and stock newsletters of yesteryear have largely been replaced with the far more effective, and far less labor-intensive, means of social media stock promotion.  Given the recent rise of the retail investor and the concomitant rise of the social media scalper, the SEC and Department of Justice are watching.  Further civil and criminal enforcement actions are all but inevitable.

[1] Securities and Exchange Commission v. Gallagher, 1:21-civ-08739 (S.D.N.Y.) and United States v. Gallagher, 1:22-CR-00122 (S.D.N.Y.).

[2] Securities and Exchange Commission v. Beck, et al. 2:22-cv-00812 (C.D. Cal.).

[3] United States v. Beck, 2:22-cr-00072 (D. Ariz.)