A New Approach to Mitigate Risks from Meme Stocks

Stock markets are interesting on a normal day, but now we have the excitement of watching professional investors face off with retail traders who have learned how to gain from the stock market via social media. We’re quickly approaching the one-year mark of when ‘meme stocks’ garnered worldwide attention.

Meme stocks refers to a select few stocks that gain sudden popularity on the internet and lead to sky-high prices and unusually high trading volume, GameStop and multiple other equities experienced a massive share price increase in January 2021 as retail investors poured money into purchasing the meme stocks. Some retail brokers reacted by temporarily prohibiting certain activity in these stocks and options. Media reports suggested that the activity was directly linked to short sale interest and the price squeeze was an act of rebellion to thwart short-selling professional investors who had allegedly short sold the stock.

The real reason for the sudden share price increase is up for debate. The Securities and Exchange Commission (SEC) published a highly anticipated report examining the January 2021 trading activity in GameStop, which many hoped would provide clarity. However, much to many people’s surprise, the SEC found no wrongdoings on the part of the companies. Instead, it found the rise in stock prices was due to a number of factors, including individual investors who shared information on social media platforms. This was despite the fact that this well-established, but fairly average, consumer electronics retailer was subject to a share price movement in around 10 days that jumped from $20 a share to a high of $500 with no underlying fundamentals to drive this change. 

Does this sound like the SEC has stayed true to its three-part mission of protecting investors, maintaining fair, orderly and efficient markets, and facilitating capital formation?

Since this new way of trading isn’t going away anytime soon, it’s important we identify ways to help mitigate risks moving forward. In this article, I suggest a three-pronged approach could help compliance teams begin to monitor for new risk caused by social trading market manipulation.

The Gamification of Investing

Robinhood was an early “free trading” pioneer, allowing users to trade stocks for no commissions with no account minimums. This coupled with Robinhood’s playful, easy-to-use interface, helped garner interest among a new class of traders, raising concerns about the “gamification” of investing. Some argue that Robinhood and other platforms have turned investing into an online social activity making it too easy, and too fun, to wager money on stocks and more complicated investments.  

More retail broker-dealers are offering trading apps that make it easier to trade from anywhere. Some have “social communication” features that allow customers to interact and chat about stocks and trades and display their trades to others. A number of features, which broadly look like the investor is playing a videogame, appear designed to engage individuals who may not typically be otherwise interested. Many brokers have reduced or eliminated trading commissions and lowered or eliminated account minimums stakes or investments. 

Social media influencers

From the GameStop stock surge to the Robinhood hack, risks faced by social trading platforms change quickly and can cause the market to be more volatile. It looks like this new way of trading is likely here to stay, as a Fidelity survey found that, of all the generations, more than 40% of Gen Z respondents were most likely to say they turn to social media influencers to educate themselves on investing.

The same survey also looked at the impact of meme stocks, which gain sudden popularity online and through social media. It found that market volatility and media attention around meme stocks piqued the interest of young adults to the world of investing.

From bulletin boards to social media

Regulators have, for years, wrestled with bulletin boards where individuals recommend stock picks where they may encourage other investors to follow suit and help drive the price up, then benefit from the price movement. The key challenge here is that everyone is entitled to a view and a bulletin board may be a way of expressing it. 

Putting social media into this equation feels like putting bulletin boards on steroids, as the reach, global audience and potential impact can be massive. This is what happened with GameStop. This, in conjunction with the fact that many of the social media followers may be millennials, some of whom may be unfamiliar with equity trading or investment but feel like they want to get ‘one-up’ on the banks, exponentially increases the concern. 

Regulators and responsibility

The regulators were vilified for taking almost no action around GameStop. Let’s bear in mind that the politicians who essentially oversee the regulators hate to see the general public lose money. We should also note that many of the main regulators have announced a much more specific retail consumer/investor protection agenda (somewhat redirecting away from wholesale market focus). Despite all the headlines and furor, a huge majority of these retail consumers did not benefit from this and actually lost money.

Some further regulatory focus on social trading apps seems likely. Could regulators themselves review social media to see if there is an anomalous amount of chatter around a particular security or ticker? Could exchanges do the same and then associate this where an anomalous price move is noted? 

This is a big ask—essentially it means monitoring all social media feeds around the world. Alternatively, if this requirement is levied on some regulated participants, such as exchanges and trading platforms, it would be fair to expect other participants such as the banks and brokers to be required to undertake some monitoring of activity which they observe through their respective channels.

A three-prong approach to monitoring

Based on my regulatory industry experience, I think a three-pronged approach is a viable option to help compliance teams begin to monitor for new risk caused by social trading marketing manipulation.

The first part of this approach is social trading feed surveillance. This means monitoring of a single feed for investors to interact with as part of their trading strategy. While not relevant for all, some of the social trading platforms encourage the use of their integrated communications feed to share ideas and express opinions, and this can become the key reason to trade for some investors.

The second part is the surveillance of employee internal communications. This means taking the current monitoring processes used on traders to the next level. With growing interest from regulators, there is likely already increased interest from brokers and platforms to surveil their traders and employees. There may be a need to enhance standard lexicons around the risk of collusion with other participants or suspicions of abusive squeeze etc.

The final part, which I believe may garner the most interest, is surveilling employee social media accounts. The goal here is to target broader social media and retail investor risk. While social media and digital opportunities present growing risks for investors and companies, they also offer thrilling new avenues for investors. I, for one, am excited to see the next generation of investors blaze new paths to success.

By identifying and reporting suspicions through surveillance, which already forms part of the regulated firms’ compliance requirements, an earlier warning system can be established for all relevant stakeholders, retail investors, social trading platforms, wholesale brokers, exchanges and regulators. A platform that alerts relevant parties sooner, allows compliance teams and regulators to evaluate risks and take action to support those tenets of protecting investors, maintaining fair, orderly and efficient markets, and facilitating capital formation.

About the author: Robert Mason has extensive regulatory industry experience and has undertaken multiple senior compliance surveillance roles. He currently serves as global regulatory lead at Relativity. Mason previously worked as a senior risk manager at Lloyds Bank Group and before that at UBS in London.