A U.S. legislator and some members of the hedge fund community are calling for regulatory scrutiny and intervention regarding last week's pummeling of short sellers by retail investors.
Sen. Elizabeth Warren, D-Mass., a member of the Senate Committee on Banking, Housing and Urban Affairs, sent a letter to Allison Herren Lee, acting Securities and Exchange Commission chairwoman, requesting that Congress and the public are given information on how the SEC "intends to address these concerns and prevent these and future incidents of potential market manipulation."
Ms. Warren said the "wild fluctuations" in GameStop Corp. and other U.S. companies' stock prices "are just the latest indication that many private equity firms, hedge funds, and other investors, big and small, are treating the stock market like a casino, giving little consideration to the companies, communities, workers, and consumers that may be affected by these risky bets."
She said the episode "reveals a clear distortion in securities markets, with benefits accruing to investors that do not clearly benefit the company's workers, consumers, or the broader economy."
Jack Inglis, London-based CEO of the Alternative Investment Management Association, in a Feb. 1 note to members highlighted Ms. Warren's letter to the SEC: "I welcome a full investigation by the SEC, Congressional committees, and any other bodies into the events in markets this past week."
He said he is sure that WallStreetBets — the forum on Reddit where the short-selling squeeze originated — "will be called upon to provide evidence in the investigations, but the role of some supposedly responsible lawmakers, who have been cheering these events from the sidelines, with a knee-jerk reaction against short selling, is concerning to say the least. Moreover, it is the Dodd–Frank regulations, instituted by lawmakers after the last financial crisis, that led to Robinhood halting trading in these stocks," Mr. Inglis said. He was referring to trading platform Robinhood Markets, which on Jan. 28 put temporary buying restrictions on a number of stocks including GameStop, BlackBerry Ltd. and Nokia Oyj due to "ongoing market volatility."
AIMA will provide its resources to help in any inquiry "and will continue to provide factual evidence that short selling is important and healthy in maintaining fair and efficient markets," Mr. Inglis said.
James Neumann, a New York-based partner and CIO of hedge fund advisory firm Sussex Partners U.K. Ltd., said he expects U.S. regulators to get involved. "It does seem like coordinated buys/sells of single stocks will meet some regulatory scrutiny and is easy to trace," he said in an email.
And in a separate email, Patrick Ghali, Zurich-based managing partner and co-founder at Sussex Partners, said "where there is clear market abuse or manipulation this needs to be looked at, however it is important that the rules — whatever they may be — are applied fairly, equally and consistently to all investors regardless of their size. Market participants should be confident that markets work as advertised," he said.
Even if authorities were to get involved, it's not clear what the response should be.
"If three hedge funds collude to drive up a stock, that might be an addressable regulatory issue around market manipulation," Andrew Beer, New York-based managing member at Dynamic Beta Investments, which specializes in hedge fund replication, said in an email. But if "10,000 individual investors are on the same side of a trading frenzy, it's not obvious that the SEC should do anything. I suspect it will be investigated vigorously and, if clear instances of illegal conduct are identified, individuals will be punished."
Markets, however, will act much faster: "Hedge funds won't put themselves in the same vulnerable position, so as shorts are unwound, the air will be let out of the balloon," Mr. Beer said.
The "speed and magnitude" of the GameStop move was driven by "cheap options trading with enormous inherent leverage, which in turn has fueled stock purchases by banks who need to adjust hedge books," Mr. Beer said. Therefore, one option for regulators could be to deleverage the system by putting limits on options trades, Mr. Beer added.
U.S. officials have moved to investigate the effect of the episode on markets. A meeting of financial regulators with Treasury Secretary Janet Yellen on Feb. 4 determined that the infrastructure of stock and commodity markets was "resilient" over the recent period of volatility in trading, according to a Bloomberg report. Officials, including from the Federal Reserve, the Securities and Exchange Commission and the Commodity Futures Trading Commission, agreed that the SEC should complete a study of the events of the period.
The SEC is looking into the episode for signs of fraud and House and Senate committees are planning hearings, the Bloomberg report noted.
The SEC in a Jan. 29 statement said it is "closely monitoring and evaluating the extreme price volatility of certain stocks' trading prices over the past several days. Our core market infrastructure has proven resilient under the weight of this week's extraordinary trading volumes. Nevertheless, extreme stock price volatility has the potential to expose investors to rapid and severe losses and undermine market confidence."