• The Star Staff

Gensler faces big challenge in tackling GameStop’s wild ride

By Deborah B. Solomon

During his last regulatory stint in Washington, Gary Gensler focused on reining in big Wall Street players that he believed were manipulating markets and assuming huge financial positions to the detriment of other investors.

If confirmed to lead the Securities and Exchange Commission, Gensler will have to confront an entirely new spin on that same game: Thousands of small investors who have banded together to amass giant stakes in GameStop and other companies with the aim of toppling big Wall Street players.

The frenzy around GameStop, whose stock has soared 1,700% in the past month, presents a huge challenge for Gensler and the SEC, which will have to reckon with a fundamental shift in the capital markets as a new breed of investor begins trading stocks in unconventional ways and for unconventional reasons.

Rather than snapping up a company’s shares because of a belief in that firm’s growth potential, the investors who piled into GameStop, AMC, BlackBerry and others did so largely to see how far they could drive up the price. Their motivation in many cases had less to do with making money than with causing steep financial losses for big hedge funds that were on the other side of that trade and had bet that the price of GameStop and other firms would fall.

Their ability to cause such wild market volatility was enabled by new financial apps — like Robinhood — that encourage investors to trade frequently and allow them to buy risky financial products like options as easily as they purchase a latte. Options — essentially contracts that give the investor the option to buy a stock at a certain price in the future — were what helped put the “short squeeze” on the hedge funds that had shorted the company’s stock.

“What’s going on with GameStop has almost nothing to do with GameStop as a company,” said Barbara Roper, director of investor protection for the Consumer Federation of America. “When you see the markets essentially turned into a video game or turned into a casino, that actually has some pretty serious repercussions for the way we use the markets to fund our economy.”

The question for Gensler and the SEC will be what they can — or should — do about it.

In a statement Friday, the SEC said that it was “closely monitoring” the situation and that it would “act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws.”

Those who know Gensler say his first move will probably be determining what actually caused the momentum and who benefited. While many big hedge funds got crushed by the trades, there is speculation among market participants and securities lawyers that other big funds may have been fueling — and making money off — some of the volatility.

“First of all, the SEC has got to figure out what the hell was going on,” said James Cox, a securities professor at Duke University School of Law. “The first question is going to be an empirical one — how much of this momentum was created by the hedge funds having to cover their short position and how much of the rest was the impact of the options trading — either buying the options or just executing on the options.”

A bigger issue for Gensler will be figuring out corrective actions. While the stock market has always been something of a game, Cox and others say the recent events have perverted their original purpose, which is to provide a place for companies to raise capital by giving investors the information they need to determine where to put their money.

“When you see what’s happening with GameStop, you ask yourself, is this manipulation, is this mass psychosis or is there something wrong in our market structure that is causing this to happen,” said James Angel, a finance professor at Georgetown University’s McDonough School of Business. “The real question is what, if anything, should be done about it.”

Gensler has spent the past several years teaching at the Massachusetts Institute of Technology, focusing on financial technology, cryptocurrencies and blockchain technology.

His classes have addressed some of the knotty issues he will have to face if confirmed to the SEC, including the rise of new financial technology companies like Robinhood and the so-called roboadviser Betterment.

In a 2019 discussion at MIT, Gensler said it would be “best to show some flexibility” when considering whether to regulate fintech companies since heavy-handed rules could snuff out innovation. Gensler declined to be interviewed for this article.

If confirmed to the job, Gensler will have to tread carefully. The motivation behind the GameStop squeeze has been embraced by lawmakers and others, who see the trades as a welcome rebellion against the power of big Wall Street players. Last week, Rep. Alexandria Ocasio-Cortez of New York, a progressive Democrat, and Sen. Ted Cruz, a conservative Texas Republican, both condemned efforts by Robinhood to restrict trading in GameStop and other companies, saying the firm was putting the interests of hedge funds above small investors.

Other lawmakers are warning against overreacting with more regulation. “When examining this episode, regulators and Congress should tread with extreme caution and avoid needlessly inserting themselves into equity markets,” Sen. Patrick Toomey, R-Pa., said in a statement.

Rep. Ro Khanna, D-Calif., said in an interview that simply blocking retail investors from certain stocks was the wrong decision and that Gensler should look to the bigger fish — namely lightly regulated hedge funds — when looking for areas to regulate.

“We probably need to increase the capital requirements on short-selling for hedge funds, to make it more difficult,” Khanna said.

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