Dickinson Wright Chair on GameStop frenzy: ‘The SEC should have used its trading suspension authority’

Dickinson Wright Chair, Government Investigations and Securities Enforcement Practice and Former Senior Counsel in the SEC's Division of Enforcement Jacob S. Frenkel joins Yahoo Finance Live to discuss the regulatory impact of the GameStop saga.

Video Transcript

AKIKO FUJITA: What exactly can be done, in light of what has played out over the last week or so? Lawmakers on both sides of the aisle weighing in, calling for an investigation into Robinhood's practices. We also heard from the SEC, saying it will review actions taken by regulated entities that may disadvantage investors or otherwise, in their words, unduly inhibit their ability to trade certain securities.

We've got an expert on this. Jacob Frenkel is Dickinson Wright Chair of government investigation and securities enforcement practice, former senior counsel in the SEC's division of enforcement. Jacob, let me just get your broad view on what has played out because we have heard the word manipulation being thrown around over the last few days or so to describe what's played out. How do you view this, and where do the regulators start?


JACOB FRENKEL: I feel like these-- in these days of the pandemic, this is a theme park visit, and this is a roller coaster ride that just won't stop. That's really what it feels like. But in terms of from a practical standpoint, I think there are a couple of issues. Number one is I was of the view several days ago that the SEC should have used its trading suspension authority.

Granted, that is an aggressive approach. But at the same time, it is a statutory authority. And you have a company and several-- particularly GameStop-- that blew through New York Stock Exchange circuit breakers 10 times over two trading days. So that meant that the circuit breakers alone were not sufficient. Now, I'm not here to advocate for the longs, for the shorts, for the small investor, you know, for the institutional investor.

What I'm really trying to do is to sort of call it from a-- as objective a perspective as possible. And that is, you know, I do believe that shorts have a necessary place in the market to ensure a proper pricing mechanism for a stock. That does not mean individual investors or longside investors can't-- and they always do-- take a countervailing view. And there is that-- you know, there is a tug-of-war, that battle between the shorts and the longs.

To me, it does not matter if we're talking about shorts or the longs. If a participant in the market is putting out materially false and misleading information for the purpose of driving the price of a stock, that is stock manipulation. That is a violation of the federal securities laws. In the case of a New York Stock Exchange listed stock, there's a specific statute, an anti-manipulation statute that governs manipulation of exchange-listed securities. If it's not an exchange-listed security, then the anti-fraud provisions apply.

So I really believe that the statutes and regulations that are in place are sufficient, which then brings us into the question, which is, well, is the SEC, then, going to regulate speech? It is not. I mean, the fact is, the stock message boards have long been a forum, both for discussion, but also to enable manipulative activity. And I think what you're going to see is a scrutiny brought to bear on the broader activity here, in terms of whether it's the institutions that were responsible for trading, whose obligation, fundamentally, is to act in the best interest of the customers and their-- and the markets.


JACOB FRENKEL: And we focus--


JACOB FRENKEL: I was going to have one quick follow on that, if I may, which is with that focus on their responsibility to act for their investors. It's not just those individual investors who are trading that particular stock, those particular securities. And those investors have signed the exact same customer agreement as all of the other investors with that firm. That obligation is much broader than to just those individual investors in that one security, and particularly exposure to margin calls and risks. I'll stop there. I know that we covered a lot in that.

ZACK GUZMAN: You did cover a lot, but it was all good. So I appreciate the walk-through, and that's one of the questions we're going to get into here now, of course, after we saw that class-action lawsuit filed against Robinhood. And they really garnered a lot of the attention.

And I know this is kind of getting into the weeds a little bit here, but when you talk about those risks that these platforms take on, obviously, you know, the GameStop stuff that was talked about in Wall Street Bets on Reddit had been talked about for a while. And you know, we were down at $4, and we say where it went. It was at $60. We saw where it went up to $100.

After Monday, though, a lot of this-- we were talking about this on Monday. So it's not like it just popped up out of nowhere on Thursday that these requirements that you're talking about there-- in clearinghouses and brokerages and the inside-baseball stuff, those rules did not just come out of nowhere. They weren't new.

So when it comes to liability for platforms like Robinhood, who may have, you know, been late to the game, they could have tapped this emergency funding we're talking about on Monday, a little bit earlier, and not just restricted buys on the part of the retail investor. So when it comes to that liability, how big is that, that maybe they could get prosecuted against for not doing enough sooner?

JACOB FRENKEL: Well, again, while I covered a lot of ground with you, there were a lot of points in your question as well. I mean, I was advocating on Tuesday for the SEC to use its trading suspension authority. I think the issue here, in part, is whether they're acting consistent with particular regulations that may be in place.

And the fact is, with respect to regulations that exist, there really are not regulations that govern this. But you don't establish regulations to deal with individual trading scenarios. The fact is, there is a rule that exists under the rules that were implemented under the Securities and Exchange Act of 1934 that requires brokerage firms to maintain a system of risk management and compliance controls that are designed to maintained-- to-- you know, that they're designed to maintain-- to ensure proper execution on behalf of customers, to impose even constraints on customer activity, customer limits, position concentration limits. Those-- you know, all of that exists within the rules.

You know, we're in a society-- I mean, we talked-- we were talking earlier about the message boards themselves and the internet and everybody being, you know, the subject of-- you know, of criticism, let alone, you know, other statements that tend to be made. I mean, the fact is, it comes back to the question is, what is the purpose of these message boards? I mean, are they being used for discussion of issues, or they're being used for the purpose of impacting the price of a stock for the-- in turn, for the purpose of inducing others to trade, whether it be buy or sell, which brings into the area-- the zone of manipulation. So yeah, are these firms--

AKIKO FUJITA: And Jacob, based on what you said there, I mean, you said earlier, also, is just laying out what the SEC regulation actually says and that it is, in fact, a violation to push forward materially false information. Is there any evidence, based on what you have seen discussed in these message boards, that that actually occurred?

JACOB FRENKEL: Well, the precise answer to your question is no, nor have I studied the message boards with that level of precision. And we could take it one step beyond, which is something that I've not heard talked about at all either here, which is-- you know, which is the SEC will certainly look at whether there were materially false or misleading statements that were put out on various media to drive the price of the stock. That is fodder for-- that is certainly fodder for investigation.

But one issue that has not been discussed I don't think by anyone is whether this concerted activity would constitute a group under the Williams Act, under section 13D. Now, granted, there has to be five-- they have to have 5% or more of the stock collectively. But again, there we go back to, what is the purpose of the group activity?

Typically, if you look at the history of the Williams Act, if you look at the history of the beneficial ownership disclosure requirements and even sort of think about what were the cases in the late 1980s and early 1990s where there were omissions to disclose, you know, group activity for the purpose of affecting a tender of a particular security, what we're really talking about here is, you know, there is a system of laws that are in place. But we really won't know until the SEC conducts a thorough investigation.

And separate and apart from that investigation, we know that Congress is going to inquire. And the SEC-- forget about the enforcement division for a moment-- but really needs to make sure it understands all the dynamics that underlie-- that were underlying what has occurred because it is not going to regulate free speech, as I mentioned. So it's not going to regulate the content of what is said on the message boards. It's not going to regulate the use of four-letter words, you know, on the-- or other forms of disparagement that we often see in the message boards.


JACOB FRENKEL: But it does need to figure out, are we moving into an era where corporate fundamentals are becoming less relevant? And I'll finish on this thought, which is I think in the late '90s, you know, there was a wonderful comment made that-- you know, to the effect of facts only account for about 10% of the reactions on the stock market. Everything else is psychology. Well, I think right now, we're looking at a time where we really need the psychologists to explain what is going on, you know, to the regulators. But I don't think we're going to see new regulations come about because of what we're seeing.

AKIKO FUJITA: And Jacob, we haven't even talked about the need for more disclosures on the hedge fund side, but that is another conversation. We would love to have you back on the show as we continue to sort of digest what has played out over the last week. Jacob Frenkel, former senior counsel in the SEC's division of enforcement. It's good to talk to you today.

JACOB FRENKEL: It's always my pleasure to rejoin you two.