Written Testimony Of Gina-Gail S. Fletcher Professor Of .
Written Testimony ofGina-Gail S. FletcherProfessor of Law, Duke UniversityBefore the United States SenateCommittee on Banking, Housing, and Urban Affairs“Who Wins on Wall Street?GameStop, Robinhood, and the State of Retail Investing”March 9, 202110:00 a.m.
Gina-Gail S. FletcherPage 2 of 19Chairman Brown, Ranking Member Toomey, Members of the Committee:Thank you for inviting me to testify at this hearing. I am a Professor of Law atDuke University, where my research focuses on financial regulation, marketmanipulation, and corporate law. Before becoming an academic, I practiced law atGibson, Dunn, & Crutcher LLP, in the areas of securities regulation, banking, andmergers and acquisitions.INTRODUCTIONA core purpose of the financial markets is to facilitate the efficient allocationof capital. 1 When functioning efficiently, the markets allow for capital to be put to itsmost profitable use, which enables firms to access capital and improves the allocationof finite resources within the markets and the economy. When the fundamentaloperation of the markets is undermined, there are far-reaching effects that extendbeyond the capital markets, affecting consumer savings, investments, retirement plans,and the rest of the real economy. 2The recent market volatility stemming from trading in “meme stocks”, mostnotably GameStop, 3 has raised concerns as to the integrity, stability, and overall healthof the markets. Over the course of a few weeks in early 2021, GameStop—a strugglingretailer of video games—saw its share price increase 1500%, crash, and then spikeagain. 4 In the wake of the volatility of GameStop’s stock price, many investors (bothlarge and small) have been left with significant losses 5 and some market participantsGina-Gail S. Fletcher, Legitimate Yet Manipulative: The Conundrum of Open-Market Manipulation, 68DUKE L.J. 479, 489 (2018).2 Id.; see Benjamin P. Edwards, Conflicts & Capital Allocation, 78 OHIO ST. L.J. 181, 184–85 (2017).3 John Hyatt, How GameStop (GME) Is Creating Volatility – and Opportunities – for Investors, NASDAQ (Jan.29, 2021, 1:54 PM), rs-2021-01-29.4 Reuters Staff, Timeline: The GameStop Battle – How It Unfolded for the Key Players Testifying, REUTERS(Feb. 18, 2021, 1:20 AM), AI0IQ.5 Harry Robertson, Short-sellers Are Nursing Estimated Losses of 19 Billion in 2021 After Betting onGameStop’s Stock To Plunge, MARKETS INSIDER (Jan. 30, 2021, 2:31 gamestop-data-shows-2021-11030020684#: :text %20New%20York%20Times; Drew Harwell, As GameStop Stock Crumbles, Newbie Traders Reckon with Heavy Losses,WASH. POST (Feb. 2, 2021, 5:34 /02/02/gamestop-stock-plunge-losers.1
Gina-Gail S. FletcherPage 3 of 19and members of the public wonder whether the GameStop volatility is the “newnormal” for the markets. 6The recent market events have raised questions as to the long-term health ofthe markets, specifically the effects of such extreme volatility and the conduct thatdrove it on public perception of the markets. Additionally, these market developmentshave brought to the fore some issues related to how the markets function and areregulated, such as efforts to promote market integrity and prevent marketmanipulation; the costs and impacts of conflicted brokers’ routing practices, includingpayment for order flow (“PFOF”); and the impact of larger numbers of small-dollar,higher risk trading in the markets.I.MARKET INTEGRITY & STABILITYA. Market Integrity: The Importance of Public PerceptionMarket integrity is key to the functioning of healthy capital markets. 7 Marketintegrity is a broad term that refers to notions of market fairness, investor protection,and the absence of misinformation and market abuse. To the extent the public believesthe markets are fair, investors are likely to participate in the markets. Conversely, if themarkets are viewed as unfair, investors may refrain from participating in the marketsaltogether or, should they participate, discount all transactions to reflect the risk ofdealing in an unfair market. 8 Public perception of the fairness (or unfairness) of themarket, underlies market integrity and, in turn, is crucial to the efficient allocation ofcapital.The GameStop incident has highlighted public perception of the unfairness ofthe markets, on the one hand, and raised new concerns about the integrity of stockprices. As trading in GameStop gained momentum, a narrative of David vs. Goliathcoalesced, with the individual, Reddit-led investors being cast as David against theshort selling, hedge fund Goliaths. 9 Many of these individual investors expressed theSee, e.g., William Watts, GameStop Saga Illustrates Rising ‘Noise-Trader Risk’ That Could Feed MarketVolatility, Warns Quantitative Analyst, MARKETWATCH, (Feb. 26, 2021, 1:55 1614365724.7 Fletcher, supra note 1, at 493.8 Id. at 492–93.9 See, e.g., Associated Press, GameStop Soars as Swarming Small Investors Face Down Hedge Funds, L.A.TIMES (Jan. 25, 2021, 1:39 PM), stop-soars; Edward Helmore, How GameStop Found Itself atthe Center of a Groundbreaking Battle Between Wall Street and Small Investors, GUARDIAN (Jan. 27, 2021,5:00), amestop-stock-market-retail-wallstreet; All Things Considered: Reddit Users Vs. Wall Street Giant in Fight over GameStop Stock Value, NPR6
Gina-Gail S. FletcherPage 4 of 19viewpoint that the markets were “rigged against the little guy” and saw their GameStoptrades as a way to right the wrongs of the past.While the realities of who was trading in which directions, how much, andwhen will take time to decipher, the views echoed in the GameStop incident arereflective of a larger narrative about the integrity and fairness of the markets. In recentyears, an increasing view is that the markets are regulated for the benefit of Wall Streetand to the detriment of Main Street. 10 During the 2008 crisis, for example, banksreceived bailouts while ordinary citizens lost their jobs and homes, struggling torecover years later. Likewise, with the COVID-19 pandemic millions of Americanslost their jobs and their health, but public corporations earned unprecedented profitsand the stock market continued to soar. The disparate impact of these two significantfinancial crises on ordinary citizens versus the economic elite, especially when coupledwith the (seeming) lack of enforcement against corporate wrongdoing, have fomentedthe strong perception that the markets are titled in favor of the wealthy, the banks, andthe hedge funds.The proliferation of these views indicates that many investors do not view themarkets as honest, fair, or accessible. Increasingly, seemingly freed by this recognitionof the apparent “unfairness,” many investors appear to be engaging in transactionsthat undermine capital allocation and distort asset prices to (attempt to) tilt the marketsin their favor.Yet, even for those who did not previously believe the markets are inherentlyrigged to favor insiders, the extreme volatility associated with meme stocks maynonetheless cause them to be concerned with the integrity and stability of the markets.This is particularly true if regulators and lawmakers fail to act—either by notaddressing the underlying cause for the volatility or by not holding someoneaccountable for wrongdoing.To safeguard the integrity of the markets, therefore, it is important thatlawmakers and regulators undertake efforts to repair the market’s reputation andbolster investor confidence. Research has shown that when investors question theintegrity of the markets, they withdraw from the markets, reducing the amount of(Jan. 27, 2021, 4:14 PM), ck-value.10 See e.g., Alexis Goldstein, Opinion, The Trouble with GameStop Is That the House Still Wins, N.Y. TIMES(Feb. 1, 2021), p-biden-wall-streetreddit.html; Zachary Karabell, How the GameStop Trading Surge Will Transform Wall Street, TIME (Jan. 28,2021, 8:44 PM), eet.
Gina-Gail S. FletcherPage 5 of 19capital available in the market in general. 11 Thus, failure to address the issues thatGameStop trading highlights may, ultimately, weaken the markets.While addressing these issues is neither simple nor straightforward, this oughtnot dissuade Congress and the SEC from investigating how to minimize the likelihoodand impact of a future iteration of the volatility we witnessed earlier this year.B. Market Manipulation: Was GameStop Stock Manipulated?A common theme accompanying discussions about GameStop’s stock pricewas market manipulation. Many questioned whether the coordinated trading ofReddit-inspired investors constituted market manipulation from a legal standpoint andwhat if anything the SEC should or could do in response.Among the initial motivators behind the adoption of the securities laws wasthe prevention of market manipulation. Although the purpose of financial marketregulations and laws has since been extended, proscribing and punishing marketmanipulation remains one of primary goals of the SEC. Market manipulation imposessignificant social and financial costs on the financial markets. Furthermore, itundermines the efficient allocation of capital by distorting prices and by contributingto the perception that the markets lack integrity.Despite its centrality to securities laws, market manipulation is undefined inthe securities laws. 12 Instead, the laws and associated regulations prohibit specific,named conduct such as price artificiality, fictitious trades, and fraud. Some havecommented that the absence of a statutory definition is the reason that this area of thelaw is confusing and contradictory. But, as others have noted, given the unexpectedways in which the markets may develop, tying regulators to a fixed definition ofmanipulation may do more harm than good. 13In identifying manipulative conduct, courts have typically looked for evidenceof willful misconduct, fraud, and/or an artificial price. Academics have also tried todefine manipulation through conduct that has an improper effect on price or effortsto dominate supply and demand to artificially distort prices.Notwithstanding the lack of an agreed upon definition, the SEC, FINRA, andthe exchanges all have anti-manipulation provisions that proscribe and punish abusiveEMILIOS AVGOULEAS, THE MECHANICS AND REGULATION OF MARKET ABUSE A LEGAL ANDECONOMIC ANALYSIS 212 (2005).12 Fletcher, supra note 1.13 As one court opined: “Congress’ decision to prohibit manipulation without defining it apparentlyarose from the concern that clever manipulators would be able to evade any legislated list of proscribedactions or elements of such a claim.” In re Soybean Futures Litig., 892 F. Supp. 1025, 1044 (N.D. Ill.2015).11
Gina-Gail S. FletcherPage 6 of 19practices that distort asset prices. But as decades of enforcement actions and litigationhas demonstrated, proving market manipulation as a matter of law can be verydifficult. Indeed, one person’s manipulation can be seen as another person’sexuberance, even if irrational.Whether the GameStop incident rises to the level of legally recognized andpunishable market manipulation is a fact-intensive inquiry, which is ongoing. But,beyond the stark question of whether this constitutes illegal manipulation, theGameStop incident highlights the ways in which social media and technology havecombined to push the limits of market regulations. It also calls into question to whatextent existing understandings of manipulation can adequately respond to and,ultimately, deter the type of misconduct that may have occurred. Regardless of theoutcome of the pending investigations into possible market manipulation, there aretwo recommended actions Congress and the SEC should consider.First, Congress and regulators should hold traders accountable for their wordsand actions, even in the absence of explicit fraud. Price distortion can occur withoutexplicit fraud and, when it does, someone ought to be held accountable. 14 There oughtto be consequences for using internet platforms and social media to encourage othersto buy/sell stock, if result is a price that is so distorted as to be completely divorcedfrom the company’s fundamentals.Unfortunately, manipulation laws have become ossified, and courts have beensomewhat hostile to new interpretations and applications of the law from regulators.This makes it somewhat challenging for regulators to address novel forms of marketmanipulation using laws that were written almost a century ago and long before mostof the things that are commonplace in today’s markets were even conceivable. Thetype of coordinated action among thousands of dispersed, small-dollar investors thatwas seen during GameStop’s rise was not imaginable when courts and regulators firstconceptualized the market power needed to squeeze or corner the markets. However,in today’s markets this is not only plausible, but it can be just as disastrous as traditionalmanipulation schemes.As the markets evolve and the types of abusive trading tactics evolve alongwith it, it becomes increasingly urgent that Congress revisit and expand the antimanipulation authority granted to the SEC. Congress and regulators should exploreupdating the laws and rules against market manipulation to ensure regulators have thetools they need to protect the integrity of the markets against intentional, extreme pricedistortions.14Fletcher, supra note 1.
Gina-Gail S. FletcherPage 7 of 19Second, the SEC has traditionally relied on enforcement actions to addressmarket manipulation. Punishing traders ex post for their conduct has been anunderstandable approach in the past, but it is not as sound in the modern marketswhere herd behavior is swift and can be disastrous. In today’s markets, the SEC shouldexplore the types of ex ante guardrails needed to protect the markets from extremeprice distortion that will undoubtedly leave destruction in its wake.As the volatility in GameStop and other stock persisted, the SEC issued astatement that it was monitoring the situation, but failed to take any action. Theagency’s refusal to act lead many to wonder why trading in GameStop stock was nothalted once it became clear that the stock price was completely and unjustifiablydivorced from the company’s fundamentals. Arguably, the SEC’s failure to act createda vacuum of authority, which resulted in a haphazard and uneven response frommarket actors. While some brokers halted trading in GameStop, others did not, causingpublic uproar. Leadership from the SEC indicating what should have been done or, ata minimum, a statement of recommended action would have had a better outcome forthe markets and less public furor.It is not beyond the scope of the SEC’s authority to proactively consider howit will respond to certain indicators of price distortion and manipulation in the markets.In light of the far-reaching consequences of manipulation on today’s interconnectedmarkets, it is imperative that the SEC consider how to address extreme volatility inreal time, particularly when such volatility may be borne from manipulative andabusive trades.II.DEMOCRATIZING THE CAPITAL MARKETSA. The Impact of Technology & Innovation on Retail Investors’ Access to the Public CapitalMarketsThe federal securities laws were adopted to ensure that all investors – not justsophisticated, wealthy, or connected insiders – have access to essential informationabout companies and basic shareholder rights. In many ways, the federal securitieslaws exist to “democratize” the capital markets.In recent years, financial innovation has further expanded the availability ofcapital for firms and enhanced retail investors’ access to the markets. 15 The creationand proliferation of discount brokers, mutual funds, exchange traded funds, and401(k) plans have made investing available to a large segment of the population.Further, the entrance of robo-advisors onto the financial scene has granted investorsJOHN V. DUCA, FED. RESERVE BANK OF DALLAS, THE DEMOCRATIZATION OF AMERICA’SCAPITAL MARKETS 10–13 (2001).15
Gina-Gail S. FletcherPage 8 of 19access to model portfolios tailored to their risk profiles and investment preferences,further increasing access for consumers seeking low-cost financial advice. 16The democratization of the financial markets, therefore, has been ongoing fordecades, but it has undoubtedly exploded in measure and kind in the past five years. 17Efforts to increase retail access to the markets have resulted in greater participation inindex funds, mutual funds, etc., which rely on intermediaries to transact on consumers’behalf. 18 Recently, with the rise of zero-commission trading, retail investors arechoosing to directly participate in the markets at unprecedented levels.In the past year or two, many low-cost brokers have eliminated explicit fees tobuy and sell stocks, thereby opening up access to the markets to those who may havebeen unwilling or unable to trade because of what were once significant explicitcommissions and fees. 19 Additionally, the ability to trade in fractional shares haslowered costs for investors who no longer need over 2,000 to buy a single share of acompany like Amazon, for example; instead, they can purchase 100 of stock or 1/20thof the share. With technology, market democratization has gone a step further—brokers allow trading through apps, thereby making it easier for younger investors toaccess the markets on their mobile devices. 20 Today, it is not a stretch to say that themarkets are truly within reach of anyone.These developments have had a noteworthy and positive impact on retailparticipation in the markets. A recent study has demonstrated that the racial gap inindividual stock ownership has been halved in less five years. 21 Similarly, a recentFINRA study found that the majority of investors who opened their first account in2020 were under the age of 45, had lower incomes, and were more likely to be raciallyAnne Tergesen, Robo Advisers Seen Exploding in Popularity, WALL ST. J. (Dec. 11, 2015, 7:08PM), ploding-in-popularity-1449860367.17 See Charlotte Gifford, Democratising Finance, WORLD FIN. (Jan. 25, /take-from-the-rich-give-to-the-poor.18 Jay Clayton, Chairman, SEC, Speech at Temple University: The Evolving Market for RetailInvestment Services and Forward-Looking Regulation – Adding Clarity and Investor ProtectionWhile Ensuring Access and Choice (May 2, 2018), -05-02.19 For example, Schwab eliminated fees for stock purchases in October 2019. See AlexanderOsipovich & Lisa Beilfuss, Schwab Cuts Fees on Online Stock Trades to Zero, Rattling Rivals, WALL ST. J.(Oct. 1, 2019, 7:04 PM).20 Alicia Adamczyk, Trading Apps Like Robinhood Are Having a Moment. But Users Should Be Careful,CNBC (Aug. 24, 2020, 3:49 PM), g-amoment-users-should-be-careful.html.21 Aaron Brown, Opinion, Stock Investors Are Younger and More Racially Diverse, BLOOMBERG (Sept. 21,2020, 6:00 AM), -21/stock-investors-areyounger-
Gibson, Dunn, & Crutcher LLP, in the areas of securities regulation, banking, and . Gina-Gail S. Fletcher Page 5 of 19 . capital available in the market in general. 11. Thus, failure to address the issues that GameSto
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