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In January 2021, a group of retail investors communicating on social media platforms agreed to buy stock in several low-performing companies. The sudden demand sent their prices skyrocketing in what became known as the “meme stock” frenzy.

Video game retailer GameStop, the most notable example, saw its share price rise from less than $4 per share to more than $400 from coordinated retail stock purchasing. As a result, hedge funds that had shorted GameStop, betting its stock would decline, lost billions of dollars. In the aftermath, many people asked: Wasn’t the coordinated action by the retail investors considered market manipulation? 

Duke Law professor Gina-Gail Fletcher, an expert on financial market regulation, says that depends on how one answers a more fundamental question: whether anyone was harmed by this behavior. 

“Market manipulation as a regulatory tool is considered a way to maintain the integrity of the market, and a way to make sure the markets remain efficient,” she explained. “If meme stocks aren't really harming the markets, and we just have a disagreement among traders that causes some to lose and other to win, then why do we really care?”

Thanks to low-cost brokerage accounts, retail traders account for a growing share of trading activity, giving them increased power in the market when they act in coordination. Fletcher wanted to take a deeper look at whether such activity is illegal and, importantly, harmful. 

In her forthcoming paper “Coordinated Retail Trading,” to be published in William & Mary Law Review, she examines the meme stock phenomenon through the lens of the Securities and Exchange Commission (SEC), the federal agency whose tripartite mandate is to maintain fair, orderly, and efficient markets, to facilitate capital formation, and to protect investors. Fletcher, a member of the SEC Investor Advisory Committee, concludes that while the laws of market manipulation are ill-suited to addressing meme stock trading, that doesn’t mean this sort of activity should proceed unchecked.

In its own report, the SEC concluded that while the trading activity had been extreme, it did not constitute market manipulation. But subsequent reports from economists and legal scholars came to the opposite conclusion. Fletcher believes the latter but says the fact that experts can reach such different conclusions shows why market manipulation needs further study. “For the entirety of its existence, it's always been heavily contested,” she said. 

Lawsuits over market manipulation tend to drag on for years, and the specific nature of meme stocks would present further challenges for the SEC in considering whether to bring charges, Fletcher said. That’s in part because the trading takes place among retail investors, who typically don’t have the power individually to move a market, and who may not have demonstrated obvious intent to do so in their social media posts. It is also unclear, she noted, who the plaintiff in a lawsuit would be – the SEC, or short sellers in the market who got squeezed betting against the low-performing stocks? Another factor the SEC might consider, she said, is the optics of suing small-dollar investors, the very constituency it is tasked with protecting.

Fletcher instead looked more closely at each aspect of the SEC’s tripartite mandate to consider whether harm occurred. “Even if you don't think meme stock trading rises to the level of market manipulation, I think it’s still clear that meme stock frenzies are harmful to the market,” she said, naming several reasons:

• Coordinated retail trading undermines the SEC’s mission to “maintain fair, orderly, and efficient markets” by artificially pricing meme stocks and disconnecting them from the actual value of the company, thereby impairing market efficiency. The frenzied pace of trading during a run-up also increases volatility and contributes to the perception of stock markets as casinos. 
• Meme stock frenzies can result in the misallocation of capital to failing companies. Some have even issued additional shares after a frenzy, creating what Fletcher calls “meme zombies” and directing capital away from more productive companies.
• The stocks that were chosen by retail investors to be meme stocks were heavily shorted, and their rapid price increase squeezed short sellers – typically hedge funds or large investors who had liquidity to place large bets. But the SEC has a mandate to protect all investors, including short sellers, who, though often unpopular, do provide liquidity and efficiency to markets.

Rather than prove market manipulation after the fact, Fletcher proposes regulation that doesn’t exclude retail traders but minimizes the harms done if such frenzies were to occur again. She suggests building on two strategies already in place to protect markets. 

The first is trading pauses. While some brokerages have paused trading during meme stock frenzies, not all of them did so or at the same time, creating heterogeneity in the market. Fletcher proposes a market-wide approach, so that individual traders aren’t affected based on which app or platform they use, and thus “make it more uniform,” she said. Such pauses could also be expanded to use a larger dataset of historical prices, so that a pause kicks in if a stock price deviates not from a narrow price band calculated over the last five minutes of pricing information but from days or weeks’ worth of price data, she said. 

Fletcher also proposes expanding the disclosure regime that already exists for penny stocks — inexpensive shares that aren’t traded on exchanges and are frequently sold to vulnerable or unsophisticated investors — to include meme stocks as well. Penny stocks require additional disclosures explaining that they are volatile and frequently involved in manipulation or fraudulent schemes. “A lot of the things that we warn people about with regards to penny stocks, we could say to be true for some meme stocks as well,” she said. 

Given the growing interest in retail trading and the social communities that have sprung around investing, such as Reddit’s r/WallStreetBets and the Robinhood trading platform, there will likely be people who will jump onto the next meme stock frenzy. If and when that happens, Fletcher says, her recommendations could minimize harm to them and other participants in the market. 

“My proposals aren't necessarily trying to stop someone from making bad decisions, but I am trying to put a little bit of friction in their decision-making,” she said.