More than a decade later, industry resistance and bureaucratic snags have conspired to leave that database — known as the Consolidated Audit Trail — years behind schedule and a shell of what regulators originally envisioned, advocates of stronger financial oversight say.
Now, the system’s limitations will make it harder for Wall Street’s Washington minders to make quick sense of the turmoil still rocking the markets. Amid the GameStop furor, regulators face a growing list of questions over the potential use of social media to manipulate stock trading; the adequacy of online brokers’ capital reserves; and the need for hedge funds to disclose more about their holdings.
“Understanding the sequence of events will be very hard to do, and it would have been relatively easy if the CAT [consolidated audit trail] was up and running,” says Tyler Gellasch, founder of the nonprofit Healthy Markets Association and a former Securities and Exchange Commission counsel. He said it points to the agency’s disappointing track record. “The smart bet on the SEC historically has been, name the issue, and the response will be muted.”
The SEC declined to comment. A spokesperson for the CAT’s operating committee said it is “not a shell and it is being built exactly to what the SEC has mandated, with no decrease in its scope. It is currently being built and will not include all customer data until July of 2022.”
Regulators aren’t waiting for an authoritative timeline of the market frenzy apparently initiated by amateur traders organizing on the Reddit forum r/WallStreetBets. As soon as Thursday, Treasury Secretary Janet Yellen is convening leaders of the SEC, the Federal Reserve, the Federal Reserve Bank of New York and the Commodity Futures Trading Commission to review the matter.
Yellen requested a “discussion of recent volatility in financial markets and whether recent activities are consistent with investor protection and fair and efficient markets,” Treasury spokeswoman Alexandra LaManna said in a statement.
Regulators face questions about whether the apparently amateur trading crowd’s activities amounted to illegal market manipulation — and if sophisticated professionals used the cloak of online anonymity to stoke the frenzy. The SEC already is sifting through social media and message boards for evidence of such efforts, Bloomberg News reported Wednesday.
But beyond nabbing any wrongdoers, those who set and enforce market rules are considering a wide array of issues raised by the emergence of retail traders as a powerful force. Possible responses range from the practical — barring online brokers from selling their customers’ orders to giant Wall Street firms — to the philosophical. Some are calling for a wholesale rethinking of a system they say operates more like a casino than an efficient machine for redistributing capital.
“The best mathematicians in America are trying to beat the other best mathematicians to a stock trade by a millionth of a second,” said Rep. Brad Sherman (D-Calif.), chair of the House Financial Services subcommittee on investor protection, entrepreneurship and capital markets. “I’d like to see our capital markets be a place for investing because you think a company is going to do well, and where companies can raise the capital they need to create jobs. Instead you have high-frequency trading, whose social utility is hard to identify, consuming enormous intellectual resources, and I don’t know with what purpose.”
The full House committee will consider the issue at a Feb. 18 hearing. House Financial Services Committee Chairwoman Maxine Waters (D-Calif.) said she is still finalizing the witness list for the hearing and aims for it to shed light on “exactly what happened.” She said she wants to hear from Reddit, Robinhood, GameStop and “some of the hedge funds.” She said a legislative response isn’t imminent. “I think we have a long way to go.”
The Senate Banking Committee has announced its own hearing, though no date has been set. And its as-yet-unscheduled confirmation hearing for Gary Gensler, President Biden’s pick to head the SEC, will focus at least in part on how he intends to address the matter.
Allison Herren Lee, the agency’s acting chair, said her first priority is looking into the decision-making by Robinhood and other online trading platforms, which caused an uproar last week when they limited trading in GameStop and other stocks that retail investors had sent soaring. In an interview Monday with NPR, Lee said the SEC wants to ensure those decisions are “compliant with regulations, that they’re transparent to their customers and that they’re consistently and fairly applied.”
Hedge funds — a number of which suffered billions of dollars in losses from taking short positions against stocks that retail traders bought up — also face greater scrutiny. Waters said in a statement their “unethical conduct directly led to the recent market volatility.” And Sherman and others have called for more disclosures from hedge funds, including their short positions, and potentially higher capital requirements.
The industry is primed to fight back. “Short sellers conduct in-depth research and analysis that can expose financial fraud and corruption,” said Bryan Corbett, who leads the Managed Funds Association, the industry’s lobbying group. “This is a highly regulated activity through both the SEC and [the Commodity Futures Trading Commission], and existing frameworks provide abundant protection for the markets and all investors.”
The GameStop mania is not the first time the SEC has probed the link between the Internet and securities fraud. But the market watchdog has lagged in policing the use of social media and other new technologies in the financial markets, a deficiency that could hamper efforts to unravel the GameStop episode, according to Joshua Mitts, an associate professor at Columbia Law School.
“They’re really behind the curve,” Mitts said. “The SEC isn’t really stepping in and saying, ‘These are the rules of the road on social media.’”
The commission in recent years has made greater use of advanced data analytics to detect cases of insider trading and accounting and disclosure violations. But the SEC’s enforcement division remains heavily populated by securities law experts and lacks the data science specialists needed to combat market manipulation cases executed via social media, Mitts said.
“The average SEC enforcement person is a lawyer who probably hasn’t done much with data,” Mitts said. “They need data scientists.”
More than two decades ago, as the 1990s tech bubble was drawing to a close, the commission pursued several cases involving alleged securities fraud involving the use of digital tools.
Any GameStop investigation will probably share similarities with those earlier Internet-era cases, according to John Stark, the first head of the SEC’s office of Internet enforcement. Many involved scam artists posting false or misleading information on websites in a bid to drive up the price of selected stocks.
In the GameStop case, which has seen an army of retail investors enthusiastically posting about the video game retailer’s shares, individuals who were paid to post about the stock and had not disclosed that fact could be vulnerable to manipulation charges, Stark said. But given the volume of postings on r/WallStreetBets, which has 8.4 million members, sifting the evidence will be a daunting task.
Along with countless Reddit postings, investigators also will confront a potential avalanche of tips submitted by members of the public through an online SEC form.
“I’m confident the SEC enforcement staff will get to the bottom of it if manipulation occurred. But it will be difficult to prove,” said Stark.
After the tech bubble burst in 2000, with the Nasdaq index losing more than half of its value, SEC officials pursued a number of fraud cases involving the use of the Internet to goose stock prices.
In 2002, the SEC reached a settlement of civil charges with Cole Bartiromo, a high school student who had engaged in an Internet “pump-and-dump scheme.” Bartiromo, then 17, manipulated the stock prices of 15 companies by buying up large numbers of shares and then posting “false and misleading information” about them on Yahoo! Finance and Raging Bull message boards, the commission alleged.
Over less than two months, Bartiromo posted more than 6,000 messages claiming news of imminent merger deals or buyouts, which he falsely attributed to sources such as Bloomberg and JP Morgan. In the case of one over-the-counter stock that Bartiromo claimed was headed to $10 per share, he sold his entire stake for less than 25 cents, the SEC told a federal district judge in Manhattan.
The settlement required Bartiromo to disgorge $93,731 in illicit gains and interest.
Two years earlier, the commission settled civil fraud charges against an even younger Internet tout. High school sophomore Jonathan Lebed, then 15, without admitting or denying the charges, agreed to pay the government $285,000 in ill-gotten gains and interest, the commission said.
On 11 occasions, Lebed purchased shares in thinly traded small companies, then used multiple phony names to post “baseless price predictions and other false and/or misleading statements,” the SEC said.
Lebed posted claims that a $2 stock would soon trade for $20 or that a stock would be the next “to gain 1000 percent,” the commission said. He often set automatic sell orders with his broker to “ensure that he would not miss the price increase of the stock while he was in school the next day,” the commission said.
“I implore investors to be highly skeptical of any advice they receive from the Internet. People should do thorough research before making investment decisions and verify all information before acting on it,” Ronald C. Long, administrator of the SEC’s regional office in Philadelphia, who led the probe, said at the time.
In 1999, the SEC filed a civil complaint alleging that four Southern California men had joined in a scheme to manipulate the stock of a bankrupt commercial printer company by spreading phony takeover rumors on the Web.
Over a November weekend, working in a library at the University of California at Los Angeles, the three created numerous accounts on Internet message boards and posted messages falsely claiming that NEI Webworld would be acquired by LGC Wireless, a privately held telecommunications company.
The rumors, which were fabricated, drove NEIP’s share price from 13 cents on a Friday to more than $15 by the following Monday, according to the SEC complaint, giving the men a profit of about $364,000.
Two of the men, who had done the same thing with several other thinly traded stocks, pleaded guilty to one criminal charge of securities fraud and were sentenced to short prison terms. Courts eventually ordered the four men to pay roughly $1 million in disgorged profits and fines.