ESMA on meme stocks: Coordinated strategies may constitute market manipulation

ESMA has released a statement regarding the recent episodes of very high volatility in ‘meme stocks’ driven by social media trading, particularly r/WallStreetBets.

The European regulator said that although market rules and structures are different in the EU, cannot be ruled out that similar circumstances may occur in the EU as well as retail investors are flocking to the stock markets.

“ESMA urges retail investors to be careful when taking investment decisions based exclusively on information from social media and other
unregulated online platforms, if they cannot verify the reliability and quality of that information.”

The regulator then goes on about gathering information, the benefits of diversification, and the ability to bear losses. Given that price volatility increases investors’ risk of loss, ‘meme stocks’ are an increased risk for retail investors, ESMA argues, adding that margin or derivatives trading exposes investors to even greater risks and investors should understand those risks.

About social media discussions, ESMA clarified it does not constitute market abuse, but coordinated strategies might.

“Organising or executing coordinated strategies to trade or place orders at certain conditions and times to move a share’s price could constitute market manipulation.”

“Similarly, special care should be taken when posting information on social media about an issuer or a financial instrument, as disseminating false or misleading information may also be market manipulation. Additionally, care should be taken when disseminating investment
recommendations through any media, including social media and online platforms, as they are subject to a number of regulatory requirements”, ESMA added.

‘Meme stock’ trading, the phenomenon of late January 2021, seems to be just starting. After the Gamestop short squeeze, r/WallStreetBets took to the AMC stock and a few other instruments, including Silver, to replicate what was deemed as a success. Most recently, the social media trading frenzy aimed at the whole Cannabis sector.

Apart from retail investors who were “caught holding the bag” in such rollercoaster markets, many within the industry got hurt by the meme trading craze. Various retail brokers serving their customers were unprepared to deal with this kind of volatility.

In the United States, talk about banning Payment for Order Flow (PFOF) has reemerged as neo brokers, namely Robinhood, not only failed to maintain the required trading conditions for their customers but have also shown the conflict of interest behind their business model.

Robinhood CEO Vlad Tenev has recently decided to go on a crusade against the two-day trade settlement period. The problem is not the Payment for Order Flow model, according to Mr. Tenev. Instead, the problem is when clearinghouses skyrocket deposit requirements overnight during times of extreme volatility.

In this scenario, investors are kept waiting for trades to clear, while clearing brokers are kept from their deposits until the settlement is finalized two days after the trade. These requirements can induce added risks. So, Mr. Tenev and others within the industry are calling for real-time settlement.