A coordinated effort by day traders to drive up the share prices of GameStop Corp. and other troubled companies is being fueled by “hate” of Wall Street insiders that must be addressed, according to the chairman of the House Subcommittee on Investor Protection, Entrepreneurship and Capital Markets.

Rep. Brad Sherman, D-Calif., said the purpose of capital markets isn’t to facilitate get-rich-quick schemes or keep Wall Street market players employed. It’s to finance the private sector. Investors should pick stocks based on which companies they think will do well, not because they want to reward or punish market participants. 

“In the long term, the stock is going to have a value that reflects the value of the company,” Sherman said in an interview with CQ Roll Call. “So if the stock is selling at a price wildly different from the value of the company, some people may make money on that, but ultimately there are going to be more losers than winners.”

“You shouldn’t buy a stock because you hate somebody else who’s on the other side of the transaction,” he said. “Some of the people buying the stock are doing it as almost a political statement against people who sell short.”

Sherman called for an examination by Congress of short selling in capital markets.

“We do want to take a look and see whether short-selling should be at least more transparent,” he said. “But we also need to change a culture where people look at the stock market as an alternative to Las Vegas.”

[Lawmakers call for hearings as apps pause trading in GameStop]

Maxine Waters, chairwoman of the House Financial Services Committee, said this week she’ll hold a hearing on the activity around GameStop, including the role hedge funds played by short selling and the impact of online trading platforms such as Robinhood Markets Inc., a regulated broker-dealer based in Menlo Park, Calif.

Lawmakers and political commentators on the left and right have taken up the cause of the day traders, who say their fight is emblematic of a system that has one set of rules for Wall Street and another for everyone else.

Policymakers across the ideological spectrum from Sen. Elizabeth Warren, D-Mass., to Sen. Ted Cruz, R-Texas, defend the day traders, saying their actions were no different from those taken by Wall Street firms everyday. 

Massachusetts Secretary of the Commonwealth William Galvin, the state’s chief securities regulator, said they’re missing the point.

“It’s not David and Goliath,” Galvin said in an interview. “It’s strictly manipulation. When you have a manipulated market it creates a bubble. That’s a danger to the entire marketplace. We’ve seen this time and time and time again, and the Securities and Exchange Commission needs to address it.”

Galvin this week called on stock exchanges to suspend trading in GameStop shares after traders connecting through online forums such as Reddit’s “r/WallStreetBets” drove up the brick-and-mortar video game retailer’s stock price by more than 1,000 percent in a few weeks. The retail chain has been hit hard by the pandemic’s closure of malls and ongoing competition from game distribution over the internet. 

Some online stock trading platforms that cater to individual investors, who tend to be less sophisticated that Wall Street professionals, briefly halted the ability of their customers to buy GameStop shares this week, citing volatility. The share price dropped Thursday amid pauses by Robinhood and Interactive Brokers LLC. Robinhood in some cases allegedly sold off holdings customers made using money the company had lent them.

The price rebounded Friday.

“People have the right to take risks, but this isn’t risk. This is clearly gambling. It has nothing to do with the performance of the company,” Galvin told CQ Roll Call.

Massachusetts is the home sate of Keith Gill, the 34-year old day trader who is credited with leading the horde of online followers in driving the market rally in GameStop, according to The Wall Street Journal.

Quick bucks

Retail investors, faced with more time at home on screens during the pandemic and greater access to online trading, have flocked to the financial markets. Many new traders who see GameStop as an opportunity to make a quick buck will lose their money, Galvin said.

He also slammed hedge funds that bet GameStop share price would plummet and sold shares short, and then got clobbered when prices of the stock unexpectedly surged. The company’s stock has been the most “shorted” on Wall Street, one factor why Reddit users seized on the stock as a buying opportunity.

Short selling means selling borrowed shares with the intention of buying them back at a lower cost and pocketing the difference, a common practice often criticized by companies, regulators and day traders. As prices spike instead of falling, hedge funds must buy GameStop shares at a loss. In a quirk of the markets, Wall Street firms were able to sell more borrowed shares than there are in circulation, which has helped push the price skyward.

The four sitting Securities and Exchange Commissioners said Friday that the agency is monitoring the volatility, which can expose investors to “rapid and severe losses and undermine market confidence.” 

“The Commission will closely review actions taken by regulated entities that may disadvantage investors or otherwise unduly inhibit their ability to trade certain securities,” they said in a joint-statement. “We will act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws.” 

Barbara Roper, director of investor protection for the Consumer Federation of America, said this episode challenges the traditional concept of market manipulation. The SEC will have to grapple with whether it has the tools to address it, she said. 

“There is clearly market manipulation going on — investors are banding together to try to send the stock higher for reasons that have little or nothing to do with their opinions about the company’s business prospects — but it doesn’t appear to be driven by regulated entities, at least not entirely,” she told CQ Roll Call in a statement. 

Online brokerage apps are also ripe for regulatory review, Roper said. 

The platforms, which don’t charge fees for executing transactions, make money for sending their trades to third parties that can profit from trading at high volumes with ordinary investors. The platforms also have been criticized for having game-like elements, which some say encourage risky behavior by users.

Questions about how those dynamics contributed to the frenzied activity around GameStop are ripe the SEC to examine, Roper said.

Trading apps may also face investigation for halting customer purchases of GameStop shares, accoridng to Robert Hockett, a Cornell University professor. The platforms have faced criticism from lawmakers, such as Democrat Rep. Rashida Tlaib of Michigan, who say the apps intervened on behalf of institutional players they depend on for investments and revenue. 

Lawmakers and the SEC should also examine trade data to determine whether any institutional players aligned with day traders and what that means from a regulatory perspective, Hockett, who worked on the presidential campaign of Sen. Bernie Sanders, I-Vt., told CQ Roll Call in an interview.

“The hedge-fund-versus-day-trader narrative might be a little bit distorted. It might be more like some hedge funds versus other hedge funds, plus day traders,” he said. 

‘Populist rage’

Hockett and Roper said the episode illustrates the disconnect between financial markets and the productive sectors of the economy, a schism that needs to be addressed. The dislocation has grown starker during the pandemic, as the country faces shortages of medical supplies, such as vaccines, syringes and even rubber gloves, Hockett said.

“We have all of this surplus capital in the economy that could be used to ramp up production of the things that we need. Yet instead it’s being gambled away or frittered away in a high-stakes poker game on Wall Street,” he said. “There’s something really profoundly wrong with the plumbing of our financial system.”

Roper said corruption on Wall Street fueled the popular embrace of the Reddit traders. However, normal people, not Wall Street, will be left holding the bag.

“There’s a company that employs real people at the center of this maelstrom, and someone’s going to get hurt before this is over,” she said.

Mark Rosenberg, CEO of the financial consultancy firm GeoQuant, said the GameStop occurrence isn’t a one-off; it’s part of a larger cultural rejection of institutions and growing social alienation. Rosenberg’s firm advises clients in the financial sector on geo-political risk.

Politicians embracing the Reddit day traders are “taking up this mantle without knowing much about the underlying dynamics of the community,” he told CQ Roll Call. “There is a chaotic element to this movement and I think that ultimately can have negative consequences beyond a few hedge funds getting bailed out by larger hedge funds.”

He likened it to the storming of the Capitol by a pro-Trump mob on Jan. 6, calling the two events peas in a “chaotic pod.” 

Both events channeled “bottom-up populist rage into establishment channels where a lot of the benefit to the participants is in challenging the status quo,” he said. “I think that’s going to continue to be a major factor of American political, social and economic life. That’s not going to change just because we have a new administration.”