Monday, February 1, 2021
ACA ALERT: MANAGING COMPLIANCE CONCERNS IN THE WAKE OF GAMESTOP CORP. STOCK INFLATION

During the past week, investors have seen GameStop Corp. stock soar to extreme heights driven, in large part, by the concerted efforts of participants in the r/WallStreetBets forum on Reddit to rally the stock rather than any change in the fundamentals of GameStop. Those efforts appear to have been designed to create a so-called “short squeeze” for hedge funds with large short positions, forcing them to cover their positions in the face of a rapidly increasing stock price and, indeed, the surge did force at least one prominent hedge fund to exit its large short position in GameStop, reportedly at a significant loss. In the intervening week, similar activity has been observed with respect to the stocks of a number of other companies, including AMC Entertainment Holdings Inc and Bed Bath & Beyond Inc.

While U.S. law broadly prohibits efforts to manipulate the financial markets (e.g., through the dissemination of false or misleading information), experts have observed that it may be difficult to prove that the activity on r/WallStreetBets constitutes illegal market manipulation. Thus far, the regulatory response has been to halt trading in individual stocks experiencing extreme volatility, and it is not obvious at this time what other actions regulators might take to combat this phenomenon. On January 27, the Acting Chair of the U.S. Securities and Exchange Commission (SEC) and the directors of the SEC’s Division of Examinations and Division of Trading and Markets published a joint statement expressing only that they are aware of the situation and are reviewing the activity.Compliance Considerations for AdvisersThese developments create a number of significant risks for investment advisers, including:

  • Negative impact to the adviser’s position in a security that becomes subject to social media-driven volatility.
  • The incentive for employees of the adviser to participate in forums like r/WallStreetBets in an effort to influence the price of a security.
  • Legal questions around the use of web scraping and other types of alternative data to incorporate social media sentiment into the adviser’s research process.

What Can Advisers Do?Investment Advisers can take the following steps to deter their traders from participating in such activities:

  • Adopt written policies and procedures to prohibit the use of social media, public internet forums, and unapproved messaging applications for business purposes except as explicitly approved by Compliance.
  • Adopt written policies and procedures to prohibit the discussion of securities in which the adviser has invested or that are under consideration for investment except as explicitly approved by Compliance.In addition to the emerging risks being discussed in this alert, such policies and procedures should address traditional types of idea sharing, such as idea dinners and other types of interactions between the adviser’s employees and other market participants, including sell-side research analysts, trading counterparties, and contacts at other buy-side firms.
  • Adopt written policies and procedures to address the use of web scraping and other alternative data.Require Compliance approval for all new data sources.Compliance diligence of alternative data providers should assess the provider’s controls to ensure the data is being collected in a manner that complies with applicable laws and that the adviser does not receive material nonpublic information, nonpublic personal information, or other information that could create risk for the adviser.Ensure that internal development teams involved in obtaining alternative data from online sources are aware they must respect terms of use and copyrights.
  • Ensure employees are regularly trained on these policies and procedures, including circulating topical reminders about how they apply in novel situations such as this one.
  • Obtain periodic certifications from employees that they have read, understood, and complied with the firm’s written policies and procedures, and consider obtaining more specific certifications based on the firm’s particular risks. For example, advisers with large positions in names known to be affected by social media-driven volatility may consider obtaining certifications from relevant personnel that they have not posted to online forums about those names.
  • Review employees’ electronic communications for indications they may be discussing investments in online forums or on unapproved messaging platforms, or that they may be discussing nonpublic information about firm holdings and trading with other market participants that do not have a legitimate business need to know such information.
  • Review firm trading and employees’ personal trading for recent activity in names such as GameStop, AMC, and Bed Bath & Beyond that are known to be affected by social media-driven volatility and, if appropriate, consider adding those names to the firm’s restricted list.
  • Ensure that trade surveillance considers trading ahead of significant price changes that are inconsistent with or outsized relative to broader market trends.
  • Re-examine disclosures to clients and fund investors to ensure that they adequately address relevant risks (such as those associated with short selling, extreme market volatility, etc.), whether driven by social media posts or otherwise.

ACA has drafted a sample reminder communication for investment advisers to send to their traders regarding this issue. Click here to download the communication.

ACA COMPLIANCE GROUP

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