Last week, a tense showdown played out on Wall Street. A battle between a band of amateur investors on Reddit and multi-billion-dollar hedge funds started a trading frenzy, sending the share prices of some previously unfancied companies such as GameStop surging. The mass buying spree led to huge gains for some in the Reddit crowd who got in early.
Meanwhile, hedge funds lost billions of dollars on their short positions.
While GameStop and other Reddit favourites surged, the broader stock market had its worst week since October, with traders expecting more volatility this week.
As more and more people wonder whether this could turn into a systemic event that sends markets crashing, it has become clear US President Joe Biden has to include Wall Street near the top of a crowded list of issues he needs to tackle early in its term.
Typically, a matter involving an individual stock or equity market trading and brokerages would fall to the Securities and Exchange Commission (SEC), which has said it is examining the matter.
On Friday, SEC commissioners said in a statement that they were “closely monitoring and evaluating the extreme price volatility of certain stocks’ trading prices,” adding that volatility can expose investors to losses and erode market confidence.
The agency added: “We will act to protect retail investors when the facts demonstrate abusive or manipulative trading activity.”
Mr Biden’s choice to run the SEC, Gary Gensler, awaits Senate hearings.
Jim Toes, president and CEO of the Security Traders Association, wrote in a Sunday letter to the trade group’s members: “The timing of last week’s events was grossly unfortunate in that it took place during a transition of power in the White House.
“The Senate, while doing its best, has yet to confirm [Gensler] and the natural turnover of SEC staff that comes with a changing of the guard could delay the response time of our industry’s chief regulator.”
A spokesperson for the Senate Banking Committee declined to comment on the timing for Mr Gensler’s confirmation hearing.
Nevertheless, the GameStop saga will likely be the primary focus and further delays to the hearing could hamstring how much the SEC can respond to political pressure.
Tyler Gellasch, executive director of the Healthy Markets Institute, an advocacy group supporting greater transparency in financial markets, said: “This is not funneling capital to its best and highest uses to drive our economy.
“That’s not what’s going on here. And if you’re the SEC, that has to be your fundamental concern.
“Your fundamental focus has to be how to make sure that our capital markets are working to drive capital to its best and highest uses to make our economy heal, and give investors reasonable returns and security and stability.”
According to The Hill, the agency’s priority will be determining whether the Reddit-organised short squeeze on struggling companies amounted to illegal stock market manipulation.
While privately coordinated efforts to drive up the price of a stock are often illegal, experts believe the public nature of the online campaign means there is little precedent to guide the SEC.
Mr Gellasch added: “What happens if coordination is out in the open?
“Is it still corruption? Is it still illegal? If what we saw on Reddit was an email between one hedge fund manager and another hedge fund manager, you would see it as an exhibit in a court case.”
Urging for the introduction of new regulations, Senator Jack Reed, a member of the Senate Banking Committee, said in a statement on Saturday: “There should not be one set of rules for big hedge funds and another set for average individual investors that disadvantage retail investors.
“We need fair rules that protect average Americans, including mom and pop investors, and the integrity of our securities markets.”
Democrats are calling on the SEC to update capital requirements for stock brokers, write clearer standards for market manipulation, force short-sellers to be more transparent and crack down on overly speculative behavior.
Senator Elizabeth Warren wrote in a Friday letter to the SEC: “The Commission must review recent market activity affecting GameStop and other companies, and act to ensure that markets reflect real value, rather than the highly leveraged bets of wealthy traders or those who seek to inflict financial damage on those traders.
“GameStop is just the latest ringing of the bell that we have a real problem on Wall Street.
“It’s time to fix it.”
Not everyone seems to be on the same page, though.
Senator Pat Toomey, the top Republican on the Senate Banking Committee, warned against overreacting with more regulation.
He told CNBC: “You certainly should be protecting people from dishonesty, from fraud, from misrepresentation, from false information.
“But to tell people what they can do with that information is so paternalistic and so contrary, really, to the interest of investors in the long term that I would be strongly opposed to that.”