Regulators eye Reddit stock rallies, but manipulation may be hard to prove: experts

This Monday, June 29, 2020 photo shows the Reddit logo on a mobile device in New York. (AP Photo/Tali Arbel)

TORONTO — Canadian regulators have said they will act if they see "abusive" or "manipulative" trading, as Reddit and other social media sites stoke stock mania.

But experts say that legal action is not straightforward: it depends on whether rallies in stocks like BlackBerry and GameStop are co-ordinated and harmful or simply cases of contagious excitement.

It's a debate that's playing out on the forums themselves.

On Reddit's Bay Street Bets, one user wrote of BlackBerry's stock, "We will support it and make it climb together," while another decried the idea that individual investors are some sort of Reddit army.

Lawyer Chris Sunstrum says that based on what's been reported so far, the stock mania on Reddit forums is still in a grey area for regulators.

"Does this constitute market manipulation? I think what the regulators are trying to figure out is, have they crossed that line," says Sunstrum of Goodmans LLP.

"Your typical retail investor just going on a chat board and giving their opinion, or helping rally the troops behind buying GameStop, is probably not going to be offside."

The warning about manipulative trading from the Canadian Securities Administrators and the Investment Industry Regulatory Organization of Canada on Monday came after BlackBerry shares whipsawed over the previous week, mirroring trends seen in the U.S. with GameStop, AMC and other securities.

Canadian silver mining companies have also seen a boost recently, although chief executives and Reddit users alike said social media is not the only factor behind the precious metal's rise.

So far, the social media dynamic around so-called meme stocks doesn't fit "neatly" into any of Canadian securities laws, says Sunstrum -- although it is still early days on the enforcement front.

Sunstrum says that out of all the potential accusations that could be brought against Redditors, market manipulation could become the biggest focus.

Canadian law prohibits doing something to artificially affect the price of a publicly traded security in a co-ordinated way, he says, though it can be a high bar to prove.

Another legal ramification for Reddit activity could be the charge of advising people about trading securities without the proper registration, though Sunstrum says it's not clear that's been the case over the past week.

Sunstrum says that other offences that could come into play include misrepresentation, where a person or company makes a statement that they know or should know is misleading or untrue in any material respect.

To fall into this category, the statement would be expected to have a significant impact on the market price of the shares, Sunstrum says, although he noted that defamation and libel could also come up as separate legal issues.

Ernest Wong, director of research at Baskin Wealth Management, says the Canadian market already has some limits in place that make it unlikely the situation in the U.S. will play out exactly in Canada. Canadian regulators and finance websites don't list short-selling activity in the same way as the U.S., and the options market here is much smaller, Wong says.

Queen's University associate professor Mohamed Khimji says further regulation also risks doing more harm than good.

"Is market manipulation the right expression? I don't really have a problem with using that expression ... I think the question is, really, is the activity harmful? Does it have negative effects on market confidence, the credibility of the stock markets in general?" asks Khimji, who researches business law.

"Any kind of buying and selling activity is going to manipulate the price at some level. That's just how trading works."

Khimji says that Canadian securities regulators tend to take the lead from U.S. regulators, and that action south of the border will give Canadian regulators something to go off. But, says Khimji, the market may adjust on its own.

"They're really just two groups that have two different trading strategies. Both sides will learn lessons by the end of it," says Khimji, referencing short-sellers as one group and retail investors as another. "I think this will just be priced in. Any short-seller of the future will think about this as a risk right here: what happened with GameStop, retail investors buying it up when it's really cheap and driving up the price."

Increasing regulation on retail investors could actually have the detrimental effect of limiting participation in the market, says Khimji.

"From a democratic perspective, I think it's just helpful for as much (of) society to participate in the markets as possible. In any kind of regulation we need to be really sure that it's going to help and not inhibit access," he says, adding the stock market "shouldn't just be for wealthy people."

This report by The Canadian Press was first published Feb. 2, 2021.