Meme Stock Events: an Analysis of the Securities and Exchange Commission and House Financial Services Committee Reports

• Publication year: 2023

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Gabriel Benincasa ^*

In this article, the author discusses reports from the Securities and Exchange Commission and the House Financial Services Committee on recent meme stock events.

Systemic risk. Lately, we have witnessed increased systemic risk in the banking sector with the seemingly instantaneous collapse of a number of banks, due in some cases to rapid withdrawals of deposits. The run-on of such banks was influenced or exacerbated by social media. Social media now plays a larger part in all financial sectors. Runs are no longer because of word of mouth, rather a social media influencer may post a statement and the run begins.

Systemic risk begins like a domino falling, and once it starts, no one knows when it will end. The runs on the regional banks resulted in regulators quickly acting to shore up confidence in the sector by guaranteeing 100 percent of deposits for certain banks. Large privately owned banks also participated in showing a vote of confidence in the banking system by making large deposits totaling $30 billion in First Republic Bank. ¹ The recent bank liquidity crisis reflects certain risks that persist in both the banking industry and the securities markets:

1. The velocity with which value/cash can transfer in milliseconds between market participants;
2. The explosive fuel social media adds to that velocity and the associated risks; and
3. Lack of comprehensive regulatory regimes (either within banking or securities regulations) to deal with this extremely troubling dynamic.

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As critical as any input for economic growth is a vibrant banking system and stock market.

During the December 2020 to January 2021 period—highlighted by the extreme volatility on January 28, 2021 (the Meme Stock Day)—the so-called meme stock events (Meme Stock Event) occurred. The event occurred due in large part to the influence of social media and many first-time stock traders entering the market, as indicated in the June 24, 2022, U.S. House Committee on Financial Services (HFSC) memorandum ² on the meme stocks (HFSC Report). ³

What Is a Meme Stock?

A meme stock is a stock that gains popularity among retail investors through social media. Of particular note during the Meme Stock Event was the massive surge in the stock price of GameStop, a video game retailer. In January 2021, a group of individual investors from Reddit/WallStreetBets coordinated efforts to drive up the price of GameStop shares. At its peak, GameStop's stock soared to the extraordinary level of $483 per share, exceeding significantly what many analysts considered reasonable based on the company's fundamentals.

Unlike bank regulators that can guarantee deposits or add liquidity to the system, the securities regulators have no such ability. The U.S. Securities and Exchange Commission (SEC) can pass rules and regulations, and enforce such rules and regulations, but it does not have access to funds to try and stop a concerted effort against a broker-dealer. The SEC cannot provide liquidity in the way that the Federal Reserve can. Given that the SEC has fewer tools to head off systemic risk like the Federal Reserve, the SEC should proceed cautiously when it proposes revolutionary changes to the market structure. Its ability to rectify a misstep is much more limited. The HFSC Report even recommended that the SEC and Congress consider funding an emergency backstop facility for National Securities Clearing Corporation (NSCC) member firms. ⁴ NSCC, which is regulated by the SEC, is the clearing agency for the U.S. equity markets.

During the financial crisis of 2008-2009, some large broker-dealers such as Morgan Stanley and Goldman Sachs had to quickly

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form bank-holding companies to access funds provided by the Federal Reserve. ⁵

Limited Tools

The Meme Stock Event is like a run on a bank, but the securities regulators have limited—if any—tools to stem the systemic risk. Social media caused a significant run-up in prices of stocks that were widely shorted, such as GameStop (GME), BlackBerry (BB), Bed Bath & Beyond (BBBYQ), and AMC Entertainment Holdings (AMC).

The run-up was preceded by posts on Reddit's WallStreetBets. The frequent posts on WallStreetBets and, in particular by the user called TheRoaringKitty, resulted in numerous stock prices rising significantly. The prices of companies such as GME, BB, BBBYQ, and AMC rose above most expectations and fundamentals. GME stock price went from a closing price $18.84 on December 31, 2020, to an intraday high of $483 on Meme Stock Day, from the previous night's close of $347.51. ⁶

It should be noted that on February 26, 2021, when much of the social media posts on GME subsided, GME closed at $101.72, and on May 1, 2023, it closed at $18.55. GME had a stock split on July 21, 2022, the pre-split price would be $74.20. BBBYQ faced significant headwinds in 2021 and recently filed for bankruptcy protection. BBBYQ stock opened at about $19 at the beginning of 2021 and hit a high of $35.30 during the Meme Stock Event. BBBYQ was trading at 24 cents as of late May 2023. Social media clearly had an outsized and unwarranted impact on the prices of the so-called meme stocks. Laying the blame on gamification or digital enhancement practices and payment for order flow (PFOF) appears misplaced and unfounded.

The HFSC Report noted "retail investors trends, like stocks gaining popularity on social media, increasingly affect the pricing and trading volume of securities." ⁷ SEC Chair Gary Gensler recently stated, "runs, when otherwise uncorrelated actors suddenly become correlated, have brought down many a financial firm over time. Financial fires at banks and nonbanks alike have led policymakers to put in place laws to prevent such fires and associated runs, as well as to help fire departments contain fires." ⁸

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The brokerage system clears all stocks through the NSCC, a subsidiary of the Depository Trust & Clearing Corporation (DTCC). If a member of the NSCC defaults, it may cease to act for such member, it assumes control of the defaulted members portfolio, and trades and losses are absorbed by collateral posted by the defaulting member and excess losses are borne by the remaining members of NSCC. ⁹ This could lead to systemic risk and potential failures by other members. Once losses start, it is hard to predict where the domino effect ends.

NSCC maintains a clearing fund into which its member broker-dealers post collateral to protect the NSCC from potential losses from a defaulting member. The clearing fund consists of cash and eligible securities. The collateral required by NSCC is composed of (1) a volatility component (VC), and (2) an excess capital premium (ECP). The VC is the largest component of the collateral collected by NSCC and it is meant to cover the future risk of the cleared portfolio over a given time horizon at a 99 percent confidence level. In addition to the VC, NSCC can charge members an ECP to address a member's significant temporary increase in its required margin.

During the Meme Stock Event that hit its peak on the Meme Stock Day, NSCC called for significant VC and ECPs from a few members. The run-up in prices in stocks such as GME, BB, BBBYQ, and AMC forced the NSCC to call for additional capital immediately from some firms. Some of these firms were caught off guard by the demand for additional capital, which was due overnight or within hours of such a call. NSCC called for $3.7 billion (combined VC and ECP) overnight from Robinhood Securities on Meme Stock Day of which a substantial amount was due to a VC for the increased price of AMC and GME, $850 and $250 million, respectively. ¹⁰ This call for extra collateral was significantly reduced the next day by NSCC. ¹¹ The NSCC was concerned with the knock-on effect if it was forced to cease clearing for such firms that had collateral calls, so it reduced the ECP for Robinhood and other brokers. ¹²

Firms faced with this immediate request for additional collateral resorted to imposing trading restrictions. The trading restrictions typically limited customers to closing their positions and not opening new positions in highly volatile stocks such as GME, BB, BBBYQ, and AMC. These restrictions are known as...