Is trading all about speculation?

Gamestop speculation on the stock market: still business as usual or already market abuse?


Guest contribution by Dr. Kilian Wegner


For two weeks now, you have not only read the business section of the stock exchange, it is about the David versus Goliath story of an Internet community against large hedge funds. Kilian Wegner illuminates the situation under German law.

In the past few days, amazing things have been observed on the US capital markets: shares of companies such as the retail chain Gamestop, whose price has been lagging behind for a long time, suddenly shot to astronomical heights, causing multi-billion dollar hedge funds, which set prices on falling prices as part of so-called short sales had got into financial distress.

The causes of this development are still partly in the dark. Their starting point, however, has been determined and is causing fierce controversy: It was users of the Reddit online discussion forum who were made aware in a conversation channel with the identifier "r / WallStreetBets" that hedge funds were betting prices against companies like Gamestop, B. had also placed Nokia or Blackberry. To do this, the hedge funds borrow financial instruments such as stocks that they do not even own and sell them on the assumption that the price will fall (so-called short sale). By the due date at the latest, they buy back the shares at a lower price in order to return them to the lender on time. The difference between sales and purchase prices then increases the assets of the hedge fund - at least if the plan works.

In view of this development, the plan arose on Reddit, where users communicate under pseudonyms, to increase the price of the stocks under pressure through targeted purchases. As a result - according to the calculation - the hedge funds, as short sellers, should be forced to give up their bets on falling prices in order to limit losses (so-called short squeeze).

If this causes prices to rise, the short sellers cannot make a profit as planned. On the contrary: you run the risk of massive losses. In order to limit the damage, they have to stock up on the shares as soon as possible on the expiry of which they had actually bet and which they have to return when they become due. However, this will drive the price even higher, which has exacerbated the situation for short sellers and caused losses in the billions on Wall Street.

For comparison: While the Gamestop shares were still around 30 euros each on January 15, it was around 230 euros on last Friday, January 29, that is more than seven times as much. Anyone who bought Gamestop shares during this time and found the right time to exit could make substantial profits or at least enjoy the feeling of having given the hedge funds, which are mostly poorly reputed on Reddit, a lesson.

How should this development be assessed under German law?

The events of the past few weeks raise many questions, ranging from the risks of such transactions for the retail investors involved, through details of their technical processes, to questions about the economic and moral assessment of what is happening on the capital markets.

However, this article deals specifically with how the events under German market abuse criminal law would have to be assessed if it had occurred in its geographical area of ‚Äč‚Äčapplication.

First, the uncovered short sales

If you first look at the uncovered short sales of the shares of companies such as Gamestop, against which the users of the sub-forum "r / WallStreetBets" have mobilized, this would be prohibited in Germany according to Article 12 of the EU Short Selling Regulation - unless , the seller would have taken the measures described in the standard to ensure that the shares sold can actually be delivered on the reporting date. Whether this has happened in individual cases cannot be judged from a distance.

A violation of the aforementioned prohibition of uncovered short sales does not in itself constitute a criminal offense, but an administrative offense in accordance with Section 120 (6) No. 3 of the Securities Trading Act (WpHG), which in accordance with Section 120 (24) var. 1 WpHG can be sanctioned with a fine of up to 500,000 euros.

In special cases, an uncovered short sale can also be assessed as criminal market manipulation or even as fraud. This is especially true if the short seller considers it possible from the start and approves of not being able to fulfill his delivery obligation.

Second: The posts on Reddit

What about the small investors who have acquired shares in Gamestop & Co (or corresponding options) in order to drive the price up at the expense of short sellers: Is this a criminal market manipulation?

If you first look at the facts of so-called information-based market manipulation (Section 119 (1) WpHG in conjunction with Art. 15, 12 (1) c) EU Market Abuse Regulation, or MAR for short), this is doubtful. Anyone who publicly announces transactions in financial instruments is not disseminating false or misleading information, as the facts require.

It can be different if someone publicly announces that they want to acquire a financial instrument and / or hold it for a certain period of time, although in reality no purchase or at least an earlier sale than announced is planned and the price is only intended to increase through the announcement . Even then, however, it is questionable whether such a false announcement is suitable for capital market manipulation. To put it simply, that assumes that a sensible average investor would take the information into account when making an investment decision. Because of the notorious unreliability of such a source, it is doubtful whether the pseudonymous announcement in a Reddit forum post would receive such consideration.

If, however, a sufficiently large number of users unite to distribute such false announcements (or if an individual user suggests this by creating numerous user accounts), so that even an average investor can no longer ignore the (possibly only faked) sheer mass of announcements it would be quite conceivable to assume information-based market manipulation.

Third, the purchase of said stocks

Even more complicated is the assessment of the question of whether retail investors are guilty of market manipulation who have acquired shares (or options) in the wake of the gamestop phenomenon.

The manipulation offense of Article 12 (2) (a) MAR, which, among other things, is specially tailored to cases of so-called abusive squeeze, could be relevant. This describes situations in which the supply on the market is deliberately reduced in order to allow price formation to be monitored. At first glance, the "short squeeze" plan developed by "r / WallStreetBets" is a prime example of this, as stocks are purposely bought here in order to force short sellers to stock up on the prices demanded by the buyers.

On closer inspection, however, the legal situation is more complex: The wording of Article 12 (2) (a) MAR presupposes that one or more persons acting "in consultation" secure a dominant position in the market. However, it is not clear from which threshold one can speak of a dominant position. It is also doubtful whether the purely factual interaction of people who communicate under pseudonyms in a public forum or only passively read the forum or only learned about the forum's content from the press or jump on the rising prices without any knowledge of the forum, can actually be described as a factual "agreement to secure" such a position. It is closer to assuming parallel behavior that is irrelevant under criminal law.

In addition, the mere internal motive of participating in a short squeeze does not make a share purchase illegal. Otherwise it would hardly be possible to define where the completely legitimate thwarting of a short selling strategy ends and where an illegal short squeeze begins, especially since the pain threshold is likely to be completely different depending on the specific short sale transaction and the liquidity of the short seller. That the mere knowledge of the existence of significant short positions in the market is supposed to make buying stocks illegal cannot be correct.

The so-called trade-based market manipulation according to Article 12 (1) (a) MAR would also come into question. According to this extremely vaguely formulated norm, the conclusion of a transaction, the placing of a trade order and comparable actions constitute market manipulation if they are accompanied by the sending of false or misleading signals regarding the supply, demand or the price of the object of the crime, or if they are abnormal or artificial Course level can be generated. The core problem of this fact is that the conclusion of transactions or the development and execution of complex trading strategies is a fundamentally permitted behavior. One cannot tell from the individual business as such whether there is legal market activity or illegal market manipulation.

The demarcation between legitimate market behavior and market manipulation can only be achieved here with a return to the meaning of the prohibition of market manipulation: The prohibition is intended to prevent the information basis for market participants from being distorted by market activities that cannot be explained from the market and their true goals and motives remain hidden from other market participants. Whether this is the case can be determined by considering the trading activity in question and its context as a whole.

When buying shares in the wake of the Gamestop wave, the decisive factor is whether the buyer is actually interested in the economic effect of the business, i.e. whether he or she wants to make a profit or avoid losses with the business, or whether instead the business related to the business is not The focus is on influencing the price, for the sake of which the economic consequences of the business are merely accepted.

Most of the people who have bought shares in companies like Gamestop in the past few days are likely to have mixed motives: On the one hand, there is a will to harm the short sellers, on the other hand, most of them should have hoped to gain from the rising prices themselves benefit. Then the acquisition of shares is not deceptive. Only if - which will hardly be verifiable in practice - the purchaser is completely indifferent to the economic consequences of the business can trade-based market manipulation be assumed.

Fourth: The trading stop through trading apps

When the prices for the shares of Gamestop & Co shot up and the short sellers closed their positions e.g. In some cases, having to accept billions in losses, numerous brokers such as the U.S. company RobinHood and the German FinTech TradeRepublic restricted trading in these stocks for some time: The only option was to sell the securities, but no longer to buy them.

As an official reason for this step, the companies state that they have placed the buy orders to protect the stability of trading or to protect customers from careless purchases. Critics accuse the brokers, however, of having acted in the interests of the attacked short sellers - mostly heavyweight hedge funds - and therefore committed market manipulation with the partial ban.

In fact, the reasons for the brokers' behavior are likely to have more complicated reasons that need further clarification. Should it turn out, however, that the brokers really wanted to influence prices in a targeted manner against the interests of their customers, this would be classified as (at least attempted) action-based market manipulation.

It is another matter whether the business model of FinTechs like TradeRepublic is generally compatible with the law of market abuse. RobinHood has already been accused of selling customer order data in advance to third parties in order to give them a trading advantage by means of so-called front running. It is to be hoped (but unfortunately also doubted due to current events) that the BaFin would effectively prevent such business practices, which constitute criminal insider trading, in this country.

The author Dr. Kilian Wegner is a lawyer and research assistant at the Bucerius Law School in Hamburg and focuses on research into criminal law, criminal procedural law and commercial criminal law with its European and international implications.