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EXPLAINER-Why regulators may scrutinize GameStop's Reddit-driven retail stock surge

WASHINGTON, Jan 27 (Reuters) - Shares of video game retailer GameStop Corp surged nearly 700% over the past week as retail investors piled in to the stock, appearing to be urged on by bullish posts in popular online forum Reddit as opposed to any fundamental changes in the company’s finances or prospects. GameStop’s interstellar surge has sparked calls for regulatory scrutiny. Why?

MARKET MANIPULATION

U.S. law bars the dissemination of false or misleading information with the aim of manipulating investors into buying or selling securities, as seen during a rash of “pump and dump” schemes during the early 2000s dot.com boom.

Regulators are likely to explore whether Reddit was used in a similar way, after thousands of messages hyped up the stock and urged other investors to hold on to their shares or buy more.

“GME IS THE HOLY GRAIL,” wrote one user on Wednesday, urging others to keep pushing the stock higher. “WE ARE STILL GOING TO THE MOON...ITS NOT TOO LATE TO BUY.”

Jacob Frenkel, Securities Enforcement Practice chair for law firm Dickinson Wright, said the SEC would likely look at whether the messaging by investors holding the stock long-term and activists betting against it was manipulative.

“With federal prosecutors having become much more sophisticated in their cases over the years on securities trading ... it is reasonable to believe that any SEC investigation could well have a parallel criminal investigation,” he added.

The U.S. Securities and Exchange Commission declined to comment, as did the Southern District of New York which could have jurisdiction over a criminal case.

STOCK EXCHANGE HALTS

Wild swings in GameStop’s shares led the New York Stock Exchange (NYSE) to halt trading in the company several times this week. But lawyers said there was sufficient marketplace confusion to warrant a longer suspension.

On Wednesday, the Massachusetts state regulator, William Galvin, called on NYSE to suspend GameStop for 30 days to allow a cooling-off period. “This isn’t investing, this is gambling,” he told Reuters in an interview. “This is obviously contrived.”

Lawyers said the incident could prompt a broader review of share suspension rules.

“I could see the SEC encouraging the NYSE to put in place rules that might smooth such swings as a result of retail investment activity,” said Marc Adesso, partner at Saul Ewing Arnstein & Lehr. NYSE declined to comment.

RISE OF LOW-COST RETAIL BROKERS

The GameStop saga has again shone a spotlight on low-cost retail trading platforms which have allowed millions of ordinary Americans to trade stocks. Consumer advocates say retail investors are taking risks they may not understand and incurring hidden costs that are rarely fully disclosed. “So much of this trading has been fueled by broker de facto claims of ‘free trading’... but that is false and misleading and the SEC should say that and stop it,” said Dennis Kelleher, CEO of progressive think tank Better Markets.

The combination of accessible retail trading and social media could upend the market if not adequately policed, Galvin warned.

“It’s diminishing the integrity of the marketplace and it’s putting individual investors at risk.” he said.

Reporting by Chris Prentice and Pete Schroeder in Washington Writing and additional reporting by Michelle Price Editing by Matthew Lewis

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