This article is part of the FT’s Runaway Markets series
The simplest and most common form of stock fraud is the “pump and dump.” It has three parts. Someone gets hold of some cheap shares; tells lies about why they are going to rise; and when they do, sells them, before the lies are discovered and the shares fall. This is against the law.
But what if we take out the middle step — the lying? Instead of spinning falsehoods about the shares, our perpetrator shouts to anyone who will listen: “If we all buy these cheap shares, then the price will go up, and we’ll make money.”
The reason to write about this now, of course, is Robinhood, Reddit and GameStop.
The third step still has to happen, of course. When everyone sells to take profits, the shares will fall, and some people will lose a bundle. So far from denying this fact, however, our perp points it out. “This is a dangerous game,” he says, “your timing better be good.”
This form of stock manipulation may seem unlikely to succeed, but it has been done. The most famous proponent was Jesse Livermore, considered the greatest stock trader in the world in the first two decades of the 20th century. His biography, Reminiscences of a Stock Operator, in which he is given the paper-thin alternative identity of “Larry Livingston”, might be the best book ever written about the market.
Reminiscences describes how Livermore ran stock “pools” in the 1920s. These were groups of well-financed shareholders, often company insiders, who had big blocks of stock they wanted to unload on the public. They did this by trading the shares back-and-forth among themselves, creating the appearance that the stock was liquid and on a bull run, drawing in speculators. The pool would then sell their stock into this feverish environment.
Livermore was such a good trader that pools often hired him to execute their plans, in return for a big slice of the profits. Surprisingly, the presence of the master manipulator made the speculators more likely to jump on board. Newspapers would breathlessly report that Livermore was running a bull pool, and it would take off, no deception involved. “After all is said and done,” Livermore said, “the greatest publicity agent in the wide world is the ticker.”
This was before the Securities Exchange Act of 1934. Section 9 of the law seems to aim directly for Livermore. It made it illegal to “to induce the purchase or sale of any security” by claiming that the price of the security “is likely to rise or fall because of market operations . . . conducted for the purpose of raising or depressing the price of such security”. That is, you are not allowed to pump up stocks simply for the sake of pumping them, as Livermore did (“market operations” is exactly how he described what he did). Deception is not required for manipulation.
If what the Redditors of r/WallStreetBets are doing is saying “let’s all get together and pump up the stock of GameStop”, either to squeeze out some big shot short-sellers, or even just to make a buck, there is a risk they could be breaking the law. There is some question (a big shot securities lawyer tells me) about the word “inducement” — whether the Redditors were in fact using their trades to make others trade — but the spirit of the law is clear enough. These kinds of games are not allowed.
But many well-intentioned laws are not enforced, for good reason. Should this one be? There are two arguments in favour of doing so.
One is that allowing the stock market to become a self-contained speculative game, unrelated to the value of underlying companies, will discourage companies from wanting to list — thus defeating the market’s purpose, which is forming and allocating capital. Given the long history of speculative secondary market excess alongside successful primary market offerings, this is unconvincing. If wild speculation was poisonous to capitalism, capitalism would have died centuries ago.
Then there is the idea that retail investors who are drawn into the frenzy will get badly hurt. They undoubtedly will. GameStop stock was always going to fall hard, because the company is not valuable enough to support it. The question is what is the fairer, more efficient way of discouraging dangerous behaviour: making certain types of speculation illegal, or letting some speculators get crushed as the public looks on? On the whole, I favour the second path, so long as rules are in place — high margin requirements, and so on — to protect the market itself from collapsing.
Livermore would probably agree with me, were he alive. But he died broke in 1940.
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