Expressive Trading, Hypermateriality, and Insider Trading
Last year, we analyzed the meteoric rise of GameStop’s stock price in early 2021. We showed that stock transactions can be dual-motivated – by a combination of profit and some other political, social, aesthetic, or similar nonfinancial motives. Emotion-driven trading is nothing new, nor is popular opposition to developments in financial markets. What is new is the ability of a mob to coalesce into a successful, coordinated response to financial markets phenomena.
Trading by this coordinated online ‘hivemind’ – what we call social-media-driven (‘SMD’) trading – has a subset, ‘expressive trading’. Expressive trading occurs when investors buy or sell for non-profit-seeking reasons, like social or political activism, or for aesthetic reasons, like a nostalgia play. A common political, social, or aesthetic goal can unite members of an online community. That, in turn, enables collective action by community members who might otherwise be incentivized to defect from the group and take profits (or cut losses).
GameStop’s price is still one or two orders of magnitude above historical levels, albeit at just over a fifth of its historic high. Perhaps GameStop’s price is destined to fall. But at least one result is permanent: the hedge funds that presumably attempted to destroy the company by driving its stock price to $0 via extreme short positions, but which were themselves driven to bankruptcy by a SMD short squeeze, are no more. It was a combination of anger at those hedge funds and the opportunity for profit that allowed the SMD short squeeze to be successful.
Effective tools are rarely abandoned, and SMD trading, having shown its effectiveness, is likely here to stay. So far, SMD and expressive trading have been wielded to benefit public companies. These same forms of trading could, however, plausibly be turned into weapons used to drive a target’s stock price down, perhaps to coerce companies into adopting SMD traders’ social goals.
Given this potential, compliance departments should be prepared to respond to SMD trading in their firms’ stocks. But a market response – one that relies on a firm counteracting a manipulation of its price by engaging in transactions that take the manipulation into account – might generate unwanted attention from the Securities and Exchange Commission (‘SEC’). Given the SEC’s aggressiveness as a regulator, the potential to run afoul of US insider trading laws is of special concern.
Our follow up article, ‘Expressive Trading, Hypermateriality, and Insider Trading’, explores this issue.
Insider trading in violation of US securities laws occurs where an issuer or insider trades based upon material nonpublic information in breach of a fiduciary or similar duty of trust and confidence. The materiality element of insider trading liability is particularly relevant in the SMD-trading context. The US Supreme Court has held that information is ‘material’ for purposes of insider trading liability if ‘there is a substantial likelihood that a reasonable shareholder would consider it important’ in making an investment decision, and there is a ‘substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the "total mix” of information made available’ (see, Basic Inc. v. Levinson, 485 U.S. 224, at 231-32 (1988)).
The effects of SMD trading have the potential to swamp the materiality of issuers’ and insiders’ nonpublic internal information that would normally preclude their legal trading. As exemplified by the GameStop short squeeze and accompanying public attention, SMD trading can have such an overwhelming effect on a reasonable investor’s investment decision about a stock that it diminishes the importance (perhaps to nothing) of nonpublic otherwise-material inside information about the company. SMD trading and subsequent SMD price changes (if sufficiently dramatic) are therefore ‘hypermaterial’, and can open the door to issuers’ and insiders’ trading while in possession of nonpublic information without violating US insider trading laws.
Consider the following scenario involving expressive trading: XYZ Corporation’s stock price had been falling over the last month (from a high of $12 down to $10), due to a short-sale attack by a small group of hedge funds. In the past week, a group of individuals in a social media chatroom have attempted a now well-publicized short squeeze, motivated by a desire to punish what they view as predatory behavior by the hedge funds. As a result, the stock price has been driven up to $300, significantly above where the stock was trading before the short-sale attack. The company's nonpublic data (earnings, etc.) that will be reported in the next week reflects the ‘true’ price of the company's shares should be $8. With knowledge of the above public and nonpublic information, XYZ and some of its insiders issue/sell XYZ shares.
Have XYZ and its insiders violated U.S. insider trading laws?
In the absence of SMD trading, the insiders’ nonpublic information that the company’s stock (currently trading at $10) is actually worth $8 is certainly material: there is a substantial likelihood that a reasonable shareholder would consider important information that a stock trading at $10 is only worth $8. But, we argue, that same information is no longer material after the SMD trading has pushed the stock's price to, say, $300. In turn, if the firm’s and insiders’ nonpublic information about the firm is immaterial, then they may respond to SMD trading by trading in the firm’s shares without violating the anti-fraud provisions of the federal securities laws.
Of course, the materiality test applied by the courts lacks the precision necessary to determine the exact point at which internal data will pass from being material to being immaterial due to hypermaterial SMD trading. This uncertainty will make it difficult for issuers and insiders who are targeted by SMD trading to know the precise point at which they can begin trading in their own company’s shares without fear of incurring insider trading liability. Nevertheless, if SMD trading drives a stock’s price far enough (in either direction), there will come a point at which the immateriality of the firm’s internal data is obvious. At that point, issuers and insiders should be free to trade without fear of insider trading liability.
John P. Anderson is J. Will Young Professor of Law at the Mississippi College School of Law
Jeremy Kidd is Associate Professor of Law at the Walter F. George School of Law at Mercer University
George A. Mocsary is Professor of Law at the University of Wyoming College of Law
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