Treasury Secretary Janet L. Yellen met with fellow regulators on Thursday to discuss recent market volatility and few wild weeks on Wall Street, in which a crush of retail investors sent stocks soaring — in GameStop’s case, more than 1,700 percent — and then plunging back to earth.
The circumstances surrounding the trades that drove the spikes, including the trading platforms like Robinhood that enabled them, have drawn scrutiny in recent weeks, prompting Ms. Yellen to convene a meeting with top financial regulators. The risk to investors of the volatile trading was shown on Thursday, when GameStop fell 35 percent.
The entire episode has caused Washington’s financial overseers to examine whether markets — in becoming both more democratized by technology and more subject to the whims of social media — have changed in ways that require new attention and potentially different regulation. Treasury did not immediately provide any comment on the meeting.
Ms. Yellen, recently confirmed to her post after being nominated by President Biden, asked for a meeting with the Securities and Exchange Commission, the Commodity Futures Trading Commission, the Federal Reserve and the Federal Reserve Bank of New York.
“We really need to make sure that our financial markets are functioning properly, efficiently, and that investors are protected,” Ms. Yellen said on Good Morning America on Thursday, saying that the meeting would be later that morning. “We need to understand deeply what happened before we go to action, but certainly we’re looking carefully at these events.”
Investors piled into GameStop, AMC, BlackBerry and other assets largely to see how far they could drive up the price, rather than because the companies had solid underlying fundamentals. They discussed their efforts on internet forums and caused wild market volatility in the process.
Many of the trades were facilitated by the popular trading app Robinhood, which had to temporarily limit some trading to escape financial problems as huge numbers of stocks changed hands.
The gyrations served to underline that a new breed of investor can exert substantial influence, at least when it comes to individual stocks. Robinhood’s trading suspensions also highlighted the limitations of the platform and drew swift criticism from lawmakers in both parties.
The S.E.C. said that it was “closely monitoring” the situation on Friday and that it would “act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws.”
While the S.E.C. and, to a more limited extent, the C.F.T.C. have the most jurisdiction over the issues at hand, the Fed has a financial stability mandate and market insight. The New York Fed’s trading desk constantly talks with Wall Street. Massachusetts regulators are also investigating one of the cheerleaders of the GameStop stock’s run-up.
Fed officials have consistently struck a watchful but unworried tone when asked about GameStop in recent days.
“I’m glad that Janet Yellen is getting all the regulators together to look at what happened,” Loretta Mester, president of the Federal Reserve Bank of Cleveland, said on CNBC on Thursday morning. “We should be monitoring to make sure that volatility doesn’t spill over into other parts of the financial market. But at this point this is not one of those kinds of situations.”
The central bank’s chair, Jerome H. Powell, declined to comment on GameStop specifically last week. But he pushed back on the idea that the Fed’s low interest rate and bond-buying policies are the big drivers behind recent run-ups in stocks.
“Financial stability vulnerabilities overall are moderate,” he said at a news conference last week. “If you look at where it’s really been driving asset prices, really in the last couple of months, it isn’t monetary policy. It’s been expectations about vaccines, and it’s also fiscal policy.”
Even if the shift that GameStop signifies is not a risk to the financial system, it could prod regulators to look into new rules, especially given the concerns of lawmakers who have already called for the S.E.C. and others to address the situation. Senator Elizabeth Warren, Democrat of Massachusetts, sent a letter to the S.E.C. last week demanding that it respond with an explanation of how the agency will address the market distortions.
“The commission must review recent market activity affecting GameStop and other companies and act to ensure that markets reflect real value, rather than the highly leveraged bets of wealthy traders or those who seek to inflict financial damage on those traders,” Ms. Warren wrote.
Securities lawyers said much of the response will depend on what the regulators determine drove the market volatility around GameStop, including the role that retail investors played, whether there was any market manipulation and if there was adequate disclosure by market participants — like Robinhood — that facilitated the trading.
When it comes to market manipulation, James Angel, a finance professor at Georgetown University’s McDonough School of Business, said he expects the S.E.C. will focus on what role, if any, big investors like hedge funds played in moving the stocks, as well as whether any high-frequency trading strategies exacerbated the spike.
Mr. Angel said it’s possible that high frequency traders engaged in a strategy known as momentum ignition, which involves initiating a series of trades with the intent to ignite a rapid move in a stock’s price.
“Any kind of order ignition trades designed to manipulate prices are the kind of thing we want them to investigate,” he said.
The role that retail investors played will be harder to address. Many of the small investors who drove up the price of GameStop did so in order to “squeeze” hedge funds who had bet on the share price falling. They communicated their motivations in public, on chat boards and social media, did not hide their intent to hurt investors on the other side of the trade and often boasted about losing money.
Barbara Roper, the director of investor protection for the Consumer Federation of America, said policing that type of behavior will be more difficult for the S.E.C.
“We’re better at regulating professional market participants than figuring out what to do when the investing population itself is driving this,” Ms. Roper said.
The S.E.C. is likely to focus on Robinhood and other technology platforms that enabled the investing, including allowing investors to trade options — a financial product that appears to have exacerbated some of the huge price swings in GameStop. Options are essentially contracts that give the buyer the right to buy or sell a stock at a given price at some point in the future. That type of trading can be both risky and disruptive, market experts said.
“The options trading rules are overdue for review,” Ms. Roper said. “There are supposed to be safeguards in place that limit option trading to more sophisticated traders or at least make sure investors understand the risks.”
Instead, Robinhood and other platforms allowed any investor to buy options with the push of a button.
“The S.E.C. will need a hypothesis. Mine is that the problem is largely a problem of leverage and that leverage comes about by the trading of options rather than individual shares,” said James Cox, a securities professor at Duke University School of Law. “We may need to really think whether there needs to be a limit on how many options a person can have and is able to execute.”
[Read more about how options trading might be fueling a stock market bubble.]
In addition to the risks of options trading, the S.E.C. may also focus on whether any of the incentives and marketing that lured investors to new financial technology platforms was misleading. Many companies, including Robinhood, have touted “commission-free” investing, which many investors may have misunderstood, said Dennis Kelleher, president of Better Markets.
“The reason many of these people are in the trading arena at all is that they were induced into it by a misleading claim that trading is ‘free,’ and now many of them think there’s free money falling all over the place,” Mr. Kelleher said. “The S.E.C. should take the position that anyone claiming directly or indirectly that trading is free is false and misleading to a reasonable investor.”