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Ex-SEC Chief: Reddit-Fueled GameStop Frenzy Was Not a Modern-Day Pump-And-Dump Scheme

Adam Jeffery | CNBC
  • Former SEC chief Jay Clayton said he does not think the GameStop short squeeze was an illegal pump-and-dump scheme "based on what I've seen."
  • "As you look at the overall participation in this, it was fairly transparent what was going on here," Clayton told CNBC on Friday.

Former SEC Chairman Jay Clayton told CNBC on Friday he does not believe the Reddit-sparked trading frenzy in GameStop shares represented an illegal pump-and-dump scheme.

Clayton, who led the Securities and Exchange Commission under former President Donald Trump, made the comments in response to a question from CNBC's Joe Kernen. The "Squawk Box" co-host asked whether Clayton felt the events of late January were a "modern-day pump and dump using social media."

"The quick answer to that is no. I don't think so, based on what I've seen," said Clayton, who recently rejoined his old law firm, Sullivan & Cromwell, after stepping down as the top securities regulator in the U.S.

Earlier this month, Bloomberg reported that the SEC is investigating social media posts to determine if fraud was a factor in the meteoric rise of GameStop shares, which went from trading below $20 in early January to an intraday high of $483 on Jan. 28. That's a gain of more than 2,300%. However, the stock has fallen sharply since, closing Thursday's session at $40.69 per share. According to Bloomberg, the SEC, in particular, is looking for pieces of misinformation that were designed to skew the market.

A pump-and-dump scheme, according to the SEC, takes place when market participants push out "false or misleading information" with the goal of unleashing a buying frenzy. After the stock price has been pumped up, a trader will dump the shares they own at the artificially high price.

Clayton said that from what he can tell, people who were trading GameStop shares were pretty clear about the motivation. "As you look at the overall participation in this, it was fairly transparent what was going on here," he contended. "People were very transparent about what they were doing and why they were doing it, which was fairly interesting."

Reddit's WallStreetBets forum was one place where retail traders flocked to post about GameStop. Keith Gill, a prominent member of the online community, took part in the congressional hearing Thursday focused on the events surrounding the GameStop short squeeze.

Gill sought to defend his actions regarding the heavily shorted stock, saying he had a genuine conviction that shares were undervalued by the market and felt confident enough to share his investment thesis. In addition to posting on WallStreetBets under the name DeepF------Value, Gill publishes YouTube videos as Roaring Kitty.

A proposed class-action lawsuit has been brought against Gill in federal court in Massachusetts. The suit alleges that Gill did not disclose his financial background and tricked individual investors into buying GameStop at unreasonably high levels.

"I did not solicit anyone to buy or sell the stock for my own profit. I did not belong to any groups trying to create movements in the stock price," Gill said in his prepared testimony, contending that he has been "abundantly clear that my channel was for educational purposes only."

"GameStop's stock price may have gotten a bit ahead of itself last month, but I'm as bullish as I've ever been on a potential turnaround," added Gill, who said he first bought GameStop shares in 2019. In his latest Reddit post, Gill said he made $7.8 million off of GameStop.

GameStop shares had been one of the most shorted on Wall Street in January. Short sellers borrow shares of a stock and then promptly sell them, with the goal of buying back shares later at a lower price. They then return the borrowed shares and make money off the difference. When the opposite happens, short sellers may seek to buy back the stock at its current higher price in an attempt to minimize losses.

During the frenzy, GameStop shares faced upward pressure from two sides. There were short sellers who were trying to cover and investors who bought the stock outright and call options.

Pressed by Kernen how social media posts about GameStop were different than historic pump-and-dump schemes, such as "Wolf of Wall Street" Jordan Belfort's Stratton Oakmont, Clayton responded, "I think in the abstract, you make a good argument that it's not different in that a group of people decide that they like this [same stock]."

However, Clayton added, "Whether they got all together and did it together like the Stratton Oakmont did, knowing the end game here, I don't think so."

Disclosure: Jay Clayton is a CNBC contributor.

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