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In light of the recent market volatility brought on by social media and the meme stock frenzy, the Securities and Exchange Commission (SEC) is beginning to investigate whether rule changes are in order for the market structures which foster these situations. During a speech on June 9^th, 2021, newly appointed SEC chairman Gary Gensler spoke of the SEC’s role in protecting individual investors who trade securities via brokerages like Robinhood, which utilize high-speed trading platforms called wholesalers to execute these trades.

In the wake of chairman Gensler’s remarks, shares of Virtu Financial, Inc., the second largest wholesaler by volume in the United States, fell 7.7% on the heels of a surge in share price during the meme stock craze of 2021. [1]

One system which the SEC has pointed to as in need of review is that of payment for order flow. Payment for order flow has ushered in market volatility in meme stocks like GameStop and AMC, because this system powers a good deal of app-based securities trading. It allows individual investors to trade at the current market price without paying commission on their orders. A familiar example exists within the app-based platform, Robinhood.

With the recent rise of meme stocks– both in the market and in the media – there has been plenty of talk about short squeezes and their impact. While short squeezes themselves are not a new concept, the unique market characteristics of 2021 have ushered them into the mainstream. Given the current market landscape, a sound understanding of short squeezes is critical in making informed investment decisions.

The COVID-19 pandemic lockdowns resulted in working from home and the distribution of stimulus checks, which when mixed with Reddit as a communications platform for retail investors, helped to fuel the meme stock phenomenon. A meme stock the term being used to describe any publicly traded company whose popularity stems from the use of social media platforms which draw everyday investors to purchase shares. [1] Classic examples from this year include GameStop and AMC, both of which have showed tremendous and at times ludicrous growth fueled by retail investors.

A short squeeze occurs when a stock’s price is rapidly driven up not because of any fundamental addition of value, but instead because of an excess of short selling. A short sale occurs when an investor makes an investment betting that the price of a stock will fall. This can take many forms, but commonly occurs when an institutional investor like a hedge fund believes a stock is overvalued and will soon fall, allowing them to turn a profit. The hedge fund will sell stock it ‘borrowed’ hoping that when they have to deliver the stock, its price will have fallen and they can purchase the stock that they have to deliver at a lower price.

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Joseph Taub, who was indicted by a grand jury in New Jersey based on allegations of tax fraud and operating a scheme to manipulate stock prices entered a plea deal where he admitted to orchestrating a market manipulation scheme and defrauding the government of taxes.

According to case documents and statements, between 2014 and 2016 Taub, with co-conspirators, set up dozens of brokerage accounts in order to manipulate the prices of publicly traded companies.  These dozens of brokerage accounts were controlled by Taub because he funded the accounts and directed the trading in the accounts.  The brokerage accounts controlled by Taub but in the name of someone other than Taub, is a type of account known as ‘straw accounts.’  Straw accounts were used to hide trading activity and market manipulation schemes since these accounts were not in Taub’s name. Taub wrongly believed that the government would not notice his nefarious actions.

According to the indictment, Taub used multiple accounts to carry out his market manipulation scheme.  He would use one account to purchase a large number of shares of a particular publicly traded company whose share price he wanted to manipulate.  In coordination with co-conspirators whose names were on various other ‘straw’ brokerage accounts, Taub would direct the placement of numerous smaller buy orders in those straw accounts.   The multiple small buy orders caused upward pressure on the stock price.  After the stock price had increased, Taub would sell the large number of shares he had purchased in his account, taking a profit.  Next, Taub would direct that the shares in the straw accounts be sold, or, if an order had not been executed, to cancel the order. According to the indictment, the co-conspirators expected to lose on their trades in the expectation that the losses would be made up on the large trade made by Taub.