Meme Stocks: How Old Regulations Kept Traders from Getting the Best Advice

This article was originally published in The Globe & Mail on February 10, 2020 and has been republished in Wealthsimple Magazine with permission.

In the last few weeks, a lot of ink has been spilled about “meme stocks,” and about brokerages halting trading in them. But not enough attention has been paid to how these financial institutions should support clients – and how most of them are failing to do so.

Let’s review for a moment. Before two weeks ago, GameStop was known to those who’d even heard of it as a struggling American retailer. Its stock was relatively moribund, trading in the US$10-to-US$20 range. Then, almost overnight, retail traders, organizing through social media, began a flurry of buying around GME, ultimately driving the price up more than 1,700 per cent over two weeks. What the GME frenzy made crystal clear is that something new is going on in trading. Until recently, conventional wisdom in the financial industry held that retail investors – like the amateur traders who buy and sell stocks online – don’t move markets.

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But in the past year, something profound was shifting in the landscape. Namely: there was a boom in retail investing. Why? There’s the increased interest in trading that started at the beginning of the pandemic (free time, new hobbies), plus the advent of new technology that makes it easier to do (Robinhood in the United States; Wealthsimple Trade in Canada), the proliferation of investing information on social media, and the fact that interest rates are effectively zero (making investing the only way to earn a return).

Industry and regulators have failed to respond to the flood of new investors entering the market, and the importance of helping them to make good investment decisions. And here we come to the big problem. The brokerages that are enabling these investors to trade aren’t even allowed to provide that help because of how they’re regulated.

During the days of the GameStop frenzy, we experienced the highest number of new user daily signups on Wealthsimple Trade to date. That’s exciting to me as a founder. There are some clear upsides: more people are getting interested in investing, and there is greater accessibility to affordable financial tools for people who are younger or have less to invest. But there are also heightened risks for novice investors, who can get swept up in the hype of a hot trading moment and “play along” despite lacking fundamental investment knowledge. Investors getting their information (and misinformation) from social media run the risk of amplifying major misconceptions about how trading works.

We were very concerned about the range of potential outcomes for our clients. What if GameStop and other “meme stocks” investors were buying up as part of this cultural moment fell as sharply as they had risen? Were investors – and novice investors especially – prepared for this possibility? Were people trading with money they could afford to lose? Or was there a much greater risk at stake?

Our team quickly sprung into action to do everything we could to make sure our clients had the information they needed to make the best decisions for themselves. We displayed notices on stocks that were experiencing extraordinary volatility, so clients wouldn’t be surprised by sudden dramatic price shifts. We published articles on our online magazine to counter the misinformation that was spreading rapidly on social media, and e-mailed our clients with information about the risks of trading when markets are volatile. I’m proud of the measures we took to help our clients navigate exceptional market conditions.

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But, as I mention above, there was only so much we could do. Canadian regulations prohibit brokerages like Wealthsimple Trade from making any recommendation that could influence an investment decision. Generally, this makes sense – it would be a bad idea for brokerages to be tempted to put their thumb on the scale for this stock or that stock. But given the environment in which we now find ourselves, it’s time for these rules to evolve.

It feels counterintuitive to me that on our Invest platform, which manages diversified portfolios on behalf of clients, we have regulatory obligations to know our client, ensure their investment is appropriate, and provide them with unbiased advice. Yet at our brokerage, where clients can trade individual stocks at much greater potential risk, we’re restricted from making recommendations to them. The current rules weren’t made in an age with social media. It’s time that those regulations were reviewed to reflect the world as it is today.

I fundamentally believe that, as a business that allows people to invest their savings in the market, we have a deep responsibility to our clients to help educate and empower them to make informed decisions. Regulators should develop a new framework and recommendations for how brokerages like Wealthsimple Trade can safely help clients achieve positive financial outcomes. Such a process for updating regulations to the modern moment is an undertaking Wealthsimple, and hopefully other brokerages, will happily collaborate on in an effort to establish a safer and fairer trading environment for all Canadians.

Written By

Mike Katchen

Mike Katchen is the co-founder and CEO of Wealthsimple.