GUEST BLOG [In]Securities: Mind Games by Aegis Frumento Esq

May 7, 2021

a Guest Blog by

Mind Games

Back in February I wrote about how GameStop was like a meme.  Since then, the term "meme stocks" has caught on to describe those issuers whose market fortunes are propelled not by their business fundamentals, but by social media hype.  Back in the day, this kind of activity, when done by an unscrupulous issuer, underwriter or broker, was called a pump-and-dump scheme. Today, however, the pumpers are all anonymous twitter or reddit denizens, unconnected to the issuer -- or even, really, to each other. They are private citizens acting on their own, not trading on any information about the issuer at all, and so pretty much beyond regulatory reach.

Yesterday, the regulators began publicly wringing their hands over it. The Federal Reserve issued its semi-annual Financial Stability Report. Basically, the Fed thinks we're in decent shape economically, all things considered. But it did point out that "in late January, concentrated trading of some meme stocks led to substantial margin increases on equity trades and equity option positions, which challenged some brokers in those markets." "Challenged" is the polite and acceptable way to say "fucked over" in mixed company.

Also yesterday, new SEC Chair Gary Gensler gave his first testimony before the House Committee on Financial Services. Being, as he repeatedly reminded the Committee, only three weeks on the job, he was not fully up to speed on what the Commission had been doing in the months before his confirmation, to say nothing of the past four years. But he gamely tried to put the meme stocks in a framework. In his prepared remarks, he noted that the volatility of meme stocks "are part of a larger story about the intersection of finance and technology, . . . forces that have had a symbiotic relationship since antiquity."

"Antiquity" may be a stretch. I doubt anyone at the Agora, the Forum or the Rialto was thinking much about the "technology" of the ancient world when they traded whatever they traded. But Gensler redeemed himself by identifying "gamification" as the first factor at play in gaming the meme stocks, and with one word reached as far back into antiquity as you care to go.

Games are as old as we are. In Elliott Avedon's and Brian Sutton-Smith's The Study of Games, they report the discovery of Sumerian game boards from 2600 B.C.E., and point out that Homer wrote of Achilles and Ajax playing something like backgammon in the Iliad. We've played games since childhood, our own and our species'. Gaming is elemental.

Many human activities come under the general heading of gaming, or play. In his more mature work, The Ambiguity of Play, Sutton-Smith ranks playful activities from the private and safe (like daydreaming) to the public and risky (like sky-jumping). From the middle are the categories "performance play" (playing the piano or acting) and "contests" (like athletics, poker and chess). I take it for granted that stock-picking is playing a game. But is it piano or poker?

One of worst legacies of the Puritan work ethic is that play is bad because it is frivolous. You'll recall that H.L. Mencken defined Puritanism as "the haunting fear that someone, somewhere, may be happy." Let's start by acknowledging that stock-picking is fun, it makes us happy, and that's why we do it. That, also, is what makes stock-picking a game, because the primary attribute of games is that they are both fun and, at least superficially, non-productive. Play is also a little bit unreal -- and that fits the reality of trading too.

So, what's Gensler talking about when he warns of the "gamification" of an activity that is already a game at its core? Gamification has come to mean incorporating the elements that make games irresistible into non-gaming activities, in the attempt to make those activities equally irresistible. Gamification can be benign. Whenever your diet or exercise app awards you points or stars for reaching some health-positive goal, you've been gamified. Likewise when your child is tricked into thinking that algebra involves shooting aliens on a screen. But then, there's the dark side, when some pseudo-game encourages you to buy something you really don't need. In fact, when we talk of gamification now, we invariably mean the commercialization of game elements to sell something. And that's what Gensler's talking about.

Gensler notes that gamification "refers to game-like features -- such as points, rewards, leaderboards, bonuses, and competitions -- to increase customer engagement." Moreover, the apps that use gamification are playing too. They use predictive data analytics "to analyze the success of individual gamification and behavioral prompts to increase activity." All this "encourage investors to trade more," which will presumably hurt their returns.

All this leads to the familiar call to regulatory arms. As Gensler told Congress, "many of our regulations were largely written before these recent technologies and communications practices became prevalent. . . . [W]e need to evaluate our rules and we may find that we need to freshen up our rule set."

All that is well and good, but let's be clear what is not being said. The securities laws are constructed on the assumption that human beings, given full disclosure of the facts of an investment, are free to decide whether or not to invest. The assumption of human agency, of free will, underlies our securities laws. However, Chairman Gensler's expressed concern is that gamification is being used to manipulate human investors -- not to deceive them with false information, but to manipulate how they think -- into making "unwise" investments. And the assumption -- the truly deep assumption -- behind that concern is that human beings, and investors in particular, do not have free will.

I don't necessarily disagree with Chairman Gensler. We all do things that don't make sense, and when we blame the devil for making us do it we are acknowledging to ourselves that our vaunted free will is not all it's cracked up to be. Gamification plays with our minds, puts our weak wills in a spotlight, and the glare hurts. And that's the rub, for our laws deal in facts, not mind games, and gamification is only about mind games. To deal with it, we'll need to do a lot more than merely "evaluate" and "freshen up" the rules.


Aegis J. Frumento

380 Lexington Avenue
New York, NY 10168

Aegis Frumento co-heads the Financial Markets Practice of Stern Tannenbaum & Bell, New York City.  He represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations).  He has decades of experience representing SEC, CFTC and FINRA regulated firms and persons in regulatory enforcement investigations, hearings and lawsuits.  Drawing on his five years managing the Executive Financial Services Department of Morgan Stanley Smith Barney, Aegis has rare depth of experience in the securities and corporate governance laws affecting senior executives of public corporations.  When not litigating, Aegis enjoys working with new and existing broker-dealers, registered investment advisers, and private equity funds, covering all legal aspects from formation to capital raising. Those clients now include industry professionals looking to adapt blockchain technologies to finance and financial market enterprises, including the use of cryptosecurities to represent equity and debt interests. 

Aegis's long and distinguished career includes having been a Managing Director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP.  He graduated from Harvard College in 1976 and New York University School of Law in 1979.  Aegis is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments.  He is the current Chairman of the New York City Bar Association's standing Committee on Professional Responsibility.

NOTE: The views expressed in this Guest Blog are those of the author and do not necessarily reflect those of Blog.

Testimony Before the House Committee on Financial Services of SEC Chair Gary Gensler / May 6, 2021

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