Taking memestocks: D&O implications

Meme investors might jump on stock tips from fellow meme investors on platforms such as Reddit and Twitter, and invest in the focused companies so as not to lose out. The companies’ share prices will then go through the roof, creating highly volatile stocks with the potential to plummet dramatically back to former levels.

GameStop has probably gathered the most media interest so far, as anti-hedge fund Redditors piled money into it, creating a stock price surge of as much as 1,700% during the peak. But this phenomenon has also affected AMC Entertainment, Blackberry, Bed, Bath & Beyond, Nokia and Koss Corp to name just a few. And it’s not exclusive to the US: Sydney-based IOUpay was targeted by Redditors who pushed up the penny stock some 6,400%. The huge jumps in meme stock share prices are generally accepted to be externally driven; the companies themselves are merely disconcerted passengers on an unexpected journey “to the moon”.

But if a company becomes the subject of a focused stock rise saga, what should the company do? What shouldn’t it do and what are the risks, and the opportunities?

Meme stock considerations for directors and officers

Should directors and officers ‘share’ the meme stock spoils?

It’s easy to see high share prices as a golden ticket to issue fresh shares in exchange for some welcome capital.

Unfortunately, it’s never quite that simple.

Offering shares in a period of extreme volatility is a regulatory and ethical minefield.

The U.S. Securities and Exchange Commission (SEC) wants to protect everyone involved. It’s asking companies looking to raise capital to provide commentary and disclosures about current conditions to the SEC and potential investors to warn them of the risks of the shares they’re looking to buy.

GameStop pulled back on offering shares during the original share spike in January owing to the timing and the legal grey area, although they raised $1.126bn in June. They provided commentary stating that they weren’t aware of any reason which would explain the stock volatility, and even warned investors that they could lose ‘significant’ funds if the price declined rapidly.

AMC Entertainment did the same, raising nearly $590m in a fresh share offering in June. Their commentary said: ‘Our current market prices reflect market and trading dynamics unrelated to our underlying business, or macro or industry fundamentals, and we do not know how long these dynamics will last.’

With these declarations made, caveat emptor – “buyer beware” – will apply. But, as with any statements or caveats provided, these can and do come under scrutiny by investors and regulators, particularly when stock volatility occurs.

Payday for directors and officers?

Koss Corporation, a family business, was valued at $26million, and then became a meme stock. Family and company executive shareholders took advantage of the rally and banked an estimated $44 million selling some of their shares during the Reddit-driven stock frenzy.

The rules for corporate officers trading their shares differ from those for your average investor. They’re usually limited to pre-established, specific times (“window periods”), in which they can freely trade their own company stock. “Window periods” usually come after earnings releases, public reports and major announcements. Corporate officers also have the option of 10b5-1 plans, allowing them to trade pre-determined numbers of shares at pre-determined times.

These rules exist to prevent insider trading. Trading outside of the windows period can incur substantial criminal and civil penalties.

But even if directors and officers of a company stick to the law and the letter, is it a wise idea to cash in during such volatile times?

One of the reasons that some of these meme stocks were targeted was because they had been heavily shorted by the hedge funds, indicating the hedge funds’ view that these share prices were, at some stage, likely to take a fall as a result of underlying poor trading conditions.

If the directors and officers, who are ultimately tasked to spearhead a company’s drive to accomplish success, cash in on shares and sell out a large portion of their position, this can indicate a conflict of interest and reputationally it doesn’t give the best impression. The Financial Times stated, in an article about Pfizer executives selling swathes of stock, ‘[as an officer] To sell most of your holdings, absent a divorce or other unavoidable event, looks bad.’

However, it’s ultimately difficult not to empathise with a decision to cash in owing to the life-changing sums involved. If the stake being sold is small or fairly immaterial, then it’s unlikely to ruffle too many feathers.

To speak, or not to speak?

Directors and officers often make announcements about newsworthy events, but meme stock events raise questions about the duties of board members and C-suite officers.

The risk of the public statement

Blackberry, Nokia, and Gamestop (during its share offering) have all released statements about their meme stock.

Going down this path could have serious implications if the statement were alleged to be misleading or false, or if there is a revelation in the following months that might reasonably move (or have moved) the dial. Such statements do carry risk, no matter how small. If allegations are made against the company, it will incur legal costs in defending the claims, even if they are proved frivolous or far reaching.

Keeping mum

GameStop made a statement during its June stock offering, but didn’t during the initial Reddit-driven rally. Neither did Koss Corp. Although remaining silent neither confirms nor denies actions, views or opinions, it can fuel unwanted speculation and rumour. This in turn may worry investors. Shareholders will want the company’s management to provide a narrative around events, and advice on how it may affect share prices.

Providing no response may be acceptable in the immediate term as the management take stock of the new situation, but at some point they will need to provide honest reports of the company’s position and current state of affairs. That is arguably the wiser path.

What next for the meme stock?

It depends who you ask. Bloomberg reports that the party may be coming to an end; but the Business Insider argues that meme stocks have fundamentally changed the marketplace, and aren’t going anywhere. The Motley Fool even associated a ‘buy’ tip with 2 meme stocks.

Taking into account all of the above, from a D&O insurer’s point of view, underwriters would be comforted to know that moves made during and after stock volatility were done so after thorough review not only from internal counsel but also ideally external counsel specialising in securities law. In any situation, the more legal opinions mooted the better to get a wider feel for the legal landscape and to obtain a wealth of views surrounding the potential risks associated. Reputational and PR views should also be considered, because while an action taken might be legal, it may not be the best look.

If a company’s director and officer shareholders are going to trade stock during a period of high volatility, D&O insurers would want to know that there are robust compliance and legal controls and processes in place. All parties involved need to follow these controls and processes to prevent adverse wrongdoing, whether accidental or otherwise. Any elements of potential controversy, doubt or ‘grey area’ could very easily lead to costly investigations and claims.

To find out more about CFC’s management liability insurance, contact the team ml@cfcunderwriting.com.