Lasting Lessons From Tuesday’s Reddit Trader Roundup

In the classic teen television show Saved by the Bell, rambunctious protagonist Zack Morris learned about leverage, risk and ethics the hard way when he hijacked a class investment project and used the funds to buy potato futures on margin without their teacher’s knowledge or consent. Wednesday, the SEC unveiled its formal response to 2021’s meme stock frenzy, moving forward with rules to potentially squeeze hedge funds out of the market-making business. I point out these two seemingly unrelated items because they are not actually unrelated, for something else happened this week: The Feds indicted eight members of Reddit’s infamous WallStreetBets community, where the meme stock frenzy was born, on multiple counts of securities fraud, alleging they perpetrated a pump-and-dump scheme. Among these eight individuals is a user whose Twitter handle was Mr. Zack Morris, co-founder of a group called Atlas Trading, which allegedly used its Discord server and Twitter to pump penny stocks the principals had positions in—and dumped once their followers pushed the price sufficiently high. As you might deduce by now, he built a compelling social media persona out of his chosen namesake’s exploits, using memes and profane jokes to win over the masses. Let us explore the many lessons here.

Inevitably, as GameStop and its fellow meme stocks soared and crashed in winter 2021, there was a wealth of suspicion about pump and dumps. A lot of it centered on the fake Mr. Morris and his cronies, and it was easy to see why. They talked up penny stocks on Twitter and Reddit. They portrayed themselves as expert traders with a knack for doing deep due diligence and finding “catalysts” for certain stocks to soar—catalysts that only they, with their deep research, found and which all others missed, giving them big market-moving power. Some portrayed themselves as rags-to-riches self-made success stories. Others gave the impression they might actually have professional trading backgrounds. Their Twitter bios contained thin disclaimers that seemed aimed at bestowing plausible deniability. Not a financial advisor. Do your own DD [due diligence]. Parody account. As was common in WallStreetBets, they posted screenshots of their positions and alleged profits. They occasionally said they were left holding the bag when their picks plunged.

The indictment, which is very good reading (and rather profane, so, PG-13), alleges this was all an orchestrated scheme to reel in unsophisticated investors to manipulate stock prices for the principals’ gain. They would pick a penny stock, take turns recommending it to their followers, make memes, claim they were in the trade for the long run, promise they don’t dump on their followers, and then sell it after a day or two. Crucially, they would then claim to followers that they still held the positions—while occasionally laughing at people for believing them in their private Discord chats, which were secretly recorded and delivered to the Feds. If followers complained about being left holding the bag, the perps would say it wasn’t their problem if people didn’t have the skills to capitalize properly on all the great information they provided—the oldest manipulation tactic in the book. As if to prove it, they posted pictures with the McLarens and Ferraris they bought with their huge, supposedly legit, trading profits—all while congratulating themselves in private for pulling off their financial heist.

You can see all the hallmarks of a classic fraud here. The flashy lifestyles. The supercars. The focus on low-float penny stocks. The transparent pumping. The only “new” thing here was the use of social media, adding memes and Tweets in place of the blogs, faxes and newsletters of old. These guys were very, very, very good at the modern Internet.

You can also see one very easy way to have avoided getting duped: Simply refusing to view stocks as a get-rich-quick mechanism would have done it. Acknowledging and accepting that investing is about long-term returns and compound growth getting you to your financial goals over your entire investment time horizon, not hitting it big with a few stocks that go hyperbolic in a day or three. Remembering that owning a stock is owning a share in the company’s future earnings, and those earnings are what lead to long-term growth—not simply capturing a slice of a no-name, no-profit company’s arbitrary meteoric rise. Also? Remembering that markets are efficient and discount all widely known information, so that if a clever person on the Internet says a stock is about to soar because of a pending merger or product announcement, that they are either a) encouraging you to trade on something that is probably already priced in, b) giving you material non-public information, which is an illegal thing called insider trading, or c) lying.

Reading through the Reddit threads on the indictment Wednesday night, it was pretty clear many users learned these lessons the hard way. That is sad, but it is also life—we all fall, learn, pick ourselves up and continue forward with more wisdom. More interesting? There are a lot of people who got duped yet don’t seem to totally mind.

Here is the thing about the meme stock frenzy: It got a lot of young people interested in investing. There were a lot of folks on Reddit last night saying things that I would summarize as, yah I know it was a scam and it is good those guys are getting held accountable, but they taught me a lot about investing and I have been doing pretty well picking my own stocks because of them. I don’t care where this community came from—it has taught me so much about how to manage and grow my money. I learned you don’t need a finance degree or fancy education to do well in the stock market. You can be self-made. I feel empowered. You could learn how to analyze stocks from these guys without falling for their lies. Seems like some of these guys actually knew what they were doing before they fell for the temptation of pumping and dumping, which is a shame because they could have been better than that—and because so many of us have used their tools in an honest manner and done really well for ourselves. Sad they didn’t do the same.

Now, I am not saying I would classify any of the trading tactics these individuals imply they learned as good and useful. I am a long-term, fundamentals-based gal who likes diversification, not a short-term trader looking for a spread. But it is true that WallStreetBets at least talked of championing young individual investors and sought to empower people to take charge of their own financial destiny. If this was people’s gateway to investing, and they stuck with it despite market volatility and the shady characters they may have encountered, that is a heck of an outcome.

There is a lot more to talk about here one day, like the podcast two of the alleged conspirators hosted and how it evolved from a penny stock fanfest to actual fundamental analysis of macroeconomic events. The potential for a Jordan Belfort-like story of how someone could start off with very good intentions and then end up at the center of a criminal conspiracy. The signs that one of the alleged conspirators seemed to be trying to grow out of the messy penny stock world and become a mainstream wealth advisor, like a Gen-Z, joke-cracking Suze Orman. So much psychology! Plus, the mystery of who flipped on the gang and leaked private recordings to the Feds. A lot of which we will probably learn more about as the trial unfolds.

So many things happened in the meme stock frenzy, some good, some bad. Some people made money. Others got fleeced. But as is often the case, a lot of the pain stemmed from illegal behavior. It isn’t unlike what is now going on with cryptocurrency exchanges after the collapse of FTX. The House Financial Services Committee seems to think crypto regulation is the answer, but as FTX caretaker CEO John J. Ray pointed out in his testimony this week, based on what he has seen, FTX was a simple case of old-fashioned embezzlement. Already illegal. Just like pump-and-dumps. Bad things happening—and people losing money—doesn’t always mean we need more rules. Sometimes it just means bad people break rules and would break whatever new rules come into being. You can’t legislate morality. Maybe it is just a matter of accepting that bad people will do bad things, but they will eventually get caught and held accountable. You just have to do everything you can to ensure you don’t fall for their lies.

That is why each and every financial fraud is worth studying. Knowing how the crooks operate helps you avoid them