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Wall Street Gets a Taste of Its Own Medicine

Authors: Saumya Rajawat and Shrey Bansal

Region Head: Saumya Rajawat

Editor: Harsh Didwania


Abstract


On 28th January 2021, the share price of GameStop (GS), a video game retail store, rose by 1500% in a couple of weeks (Staff, 2021). Despite the company’s weak fundamentals and poor performance, the rise in the stock was carried by an avalanche of buying interest from retail investors on Reddit. The volume of the trading activity and the following sharp price gain caused panic on Wall Street, as hedge funds shorting the stock began counting their losses in billions and the world turned to look at the future of financial trading and regulations in an ever technologized world.


Introduction


On January 4, 2021, GameStop, a video game retail store, was trading at $17.25. On January 28, 2021, the stock price had risen to $483.00. But GameStop hadn’t been having the most glorious times, with consecutive losses and closure of several of its stores (Valentine, 2020). This sudden shift in the price lent some credit to an investment in the bearish company to take it to a digital platform (Squire, 2020). But it was primarily the Reddit forum, r/wallstreetsbets, and a swarm of retail investors, that had caused the large GameStop price surge. And much as we may prefer the comfort of rules and governance in unprecedented, highly volatile market events like this, the GameStop situation evokes a need for new rules itself in a rapidly changing industry.


r/wallstreetbets and Short Squeezes


r/wallstreetbets, which hosts 6m subscribers (Bris, 2021), is a subreddit for individuals who enjoy making controversial bets on risky securities and boasting their gains and losses on the platform. The GameStop saga began with Keith Gill, a financial analyst and YouTuber known as Roaring Kitty, who had been analysing the GameStop stock and showed a positive intent on its outlook. Though the traders on the r/wallstreetbets were optimistic about Gill’s analysis, the purchase mania was primarily invoked by a motive to ‘stick it’ to hedge funds like Melvin Capital, who had been shorting the stock since 2014 (Chung, 2021). Shorting is a trade that enables an investor to bet on the fall of a stock’s price. To short a stock, an investor borrows and sells it at the market price, only to purchase it back when the price dips. The purchased stock is returned to its owner whom it was borrowed from, with the trader pocketing the gain. Shorting is a risky move, as the price of a stock could rise infinitely, creating a short squeeze; for the trader to then return the borrowed stock to its owner, he may become forced to buy it back at the rising price. r/wallstreetbets, guided by resentment towards the large hedge funds who have long considered themselves the upper echelon of the financial industry but been bailed out of crises by the taxpayers’ money, created an environment for GameStop’s price to rise rapidly. The goal was to start this short squeeze and force the hedge funds to close their positions at a higher price, thus creating big losses in their books.


The hysteria was exacerbated by Robinhood, an online brokerage firm that halted the purchase of GameStop’s stocks on its platform amidst the frenzy, violating the principles of a free market system. Politicians, institutional investors, entrepreneurs were involved as the conversation became bigger than a stock market event to a question about how regulation might look like in a world where technology, social media, and finance collided.


Market Manipulation, Or Perhaps Not?


Keith Gill has been alleged to have manipulated the market through his Reddit posts to benefit his investment but harm the books of hedge funds. As per the SEC, “a scheme to manipulate the price or availability of stock in order to cause a short squeeze is illegal.” It is argued that Gill cyber manipulated the GameStop price; after his encouragement of the stock in his Reddit posts and YouTube videos, the retail market swung to buy GameStop. Whereas Melvin Capital ended up needing a bailout, Gill’s personal investment in GameStop rose from $745,991 to $47,973,298 (Boswell, 2021). SEC has also taken a tough stance on similar actions in the past; in 2001, it settled a civil fraud charge against a high school sophomore Jonathan Lebed (Key Points About Regulation SHO, 2015), who had used chatrooms to encourage investors to buy stocks he had invested in. Under the settlement, Lebed had to pay the government $285,000 in ill-gotten gains and interest.


There are also fears that such an ability of a group to control the market can make investing dangerous. It can increase the overall volatility of the markets, which involve long-term investments of the general public investing for their future. Moreover, an antagonism towards short-sellers may not be beneficial, as they make the markets more efficient by facilitating the fair price discovery of assets and improving liquidity (Beber, 2013).


However, there are some defences to the accusations on Gill. One of the arguments states the questionable tactics used by big players in Wall Street, and claims the GameStop event a similar gambit but with the financial elites on the losing end (NPR Cookie Consent and Choices, 2021). Gill and several others posit that he didn’t sway the GameStop price, rather shared his opinions and analysis on it. Brian Belski, chief investment strategist at BMO Capital Markets, believes the Reddit activity to be no different from contrarians speaking publicly about the outlook of a stock, often influencing the public to believe and invest in it (Alini, 2021). According to Jaime Rogozinski, the founder and former moderator of r/wallstreetbets, "For too long it's been an invite-only club. And it's been the elites on Wall Street and nobody on Main Street". The GameStop masse purchase is a symbolic movement in the democratisation of financial markets, by providing retail, small capital investors the same access to the financial markets without the necessity of large fees or numerous research analysts, and a protest against the Wall Street’s corporate greed. This sentiment strikes a chord with the public in a time ravaged by a recessionary economy and great unemployment, one akin to a similar crisis about 12 years ago, perpetuated by the same establishment they are now wanting to defeat.


Therefore, instead of a clear-cut case of market manipulation, the GameStop movement can be considered a reckoning of a shift in the financial industry, with technology and online communities on social media empowering retail investors. The old rules of Wall Street may not simply work for this new world, and nor may the old rules of market manipulation activities.


The Game of Online Brokerages


Amidst the GameStop buying swarm, Robinhood halted the trading for the stock, citing a need to meet capital obligations. Many traders had borrowed heavily to maximise their GameStop position, and if they failed to repay, Robinhood might have become forced to pick up the tab. Robinhood’s action seemed legally plausible, and it reopened trading a few hours later (Bris, 2021). However, to have a platform that promotes democratic markets (Our Mission, 2021) halt public trading and deprive its users of participating in the market in this manner was a dubious and hypocritical move. It invoked censure from several public figures (Higgins, 2021) and necessitated for the SEC to investigate. Questions were also raised about the association between Robinhood and Citadel Securities, as it was the hedge fund division of Citadel which had helped bail Melvin Capital from its GameStop predicament (Fitzgerald, 2021).


Conclusion


The GameStop will be remembered as a cultural event, where small investors banded together to fight against a system that has tried to crush a little man, calling for a systemic change. It compels the regulators to design rules and regulations that suit the changing investment landscape with online brokerages and social media involved; there is also a call for more transparency from hedge funds. Though the price of GameStop may have fallen from its peak, the story of a new era of finance is far from over.



References


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