Cosgrove Gaynard Solicitors

The Wall Street short - GameStop

Anyone who has kept a close eye on the world of finance in the last few decades will know that, for better or worse, the powers that be on Wall Street and in other global financial centre's really do rule the roost. While opportunities for retail investors to make a profit do exist, the hedge funds and investment banks of this world have advantages of time, staff resource and capital.

That’s why the recent news about a small group of Reddit users managing to subvert the so-called “shorting” practices of the big Wall Street hedge funds has been so fascinating to many.

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Their aim?

To show Wall Street and others that their hegemony is not permanent.

‍The beneficiary?

GameStop – a struggling American “main street” business which has now found itself surging due to rising price values.

But what exactly has gone on here?

Why has the value of GameStop stocks suddenly surged – and what are the consequences for GameStop in particular? This article will find out.

What has happened with GameStop?

GameStop is an American business which sells video games and associated equipment, such as electronics. In recent years, GameStop has found itself struggling when it comes to getting customers. The coronavirus pandemic has played something of a role in this, but the rise of Internet-based gaming and deliveries has meant that the items it sells are either increasingly redundant or more easily or cheaply available through some other route.

The recent rise in GameStop’s value had nothing to do with changing customer demand. Instead, it came about as a result of a small group of dedicated speculators in a Reddit subforum called “WallStreetBets”. These people consciously planned to buy up GameStop stocks in order to boost the value because hedge funds like Melvin Capital, which had invested a significant amount of capital in financial instruments which only rise in value when GameStop’s value declines.

These instruments are highly risky, and are known as “shorts”. To short a stock, a hedge fund or other institution has to essentially borrow stocks on the promise that they’ll allow them to revert to the original owner in a specified period of time. The hedge fund then sells on the stock at a high price, and waits for the stock to dip in price – before, in theory, buying them back once the predicted lower price materialises, and pocketing the difference. The Reddit users, however, managed to make the stock price swell through concerted, collective action – meaning the hedge funds not only failed to make their expected profit, but also had to cover the cost of the sudden price rise when buying them back.

The motivation of the Redditors?

Many of them, at least according to posts found in the subreddit, was to exact some sort of revenge on the hedge funds and other financial institutions which – in the view of the users – were responsible or partly responsible for the financial crash over ten years ago. The users appeared to take the view that their generation was fighting back against the “baby boomers” who, they allege, run the hedge funds and have benefitted most from financialisation.

What can GameStop do now?

In recent days, much of the focus has been on the behaviours of either the Redditors who are buying up GameStop stocks or the institutions in the financial markets who stand to suffer. But what has been largely lost in much of the mainstream media analysis of the issue is the response or potential future responses of GameStop.

The reality is that this is still a functioning company, with members of staff and other overheads. The company is headquartered in the US state of Texas, and it is responsible for outlets across the nation – which, despite the struggling nature of the firm and the industry in which it operates, are still going. But the battle between Reddit and Wall Street has had transformative effects for GameStop. It makes enormous losses of almost $300 million a year – meaning that a rise in stock value was hardly expected.

The most obvious thing for the firm to do is to free up some more of its stock in order to meet the demand of the many Redditors – and now others – who want a slice of the action. But this isn’t as simple as it might seem. If the company decided to open up lots of new stock, the people who invested in the firm prior to this latest development would most likely look unfavourably on this. After all, it would represent a benefit to the shorting hedge funds – and the current stockholders may expect GameStop to show them some loyalty.

And despite the fact that the US is often touted as an example of the free market working well, it’s not actually the case that a firm can just open up its stock in this way. There is a strong risk that GameStop would, if it sold its shares, face a lawsuit.

The reason that GameStop could face legal penalties if it made the decision to open up new stocks is that the US regulator has a responsibility to police the markets and ensure that prices are set independently. The Securities and Exchange Commission, which monitors stock selling and has a significant amount of power, specifies this in Regulation M of its rules: rule 105, in particular, can in fact ban stock sales if they would other prevent “independent pricing mechanisms” from kicking into force.

Perhaps a more interesting question, however, is whether or not WallStreetBets and Reddit will face any legal action from the regulator. There has been some speculation that the actions of those on the forum amount to market manipulation because there has been a concerted effort to boost the price. Case law does exist on the topic, and regulators have in the past followed up on cases where similar things have happened. Whether or not it will in this instance, though, remains to be seen.

Sources: https://www.bbc.co.uk/news/newsbeat-55841719

https://www.bloomberg.com/opinion/articles/2021-01-27/reddit-driven-surge-puts-gamestop-and-ryan-cohen-in-a-weird-spot

https://www.bloomberg.com/opinion/articles/2021-01-26/will-wallstreetbets-face-sec-scrutiny-after-gamestop-rally