If anyone needed any evidence we truly are in a brave new world, the events of the past week in the stock market made clear we are anything but. If you thought that the failure of the Trump-led insurrection against the US Democracy would be the end of insanity, you were sadly mistaken. This past week saw perhaps the wildest swing in certain stocks since the Panic of 1907 and that event led directly to the creation of the US Federal Reserve Bank.
As Jed Gardner, Senior Vice President at Linedata Technology Services, said about the Coronavirus health crisis and its impact on business, “we have moved from disaster recovery to business continuity to business as usual during the time of Coronavirus. He explained that risk managers, compliance professionals and business executives now have to plan for the unknown unknowns in their business plans and risk management strategies.” Over the next few days, I am going to explore the GameStop Corporation imbroglio, focusing on the lessons for the compliance professional. Today, I am going to begin with some background into what the GameStop saga is and how the converge of forces that came together for it to occur portend changes for every business and every Chief Compliance Officer (CCO).
According to Matt Phillips, writing in the New York Times (NYT), GameStop is a “video game retailer whose stock is suddenly the darling of day traders who are putting the squeeze on Wall Street’s big players. The stakes are enormous: The surge in trading drove GameStop’s value up by more than $10 billion on Wednesday alone. On Thursday, as several trading platforms temporarily placed restrictions on the stock, the shares slid 44 percent, only to soar again on Friday after the trading restrictions were eased. Exactly why GameStop’s value — on paper, at least — has rocketed to stratospheric levels has to do with a mix of traditional investing, rampant enthusiasm, stock market mechanics and the belief that anyone with a Robinhood account can meme a fortune into existence.”
The maneuver switch started the volatility is a short squeeze, with investors “betting on which way a stock will go — up or down. These bets are placed by buying the shares themselves, or stock options”. Investors who bet against a stock are called “shorts”; which in GameStop’s case, included least two big hedge funds. The action of shorting a stock essentially means borrowing shares from a broker and selling them, with the agreement they will then return the shares at a later date or time. If the price falls, you can then buy back the shares and pocket the difference.
Does this sound like manipulation? In some cases, it is “but shorting a stock is risky — if the price rises, you can lose big.” Your organization can make a bad bet. But someone or some group can push back from the other side to drive up the stock price by purchasing many shares. “This is the squeeze. Shorts have to close their position — that is, buy up the shares they owe their brokers and return them. This demand kicks the stock higher, and a short who acts too late could be ruined.”
A classic example of this to and fro by financial behemoths was the fight between Bill Ackerman and Carl Icahn over Herbalife Nutrition. Ackerman was the short and Icahn was running the squeeze. Eventually Ackerman’s loses got so high he had to throw in the tool and close out his position, losing millions in the process.
Yet, in the case of GameStop, it was not big boys of finance employing the squeeze but the little guy, the individual investor, basically Joe Q. Public. These were amateurs, indeed called “armchair traders”, who have come into the market in a big way, driving up the price. There were a variety of reasons for this change in the squeezers. “Some smelled opportunity after stocks tumbled last spring, some were trying to scratch a gambling itch after sports leagues shut down, and for some it’s just a game — trying to ring up dollars instead of points. All this has been made easier by the free trades available through platforms like Robinhood and E-Trade.”
John Stark Reed said, “The Reddit story began to unfold when a group of energetic Reddit users decided to strike back against hedge funds by launching a buying spree of the stocks of GameStop and a few others, causing their prices to soar, and thrusting a “short squeeze” on the hedge funds holding those corresponding short positions.” Enough of these traders but enough to drive the GameStop price up. Moreover, “If it goes high enough, the brokers who would be on the hook have to buy more shares, lest they get stuck having to buy a lot of expensive shares all at once. That increases demand, which increases the stock’s price. Which means the brokers have to buy more shares,” and the entire cycle starts again.
There were some big losers amongst the shorts, as a “A spokesman for Melvin Capital — which needed a $2.75 billion cash injection on Monday because of the squeeze — said the firm had closed out of its short position. Indeed, Melvin Capital lost 53% on its investments in January. Andrew Left of Citron Research, another short, said he had covered the majority of his short position “at a loss, 100 percent.”
The other new wrinkle in this phenomenon was the social media angle. Donald Trump used social media effectively to cause his supporters to storm the US Capital. As Matt Kelly is want to say, social media does not create the message but amplifies it. But here these average Joe traders used social media to amplify their message through Reddit; trading tips and urging each other to “Buy High and Sell-Never”.
While not new, some trading platforms have been aggressively pushing new traders. E*TRADE Financial Corporation has been around for 15 years or so but it charges $5.95 for a trade. Robinhood on the other hand lets traders transact at no charge. Interactive Brokers and others placed more restrictions on trading of GameStop and other stocks that have been caught up in the frenzy. Robinhood shut down trading on Thursday and then limited the ability of traders using its app to buy the call options, for example. How could they do so and, more importantly, why would they do so? Those are only some of the questions I will be exploring over the next few days.
If you are a CCO or compliance professional, you need to consider many questions brought up by the GameStop trading. How do the issues surrounding it impact compliance? What happens if the shorts target your company? How will new social media channels impact your organization? Where do the regulators come in? Who are your stakeholders? These are but a few and there are many, many more. But just as Jed Gardner said, you now must prepare for the “unknown unknowns”. How will you do so?
Finally, if you thought 2021 would be less of a wild ride than 2020, all I can say is to quote Bette Davis, “Fasten your seat belts, it’s going to be a bumpy night”.
Tomorrow we look at the shorts.
[View source.]
