Earlier this year, we saw the rise of shareholder activism in the Reddit v. Goliath story on Wall Street. Let’s take a look back at this story.
What is GameStop and why was everyone so fixated on it?
The GameStop situation involved a convergence of a variety of issues from a technological perspective, a financial markets perspective, and shareholder activism perspective that for many seemed new. Jim Lundy, Co-Head of the White Collar Defense & Investigations Practice at Faegre Drinker in Chicago, says many of these issues were “probably non-existent 20 years ago, or if they were, they were in the far corners of the trading world. But one thing that is common is the concept of the short squeeze. What happened with GameStop and the Reddit platform was just a new spin – based on technological advances and more social activism – on an old situation,” Many people have called it the regular folks – the home traders, the gamers – versus the hedge funds who were shorting GameStop. Additionally, the markets themselves have become incredibly efficient with electronic trading used by hedge funds – reactions that take place can very quickly lead to significant increases in volatility and significant increases or decreases in price that result in a disconnect from the true value of a company. And not just efficient for the hedge funds - but the retail trading platforms like Robinhood have also made access to trading easy for home traders. Reddit itself made info-sharing and group strategizing really efficient. None of this would have been the case ten years ago. Says Lundy, “I think that's obviously what we had here, when you brought all that together, that increased volatility in the inflation in the value and the inflation of the price is what led to this being such a high-profile matter.”
So, what exactly is a short squeeze?
It’s a procedure where an investor borrows shares and immediately sells them, hoping that in the future it will be able to buy them back more cheaply when it needs to redeliver them to the person from whom they’ve borrowed and make a profit. It’s betting on the share price going down, and it’s a regularly used instrument by hedge funds and sophisticated investors to gain from companies that they think are overvalued. So where can this go wrong? “Where it can go wrong for them is if the price then begins to move upward,” says Nick Heather, Head of the Listed Investment Funds team at Gowling WLG in the UK. “If the price begins to go upward, they know they’re going to have to pay more money to buy back the shares to deliver to the person from whom they borrowed them. They then start to panic and try to close out their positions by buying the shares in the market, which causes the price to go up. That’s essentially what happens in a short squeeze.” Not a new concept, as this is what happened in 2008 with Volkswagen and Porsche, with hedge funds losing USD 30 billion in that situation.
If this isn’t exactly a new phenomenon, why all the hype with GameStop?
“It seemed more like a moral crusade of the good guys against the ‘evil’ hedge funds, however people forget that a lot of hedge funds are managing money on behalf of people’s pension funds as well. So they aren’t as evil as they might be portrayed,” says Heather. Some debate that there may have been a deliberate attempt to exploit the short squeeze, and this combination of social media and gamers ‘sticking it to the man’ made this ripe for the media.
Speaking of social media, does this whole GameStop phenomena have more to do with social media and how it affects the market, than the market itself?
Svenja Maucher, Co-head of the Commercial Technology and Data Practice at Taylor Wessing in Germany, doesn’t think gamers were looking to cause damage to hedge funds’ other shareholders. Gamers, as you might know, are a very loyal group – loyal to the games they play and the companies they support. They just wanted to support GameStop because they believed in the company. “It was the right target group – the gamers – and they know the social media environment.” It just happened to be the right target, at the right time.
Let’s turn to how this affects our legal practices and our clients. Do we see this happening with other companies, as social media continues to influence every aspect of our lives, or was this more of a one-off, right time right place situation?
Lundy advises that thinking this is a one-off is to do so at your own peril. “While the circumstances that came together with GameStop are unique, they can happen again,” says Lundy. Maucher raises a good point that there is a theme of loyalty and a collective effort among gamers. When you take that and overlay it with what regulators around the globe are doing with their encouragement of shareholder activism, there is a risk that this can happen again, particularly in ESG. Can we contemplate this happening against an oil company that a group of socially active shareholders may think is not engaging in initiatives and policies that align with the interests of that group?” Says Lundy, “Taking that hypothetical, to the extent that a group has a common identity and they can use a social media platform like a Reddit to take certain actions in the marketplace to drive the stock price up or down as part of a collective effort, that’s something that could happen.” It’s clear that what needs to occur is some effort by companies to figure out the right way, from a risk management perspective, to be able to monitor for and assess the potential of this happening in a particular industry or company.
Is this shareholder activism and is it really becoming a tool that would be applicable to something like ESG?
Maucher says no, she wouldn’t characterize this as shareholder activism. “I think it’s an exercise of the minority rights of the shareholders to block the management or block some of their decisions,” she says. This is a new way of coordinated retail investment by private investors. The question of whether or not this could happen in the future depends on the target group and the company, in particular companies such as game or big entertainment companies that are supported by consumers. Maucher says that in Germany and Europe, there were a lot of warnings from the authorities to private investors that their behavior could be considered market manipulation. She would advise clients to closely monitor social media platforms, in particular when a company is in the midst of a merger or acquisition.
How could this affect other areas of practice or other clients?
Yosbel Ibarra, Co-Managing Partner of of Greenberg Traurig’s Miami office, says that although the SPAC market has cooled tremendously, many SPACs are backed by celebrities like Jay Z and Shaquille O’Neal, and there is the possibility of this GameStop model affecting that industry. Heather notes that in recent years, as a result of technological advances, regular people are able to train themselves to day trade and they are trading their own stocks and managing their own pensions. At the same time, they’re banding together on these bulletin boards on internet sites, and someone posts about Jay Z’s new SPAC and the share price goes up. “Previously, only small numbers of retail investors buying a stock didn’t really make any difference at all, but now, as we’ve seen with GameStop, this sort of hype around a stock and the feeding of that hype with online bulletin boards is going to become an increasing phenomenon,” says Heather. He says that regulation is going to be really difficult.
Speaking of regulation, what does the regulatory landscape look like, particularly in the US?
Lundy says it’s going to be difficult for the DEC and DOJ to investigate and bring charges. Maucher agrees the same is true in Germany. We’ve talked a lot about the hype of the GameStop scenario. “Hype is not manipulation, over-valuing a company because you believe in it, because you’re a gamer and you believe in the company isn’t manipulation,” reminds Lundy. Doing irrational things with your money and investments isn’t illegal, and when you compound that with social media and thousands of retail investors getting the power of the retail investor isn’t illegal either. It’s simply hype on steroids due to social media. In a previous life, Lundy worked with US Federal Prosecutors. Building on that experience – and without knowing for sure - he suggests that what they will do is try to target the leaders of the movement, who should have had knowledge of what the repercussions could be. Lundy mentions some coverage in the financial press about individuals who worked in financial services firms who were also gamers, and could be targeted by the SEC enforcement lawyers as having been such leaders. It’s a matter of making examples out of certain people.
The SEC has a long history of putting the burden on gatekeepers when they have difficulty regulating the underlying conduct; so, for example the Robinhoods or other electronic trading platforms. It’s likely the SEC will put obligations on them as part of their compliance program and risk management function. “Things such as monitoring and assessing trends on social media and monitoring and assessing whether or not there becomes a disconnect between the pricing of a company in the true underlying valuation,” says Lundy.
Some final thoughts
It’s clear that retail investors are not going away and will become increasingly powerful in the market. Social media and technological advances in trading platforms make it easy for anyone to trade, but will make it difficult for regulators to control. Compliance teams and those responsible for the risk management functions in companies, particularly at the time of a merger or acquisition, will have their work cut out for them.