• The London Financial

Everything you need to know about GameStop

By Chloe Chan, Research Analyst at King's Global Markets

The Texas-based American video game company GameStop rose to fame in early January 2021 due to a short squeeze of the stock, which resulted in over +1500% increase in its share price. Within the course of 2 weeks, GameStop (NYSE:GME) was trading at an all-time high of US$483 as of 29th January 2021. This phenomenon was coined as a “short squeeze”, meaning that there was a sudden rapid increase in the share price caused by an excess of short selling of the stock in the market. Put simply, there is a shortage of supply coupled by an excess of demand for the stock, where short sellers have to purchase their stocks to cover for their short positions.

In GameStop’s case, the short squeeze was triggered by a group of users on a forum page (known as a “subreddit”), r/wallstreetbets, of the discussion website Reddit. The users heard of the short positions that hedge funds have entered for securities such as GameStop, cinema chain AMC, tech company BlackBerry (coined as “meme stocks”); they therefore began to retaliate against these hedge funds. The magnitude of this short squeeze was realised when it was reported that around 140% of GameStop’s public float was entered as short positions. At the height of the short squeeze on 28th January 2021, GameStop share price reached a shocking pre-market value of US$500 per share, which was nearly 30x the initial trading price of US$17.25 at the beginning of the month. It was also on that same day that numerous brokerages, especially commission-free trading platforms such as Robinhood, Schwab, eToro and Interactive Brokers imposed trading curbs and suspended trading for numerous “meme stocks”.

Subsequently, this drove down the share prices by -44% and -57% for GameStop and AMC, respectively. Within hours, a Robinhood customer filed a lawsuit against the group in federal court on the basis that Robinhood “completely blocked retailer investors from purchasing for no legitimate reason”. Democratic New York congresswoman Alexandria Ocasio-Cortez has also spoken up on her personal Twitter: “This is unacceptable. We now need to know more about their decision to block retail investors from purchasing stock while hedge funds are freely able to trade the stock as they see fit”, in which rival Republican senator Ted Cruz responded “totally agree”. This decision to halt trading of GameStop and other related securities sparked debate and tremendous backlash from customers towards these brokerages. In particular, the accusations began to circulate that the brokerages attempted to artificially manipulate the market.

Schwab’s immediate response was that “it is not uncommon… to place restrictions on some transactions in certain securities in the interest of helping mitigate risk for our clients”. eToro’s chief investment officer Gil Shapiro also said, “Whether or not we are in bubble territory… we have been urging our users to stick to the basics of investing: diversify, avoid leverage, and only invest in markets and instruments with which you are familiar”. Retail investors do not seem to be convinced, and thus these messages and responses were unable to dampen enthusiasm at all.

Following a dozen class action lawsuits filed against Robinhood in US courts, the US House Committee on Financial Services also held a congressional hearing that began on Thursday 18th February 2021. Key individuals called to give a testimony included managerial members of various parties. Lawmakers are granted the opportunity to question Robinhood’s CEO Vlad Tenev, Melvin Capital’s CEO Gabriel Plotkin, Reddit’s CEO and co-founder Steve Huffman, Citadel’s CEO Kenneth Griffin and Reddit user Keith Gill (also known as “Roaring Kitty”). JMP Securities analyst Devin Ryan predicted that the congressional hearing would focus on: the detailed progress of the event, ensuring the legality of all activities, and determining a way to avoid similar events from reoccurring in the future.

Keith Gill delivered his opening statement before the House Committee on Financial Services and stated that he had started extensive research into the stock market for a few years now. He first took an interest in GameStop shares when the stock value fell in June 2019 below what he thought was “its fair value” and believed that GameStop was undervalued. He claimed that the publicly available information, which informed his research, shows that “first, the markets were underestimating the prospects of GameStop’s legacy business and overestimating the likelihood of bankruptcy”. He also stated that the allegations made towards him that he used social media platforms like Reddit to promote GameStop shares to manipulate the market is “preposterous”. He simply concluded with “I like the stock” indicating that his choice to invest and post about GameStop carried no intention towards market manipulation.

On the other side of the hearing, members of the House Committee on Financial Services grilled CEOs of hedge funds and commission-free trading platforms. Democratic representative Brad Sherman posed a question to Citadel’s CEO Kenneth Griffin asking him “2 identical orders come in, same stock, same quantity, one’s from Robinhood, one’s from Fidelity, what happens?” in which Griffin repeatedly swerved and avoided. When questioned about the suspension of stock purchases for a few selected securities, Robinhood CEO Vlad Tenev said that it was purely a “collateral depository requirement decision”.

Following the initial progression of the hearing, a few central points of concern could be observed throughout the questioning of these individuals, which primarily surrounded the following:

  1. Whether there is a difference of how investors’ orders are executed depending on whether there is a presence of payment for order flow

  2. Why there was a restriction in purchasing, yet not for selling certain securities

  3. Whether there is a practice of hedge funds communicating with commission-free trading platforms to acquire information that is not publicly available

  4. Whether there was a “liquidity problem” with Robinhood and the possibility of it being one of the reasons for purchase suspension

The hearing is still underway and thus a lot can happen in the upcoming sessions. However, there is a collective sentiment amongst the public.

In my opinion, considering the responses from major financial institutions such as Citadel, Robinhood and Melvin Capital, there is reasonable suspicion of collusion between these commission-free trading platforms. Indeed, the term “commission-free trading” is quite misleading, because it essentially does not exist. The current system in place does not operate like a traditional commission basis trading platform; yet, it cannot claim to be entirely free due to the issue of payment for order flow. As Rep Alexandria Ocasio-Cortez has pointed out, hedge funds like Citadel pay Robinhood for order flow, and it is the presence of payment for order flow that allows the company to offer “commission-free trading” and for retail investors to enjoy the luxury of “free” stock trades.

It is a common fact that the stock market is not a level-playing field. While retail investors are only provided with publicly available information, institutional investors have tremendous funds and resources allocated to research and execution, which provide them with an advantage. However, this historical phenomenon has shown us that retail investing is a force to reckon with given its ability to influence the markets. Therefore, there is a need for institutional investors to rethink their strategy in investing.

At the moment, there is talk about a financial transaction tax due to the entire frenzy caused by GameStop. This issue has highlighted the serious underlying issues in financial markets, namely investor protection and market integrity. Apart from the desperate need for tax revenue, lawmakers see this as a way to regulate and maintain the functionality of healthy financial markets. According to a 2018 research estimate, it has shown that a mere 0.1% tax on stocks, bonds, and derivatives transactions would raise up to US$777 billion revenue for the federal government. Surely, this tax has its merits and would potentially be effective in preventing an event like the GameStop short squeeze from reoccurring; yet, it is possible that it would face fierce retaliation on Wall Street but also among retail investors. Arguably, this would greatly disincentivise improvement and hinder progress in the American financial markets.

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