GameStop – a game of chicken?

The race to purchase shares in ailing American video game retailer, GameStop, has taken the investment world by storm over the last week, with amateur traders waging war on professional hedge funds.

The first round of this game of chicken went to the amateur investors, but this is unlikely to be the end of the story.

What happened?

Several hedge funds took short positions on GameStop, betting against the retailer which has been struggling since the pandemic. Amateur investors rallied together via forums such as Reddit to drive share prices up, rather than down as the hedge funds had anticipated. GameStop's stock increased by over 600% in a week and market data suggests hedge funds have lost more than $19bn as a result of this crusade. Even Elon Musk, the world's richest person, got involved and tweeted a link to Reddit.

The so called amateur investors have made a lot of money in the last week but just as importantly have given the hedge fund industry a big poke in the eye in the process.  But at some point, the shares in GameStop will move back to a "normal position" so it may be that those investors late to the race will lose money and the hedge funds, who presumably are taking new short options will once again make money.

Another interesting feature was the role of the brokerage platforms. Notwithstanding Musk's backing of this war, some of the brokerage platforms restricted trading for certain companies, including GameStop. The allegation is those platforms were prepared to sell out their customers (who do not pay any fees for the service) in favour of the big funds (who finance the platforms through payments for "big data").  

Implications?

Many people find the practice of short selling to be unedifying – this is the practice of some hedge funds making money out of other companies' failures and other investors' losses.   But whilst the motives of the amateur investors in attacking this form of perceived corporate greed might be admirable, their means of collaborating together to move the market sets a dangerous precedent which financial regulators will wish to clamp down on if possible. The financial regulators abhor any form of market manipulation. That said, it is difficult to see how the regulators can prevent similar "flash mobs" from sharing information and colluding via anonymised social networks. By definition the amateur investors are not regulated entities and the group is possibly too anarchic for any realistic criminal actions.

The financial regulators are no doubt closely following the situation. In the UK, the FCA has previously placed temporary bans on short-selling and we could see the FCA taking similar action now, since we are not convinced what social good short selling achieves particularly in this time of a global pandemic where stock markets are not behaving rationally. President Biden's new administration has also announced it is 'monitoring' the rise in share prices for companies such as GameStop. We expect to see more developments on short selling on the horizon. 

It is reported that some of the hedge funds have lost masses of money, so this begs the question whether they might face any civil claims from disgruntled investors or regulatory investigations?  Despite losing money the hedge funds have done nothing wrong, although it is possible there will be claims if the hedge fund managers failed to respond quickly enough to changes in the market, or if their short selling strategies were outside of their mandate. However, one can assume the relevant mandates are sufficiently wide and contain adequate caveats, allowing them to operate a wide discretion in respect of their investment decisions. Regardless of the merits of these claims, they are expensive to defend and, unlike Musk, they cannot afford not to have the right insurance in place to cover those costs.  Could some of them have responded faster? Perhaps. Only time will tell.

It appears the Reddit crew have already moved onto speculating on the price of Silver, with its price escalating by over 20%. We will need to watch this space to see if the regulators take any action but, in the meantime, perhaps the safer option is to stay in the race for the long sell. Citron Research has already indicated that it will focus on investment growth and who knows, perhaps other hedge funds may revisit their own strategies and invest for growth and success rather than gambling on a company's bad fortune and other investors' losses.