The Effects of the GameStop Market Disruption – Business Law Digest

by marquis cardwell

Gamestop’s market disruption has exposed the strength of self-directed investors and the power of online forums, which will force investment institutions to adapt their strategies to rapidly growing market forces. this market disruption was fueled by r/wallstreetbets, a reddit forum that actively targets stocks that have the potential to exploit structural market weaknesses.[1] this forum was able to amass millions of reddit users (“redditors”) to invest in gamestop, against which hedge funds were betting heavily and predicting stock prices would fall.

The short selling strategy, which was being used by these hedge funds and other traders, is applied when there is speculation that the share price will decline.[2] In response, traders borrow shares from investors who already own the shares and then sell them on the market at current prices; then buy the shares back when the price drops and return them to the original investor keeping the difference.[3] Although taking a short position can lead to high returns, it also carries high risk because the stock price could rise instead of fall as expected. this would cause the trader to incur a loss by paying the borrowed investor’s interest and at the same time buying back the borrowed shares at a higher price than anticipated.[4]

Reading: How will gamestop affect the stock market

A short is when a stock rises sharply, forcing traders speculating that the stock’s price would decline to buy the higher-priced stock to avoid further losses.[5] Redditors implemented this practice when they increased the stock price and forced traders to take short positions on Gamestop to buy back the stock at higher prices to mitigate their potential losses.

This phenomenon increased the upward pressure on gamestop’s share price, leading to disastrous financial losses for hedge funds and traders who bet against gamestop. As a result, gamestop’s stock price increased by 1,910%, costing hedge funds $5 billion over the course of two weeks.[6]

the influences and underlying effects of gamestop’s market disruption

The riots and market disruption that followed were a testament to the growing market presence and influence that self-directed investors have in the market. self-directed investors are seen as people doing their own research through digital forums, such as twitter and reddit, rather than relying on financial experts to make market decisions.[7] On the other hand, hedge funds and prominent financial institutions use financial analysis and historical market trends to justify their investment strategies, while self-directed investors tend to rely more on passion and personal interest to direct their investments. [8] Self-directed investing leads to riskier investments in the hope of higher returns and away from the notion that a company’s stock price is representative of expected future cash flows. As a result, there is a growing percentage of investment capital that cannot be calculated through traditional analysis.

The self-directed investor subgroup was relatively small until internet access and innovative trading platforms became more prevalent over the past decade.[9] The growing estimate of self-directed investors is projected to be around 54 million investors in the US alone, prompting hedge funds and other financial institutions to pay attention to the growing counterparty in the market.[10] In addition, the accessibility of online trading available through platforms such as Robinhood, which was used by the majority of Reddit users to invest in Gamestop, and other simple app-based platforms has raised concerns about the gamification of investment.[ eleven] gamification is when companies implement marketing techniques to increase investor engagement without equipping or informing new investors about the risks and financial consequences that come with trading.[12] For example, regulators in Massachusetts accused Robinhood of using gamification, stating that “[Robinhood] used colored confetti that appeared on the screen after deposits and trades to incentivize continued and repeated engagement with the app.” [13] On the other hand, it is important to note that online brokerage platforms such as robinhood have been able to successfully increase access to investment markets that have long been perceived to have blocked individual investors and provide the average investor a feasible way to trade.[14]

the current legal and regulatory landscape

Since the gamestop incident had such a pronounced effect on the stock market, government regulators and the SEC are monitoring the situation for possible legal ramifications, if any, that apply to publishers involved in market disruption, robinhood and any other figures that have been involved.

pump and dump

A pump and dump is a scheme that attempts to increase the price of a stock through recommendations based on false, misleading, or grossly exaggerated statements.[15] this scheme traditionally begins when an investor buys shares in a company and falsely tells others they have inside information to suggest that the share price is going to rise.[16] under this assumption, other investors begin to invest in the aforementioned shares, which subsequently increases the share price.[17] the initial investor then sells the shares at the higher price before the false information becomes public, allowing initial investors to make a profit while misled investors suffer huge losses.[18] For example, Enron executives used a pump-and-dump scheme in 2001 by falsely reporting earnings and selling their shares at the inflated price before the false information became public.[19]

The main difference between the above scenario is that there was no alleged claim that false or misleading information was shared within r/wallstreetbets. instead, one of the users, named /u/keyboredwarrior, stated: “we just have to hold them and bleed them to death…. we have nothing to lose by holding the shares, they have billions to lose.”[20] Rather than declaring monetary gain as their primary goal, reddit users claimed that “punishing” hedge fund short sellers was their primary motivation.[21 ] Given this information, a successful claim is unlikely. of pump and dump is tested against early reddit users who cornered other investors.

market manipulation

Another possible claim is market manipulation, which is when an individual artificially affects the supply or demand for the stock, causing drastic changes in the stock price.[22] To prove a claim of market manipulation, the following four-part test must be met: “(1) that the defendant had the ability to influence market prices; (2) that the defendant had the specific intent to create or effect a price or price trend that does not reflect the legitimate forces of supply and demand; (3) that artificial prices existed; and (4) that the defendant caused the artificial pricing.”[23] Public encouragement within the reddit forum to increase stock prices to shrink hedge funds presents some support for collusion. however, it will be difficult to prove that r/wallstreetbets colluded based solely on the fact that one investor encouraged others to invest in a stock. For example, this scenario is not unlike when Elon Musk publicly announced his stance on Twitter to his millions of followers regarding Bitcoin, which “coincidentally” increased the share price before Tesla announced its investment.[24] Furthermore, Robert Reich, former Secretary of Labor, said: “If Redditors Rally GameStop is unacceptable market manipulation, what would you call it when greedy Wall Street bankers gambled our entire economy away in 2008 and faced no consequences?”[25]

robinhood: market manipulation

Market manipulation has also been discussed in relation to the actions carried out by robinhood. On January 28, robinhood restricted its users’ ability to buy shares of gamestop and other companies targeted by r/wallstreetbets.[26] the next day, robinhood allowed retail traders to buy only one share of each target company, while hedge fund investors were allowed to buy and sell the shares in unlimited volumes on other select investment platforms.[27]

robinhood stated that market volatility and regulatory requirements were the reasons for the restrictions. the firm stated that they must hold a substantial amount of capital to process all trades and the rise in “volatile” stock trading prompted its clearinghouse, an intermediary between seller and buyer, to request more collateral to secure the shares. operations.[28] In response to this, robinhood stopped buying eight stocks, including gamestop.[29]

This action has been scrutinized by many people as market manipulation because the actions taken by robinhood to limit retail investment caused drastic changes in the share price and disproportionately harmed individual traders. Jill Fischer, a professor of securities law, stated: “It’s a bit problematic to think about banning clients of some brokerage firms from trading stocks while others are free to do so.”[30] she also stated, “it is much more common if there is a stock that is mispriced or a stock that is unduly volatile for exchanges to take action so that all investors are treated equally.” traders, who frequently trade on robinhood, were robbed of their means to trade.

Robinhood’s actions have also drawn the attention of various politicians and the SEC, who have stated that they will review actions taken that may have harmed investors’ ability to trade.[32] there have also been several class action lawsuits filed against robinhood which will be decided soon.

the future perspective of the investment

The reality of the situation is that self-directed investors are growing at an exponential rate, given the increased accessibility of online trading platforms. this trend will undoubtedly make traditional financial institutions and hedge funds realize the unpredictability that comes with self-directed investors. Although some financial experts believe that these market disruptions will have only minor repercussions, traditional investment firms and investors will need to recognize the growing presence of self-directed investors and how it will affect their investment practices. Furthermore, as a result of the Robinhood debacle, regulators will most likely impose regulations on online trading platforms to prevent disadvantaged trading as seen here. The regulations and court decisions that are made in response will undoubtedly shape how financial institutions, hedge funds, and individual investors will operate in the future.

See also : Why Is the Stock Market So Strong When the Economy Is Weak? – Knowledge at Wharton

[1] Tracy Alloway, How ‘Flows Before Pros’ Are Disrupting Stock Markets, Bloomberg (January 27, 2021), https://www.bloomberg.com/news/articles/2021-01 -27/how-flows-before-the-pros-is-disrupting-quicktake-stock-markets

[2] katherine wiles, Is it legal to deliberately bankrupt a hedge fund?, market (January 29, 2021), https://www.marketplace.org/2021/01/29/is- it-legal -deliberately-bankrupt-a-hedge-fund/

[3] brian cromwell, what just happened? the gamestop frenzy, legal questions and lessons for business, jd supra (February 4, 2021), https://www.jdsupra.com/legalnews/what-just-happened-the-gamestop-frenzy-2892854/

[4] id

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[6] chris arnold, gamestop mania probably won’t happen again. Here’s How To Invest Wisely, npr (February 5, 2021), https://www.npr.org/2021/02/05/963787901/gamestop-mania-likely-wont-happen-again-heres-how- to -invest wisely

[7] Hamza Mudassir, The Gamestop Saga Started Unstoppable Disruption, Entrepreneur (February 1, 2021), https://www.entrepreneur.com/article/364487

[8] id

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[11] mikhail klimentov, the gamestop stock situation is not about populism. it’s about whether the market is ‘real’, washington post (February 1, 2021), https://www.washingtonpost.com/business/2021/02/01/understanding-gamestop-situation/

[12] id

[13] id

[14] alloway, supra note 1.

[15] cromwell, supra note 3.

[16] id

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[17] id

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[19] pump and dump, http://thestockmarketwatch.com/learn/pump-and-dump/ (last visited March 23, 2021).

[20] cromwell, supra note 3.

[21] id

[22] id

[23] id

[24] Christine Lee, SEC Must Monitor Tesla’s Elon Musk For Market Manipulation: Roubini, Yahoo! finance (February 10, 2021), https://finance.yahoo.com/news/sec-monitor-tesla-elon-musk-063109452.html

[25] trickery, supra note 2.

[26] oscar gonzalez, robinhood backlash: what you need to know about the gamestop stock controversy, cnet (March 17, 2021), https://www.cnet.com/personal-finance/ investing/robinhood-backlash -what-you-need-to-know-about-the-stocks-for-the-game-controversy/

[27] id

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[29] id

[30] david brancaccio, gamestop shares rise again after robinhood relaxes restrictions, market (29 Jan 2021), https://www.marketplace.org/2021/01/29/gamestop -shares-back-up -after-robinhood-relaxes-restrictions/

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Source: https://amajon.asia
Category: Stocks