GameStop: What a “Meme Stock” Teaches us about Market Manipulation

“[GameStop] is about more than just money, [GameStop] is about sending a message”, writes one user on the popular online messaging board Reddit. In recent weeks, the video game and electronic retailer GameStop has become the battleground for a stock trading war between retail investors and powerful hedge funds. To understand how this conflict ensued we must look no further than to Reddit’s “r/WallStreetBets” forum—a Reddit community where participants discuss stock and option trading.

In April of 2020, one of the Reddit users of this forum pointed out that 84% of GameStop’s stock was held in short positions at the time of the post and that the stock was undervalued. In the following months, more posters made an appeal to the stock’s intrinsic value, but the stock stabilized after a small spike on the day of the initial post. In August of 2020, however, the stock surged again when Ryan Cohen, co-founder of Chewy, Inc., disclosed a 5.8 million-share stake in GameStop. At that point, 120% of GameStop’s stock was in short positions on the theory that GameStop would not make it to the new console cycle, but it did and 70% of the shorts were under water. Shares began to rise steadily during the last four months of 2020 as Reddit users continued to share information about the stock amongst themselves. Their goal was to hold their investments and trigger a massive short squeeze, as we have previously seen in the cases of Blue Apron and Volkswagen.

This battle between the retail investors and the hedge funds came to a head in the first three weeks of January 2021. On January 21, the short interest was almost 140% and interest in GameStop’s stock has become a worldwide phenomenon with retail investors continuing to buy and causing the stock to surge to a record high of $490 on January 28—an increase of more than 600% in less than one week. Reddit users’ attacks against the Wall Street giants, however, have not been without consequences. Hedge funds, like Melvin Capital, have continuously struck back and placed on full display the manipulative tactics which have been in regular use on Wall Street for decades.

Market Manipulation

The Securities and Exchange Commission (“SEC”) defines market manipulation as someone artificially affecting the supply or demand of a security, for example, causing stock prices to rise or to fall dramatically. Such manipulation may involve techniques of spreading false or misleading information about a company, engaging in a series of transactions to make a security appear more actively traded, and rigging quotes, prices, or trades to make it look like there is more or less demand for a security in the case.

There are several ways to manipulate the market and hedge fund managers are undeterred from using these tricks to push stocks in their favor. In a December 2006 interview, American television personality and host of Mad Money on CNBC, Jim Cramer, famously described activities hedge fund managers use, such as spreading false rumors to reporters. According to Cramer, he himself used these strategies when he was running his hedge fund with as little as $5 million in capital and encouraged others to do the same because it is “a very quick way to make money”. In short attacks, hedge fund managers’ manipulation tactics become particularly apparent. First, they distribute misinformation about a stock widely to create doubt in investors’ minds who currently hold the stock. Next, high volume shorting takes place to drive the stock price down. As the short attack continues, the bad news spreads, causing many investors to sell the stock or discourage others from buying. An example is the Guinness share-trading fraud of the 1980s when the London stock market was manipulated to inflate the price of Guinness shares to assist Guinness’ takeover bid for the Scottish drinks company Distillers.

While the “tape is being painted”, shorts use computerized trading to control the direction of the share price, on a daily basis. As such, at specific times, the shorts overwhelm the buyers of the stock by selling a large number of shares back and forth in rapid successions to drive down the price and eliminate these buyers for the stock. This attack usually continues for several months or well over a year to ensure that the shorts fully control the stock’s share price and drive it down at the right time when they can buy back the shares at the lowest possible price. In many instances, these attacks have devastating effects, as was the case in the 2008 global financial crisis when hedge fund managers, including Michael Burry, bet against mortgage-backed securities for profit which left millions of people unemployed and homeless. Burry, on the other hand, earned a personal profit of $100 million and a profit for his remaining investors of more than $700 million.

This type of market manipulation typically involves collusion between a number of major players and violates federal securities laws under the jurisdiction of the SEC. Nonetheless, hedge funds have not been deterred and continued these practices to this day. In the case of GameStop, it is not different. As interest increased and millions of people have been focusing their attention to GameStop’s stock, Melvin Capital and other shorts have used trick after trick to regain control of the stock, falsely reporting that they closed their short positions when they did not, causing the stock price to soar, and even seemingly colluding with the investment and trading application, Robinhood, to restrict transactions for GameStop’s stock to position closing only. Robinhood’s platform is specifically geared towards millennials who are the majority of Reddit’s user base. Notably, Melvin Capital is owned by Citadel—a customer of Robinhood—, and Robinhood is said to receive 40% of its revenue from Citadel.

It is not clear who is going to win the battle between r/WallStreetBets and Melvin Capital and other hedge fund managers, but it is clear that market manipulation has been a staple in Wall Street’s trading activities for a very long time. We have the knowledge and experience to represent parties in securities disputes related to market manipulation. If you believe you have been the victim of stock manipulation, you should hire an attorney who truly understands this complex area of law. We can answer your questions about stock market inflation, stock manipulation losses you may have suffered and potential remedies you may have at your disposal.