02/04/2021
Alexander Wolfe | Staff Columnist
On Reddit, TikTok, Twitter and Discord, average day traders have managed to unite the internet in support of destroying a select group of hedge funds that moved to abuse a few popular, cheap stocks. From Ben Shapiro to Dave Portnoy to the people who repost “explained” stories on their Instagram, everyone except the hosts of Fox Business and CNBC seems to be coming together to destroy these quite parasitic hedge funds.
As the party winds down, we should reflect on the other, darker side of the moon r/wallstreetbets is shooting for.
Artificial stock values are nothing new to stock exchanges. The South Sea Trading Company famously ballooned to nearly 50% of the London Stock Exchange in 1720 before plummeting by nearly 90% in a month and causing one of the first well-documented market crashes in world history.
More popular today are the ‘pump-and-dump’ schemes whereby organized firms advertise their investment in a particular stock, usually cryptocurrency, before cashing out to turn a profit after the value has inflated.
The problem with trading GameStop stock at $480 is that eventually, the value will have to diminish. Whoever is either late to the party or slow to sell is going to get slammed, especially if they placed a substantial portion of their investments in GameStop.
A further problem may arise if r/wallstreetbets continues to act as an informal pump-and-dump forum. The Securities and Exchange Commission (SEC) has the liberty to fine Reddit or Discord for allowing insider trading on their platforms, and if a pattern persists of stocks creating volatile market fluctuations, expect to see a heavy regulatory hammer come down on anyone looking to coordinate a push against a short-selling scheme.
In the grand scheme of things, the politics of this moment are almost as weird as the actual financial mechanics. You have free marketeers who traditionally align with big business looking to maintain the current environment with diminished regulations, leftists who see this as a real tool in order to “eat the rich” and centrists who are both confused and entertained by the whole situation.
The tightrope between stopping Wall Street corporations from privately squashing an army of Elon Musk enthusiasts and preventing those same traders from organizing at all is razor thin. The question becomes: What should be considered insider trading, and if a spontaneous Internet groundswell is insider trading, should it be regulated?
The particularly maddening side to this moment is how legally coordinated the hedge fund response has become, because even though Robinhood, Melvin Capital and Citadel go by different names, they largely are influenced by the same people.
When Melvin Capital, the leading hedge fund looking to short GameStop, signaled it was about to fail, Citadel, another fund, bailed it out for $2.75 billion. Citadel does not own Robinhood, but it does do substantial business with Robinhood by paying for access to Robinhood traders’ order forms. Citadel was fined $700,000 for trading ahead of the execution of the traders’ orders. Now, Citadel can control the platform, destabilizing the company it just bailed out.
This does not necessarily mean Citadel or Melvin Capital have done anything illegal. The class action lawsuit filed on Jan. 28 points to Robinhood’s forcing users to sell their shares of GameStop and other trending stocks. Whether or not Robinhood did so at the urging of Citadel is a separate question entirely, which itself drags the conversation back to insider trading.
In short, as we head toward the end of a second week of explosive trading, I am waiting for the federal government to appear as though it is looking to tackle the issue. In the meantime, if you are willing to risk some money to stick it to Wall Street, buy one of these stocks, but accept the reality that you will probably lose money if you stay in the game too long.
Melvin Capital must still close on its short bets, and with this new infusion of capital, the firm should be prepared to dig in its heels and wait out the trend as traders cash out. Not to say that everything is hopeless — long term damage has, and will continue to be done to these short-sellers — but in the long-run Wall Street has always been able to weather the storm.
