Explainer: How amateur traders on Reddit sparked a Wall Street 'bloodbath'
Hedge funds have suffered heavy losses as a result of the internet-fuelled surge in stock prices of certain companies.
It is being described as the David Vs Goliath of the financial world.
Some established hedge funds handling billions in trades have suffered major losses due to the actions of individual amateur investors who have come together on message boards like Reddit and Discord to boost the share price of companies the investors had hoped would fall.
Individual retail investors have long discussed stocks on Reddit and other social media forums, but in recent months Wall Street has had to pay attention to what they are saying. Long dismissed as ādumb money,ā retail traders in recent months have put enough money into the market to make stocks move in ways that defy fundamental analysis.
The most stunning recent example is a nearly 700% rise over the past week in shares of GameStop Corp, without any fundamental change in business for the video game retailer that Wall Street had long given up for dead in the age of Amazon and online downloads. The sharp upswing in GameStop shares has mowed down sophisticated traders who had taken short positions on the stock, betting against it. The surge was fueled in large part by a series of posts talking up the stock on popular forums such as wallstreetbets on Reddit.
Americans stuck at home during lockdown, some flush with cash from stimulus checks and forced savings, have been chasing higher on the stock market at a time of zero interest rates. Their trades are becoming a force to reckon with.
Hedge fund Melvin Capital Management, which had suffered heavy losses by betting against video game retailer GameStop, has closed out the position and repositioned the portfolio, a spokesman for the firm said. The spokesman also said that the firm, once among Wall Streetās best performers, is not collapsing.
GameStop's interstellar surge has sparked calls for regulatory scrutiny. Why?
US law bars the dissemination of false or misleading information with the aim of manipulating investors into buying or selling securities, as seen during a rash of "pump and dump" schemes during the early 2000s dot.com boom.
Regulators are likely to explore whether Reddit was used in a similar way, after thousands of messages hyped up the stock and urged other investors to hold on to their shares or buy more.
"GME IS THE HOLY GRAIL," wrote one user on Wednesday, urging others to keep pushing the stock higher. "WE ARE STILL GOING TO THE MOON...ITS NOT TOO LATE TO BUY."
Jacob Frenkel, Securities Enforcement Practice chair for law firm Dickinson Wright, said the SEC would likely look at whether the messaging by investors holding the stock long-term and activists betting against it was manipulative.
"With federal prosecutors having become much more sophisticated in their cases over the years on securities trading ... it is reasonable to believe that any SEC investigation could well have a parallel criminal investigation," he added.
The U.S. Securities and Exchange Commission said in a statement on Wednesday the agency was "actively monitoring" market volatility without offering specifics. The Southern District of New York, which could have jurisdiction over a criminal case, declined to comment.
Wild swings in GameStop's shares led the New York Stock Exchange (NYSE) to halt trading in the company several times this week. But lawyers said there was sufficient marketplace confusion to warrant a longer suspension.
On Wednesday, the Massachusetts state regulator, William Galvin, called on NYSE to suspend GameStop for 30 days to allow a cooling-off period. "This isnāt investing, this is gambling," he told Reuters in an interview. "This is obviously contrived."
Lawyers said the incident could prompt a broader review of share suspension rules.
"I could see the SEC encouraging the NYSE to put in place rules that might smooth such swings as a result of retail investment activity," said Marc Adesso, partner at Saul Ewing Arnstein & Lehr. NYSE declined to comment.
NYSE said it employed advanced technology to investigate suspicious trading activity, according to a representative.
The GameStop saga has again shone a spotlight on low-cost retail trading platforms which have allowed millions of ordinary Americans to trade stocks. Consumer advocates say retail investors are taking risks they may not understand and incurring hidden costs that are rarely fully disclosed. "So much of this trading has been fueled by broker de facto claims of 'free trading'... but that is false and misleading and the SEC should say that and stop it," said Dennis Kelleher, CEO of progressive think tank Better Markets.
The combination of accessible retail trading and social media could upend the market if not adequately policed, Galvin warned.
"It's diminishing the integrity of the marketplace and itās putting individual investors at risk," he said.
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