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Money Stuff: GameStop Is Just a Game

January 26, 2021
Money Stuff
Bloomberg

Infinite Game

Of course the chart of GameStop Corp.'s stock price from yesterday is nuts. It closed on Friday at $65.01, opened yesterday at $96.73, got as high as $159.18 and as low as $61.13, and closed at $76.79. Almost 178 million shares traded, worth almost $17 billion. GameStop's 10-day realized volatility is 308%. I am typing these words before the market opens on Tuesday, but by the time I send them the stock will have been trading for hours, and I am sure that it will have touched $4 and $4,000 and every number in between. It seems meaningless to talk about the price of GameStop stock, as though a single number could represent such an elusive concept. GameStop stock has all the prices at once.

Maybe the craziest thing in the chart is not the wild spikes up and down, but the flat lulls when no one was trading because the stock exchange wouldn't let them. "The stock surged as much as 145% to $159.18 on Monday," reports Bloomberg News, "triggering at least nine trading halts." The theory behind a trading halt is basically that the stock has moved around too much, too quickly, for people to really mean it. The stock has gapped up or down because people aren't paying attention: It is "really" worth $100 or whatever, and lots of people in the world would happily buy it for $100 and lots of other people would happily sell it at $100, but they're all out at lunch and there are just a few algorithms trading the stock and they have accidentally pushed it down to $90. (Or up to $110.) So the exchange halts trading for five or ten minutes, so that everyone who wants to buy or sell has time to get back to their desks and put in orders. "This stock is trading at $90, that's a steal," people will think, if they have five minutes to think about it, and they'll put in buy orders and push the stock back to its natural price when it reopens. 

I do not think this theory really applies to GameStop. It has all the prices at once. If you halt GameStop for going up too much, people are just going to hang out on Reddit talking it up more until it reopens. Or the other way: Between 10:45 and 11:15 yesterday, GameStop fell from $159.18 to $88.09, with four trading halts along the way. When the stock plummeted from $159.18 to $132.32, and then was halted for five minutes, nobody said "oh wow this $159 stock is trading at $132, what a bargain, I'd better jump in." Those concepts mean nothing now.

Here (via Robin Wigglesworth) is a post on Reddit's r/wallstreetbets forum asking "Can I get a flair for buying GME at the literal top ($155.29)?" (It was not the literal top, but close.) "This is the way," a chorus of redditors replied. It is a way! Gleefully getting top-ticked on a stock—buying it at its highest price ever and then bragging about it as the price collapses—in order to earn the strange respect of your friends on Reddit: That is a thing you can do. You might enjoy it. I am not going to say it is irrational; people have spent their money on worse things. But it is not the sort of rationality that the stock market is set up for. "When stock prices get too high, sensible value motives will take over": Nope.

We talked a lot about GameStop yesterday, but I missed this terrific article by Bloomberg's Brandon Kochkodin taking the long view of Reddit's infatuation with the stock. GameStop first came to WallStreetBets' attention in March 2019, when it was trading around $10, and a user made a deep-value case that was "not contingent on a turnaround or business expansion." Stuff soon got weird though, with another poster proposing a WallStreetBets takeover of GameStop. And then the main character appeared on the scene. We talked about him briefly yesterday; he goes by "Roaring Kitty" on YouTube, and by an unprintable name on Reddit. He started buying GameStop in 2019, took a victory lap on Friday with chicken tenders and champagne, and as of yesterday he seems to have turned a $53,566.04 investment into $13.9 million.

But is it securities fraud?

If a lot of people on Reddit band together to drive the price of a stock higher, is that illegal? I have been asked that question a lot recently, and I want to be clear that:

  1. I don't know, and
  2. If I did know, I wouldn't tell you, because I do not give legal advice in this newsletter, and I particularly do not give legal advice that people on Reddit might read while pumping up stocks.

That said I suppose we should talk about the question in general and extremely not-legal-advice terms. I guess my answer would be that it might be illegal in all sorts of ways, but it is not obviously illegal, and if the U.S. Securities and Exchange Commission were to go after WallStreetBets for this stuff they will be breaking new ground and going beyond their previous cases. I do not want to say "this stuff is all fine," but I will say I am not all that bothered by it.

There are two main things that are illegal. One is "securities fraud." This basically means lying about a stock. The other is "market manipulation." Nobody knows what this means. Legally, it means something like:

To effect, alone or with 1 or more other persons, a series of transactions in any security … creating actual or apparent active trading in such security, or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others.

So if you buy stock with the purpose of pushing the price up so that other people will buy it, that's market manipulation. If you buy stock hoping that the price will go up because other people buy it, that's not market manipulation; that's just normal. Those things are not so different. There is a "traditional four-part test for manipulation that has developed in case law": 

(1) That the accused had the ability to influence market prices; (2) that the accused specifically intended to create or effect a price or price trend that does not reflect legitimate forces of supply and demand; (3) that artificial prices existed; and (4) that the accused caused the artificial prices.

So consider the general concept of a "pump-and-dump" scheme. The most classic pump-and-dump goes like this:

  1. I buy some GameStop stock.
  2. I put out rumors—in my subscription newsletter, on Reddit, in fake press releases, whatever—about some catalyst for the stock to go up. "Hey I hear from an inside source that GameStop just got an exclusive contract to supply downloadable video games in Tesla cars," etc.
  3. People see these rumors, believe them and buy GameStop stock, pushing the price up.
  4. I sell the stock to them at the higher prices.

This is very straightforwardly illegal and the SEC goes after this stuff all the time, alleging securities fraud. Lying about stocks. Here is the SEC's "Investor Alert: Social Media and Investing -- Stock Rumors," which pretty much defines a pump-and-dump this way:

For example, in a "pump-and-dump" scheme, promoters "pump" up the stock price by spreading positive rumors that incite a buying frenzy and they quickly "dump" their own shares before the hype ends. Typically, after the promoters profit from their sales, the stock price drops and the remaining investors lose money.

There are variations. The SEC has gone after forms of dishonesty that aren't quite lying about the stock. For instance, if you are a widely followed stock promoter with a subscription tip newsletter, and you email tips to your subscribers and then sell your stock to them while saying that you're buying, that seems dishonest, and the SEC will go after you. Or if you are a promoter or research firm and you put out positive research about a company, but you don't disclose that the company paid you to put out the research, that is also bad. 

Now, I think you could do a pump-and-dump without any actual lying. For instance:

  1. I email subscribers to my expensive private newsletter saying "hey let's pump GameStop."
  2. We all buy GameStop, knowing that we're just doing it for the pump, with no real or fake catalyst for the stock to go up.
  3. It goes up, because we bought a lot of it. 
  4. Other people, innocents and high-frequency trading algorithms, see it go up on heavy volume and think "hey this is a good stock, we should buy it." They buy it, pushing the price up.
  5. We sell the stock to them at the higher prices.

In this version, I have not lied about a stock. On the other hand, I have effected transactions in the stock to create trading activity and raise the price, for the purpose of inducing people to buy it. Seems like market manipulation, "painting the tape" or something. The SEC goes after stuff like this occasionally.

I think that in modern markets you could even do a bit better than that and have a completely honest pump-and-dump:

  1. I show up on Reddit and say "hey let's pump GameStop."
  2. We all buy GameStop, knowing that we're just doing it for the pump, with no real or fake catalyst for the stock to go up.
  3. It goes up, because we bought a lot of it. 
  4. Other people see us doing this, read my Reddit post, know we are pumping the stock, and also buy it, because we seem to be having fun, and they like fun too.
  5. Eventually some of us get bored and start selling and the price collapses.

The point here is that it is at least theoretically possible that no one buys stock for any reason other than "hey it's a fun pump." That is, no one is deceived about the fundamentals (there's no fake news about the company), and also no one is deceived about the technicals. No one says "huh this stock is up on a lot of good buying pressure, I should buy some"; everyone who buys says "hey this stock is up because it's being pumped, and if I get in now I might still get out before it collapses, and that'll be fun." It is "respect the pump" as a quasi-mystical mantra.

I bet the SEC would say that's market manipulation, but I am not so sure. I suppose we did our trading "for the purpose of inducing the purchase or sale of such security by others," but not by deceiving them about what's going on. "Join us in a fun game of chicken," was our basic message here. Did we try "to create or effect a price or price trend that does not reflect legitimate forces of supply and demand"? Who's to say what's "legitimate"? Surely the price did not reflect expectations about future cash flows, but just as surely the price reflected supply and demand: We all wanted to own it because we were having fun, so the price went up. 

Anyway, the actual GameStop situation. I suppose it's possible that someone on Reddit has posted fake rumors about GameStop's business, but I haven't seen any. The posts I've seen about GameStop have been either (1) substance-free "GME to $1,000" stuff or (2) arguments based on publicly available information plus personal opinion and guesses about the future. They might be wrong or exaggerated or misstated, but it's not, like, core fraud.

Is it manipulation? Well, there is not a lot of deception here. No one is buying GameStop stock because they think to themselves "boy this stock is going up a lot on heavy volume, must be a bunch of big institutions who see fundamental value here." There is absolutely wall-to-wall coverage of GameStop in financial media, and it pretty much all says "lol those crazy redditors, pushing up the stock for no reason." So at worst this is a sort of honest pump, people banding together to do it for the lolz and hoping they can get out before it collapses. 

I'm not even convinced it's that though. The stock closed Friday at its all-time high. Roaring Kitty was up $11 million. Everyone came back on Monday and did it again. My model here—and I should emphasize this is purely a guess—is that the people most identified with the GameStop trade on Reddit, at this point, are much more interested in securing their legendary status on Reddit than they are in taking profits at the expense of whoever came in later. 

You could have other miscellaneous theories about words like "collusion" and "short squeezes." Is it illegal for people to band together to all buy stock at the same time? "If institutional investors had an internet site or chat where they arguably cajoled each other or coordinated to buy stock to move the price higher," one reader asked me by email, "wouldn't that be stock manipulation and wouldn't the SEC get involved?" 

Well, a while back there were reports that the SEC was looking into hedge fund "idea dinners," where hedge funds get together to pitch each other on their third-best ideas.[1] That sounds like institutional investors having a chat where they cajole each other to buy stock in a coordinated way. But the SEC wasn't concerned about market manipulation. The SEC was concerned that the hedge funds might be a "group" under the securities laws, if they teamed up to own more than 5% of the stock, and that they hadn't made the necessary group disclosures. This is less of a concern for small retail investors, just because they are less likely to get above 5% of the company.[2] Also it doesn't seem like the idea-dinner probe went anywhere. Telling your friends that you like a stock and they should buy it is, more or less, fine.

Or is a short squeeze illegal? One popular topic on WallStreetBets is recalling stock borrow. Kochkodin's article describes one call to action in April 2020:

The final all-caps sentence imploring GameStop owners to call their brokers and tell them to not lend them short opened a new theater to wage war against short-sellers.

It's a little known fact, and one that you wouldn't expect to learn on a Reddit message board, that a stockholder can request that shares they own outright not be lent out to short-sellers.

If everyone bands together to recall stock borrow, there will be fewer shares available for short sellers, and the short sellers will be forced to cover their bets by buying stock, pushing the price up more. Is that illegal? Is it illegal to make borrow impossible with the goal of messing with short sellers?

The SEC might think so, actually. In 2012, it brought charges against Phil Falcone and Harbinger Capital Partners LLC for, among other things, having "conducted an illegal 'short squeeze' to manipulate bond prices." I confess I do not understand why the SEC thought a short squeeze was illegal, or what they think the fraud was, but the Falcone short squeeze is one of my all-time favorite financial stories and I advise you to read the complaint for humor and inspiration. Quick summary: Falcone owned some bonds of a company called MAAX Holdings Inc. "After hearing rumors that a Wall Street financial services firm was shorting the MAAX bonds and also encouraging its customers to do the same, Falcone decided to seek revenge." So he bought all the MAAX bonds. Then he bought more: Short sellers would borrow MAAX bonds (presumably from him), and then sell them to him, so that he ended up with "22 million more bonds than MAAX had ever issued." Then he stopped lending them out, forcing the short sellers to buy bonds to cover their shorts. But there were no bonds to be bought, since he owned them all (and more). At some point an executive from the "Wall Street firm" called up Falcone to talk about the situation, and even in the SEC's dry language you can tell that it was one of the greatest conversations in all of Wall Street history:

At some point, the conversation turned to the trading in the MAAX bonds. The senior officer asked Falcone how the Wall Street firm might satisfy its obligation to Harbinger. Falcone stated that the Wall Street firm should just keep bidding for the bonds. Falcone acknowledged that the Wall Street firm would suffer some losses doing so, but told the senior officer and the others that sometimes you are just on the wrong side of a trade.

In the course of this discussion, Falcone stated that he knew that the short position in the MAAX zips had created a "long" position in excess of the issue size. When the senior officer asked how he could possibly know this, Falcone stated that he was working the position himself and that he (i.e., Harbinger) had acquired approximately 190 million bonds. The senior officer and the other the Wall Street firm personnel were stunned.

"Just keep bidding for the bonds," "sometimes you are just on the wrong side of a trade," I love it so much.

Where were we? Oh, right, GameStop. I suppose a really coordinated successful effort to squeeze borrow might count as market manipulation, at least in the SEC's view, but I'm not sure how serious this effort was. In any case it hasn't worked. "Despite a punishing two weeks and relentless chat-room taunting, GameStop Corp. haters are showing no signs of surrender," Bloomberg reported yesterday; short interest has barely budged, and there are still shares available to borrow.

I don't know. Taking a step back: Should the SEC care about all of this? On the one hand, I do not see a whole lot of deception in this GameStop situation. The SEC's core concerns, about people lying about stocks and tricking the innocent, don't seem especially implicated here; everyone is having reasonably informed and consensual fun. 

On the other hand it is all pretty dumb? Like if you are a securities regulator, you can think of your job narrowly as preventing people from lying about stocks, or more broadly as encouraging capital formation and fostering confidence in markets and moving markets toward efficiency and perfection. And, you know, this is the opposite of that. A popular conclusion from the GameStop story is "well I guess the stock market is nonsense now," and I'm not sure that conclusion is wrong. Seems like the sort of thing the SEC wouldn't like. But what can they do about it? 

Meanwhile

New Larry Fink letter dropped. We talk about these every year, and perhaps we'll talk about this one tomorrow, but today I don't feel like it. In a world where stocks are tokens for fun YOLO trading, doesn't it just feel quaint, that Fink and BlackRock Inc. buy all the stocks, hold them forever, and tell companies what to do? "Mr. Fink is now calling on all companies 'to disclose a plan for how their business model will be compatible with a net-zero economy,' which he defines as limiting global warming to no more than 2 degrees Celsius above preindustrial averages and eliminating net greenhouse gas emissions by 2050." Companies, what are companies, we trade stocks here. I want to read Roaring Kitty's letter to CEOs. 

A funny trade

Yesterday Bloomberg's Tracy Alloway wrote about five lessons from the GameStop/WallStreetBets situation. They are good. Here is one of them:

The shorts have become the target. Once upon a time, short-selling firms would unveil a new position to great anticipation and attention (if not acclaim). The current scrum over Gamestop — in which retail traders have gone head-to-head with short-selling firm Citron — suggests that might become a thing of the past. As Scott Nations at Nations Indexes points out: "The old game of shorting a stock then putting out a negative report is done. From now on that will just be the signal to start a massive short squeeze." A hedge fund or short-seller advertising a bet against a stock might now be the equivalent of waving a red flag to r/wallstreetbets' herd of bulls: a signal to charge in with call options and force a move higher. The predators have turned prey.

In related news, venture capitalist Josh Wolfe suggested a funny trade to me. Here's the trade:[3]

  1. You are, say, Andrew Left of Citron Research, or Gabriel Plotkin of Melvin Capital Management—some hedge fund manager who has attracted the ire of the WallStreetBets subreddit for shorting GameStop.
  2. You buy a bunch of some smallish-cap stock. (Not a 13D-disclosable amount, but a bunch.) Ideally it would be one that has gotten some bullish attention on WallStreetBets, but not too much. Not a meme stock, just something some redditors like.
  3. You put out a research note on the stock. At the back of the research note, you have the usual boilerplate disclosing that you might be long or short the stock, you might trade derivatives, you make no promises to hold your position for any particular period, etc.[4]
  4. But at the front of the research note, you say in giant letters "This stock is terrible, it's going to zero, it has only been propped up by Reddit buying and you know how dumb those guys are." Perhaps you record a video in which you talk about the stock for a minute and then spend the rest of your time calling redditors names.
  5. Enraged redditors band together to drive the price of the stock up, to spite you, like they did with GameStop.
  6. Remember, you had bought the stock, so you sell it at a huge profit.

I like it! I mean, boy is this neither legal or investing advice, but it is funny. It might not work, of course; people might read your report and be like "oh yeah this company is bad" and sell the stock, and then you'd lose money. But if Reddit has as much magic power as it seems to after GameStop then, sure, it might work. 

If it does work, it seems like … obviously … somehow … fraud, but how? You have disclosed that you could be long or short the stock. (Try, in the body of the report, to say things like "this stock is bad," not "we are short this stock.") You have made a bearish case that perhaps you do not believe, though it is hard to prove your beliefs. You have made a bearish case and some bullish trades, sure, but you might reasonably argue "we are bearish in the long term, but we are just making a tactical trade based on market dynamics, what's wrong with that." That's not a great argument. But your best argument is: Look, we put out a bearish report, sure, and one could say it was dishonest, sure, but the stock ripped up, so no one can say that our bearish report deceived anyone. I mean, or maybe it did, but in a weird and reflexive way.

I dunno. If "spite" is a predictable driver of stock prices, you might as well exploit it. Perhaps market psychology, in 2021, is sometimes reverse psychology.

Oh, Melvin

Huh:

Citadel LLC and Point72 Asset Management are investing $2.75 billion into hedge fund Melvin Capital Management, which has been hard hit by a series of short bets to start the year.

The influx of cash is expected to help stabilize Melvin, which in 2021 has lost 30% through Friday, said people familiar with the firm. Melvin started the year with $12.5 billion and had been one of the best performing hedge funds on Wall Street in recent years. The losses stem from Melvin's array of short bets against companies and have stunned clients and other traders. Among other short positions, Melvin bet against the surging stock of videogame retailer GameStop Corp.

Citadel and its partners are investing $2 billion and Point72, which already had more than $1 billion invested in Melvin as of 2019, $750 million. The investments are in Melvin's fund and include non-controlling revenue shares in the firm. Melvin founder Gabe Plotkin was a top portfolio manager at Point72's predecessor firm, SAC Capital Management, before he left to start Melvin.

It is sort of a perverse badge of honor on Wall Street to get absolutely killed on a huge trade. I'm sure that now Plotkin can get into the exclusive clubs where, like, the guys from Long-Term Capital Management hang out and tell war stories. "I can see by your scars that you took a bailout from Ken Griffin," one of them will say, lighting a cigarette with a faraway look in his eye. "I took a bailout once. It was the Russian crisis of '98 that did me in. What got you?" And Plotkin will have to say "well see there's this subreddit."

Oh, Apollo

The bad news, for Leon Black, is that he has to step down from running Apollo Global Management for paying too much money to Jeffrey Epstein:

Just months after Apollo announced an internal investigation into Black's long association with the late financier, the investment firm said in a statement Monday that he would retire as CEO no later than July 31, while remaining chairman. Marc Rowan, one of Black's top lieutenants, will succeed him as CEO as part of a governance overhaul that will also eliminate weighted voting rights.

Apollo said an outside law firm hired to conduct the review found that the asset manager never retained Epstein for any services and that he never invested in any Apollo-managed funds. While the law firm, Dechert, found no evidence that Black was involved in any way with Epstein's criminal activities, its report revealed that the CEO had paid $158 million to the disgraced financier from 2012 to 2017, a sum much greater than previously known.

The good news is that he paid Epstein all that money for actual tax advice, and also that the tax advice was excellent:

Mr. Black "believed, and witnesses generally agreed, that Epstein provided advice that conferred more than $1 billion and as much as $2 billion or more" in tax savings, the report states.

It also supports Mr. Black's contention that he paid Epstein a fee he believed was roughly equivalent to 5% of the value that the late financier generated on an after-tax basis. It describes the two men's relationship deteriorating beginning in 2016 after a fee dispute. Mr. Black's last payment to Epstein was made in April 2017.

Mr. Black also asked employees of his family office; attorneys at law firm Paul, Weiss, Rifkind, Wharton & Garrison LLP; and other outside accountants, lawyers and tax professionals to vet and challenge Epstein's advice when it was given, the report states.

"In short, there is no question that Epstein performed substantive work for Black and that Black genuinely believed that Epstein was extremely smart, capable, and saved him substantial amounts of money," the report says.

After Epstein was arrested on sex-trafficking charges and died in jail, there was quite a bit of wild speculation about where his money came from, and specifically about why billionaires were so willing to pay him so much money for somewhat vague services. After all that speculation, finding out that Leon Black paid Epstein $150 million for differentiated advice that really saved him $2 billion of taxes is in some ways the most boring possible explanation.

At the same time … what? Why was Epstein, who was not a lawyer or an accountant or a college graduate for that matter, so good at tax? I actually don't have too much trouble believing this—in my experience, some people are just born with a natural gift for tax structuring, and need surprisingly little formal training to achieve their potential—but it is fascinating. Black would go his lawyers and say "hey my guy found this way to save a billion dollars in taxes, is it legal," and the fancy lawyers in the Paul Weiss tax department would say "wow, sure is, this is amazing, why didn't we think of this, this guy is a Michelangelo of tax minimization"? I don't know, it's just a weird niche. Also what did Black actually do to save all those taxes?

Things happen

Robinhood Traders Face the Taxman After Falling In Love With Stocks. Companies raise $400bn over three weeks in blistering start to 2021. Commodities Traders, Producers Earn Cheaper Rates From Banks for Lowering Carbon Production. Morgan Stanley, Goldman Lead Bonus Bounces for Bankers in Asia. Saved Stimulus Checks Expected to Help Spur Economic Recovery. AMC Nets $917 Million in Financing to Ward Off Bankruptcy. Did everyone spontaneously applaud Amanda Palmer in a Havelock North cafe?

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[1] I kid. They pitch ideas that they think are good and will appeal to their friends. There is some incentive to pitch good ideas, because it can be helpful to you if your friends all pile into your trade, pushing up the price. There is some incentive *not* to pitch your best ideas, because you might want the best trades all for yourself.

[2] There was another idea-dinner probe in 2010 about whether hedge funds colluded to drive down the euro, but nothing came of it. 

[3] I have elaborated a little; the idea is Wolfe's, as is describing it as "reverse psychology," but any errors or infelicities are mine.

[4] Here's Citron's actual boilerplate: "As of the publication date of a Citron report, Citron Related Persons (possibly along with or through its members, partners, affiliates, employees, and/or consultants), Citron Related Persons clients and/or investors and/or their clients and/or investors have a position (long or short) in one or more of the securities of a Covered Issuer (and/or options, swaps, and other derivatives related to one or more of these securities), and therefore may realize significant gains in the event that the prices of a Covered Issuer's securities decline or appreciate. Citron Research, Citron Capital and/or the Citron Related Persons may continue to transact in Covered Issuers' securities for an indefinite period after an initial report on a Covered Issuer, and such position(s) may be long, short, or neutral at any time hereafter regardless of their initial position(s) and views as stated in the Citron research. Neither Citron Research nor Citron Capital will update any report or information to reflect changes in positions that may be held by a Citron Related Person."

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