Gamestop: Is it Game Over?

You will have heard the latest David and Goliath story – the epic battle between an army of amateur traders and multi-billion-dollar hedge funds that has left regulators, investors and businesses reeling. It is a heartening tale of the little guy “sticking it to” the man, but what exactly happened? And more importantly, is it legal?

On 12 January 2021, GameStop Corp (the American brick-and-mortar video game retail outlet and parent company of Aussie favourite EB Games) (“GameStop”) closed at a share price of USD19.95 per share. By 27 January 2021, thanks to amateur traders and the subreddit known as r/WallStreetBets, GameStop closed at USD347.51 per share – an eye-watering 1700% appreciation a mere 15 days later.

So, what happened?

Sometime in mid-January, small-time investors on r/WallStreetBets noticed hedge funds had taken an aggressively “short position” on GameStop, buying shares in GameStop stock with the intention of short selling.

A short sale occurs when an investor (“the Short Seller”) borrows, and subsequently sells, shares of a stock they believe will decrease in value by a future date. In brief:

The Short Seller borrows shares of stock from another investor (“the Owner”) for a fee or on loan.
Betting on a future fall in the stock price, the Short Seller sells the borrowed shares to a third investor at its current price (“the Current Price”).
Remember, the Short Seller must, sooner or later, return the borrowed shares to the Owner.
So, some time later, the Short Seller repurchases the shares at the new price (“the New Price”).

If the price of the stock falls as predicted, the Short Seller will gain the difference between the Current Price and the New Price, and profit on the short sale.

In the case of GameStop, the Short Sellers were several institutional investors, including the multi-billion-dollar hedge fund Melvin Capital. These Short Sellers seized the opportunity to make a profit by betting against the brick-and-mortar video game retail outlet hit hard by the coronavirus pandemic.

In response, the r/WallStreetBets community banded together to purchase as many shares of GameStop stock as possible (“the GameStop Play”). This caused the stock price to rise exponentially, and the Short Sellers, who were forced to repurchase shares at exorbitant prices so they could be returned to their Owners, were caught in a short squeeze. This is where the Short Sellers rushed to repurchase the shares before the share price increased even further, thereby causing further increases in demand and share price.

Yeah, yeah… I’ve seen the memes. Is it legal?

Many people are questioning the legality of r/WallStreetBets investors’ actions, in particular, whether the mass effort by its subscribers amounted to market manipulation.

Section 9(a)(2) of the Securities Exchange Act of 1934 15 USC § 78a provides it is unlawful for a person to engage in market manipulation by “creating actual or apparent active trading in … security or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others”. However, the r/WallStreetBets investors will be found guilty only if it is found that:

they had the ability to influence market prices;
they intended to create or effect a price or price trend that does not reflect legitimate forces of supply and demand;
artificial prices existed; and
the WallStreetBets investors caused the artificial prices.[i]

While the effect of the GameStop Play has been to create artificial prices that do not reflect the true value of the stocks in question, it is unlikely their actions amount to market manipulation. The r/WallStreetBets investors did not intend to create an artificial share price. They simply stated their individual intentions to purchase shares in GameStop and encouraged others to the same. This is an activity hedge funds and institutional investors engage in as a matter of course. That online discussion by retail investors led to a surge in demand cannot amount to the intentional manipulation of the market.

What about Australia?

Anyone thinking of beginning a similar movement in Australia would be well-advised to keep an eye on section 1041A of the Corporations Act 2001 (Cth). This section prohibits market manipulation in Australia and provides a person must not take part in, or carry out one or more transactions that have or are likely to have the effect of:

creating an artificial price for trading in financial products on a financial market operated in Australia; or
maintaining at a level that is artificial (whether or not it was previously artificial) a price for trading in financial products on a financial market operated in Australia.

The High Court of Australia considered this provision in Director of Public Prosecutions (Cth) v JM (2013) 250 CLR 135.

The Court held “market manipulation is centrally concerned with conduct, intentionally engaged in, which has resulted in a price which does not reflect the forces of supply and demand”.[ii] Forces of genuine supply and demand are “those forces which are created in a market by buyers whose purpose is to acquire at the lowest available price and sellers whose purpose is to sell at the highest realisable price”.[iii]

The High Court held market manipulation refers to transactions where the buyer or seller undertook that transaction “for the sole or dominant purpose of setting or maintaining the price at a particular level”.[iv] Transactions such as those undertaken by r/WallStreetBets investors, which merely have the effect of creating or maintaining an artificial share price are unlikely to fall within this definition.

What now?

The answer is anyone’s guess.

The GameStop Play is an inspiring story of the power of the many. Small-time investors on r/WallStreetBets are certainly giving hedge funds and other professional investors a run for their money. But with the United States Securities and Exchange Commission closely monitoring the US market and powerful players demanding the regulation of r/WallStreetBets investors, the question is – are they here to stay?

[i] In re Indiana Farm Bureau Cooperative Assn., Inc., [1982–1984 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 21,796 (CFTC Dec. 17, 1982); In re Hohenberg Bros. Co., [1975–1977 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 20,271 (CFTC Feb. 18, 1977); In re Cox [1986–1987 Transfer Binder], Comm. Fut. L. Rep. (CCH) ¶ 23,786, 1987 CFTC LEXIS 325; DiPlacido v. CFTC, 364 F. App’x 657, 661 (2d Cir. 2009).

[ii] Director of Public Prosecutions (Cth) v JM (2013) 250 CLR 135, [70].

[iii] Ibid [71].

[iv] Ibid.

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Gamestop: Is it Game Over?