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Power of the people or market abuse? Caution: the Gamestock ploy is not for everyone.

BIScom Subsection: 
Author: 
Nigel Morris-Cotterill

The best thing about the Gamestock story is that a short-seller tried to manipulate the market by doing deals then trying to talk down the stock. The market turned the other way, leaving the short seller out an estimated 30% of their entire funds under management.

That's good news for everyone except those who might lose if the company can't make its payouts which may or may not be the case. Remember all those so-called hedge funds who found themselves in that position in 2004-7, prefacing the financial crisis that others denied? And they weren't the Ponzi types. Nor is it alleged that the short sellers in this case are.

But there is a dark side to this good news story.

In relation to the mayhem caused on US markets by the mass movement of share prices by groups exchanging information online, it would be unfortunate if regulators found a way to argue that the thousands of small investors who found a way to attack short selling were some form of concert party.

Having said that - most of those interviewed seem to be sheep not sophisticated investors and in a market that has great similarity, in how it is working, of a pump and dump scheme, many are going to be hurt. Someone is always the last one out.

I know it is said that short sellers have apparently pre-sold more shares than have been issued so a collapse in the price can't happen. Never say never... At least one fund has, reportedly, cashed in multi-milliard losses.

Much of the conduct is remarkably similar to the bulletin boards and social media that saw that particular form of fraud take hold since the early days of IRC and similar services.

There's nothing new: to claim that it's possible because of "apps" is nonsense - we've had online day-trading for more than 20 years; we had IRC since the late 1980s.

Sadly, the regulators and Senate committees already seem to be looking at how to protect the existing form of markets rather than to look at the market manipulation aspects on both sides.

And there is contagion. In Malaysia, where there has been pressure on the makers of medical and other gloves, small investors have piled onto local fora to encourage small investors to pick up the slack. Last year, in March, Bursa Malaysia (which has long fought a losing battle to establish that name - it's still generally known as the KLSE or Kuala Lumpur Stock Exchange, banned short selling because the markets were in a muddle due, it concluded, to the effects of the coronavirus. My own apartment overlooks the KLSE and its car park has spent most of the last year mostly empty. However, the rules on short trading were relaxed, in a form modified from earlier rules, as from 1 January.

The dive in the price of glove manufacturers over the past few months has not, then, been to short selling. Some has been a response to the companies announcing that while they were permitted to operate, as essential businesses producing personal protective equipment, they couldn't ship stock because cardboard box manufacturers were closed. Also, the USA decided that at least one Malaysian glove manufacturer was using labour that did not meet US requirements. Another was found but denied that its workers were living in disgraceful conditions. Evidence came out that the vast majority of employees in some factories were migrants working for minimum wage - from which deductions were often made. Then, worst of all, the factories were discovered to be hotbeds of CoVid-19 leading to disruption in production. It is not surprising that prices drifted away - which is exactly the opposite of what might have been expected given that Malaysian companies dominate the production of medical gloves worldwide.

However, copycat action following that in relation to GameStock has spread across the world and to other stocks in the USA.

Now, there are several concerns. The first is merely hearsay - it has been reported that so-called hedge funds are now turning to the game to profit from the difficulties of competitors. I pass no comment save to report what I have seen elsewhere.

Where I am very concerned, because I am seeing patterns emerging that I have seen many times before, is that what some people are terming "a movement" has already been hijacked not by short sellers but by pump and dump fraudsters. Why? Because it is now impossible to tell the difference between fair opinion, false rumour and folly.

When RobinHood, the trading platform that halted trade in GameStock, took action, there was widespread condemnation but on any analysis, all it did was to put into effect a circuit breaker such as many stock exchanges implement. They did not have to take the SEC's nuclear option of suspending the company from the market. Trading was allowed after a period but on restricted terms. This, in my view, was a highly responsible course of action. And it was, in my view, made doubly necessary because RobinHood allows options trading on its platform. In short, it's a gambling platform for unsophisticated investors who may be playing with money they don't have. Short selling is, of course, a form of option.

Other trading apps, which have not seen the kind of activity that has been demonstrated on RobinHood, do not allow options trading. That, at least impliedly, indicates that options have been a feature of the rapid growth on RobinHood.

But it's not the only reason: show me a hashtag and I'll show you a lemming. While the trading platforms are supposed to be doing KYC, what they are not doing is any form of financial due diligence. It is beyond comprehension that everyone buying knows what they are doing. It is a certainty, in my view, that what is really happening is bandwaggoning (as happens with pump and dump) and the financial equivalent of betting on raindrops running down a window. It is as clear as it is possible to be without making a comprehensive survey that the vast majority are buying on a bull run with no concern for the company's financial position nor with an eye on a likely bursting of the bubble.

Which brings us back, once more, to the connection with pump and dump.

The ability to move the markets in such an extraordinary way is usually restricted to small companies - often penny shares in low volume markets. This is different. This is moving from Sunday afternoon amateur racing to Formula One, from making sandcastles to building the next "World's biggest tower."

Percentages of both price and volume are indicators of trouble: maybe exchanges need to add in two new measures - percentage of new shareholders and percentage growth of existing shareholders - and to collect and analyse that as close to instantly as possible - as they do with automated trading, and to be prepared to adopt circuit breakers in appropriate cases.

The risk to millions of shareholders around the world is obvious. Regulators and exchanges need to think: do we want the status quo or do we want to get ahead of this kind of thing becoming common.

Let's break the habit of a lifetime and take the second option, eh?

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