In the last few weeks, I have come across three different stories of three different kinds of equity-market manipulation. None of these are secret any more - two have been caught and punished and the third was done openly and probably legally. However, together they span a spectrum that shows the enormous challenge that investors and regulators face and how those challenges could get more and more intractable.
One of these stories is from India and the other two from the US. A couple of weeks ago, SEBI announced action against a TV anchor, one Hemant Ghai of the CNBC Awaaz channel, for manipulating stock prices. Ghai's modus operandi was simple and effective for one who had been given a platform from where he could address a large audience. He would buy stocks in the name of close relatives, jack up their prices by talking them up and then sell them at the higher levels. It's the classic 'pump and dump' racket that has been around since the beginning of markets. SEBI's investigation found plenty of evidence of what he was doing. Anyone who has a platform in the media from where he or she can influence the actions of short-term traders can do this with ease. The internal controls of the organisation and the vigilance of the regulator are all that can save investors.
The second case is that of Deutsche Bank being fined $130 million in America for something that's called 'spoofing' in that market. Here, a large institution like the bank would place a huge sell order for a stock somewhat below the market price. This would spread panic among those holding the stock and drive the price down but the bank would already have cancelled the order and would purchase some of the stock. It would then do the reverse, and drive prices up and then sell. It sounds simple and probably needs more than a little skill to execute but some traders in Deutsche Bank have been proven to have done this, hence the fine.
The third case is the most fascinating and is still in progression. This is the GameStop story that some of you may have heard of. GameStop is a US store chain that sells computer games. Given the shift to online game delivery and the general retreat from physical stores because of the virus, GameStop is considered to be a dying business and the stock was being heavily shorted, primarily by a hedge fund named Melvin Cap. Here the story gets weird. A group of people on the Reddit online community, specifically in the 'wallstreetbets' sub-reddit, figured out that Melvin was shorting the stock heavily and started an online campaign in their community to buy the stock and trap Melvin into a 'short squeeze'. 'wallstreetbets' has close to three million members and the campaign was wildly successful.
The GameStop stock is up about 800 per cent in 10 days and short-sellers are said to have lost $5 billion during this time. Melvin has had to borrow heavily and may have to liquidate itself. Some more hedge funds are also said to be on the line. If these funds have to liquidate other stocks heavily, it could trigger a larger decline. This is the quintessential story of social media colliding with traditional equity investing and trading. I have no idea how it will all end but we are in for some strange times. The power of social media to mobilise crowds is an unknown quantity in the investment markets and we are really only beginning to get a taste of it now.
By some reports, Melvin Capital (and perhaps other operators) left themselves open to this squeeze because they had done extreme naked shorting. Naked shorting is selling of stock that either does not exist, or cannot be borrowed or bought by the seller when the need arises. It seems that something like 140 per cent of the total stock of GameStop had been sold. So, if the reddit mob caught the short sellers with their pants down, they are teaching Wall Street a useful lesson.
In any case, the strange thing is that what the 'wallstreetbets' crowd is doing looks entirely legal. There's nothing wrong or even unethical about a short squeeze - it's practically the oldest trick in the traders' book even though the shape it has taken now is brand new. In the 80s, on the BSE, there was a famous bear operator named Manu Manek, who was fictionalised as Manu Mundra in the recent TV series on Harshad Mehta's life. The shorting and short squeezes of those days look like a quaint little game compared to what is happening now. It seems bizarre now but I remember that in the days of physical share certificates, stocks became easier to manipulate during the phase when a large number of certificates had been sent to the companies' registry for transfers and were therefore not in the markets.
But what happens when you can gather a mob of a million retail traders, each placing a small bet which they can afford to risk losing, which can together blow away a large institutional investor? The traditional regulatory structure in any market is not designed for this and I doubt if they can do anything to counter it. They can catch a crooked TV anchor or a bank but figuring out a million small retail traders acting in concert will be a hard problem to tackle.
If you are excited by all this, then hurry along to https://www.reddit.com/r/wallstreetbets/ and become a member. On the other hand, if you feel that investing means investing, where you buy some good, well-chosen stocks that you can hold for years and build wealth, then hurry along to https://www.valueresearchstocks.com/ and become a member.
The choice is yours.
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