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Market Manipulation: A Lesson for Investors from the Robinhood & GameStop Dilemma

By: Sharif Small

Do you remember the story of Robin Hood? Ok, maybe you don’t remember the details; it’s been a while, but somewhere in your distant memory, you should at least remember the moral of this legend. The story of Robin Hood and his band of outlaws, known as the Merry Men, is a permanent part of popular folklore and is a constant reminder about some of the inequities we face throughout our lives. The essence of this tale is that Robin Hood was a noble thief who took taxes from the rich and redistributed this wealth to the poor people of England.

However, free-trading mobile app and broker, Robinhood, may have done quite the opposite, as the company came under heat in late January for intentionally depriving retail investors the ability to invest in GameStop and other stocks to protect institutional investments. This dilemma was initiated by WallStreetBets, a group of retail traders in a forum on Reddit, who formed a coalition to bid up the prices of stocks that were being heavily shorted by a few Hedge Funds. So, who was wrong?

Background of WallStreetBets-Driven Mania

The collaboration of these WallStreetBets traders led to a stock price rally for the brick-and-mortar video gamer, GameStop (GME). GME was not the only stock that was heavily traded by WallStreetBets and other social media platform users. Other heavily traded stocks included American Airlines, AMC Entertainment, Blackberry, Bed Bath & Beyond, Koss Corp, Naked Brand, Nokia and Tootsie Roll Industries. GME, however, rallied on a trading frenzy, fueled by a message board on the Reddit platform. On Monday, January 25th, 2021 the stock closed up approximately 18 per cent after multiple trading halts throughout the day. This movement began to raise eyebrows as GME was traded more than any other S&P 500 stock on that day.

The next day, Tesla’s CEO Elon Musk chimed in on the situation and tweeted, “Gamestonk” to his near 50 million Twitter followers. By Wednesday, GameStop was the talk of the town and hedge funds such as Melvin Capital, Citadel and Point 72 had to close out their short positions after realizing huge losses. By this time, other stocks, like AMC and Bed Bath & Beyond became fueled by the Reddit frenzy and started to soar as well. GME finally pulled back for the first time in the six-day period by around 44 per cent but closed the month of January with a massive 1625 per cent price gain.

Robinhood’s reaction to WallStreetBets-Driven Mania

As the trading frenzy worsened, Robinhood took the decision to adjust its margin requirements, making it more difficult for traders to use leverage to purchase the stocks. In an interview on CNBC, the CEO of Robinhood, Vlad Tenev, stated that the decision his company made was not to prevent investors from buying the stocks, but to limit the purchase of those stocks in order for the company to meet its large deposit requirement with the clearinghouse. The broker raised over US$1 billion overnight from investors and had to tap into credit lines to ensure those requirements were met.

However, it was the very act of restricting investors to purchase these stocks that led to Robinhood being accused of market manipulation, as it purposefully and knowingly removed GME from its investing platform amid an unprecedented stock rally thereby depriving retail investors the ability and right to invest in the open market. The company was also accused of protecting institutional investments at the expense of its retail clients when it halted other stocks such as Blackberry, Nokia and AMC Theaters.

What is Market Manipulation?

Market Manipulation can be defined as the act of influencing the behavior of a market, or artificially inflating or deflating the price of a security for personal gains. According to this definition, both WallStreetBets traders and Robinhood have conducted some degree of market manipulation.

A WallStreetBets user known as “Roaring Kitty,” whose real name is Keith Gill, is being sued for misrepresenting himself as an amateur investor and profited by artificially inflating the price of GME. He is accused of demonizing investment professionals by characterizing them as villains in order to motivate other traders.

As for Robinhood, it now faces roughly 90 lawsuits from investors after this situation, generally claiming that Robinhood’s actions were unlawful and unfair. Robinhood has the responsibility to treat all investors with equity and fairness and provide them with access to the financial markets under consistent rules and transparency. While it is unfair for a broker to “cherry pick” securities and limit investor’s options, the movements on these stocks were driving Robinhood’s clearinghouse deposit requirements to levels that were unsustainable for them.

What Investors can learn from this?

This brings to the forefront the importance of understanding the conditions under which you trade with your broker and evaluate their financial statements periodically. If a brokerage is offering a service for free, it is important to understand what funds their business and what rights exist for them as a broker and for you as a client.

This course of events is a reminder that market manipulation is a reality and can occur. The Jamaica Stock Exchange (JSE) has implemented robust market surveillance and monitoring systems that are in alignment with international standards to deter market manipulation and insider trading and we implore all investors, both institutional and retail, to remain vigilant and refrain from participating in any suspicious activities that could potentially be categorized as market manipulation.

Lastly, when looking to transact in a stock, always have a clear rationale guiding your entry and exit that aligns to your investment strategy.

Sources: https://www.cnbc.com/2021/01/30/gamestop-reddit-and-robinhood-a-full-recap-of-the-historic-retail-trading-mania-on-wall-street.html
https://www.cnbc.com/2021/02/17/robinhood-faces-lawsuits-after-gamestop-trading-halt.html

Sharif Small is a Research Analyst at Victoria Mutual Wealth Management with experience in the Investment Banking industry. Sharif was the First Quarter Winner of the Jamaica Stock Exchange Stock Market Research Competition 2019/20 and the 1st Runner up for the overall competition in 2017/18. He currently holds an MBA in General Management from the Mona School of Business. His other interests and hobbies include painting, cooking and reading.

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