GameStop Stock Manipulations, with Ethical Questions about Finance
April 7, 2021 via Zoom
Gordon Haist, Moderator
Paul Weismantel, Presenter
The moderator for this session was Gordon Haist and the presenter was Paul Weismantel. A more descriptive title was offered by Betsy Doughtie: “GameStop Stock Manipulations, with Ethical Questions about Finance.”
Haist introduced Weismantel, who a year ago gave us a presentation on social media disruptive innovators. We described him then as a “deep level” digital electronics and social media expert. For over 35 years Paul was a product manager in major multi-national companies and managed growing businesses through technology and market transformations. Now retired, he has grown curious about the GameStop phenomenon and rightly sensed that it would not be a unique event. Other market manipulations of a similar sort could follow.
The program began with Haist reading Neil Funnell’s three questions, which framed the discussion:
What is the purpose of the financial markets?
Do they serve the common good of society?
What is the value-added of trading stocks in the aftermarket?
Haist followed this by reading Paul’s initial responses, on which he developed his presentation:
Financial tools that support trading rather than investing do produce liquidity, but the question is whether this benefit outweighs the damage they can cause.
To protect individual investors, is transparency sufficient, or should short sales and options be limited?
If fairness requires full transparency in large firm and power trader positions, are individual investors prepared to have their trades and investments become public?
Following the revelations of FaceBook abuse, does Reddit warrant congressional investigation for its role in amplifying and socially organizing questionable behavior (as its role in GameStop clearly suggests)?
Paul then gave his presentation. He began by presenting the traditional model for trading through a broker, noting that the broker has several choices and is expected to follow the SEC norm to exercise the best execution.
He then described the GameStop “players”:
hedge funds, etc., which built up huge “short” position share coverages, brokers and market makers playing both the “short” and “long” sides of trades (short=holding stocks you do not own for speculative sales; long=investor-owned stocks the sale of which is controlled by the owner);
No-fee brokerage houses (e.g., Robinhood) that offer access to all traders;
high frequency traders (e.g. Citadel) that take trade orders from smaller brokers;
Reddit’s use of “Wall Street Bets,” a social media group, to drive a buy option frenzy to raise GameStop’s stock price and punish “short” positions; and
the NYSE which functioned as a stock listing exchange and gave no regard to possible manipulations.
Paul compared GameStop trading to Blockbuster, which functioned similarly as a retail operation in a digital world. In 2019-2020 its stock price was pulled down by the rise of short sales of its stock. Betting against the future, hedge funds borrowed GameStop short stocks from brokerages and market makers. Paul pointed out that brokerages and market makers had the responsibility of not allowing an excess of 100% of short stocks of a company, but on January 30 Wall Street Bets announced that GameStop had 140% shorts vs. shares outstanding. Since long shares can only total 100%, it appears that brokerages and market makers held back 40% of long shares and gained “merrily,” as did Reddit traders, at the expense of hedge funds. Hedge funds had built up a huge short position covering (95% of outstanding shares by April 2020, as contrasted with 20% short shares, which normally is considered as extremely high).
Paul discussed the ethical questions that result from the GameStop trading frenzy.
Since emotions can drive market actions to excess, should the short sales of any one stock be limited to less than 100%?
Should the SEC require market powers that take active positions “in the dark” to be more transparent?
Should the SEC or congress protect novice traders by limiting public access of no-fee brokers to complex trades?
Do wholesaler “payments for order flow” to brokers constitute a conflict of interest given the SEC requirement that brokers should choose the “best execution of client orders”? Is the current one-time notice sufficient for transparency?
Reddit’s use of its social media user group “Wall Street Bets” to share a turn-around story on GameStop to drive a buy option frenzy raises questions about the group’s leadership and rules. Should Reddit establish some control over the group?
The wholesaler raised the capital margin Robinhood deposited to cover all the buy options. Was it ethical for Robinhood to stop buying options in order to protect their own finances? As their position grew, what should have been their obligation for transparency?
What role should the NYSE have in policing the “behind the curtain” behavior of market makers and wholesalers?
In answer to Bill’s question, who are the market makers, Paul mentioned Goldman Sachs as one example.
Neil questioned if there should be a tax on trades. Perhaps a transaction charge. Paul questioned how this could be done, and on what value would you tax?
There was quite a discussion about transparency.
Bill felt it is in the public’s interest to have transparency on all transactions. Paul countered that this would most likely cause irreparable harm in some transactions, but the idea is still worth discussing. Bill said transparency protects against dishonesty.
Paul said that trust within individuals running large corporations led to the 2008 losses. Paul likes transparency all the time. Gordon asks if this includes transparency with assets and transparency with speculation? Paul does not know.
Hank asked if privacy is the opposite of transparency.
Bill then asked if markets can provide liquidity and avoid the gambling aspect of markets.
Paul said protections were needed, but how to identify who needs protection. Day traders make a living on the trades-do they need protection? Taking away options is not a good idea.
Hank asked if liquidity is the outcome or the purpose of the stock exchange?
Paul said the stock exchange was created to provide liquidity but now lives for preservation of liquidity alone.
Disclosure? When Warren Buffet purchased Apple stock transparency was required, yet it was done in such a way to protect Warren Buffet’s privacy. Neil said the same was true on the sale side.
Gordon then raised one of the key questions of the discussion: Do the financial markets serve the common good? Neil answered that trading such as GameStop doesn’t serve the community and does nothing for the economy. Gordon replied “what is the common good? Is it for the good of the markets themselves”?
Hank brought up the question of Wall Street versus Main Street and said that 60% of Americans are impacted by the stock market in some form. For many it is tied to their 401K, pensions, or other investment products such as insurance products. Many small investors have no idea of how it works.
Paul said that often financial companies are not required to act in the best interest of their clients. He added that for those owning a 401K there are few options for choosing investments. Investors should always ask their broker if he is acting in a fiduciary manner for the client. Bill added the question of commissions versus fees, and that we don’t always know how the broker is compensated. Paul said all brokers should have business cards that read “I am a fiduciary broker”. A few years back congress tried to pass regulations of fiduciary brokers but the bill went nowhere.
Gordon wrapped up the meeting with the statement: Transparency versus privacy in the financial world is a critical question.