Wall Street vs Reddit - Could the Gamestop Stock Situation Lead to a Wave of Legal Consequences?

By Tanya Kriplani Manglani


2020 was a year filled with unexpected, unprecedented turns. 2021, so far, has been no different; who, after all, could have predicted a showdown between Wallstreet and Redditors over GameStop stock?


WHAT HAPPENED?

Whilst this is an evolving, complex situation with many different facets and factors at play. It started, however, due to a Reddit user noticing how a lot of Wallstreet hedge funds were shorting GameStop stock ($GME).


Shorting, also known as short selling, is a trading strategy in the investment world dependent on the speculated belief that any given stock is going to fall in value. When an investor believes that the price of a stock is going to fall, they can borrow shares of said stock and then sell them immediately; if their predictions are correct, the price of the stock will decrease in due course. When this happens, the investor can buy back the shares they borrowed at a lower price than the one they sold at and return these to their lender – the difference between the price they initially sold the borrowed shares at and the price they were able to buy them back for, as such, becomes profit. There is also the potential for the stock’s value to fall to zero; in this case, the investor no longer has to return their borrowed shares to their lender as these no longer exist and can instead pocket the whole amount they sold their borrowed shares at.


Of course, the risk with this strategy is that it relies on the speculated decrease in value of a stock; there always remains a chance that the stock will increase in value, which could potentially lead to infinite losses for investors, who would be forced to buy back the shares they owe to lenders at higher prices than the one they sold at.


In this particular case, many hedge funds, such as Melvin Capital who have made headlines over this situation, had dedicated incredibly large amounts of money in shorting $GME, clearly on the assumption that its value would decrease, which would allow them to turn huge profits. A Redditor and investor with the username DeepF****ingValue noticed these hedge funds’ behaviour and posted about it on the subreddit WallStreetBets, along with an incredibly detailed theory outlining a plethora of reasons explaining how he disagreed with these hedge funds’ prediction that $GME was going to fall in value. In fact, this user was so certain that $GME was not only not going to fall in value, but on the contrary had the potential to exponentially increase in value, that he poured $50,000 into acquiring shares of this stock.


Over time, his theory gained more and more traction amongst the investing community on Reddit, compelling more and more people to invest in the stock, which led to small increases in its price, which to hedge funds, most likely, seemed negligible. In the summer of 2020, $GME’s price was fluctuating between USD4 and USD5. At the beginning of this year, it was circling the USD20 figure. On the 27th of January, the culmination of the WallStreetBets community’s efforts made $GME’s price to shoot to over USD300, turning user DeepF***ingValue’s initial $50K investment into well over $20 million.


WHAT ARE THE LEGAL IMPLICATIONS?

Again, given the fact that this is a complicated situation involving a number of elements and is still unfolding, it is hard to compile an exhaustive list of legal implications that it could have. Wallstreet hedge funds, faced with losses that could potentially bankrupt some of them, for example, have been calling for an investigation to be conducted, alleging the relevant Reddit community’s actions to be market manipulation. In response, a lot of people have instead turned the finger towards these hedge funds, alleging that investing strategies like shorting themselves are a form of market manipulation but are allowed due to the fact that the stock market is largely unregulated, something which again, is attributed to these hedge funds’ lobbying efforts. This, of course, could lead to the federal legislation and treatment of the stock market to be rethought.


A legal consequence that has already come of this situation, however, is that multiple lawsuits against trading apps, both at the individual and class-action level, have been launched.


This is because the overwhelmingly large majority of investors who were either part of the WallStreetBets community, or involved themselves financially after the situation garnered so much attention due to the steep incline in $GME’s value acquired their shares not through stock brokerages, but through apps like Robinhood, which brands itself as “democratizing finance for all”. After the price of $GME shot up and started to become the subject of headlines and social media trends alike, however, pretty much all of these apps restricted the trading of the stock, allowing users to only maintain or sell their shares, without the possibility of buying more.


This has led to a wave of legal action against Robinhood and a number of similar apps, such as Trading212 which is popular in the UK, on various grounds; dissatisfied users are bringing everything from questions about the legality of these apps’ decision to restrict the trade of $GME so much to claims of losses due to the decision to courts. Class action lawsuits are being filed on the allegation that apps “purposefully, willfully, and knowingly removing the stock ‘GME’ from its trading platform in the midst of an unprecedented stock rise, thereby deprived [sic] retail investors of the ability to invest in the open-market and manipulating the open-market.”


Whether or not these claims will lead to successful outcomes for the plaintiffs has been brought under question by experts; what is undeniable, however, is that the legal community will be the one most tasked with dealing with the aftermath of this situation.

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