IN-DEPTH: Game stopped

The trading frenzy involved in the GameStop short squeeze in early January birthed multiple investigations, hearings, and a debate within the U.S. Securities and Exchange Commission (SEC) regarding short selling disclosure regulation.

GameStop saw a sudden surge in its share price, from around $20 to over $400 at its highest, which forced hedge funds that had bet against the stock to either put up more margin or buy the stock to close out their positions. In doing so, they only sent the stock price higher. Hedge funds like Melvin Capital and Citron Research reportedly lost billions of dollars in the short squeeze, while brokerage firm Robinhood came under fire for halting trading during the midst of the volatility.

House lawmakers met in mid-February to examine the GameStop saga and discuss the lack of short selling data, according to a memorandum issued before the hearing. The memo also noted that the regulatory body had failed to fulfil responsibilities under the 2010 Dodd-Frank mandate that ordered the SEC to impose rules to diminish the opaqueness surrounding the mechanics of short bets.

SEC insight

Historically, the SEC has refrained from setting rules around the disclosure of short selling. Some officials have been concerned that reputable investors disclosing short positions could prompt crowding into those trades, which would raise the cost of borrowing the stock. There is also some investor sentiment that too much transparency around short selling could put a damper on the activity, taking away one of the market’s potentially most important share value moderators.

Despite this, stock market index Nasdaq has decided greater disclosure is the way to go. Last month, Nasdaq endorsed the requirement for institutional investors to report on bearish bets when filing with the SEC to help public companies engage with investors that may be attempting to drive down stock prices. While that information may not have prevented the squeeze from happening in GameStop’s stock, it would have given the SEC insight into the size of positions and how many funds accounted for the short interest.

Republican SEC Commissioner Hester Peirce agreed with the sentiment that short sellers provide a useful service to the market when she appeared on CNBC in February, but noted that the regulator, now under new Democrat leadership, could consider using its authority to adjust short seller limitations and provide greater transparency.

Meritocratic market

Not everybody thinks the SEC should do so, though. Speaking to Activist Insight Shorts Quintessential Capital Management’s Gabriel Grego said he believes the market should be a meritocracy that polices itself without rules imposed upon it. Grego explained that within a meritocratic system, there is an incentive to sniff out unethical, fraudulent, or criminal behavior that no market regulator could keep tabs on within every single company.

Bringing it back to GameStop, Grego used the squeeze as an example of the meritocracy he admires. There were reckless investors on both the long and the short side, he notes, while those that timed their bets cleverly made money. “That’s the best regulation,” Grego told Activist Insight Shorts. “If you’re right, you make money and if you’re wrong you lose money and will be more careful next time.”

Some investors do not see an issue with short sellers’ involvement in the GameStop saga at all. Muddy Waters Research founder Carson Block told Activist Insight Shorts that he does not understand what problem the SEC is trying to address. With the fallout of the situation taking money from short sellers and putting it into the pockets of retail investors, Block explained his belief that short selling is misunderstood. “Politicians feel a compulsion to be seen to be doing something, but I don’t think most of them could identify the problem with GameStop,” Block added. “If someone can elucidate the problem short selling is causing then we can talk.”