Warm Southern Breeze

"… there is no such thing as nothing."

GameStop? GameOn? Face It: The United States Has Two Sets Of Rules

Posted by Warm Southern Breeze on Monday, February 1, 2021

Unless you’ve been in a cave in Tora Bora for the past week, or so, by now, you’ve probably heard of the Reddit/GameStop/Robinhood ordeal.

Here are the “players”:
• Vlad Tenev, CEO of the trading app Robinhood
• National Securities Clearing Corporation (NSCC)
• Day traders using the Robinhood app who also were participants in a Reddit group Wall Street Bets (properly as “r/wallstreetbets” – a forum called a “subreddit” on the popular website Reddit, which is a social platform and discussion group that also rates web content.)
• GameStop, a electronics/video game retailer

Robinhood (the company) became the target of widespread outrage last week after it stopped users from purchasing shares of GameStop, AMC, BlackBerry, and other so-called meme stocks that had significantly increased in price over the past week, which was fueled by WallStreetBets Reddit users.

The long and short of it (a most befitting pun, wouldn’t you say?) is that a no-fees stock brokrage company named Robinhood, which uses an app for a mobile device to effectuate trades, had ceased processing orders on a company named GameStop, which raised the hackles of some observers, including Elon Musk, and other news reporting groups.

The reason why Robinhood ceased activity on trades for GameStop, and other companies was because a loose-knit group of day trader investors in the subReddit forum WallStreetBets – which totals over 4 million strong, and describe themselves as “degenerates” – decided to take on the abuses of Wall Street power players, most typically as hedge funds.


Investopedia writes this about hedge funds:

Hedge funds are alternative investments using pooled funds that employ different strategies to earn active returns, or alpha, for their investors. Hedge funds may be aggressively managed or make use of derivatives and leverage in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark).

It is important to note that hedge funds are generally only accessible to accredited investors as they require less SEC regulations than other funds. One aspect that has set the hedge fund industry apart is the fact that hedge funds face less regulation than mutual funds and other investment vehicles.

Each hedge fund is constructed to take advantage of certain identifiable market opportunities. Hedge funds use different investment strategies and thus are often classified according to investment style. There is substantial diversity in risk attributes and investments among styles.

Legally, hedge funds are most often set up as private investment limited partnerships that are open to a limited number of accredited investors and require a large initial minimum investment. Investments in hedge funds are illiquid as they often require investors to keep their money in the fund for at least one year, a time known as the lock-up period. Withdrawals may also only happen at certain intervals such as quarterly or bi-annually.

A former writer and sociologist Alfred Winslow Jones’s company, A.W. Jones & Co. launched the first hedge fund in 1949. It was while writing an article about current investment trends for Fortune in 1948 that Jones was inspired to try his hand at managing money. He raised $100,000 (including $40,000 out of his own pocket) and set forth to try to minimize the risk in holding long-term stock positions by short selling other stocks. This investing innovation is now referred to as the classic long/short equities model. Jones also employed leverage to enhance returns.

In 1952, Jones altered the structure of his investment vehicle, converting it from a general partnership to a limited partnership and adding a 20% incentive fee as compensation for the managing partner. As the first money manager to combine short selling, the use of leverage shared risk through a partnership with other investors and a compensation system based on investment performance, Jones earned his place in investing history as the father of the hedge fund.

Hedge funds went on to dramatically outperform most mutual funds in the 1960s and gained further popularity when a 1966 article in Fortune highlighted an obscure investment that outperformed every mutual fund on the market by double-digit figures over the previous year and by high double-digits over the previous five years.

High-profile money managers deserted the traditional mutual fund industry in droves in the early 1990s, seeking fame and fortune as hedge fund managers. Unfortunately, history repeated itself in the late 1990s and into the early 2000s as a number of high-profile hedge funds, including Robertson’s, failed in spectacular fashion.

Since that era, the hedge fund industry has grown substantially. Today the hedge fund industry is massive—total assets under management in the industry are valued at more than $3.2 trillion according to the 2018 Preqin Global Hedge Fund Report. Based on statistics from research firm Barclays hedge, the total number of assets under management for hedge funds jumped by 2335% between 1997 and 2018.

The hedge funds had all “shorted” GameStop, which is well-known tactic to make money by the failure of a stock – “failure,” defined as a reduced price. In this case, Wall Street hedge fund managers had all “shorted” GameStop, and others, waiting for the price to drop before they sold the shares they were holding.

In a “short” sale (as it pertains to Wall Street trading), an entity “borrows” a stock from its owner, and holds it for a period of time, in anticipation that its price will drop enough so that they can then sell it (return its purchase price to the owner), and pocket the difference. It’s not illegal, and has been done for quite some time.

As you might imagine, by so doing (shorting), a stock can significantly, and adversely be affected.

But… a short sale can “go bad,” and that’s what the 4 million+ members of the subReddit group WallStreetBets did – ruin the day (or even longer) of many vulture capitalists hedge fund managers by driving up the price per share of GameStop.

GameStop, which has the ticker symbol GME, and is traded on the New York Stock Exchange (NYSE), has faced a decline in sales, 7 brokerages have issued twelve-month price objectives for GameStop’s shares which range from $3.50 to $33.00 per share. And on average, they expect GameStop’s per share stock price to be $11.93 in the next twelve months. That suggests that the stock has a possible downside of 96.3%.

For the last 5 years, GameStop stock price has been relatively stable, and only minimally changed, and has ranged from the lower $30 range to slightly over $4 per share. Their last dividend payment was March 14, 2019, which was $0.38 per share, which represented an increase from 2012 when it was $0.12 per share. Aside from the most recent price fluctuations, over its lifespan, GameStop’s price per share has ranged from $3.91 to $63.68 from February 2002 though August 2020.

At its highest, GameStop was valued at $483 per share on January 25, 2021. That’s where the Wall Street Bets Redditors (participants in Reddit) come into play. Their trading of the stock – specifically as purchases – drove up the stock to terrific heights, which in turn, caused problems with the hedge funds that held a short position on the stock – SIGNIFICANT problems.

In effect, the Redditors caused what’s called a “short squeeze” which is a market condition that occurs when investors who are betting against the stock (thinking it will fall in price) are forced to close out their position by buying the stock, which in turn, adds fuel to the fire.

So far this year, the Redditors have cost short-sellers over $19 billion in losses on GameStop alone. Much of Wall Street’s trades are now done by computer algorithm, which almost completely eliminates human involvement. So day traders, and others who may use apps to trade, are an anomaly in an otherwise almost-wholly automated market.

Melvin Capital, a roughly $12 billion hedge fund has suffered a more than 30% decline largely due to its short position in GameStop.

Maplelane Capital, another New York-based hedge fund, similarly faced a decline of about 30%, accoring to The Wall Street Journal’s report.

Andrew Left, a famed short-seller with Citron, also felt the heat from Reddit investors after he predicted last week that the stock would fall by 50%. He ultimately closed out his short in GameStop for a loss, as did Melvin Capital.

The epic short-squeeze in shares of GameStop last week focused attention upon the common practice of Payment For Order Flow by brokerage firms after Robinhood restricted trading in a handful of volatile stocks.

Payment For Order Flow (PFOF) is a practice in which brokerage firms are compensated to route their customers’ trading orders to certain market makers to execute the trades rather than directly to an exchange, which creates a potential conflict of interest between the brokerage and the customer.

The PFOF practice has enabled $0 commission trading, which was jump started by Robinhood’s launch in 2015, and was considered groundbreaking at the time when most investors had to pay upwards of $10 for every buy or sell order.

According to a SEC filing by Robinhood, they make a bulk of their money from the PFOF practice, and generated upwards of $100 million in revenue in the first quarter of 2020 from a number of market makers, including Citadel Securities.

Now, another free-trading brokerage firm is bucking the PFOF practice and shifting its business model to tipping.

In a blog post on Monday, Public.com said it would end the practice of selling its customers’ order flow to market makers, and would instead route them directly to exchanges like the Nasdaq and New York Stock Exchange.

The company issued a press release which stated in part that they would remove that inherent conflict of interest from their business model, “To align our incentives with those of our members, we will stop participating in the practice of PFOF and instead introduce a tipping feature on trades. Trades will remain commission-free and tipping is entirely optional.”

APEX, which is Public.com’s clearinghouse firm, was notified on January 30 of their intent to be taken off the “PFOF rails,” according to a blog post by the company, noting that all trade orders at the brokerage firm will be directly routed to exchanges for execution. The company said that transition away from PFOF and towards tipping could take a few weeks, but that “Transparency is a core pillar of building trust, and we think it’s important that we live up to our name. Direct routing to the exchanges is more expensive, and therefore we’re turning what used to be a revenue stream (PFOF) into a cost center and we’re optimistic that the difference will be offset by the optional tipping feature.”

Now, nearly every brokerage firm offers $0 commission trading.

But the PFOF practice is facing backlash from many, including venture capital investor Bill Gurley, who tweeted on Sunday, “If the SEC/government wants to ‘fix the plumbing’ the number one thing they should do is ban Payment for Order Flow.”

Gurley said that the practice “smells bad” and is already outlawed in the United Kingdom, and in Canada.


We’ve Seen This Before: The Current GameStop Drama Has Grassroots In The 2008 Housing Crash

by Liam O’Hara

• Main Street played by the rules, but Wall Street changed them mid-game.

• Retail traders on Reddit’s r/wallstreetbets had a simple buy-and-hold strategy for an overleveraged short position on GameStop held by Melvin Capital — until Wall Street shut it down.

• The game has been rigged all along and now it’s out in the open for all to see.

It’s been only a few days since news about the feud between Main Street and Wall Street entered the public’s awareness and the internet is already filled with more articles and stories about it than one could realistically hope to keep up with.

As a retail investor who bought a long position in GameStop (I am not a financial advisor, I just like the stock) only hours before its historic ascent, I only have my limited perspective and experience to offer. But, as a millennial who came of age during the subprime mortgage crisis of 2008 — and decided to study finance and accounting specifically because of it — I believe I have a somewhat unique, but relatable viewpoint.

For many retail traders, GameStop was a chance to get in on the ground floor of an arguably undervalued stock with the added benefit of watching the high and mighty of Wall Street squirm after being caught in an embarrassing position.

We’ve been through this type of thing before.

It is impossible to escape the fact that many of these small-time traders have vivid memories of the financial equivalent of an atomic bomb that Wall Street and government regulators dropped on the world in 2008. In the fallout of the housing crisis, hundreds of millions of people’s lives were upended.

Save for a few, like Lehman Brothers and Bear Stearns, many Wall Street banks came out ahead because of obscure and convoluted financial derivatives that left regular people holding the bag.

Unemployment skyrocketed, families’ houses were foreclosed on, pensions were decimated, and the middle class was suddenly forced to scrape by just to feed their families. To add insult to injury, the federal government awarded these same banks $700 billion dollars of taxpayer money because they were “too big to fail.”

I was only 18 years old then and didn’t understand much about what was happening, but seeing my family suffer motivated me to learn more, and I’ve learned much since then. In many ways I’ve been waiting 13 years to write about it.

I was raised in a working class family in the suburbs of middle America.

My parents both worked hard to provide the best upbringing and educationavailable to us. Both are college educated and have worked in a variety of jobs, with my mother eventually settling into a role working for the county, and my father working in mortgage lending until the subprime mortgage crisis when he was forced to look for work elsewhere which he found at a large manufacturing company.

As the dust of the crisis settled and the recession loomed on the horizon, my dad was eventually let go during one of the multiple rounds of layoffs by his employer. We were fortunate enough to keep our house, but had little more to spend since most of the jobs available at that point were minimum wage. Between meager wages, intermittent unemployment benefits, and trips to the food banks, we managed to make it through one of the deepest recessions in decades.

In October 2008, two months after I began my freshman year at university (only made possible by generous scholarships), the $700 billion Troubled Asset Relief Program, or TARP, was signed into law by Congress, buying up countless junk derivatives from the Wall Street institutions the American public had entrusted their working lives and retirements to.

None of what I was witnessing made any sense to me, so I decided to dedicate the next four years of my life to studying money.

I didn’t want to be caught unaware again. In fact, I wanted to be on the inside to potentially prevent things like this from happening.

I enrolled in the accounting and finance programs hoping to gain an insight into financial markets and how the economy operated overall. I was taught about efficient markets and the five forces of competition, business law and ethics, and the history of monetary theory and banking.

But what I was learning and what I was seeing on the news didn’t seem to line up. It seemed like there were other forces at work.

Additionally, I became disillusioned with institutional finance because of direct contact with some of the people intimately involved in it. I remember thinking that a particular adjunct professor whose day job was as a regional bank president could also do very well selling snake oil. Of course I met plenty of honest, hard working people during my time in school, but there was a distinctly distasteful aspect of what I was seeing overall. I was disturbed by it, but could never explain exactly why.

I graduated in 2013, but never set foot in the industry, opting to start my career in the military instead.

Fast forward to January 2021: The US is on the heels of one of the most hotly contested presidential elections in American history and trust in established institutions is at an all-time low. Income inequality continues to be a growing concern as evidenced by populist candidates on both sides of the political spectrum gaining mainstream acceptance. There is increasing anti-establishment sentiment engendered and compounded not only by years of stagnant wages and ever increasing costs, lack of access to affordable healthcare, education, and housing, but also by callous and duplicitous public health mandates that those in power have been routinely caught breaking over the last year.

It has become too obvious for even the most reclusive to ignore.

There are two sets of rules in this country — an unquestionable double standard.

The decades-long routing of the middle class and blatant displays of elitism by those in power have come to a head during the still ongoing GameStop short squeeze.

Millions of regular working Americans across all demographics found some solace in learning that they could potentially take on and beat Wall Street at their own game. What started as a bunch of motley internet retail traders YOLO-ing calls on a meme stock, became de facto class warfare. Melvin Capital became Wall Street in effigy. The common man, battered by years of exploitation and told to simply suck it up, had finally pinned their bully.

However, instead of taking their lumps and being told “better luck next time”, the elites pulled the rug out from under their competition mid-game. They would not allow themselves to be beat and would pull out every dirty trick they could imagine.

Melvin Capital founder Gabe Plotkin. image by Alex Flynn/Getty Images/Bloomberg

What we’ve witnessed over the past few days is both good and bad for the public at-large.

It is good in the sense that millions of everyday Americans have been disillusioned, just as I was in school over a decade ago. The curtain has been pulled back to reveal that the system is an oversized carnival game with all of the decks undeniably stacked in the favor of the select few at the top.

Over the years, well-meaning people on both sides of the aisle have petitioned Congress to further regulate the Wall Street casino, possibly not realizing just how cozy our government is with it. Further regulations have created higher barriers to entry that have squeezed out smaller banks and institutions. Dozens of large banks have been consolidated into only a handful of major players. The game has been rigged all along and now it’s out in the open for all to see. An uncomfortable truth is better than a comfortable lie.

This leads me to the bad.

It may be that Melvin, Citron, Citadel, Point72, Robinhood, and all the others involved so brazenly flaunted the trading halt of GameStop and the other meme stocks because they knew whatever penalties and fines they’d receive would be less severe than the public backlash.

They knew the potential regulatory repercussions would be preferable to playing by the rules and taking their losses. “Rules for thee, not for me.” The recent revelation that our newest Treasury Secretary, Janet Yellen, has taken over $800,000 in speaking fees from Citadel alone does not bode well for an unbiased assessment by our representatives in government.

Janet Yellen Speaking at Biden Lecturn December 2020.JPG

Treasury Secretary Janet Yellen. image by Leah Millis/Reuters

Do retail traders, and by extension the American people, have any advocates with teeth? If we are left holding the bag once again, are we willing to openly admit that we no longer have a government by and for the people, but rather by and for the banks and special interests?

Unfortunately, we’ve seen lately that those in power believe might makes right and they will wield it as they see fit. I believe this is yet another wake-up call America has so desperately needed. I am happy the truth has been made known.

To retail traders, I understand your frustration.

I am in the same position. We have seen the incredibly damaging effects that Wall Street and their friends in government have wreaked on the American public for years and it may be right to be indignant.

But we are at risk of perpetuating some of the worst of the human condition. Schadenfreude and the desire to see those on Wall Street suffer loss will not bring the satisfaction you may be looking for.

After all, we are all prone to error and selfishness and hope to be forgiven and to receive mercy.

I urge you, if only for your own well-being, to forgive those you feel wronged by in this situation. Yes, we should expect and even call for accountability because it is right, but only with the right motivation.

Finally, to those who are in positions of power, financial, governmental, and otherwise:

I urge you to wield your power cautiously as you would want others to exercise it over you. You may one day realize the deck that is now so carefully stacked in your favor may actually be a house of cards.

Liam O’Hara has a B.S. in finance and accounting and is a military veteran with experience as an entrepreneur, investigator, business manager, and retail trader and investor. After growing up in Colorado and Oklahoma, he now calls the Los Angeles Area home. You can connect with him on Linkedin and Instagram.


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