How a Failing Video Game Store Exposed the Fragility of the Market

Abigail Heeter

Associate Editor

Loyola University Chicago School of Law, JD 2022

Failing video game company, Gamestop has broken the internet this week, but not for anything that they intended to do. Their stock has been the center of controversy after a group of internet investors banded together to outsmart hedge funds at their own game. By causing a hedge fund to short squeeze their investment in Gamestop offerings, they have brought to light the possible need for regulation in the market.

The decline of Gamestop

It is no secret that Gamestop has had a less than optimal past few years. The brick-and-mortar video game connoisseur has been following the footsteps of other storefronts that specialize in selling physical copies of media, such as Blockbuster. The uphill battle against the evolution of technology in the modern era makes the need for their services obsolete. For Gamestop, between the development of video games being available for purchase directly on the gaming console and the meme-worthy practice of buying back games for sometimes 1/60 of their original price, Gamestop has fallen out of favor with consumers. This decline has been reflected by their stock price in recent years. From 2013-2015 Gamestop enjoyed share prices consistently between $30-$60, with fluctuation in between. However, around 2016 the price of Gamestop stock began to drop and has continued to do so consistently over the last five years. In the last year, their stock price was never greater than $7, until the last couple of months.

The discovery of a gold mine

A community of (mostly) amateur investors that track the prices of stocks to watch on the infamous forum, r/wallstreetbets on Reddit, began to notice that near November the price of Gamestop stock began to rise, for the first time in a long time. While this was partially attributed to the recent release of new generation consoles by both Microsoft and Sony, the long-time giants in the video game industry, these investors expected there was another reason the stock price continued to rise even after release. Their hunch was proven correct when one Redditor, Keith Gill, posted an observation that a large hedge fund, Melvin Capital, had made a significant number of short trades on Gamestop. Many commenters on the thread made a pact to buy as many shares of Gamestop as they could as a statement to the hedge fund that Gamestop would not fail. This, in consequence, made the price rise causing the hedge fund to short squeeze when they had already lost over 13 billion dollars in the investment. Since then, this massive sale has caused the value of the stock to rise even more and the hedge fund has had to declare bankruptcy. The Gamestop stock price hit a high at $469 on January 28th, higher than the company had seen even at the height of its popularity.

The aftermath

The aftermath of this plot has caused a divide amongst many. Some feel bad for the investors who have lost millions but also, the majority sees this as proof that only the rich are allowed to get richer. Seeing their success that the public is capable of manipulating stock prices, not just hedge funds, the same Reddit community began to initiate the same process targeting other low-priced offerings that had garnered the attention of hedge funds such as AMC, Blackberry, Express, and Bed Bath and Beyond. After reports of this became viral Robinhood, a popular trading platform for amateur investors, made headlines by removing the ability to trade on these securities on their app. This left those who had invested with the hopes of selling at a high profit infuriated and feeling as though they lost control of their investment decisions. The legality of this decision has been questioned by many and a class action lawsuit was filed on January 28th in the Southern District of New York for breach of contract, implied covenant of good faith and fair dealing, fiduciary duty, and negligence. Additionally, a complaint was filed in the U.S. District Court of the Northern District of Illinois, asserting similar claims. Others speculate that it is possible that Robinhood breached Financial Industry Regulatory Authority (FINRA) regulations, such as rule 5310.1, which mandates that every broker-dealer “must make every effort to execute a marketable customer order that is received promptly and fully.” However, an attorney specializing in securities fraud recently weighed in on the matter and said that when reviewing Robinhood’s sign up agreement that they reserved the right to block or restrict trades at any time.

Concerns of market depletion

The CEO of Robinhood has asserted that they did not stop trades of these volatile offerings due to pressure from institutional investors, but many are skeptical that stopping these trades was done with the sole purpose of protecting hedge funds. However, what many people are not talking about is how other big-name brokerages, such as TD Ameritrade, also halted trading on these securities during this time and the concern of these firms may justify doing so. Because of the volatility of this one offering, the panic following was responsible for a drop in the S&P 500 of 2.5%, its worst day in almost four months. While many think that this is a joke on Wall Street, the risk that the market crashes and the government has to bail out various institutional investors is realistic. Many investors are yet to see their other securities that were not even the target of the manipulation return to their prices that they were at prior to these events. Additionally, because of the large volume of trades of Gamestop stock were occurring all at once, Robinhood feared that they would face liability because their exposure was greater than their capital, also influencing their decision to halt trading on the security.

There is also discussion as to the possible liability of the Redditors who conducted this scheme. Section 9(e) of the Securities Exchange Act of 1934 mandates that it is illegal to buy or sell stock for the sole purpose of manipulating its price. However, there is a scienter requirement to this statute and there has not been much litigation surrounding it, making the possibility of its enforcement difficult.

While the Redditor investors responsible for this stunt have proven the power of the layman investor, they also shown the increased need for regulation of securities. The area of securities regulation is one of the many areas that has fallen behind the advancement of technology in the market. Whether you are on the side that believes that amateur investors shouldn’t have been able to collude in this way to manipulate the price or the side that believes that this is what hedge funds are in the business of doing and brokerages are only protecting institutional investors, there is plenty of room for increased regulation.