The US markets functioned well during January’s GameStop volatility, while short-selling was not the main cause of the unprecedented rise in the “meme stock” according to a long-awaited Securities and Exchange Commission (SEC) report.
The report published on Monday provides a postmortem into how amateur traders using commission-free retail brokerages drove shares in GameStop and other popular meme stocks to extreme highs, squeezing hedge funds that had bet against them.
Amid the intense volatility, several brokerages restricted trading in the affected stocks, curbing the rally, infuriating retail traders, sparking outrage from policymakers, and leading to a congressional hearing.
Despite the extraordinary series of events, the Commission concluded that the basic plumbing of the market remained “sound,” an SEC official said.
Massive short squeeze
A key narrative of the GameStop incident is that an army of retail traders set off an enormous short squeeze by driving up stocks that hedge funds were betting against. They did so by flooding the market with purchase orders, forcing the hedge funds to also have to buy shares to cover their shorts, pushing GameStop even higher.
Short-sellers borrow shares from brokers and then sell them into the market, with the agreement that they will buy the shares back and return them to the lender at a later date. If the price has fallen, the short seller can buy the shares back at a lower price than they paid for them, locking in a profit.
When a heavily shorted stock soars, short-sellers are forced to buy the shares back at higher prices to close out their positions, pushing the stock even higher – known as a “short squeeze.”
Yet the SEC said that story is not entirely backed up by the evidence. GameStop purchases by those covering shorts were “a small fraction of overall buy volume” and the company’s share price remained high even after the direct effects of such trades should have waned, according to the regulator.
Social media manipulation and pressure
The report does not address several outstanding questions, including whether bad actors manipulated social media to whip up positive sentiment in GameStop, or whether hedge funds tried to pressure retail brokers to restrict trading in GameStop, something that all parties concerned have denied.
Perhaps the biggest victim of bullish investors banding together on Reddit and other social media platforms to push GameStop higher was Gabe Plotkin’s Melvin Capital. The hedge fund had a big short on GameStop and its January losses led to the firm getting a $2bn cash infusion from Ken Griffin’s Citadel and roughly $750m from Steve Cohen’s Point72 Capital Management. Still, the SEC said the hedge funds mostly emerged from the situation unscathed.
“Staff believes that hedge funds broadly were not significantly affected by investments in GME and other meme stocks,” the regulator said in its report. “Staff did not observe that any advisers to private funds and registered funds experienced liquidity issues or difficulties with counterparties.”
Then there was the hotly debated topic of whether hedge funds pushed Robinhood to restrict customers from adding to their GameStop positions in late January as the stock was surging.
Robinhood has repeatedly argued that it halted buy orders due to demands from its clearinghouse that it posted more capital to deal with the heightened risk. The issue was a top focus when Robinhood Chief Executive Officer Vlad Tenev faced a barrage of questions from lawmakers during a February House of Representatives hearing.
In its report, the SEC did note that clearing houses demanded billions of dollars in additional margin from member firms and that brokers temporarily barred clients from purchasing additional shares.
The agency’s chair Gary Gensler told Congress earlier this year that the agency would address other issues raised by the saga, including short-selling disclosures, game-like trading prompts used by brokers, and brokers’ practice of sending customer orders to wholesale market makers for a fee.
“January’s events gave us an opportunity to consider how we can further our efforts to make the equity markets as fair, orderly, and efficient as possible,” Gensler said in statement issued on Monday.