Random Thoughts – Randocity!

This is exactly what Wall Street and SEC regulators are now trying to determine. Let’s explore.

Reddit and GME

A subreddit named wallstreetbets has surfaced and it appears to be the location where a large group of people (on the order of 250k or more people) are congregating. The difficulty is, it seems that this subreddit is being used to coordinate efforts to manipulate the GameStop (GME) stock to affect the following:

1. Lose money for the hedge funds which are shorting this stock
2. Manipulate the price upward heavily to make money

The question remains, is this considered a form of market manipulation, collusion and/or conspiracy?

What is Collusion?

Investopedia states:

Collusion is a non-competitive, secret, and sometimes illegal agreement between rivals which attempts to disrupt the market’s equilibrium. The act of collusion involves people or companies which would typically compete against one another, but who conspire to work together to gain an unfair market advantage.

https://www.investopedia.com/terms/c/collusion.asp

 

The subreddit has, so far, been a public forum that anyone can join. It was private for only a very brief period of time on January 27th, 2020. As a result, it doesn’t fall under the ‘secret’ category.

The Oxford Dictionary defines collusion as:

secret or illegal cooperation or conspiracy, especially in order to cheat or deceive others.

Oxford English Dictionary

 

This is minimal in terms of what it says, but one thing it does clarify is that it doesn’t necessarily need to be ‘secret’.

Wikipedia defines collusion as:

Collusion is a deceitful agreement or secret cooperation between two or more parties to limit open competition by deceiving, misleading or defrauding others of their legal right. Collusion is not always considered illegal. It can be used to attain objectives forbidden by law; for example, by defrauding or gaining an unfair market advantage.

https://en.wikipedia.org/wiki/Collusion

 

Based on all of these definitions above, it does appear that “gathering a group of people together” to “gain an unfair market advantage” is probably enough to be considered collusion. As Wikipedia states, not all collusion is illegal. However, defrauding or gaining an unfair market advantage IS illegal.

Sticking It to the Man

While the wallstreetbets subreddit believes they are “sticking it to the billionaires”, they may, in fact, be sticking it to themselves. I see this situation as the virtual equivalent of the mob insurrection on Capitol Hill. While that situation wasn’t considered ‘collusion’, it does bear a lot of similarities to the Capitol Hill situation.

How? This GME reddit is 250k people all congregating to a achieve a common goal… to raise the price of the GME stock and, at the same time, stick it to the hedge fund investors who were heavily shorting the stock.

Stock Shorting

I’m going to take a little bit of a detour here to explain stock shorting. When a hedge fund shorts a stock, they are “hedging” that the stock’s price will go down. If the stock price does go down, the hedge fund makes money through borrowing, selling, then buying back the stock and then returning the stock to the lender. If the stock price goes up, however, the hedge fund must still buy and sell the stock at a loss (see below).

Stock shorts are actually buying and selling of borrowed stock. The hedge fund borrows a specified number of shares from a broker, then sells the stock immediately at the current price. For example, they could borrow 1 share and sell it at $100 market price. $100 goes into their brokerage account. When the price goes down to $50, they buy the stock back at that $50 price ($50 goes out of their brokerage account), then they return the stock to the lender and keep the $50 difference in their account. It’s a way for the hedge funds to make money without ever having to own that stock. Technically, you could do this with anything, such as a car, but the odds of a successfully shorting with a car are much lower.

Now that we understand how you can make money on shorts, let’s apply this to what the redditors are doing with GME and find out more about whether this is collusion, conspiracy or both. Someone in the wallstreetbets subreddit thread determined that GameStop, AMC Theaters, Bed Bath and Beyond and perhaps even other stocks were heavily shorted by hedge funds.

Hedge funds typically place a lot of stock shorts on companies that are on the verge of collapse. It makes sense. If a company is on the verge of going out of business, the odds of the stock dropping go up dramatically. Therefore, hedge funds heavily short the stock to make money. By ‘heavily’, they borrow as much stock as they can get their hands on. The more they borrow, they more they can make if the price drops.

What happens if the price goes up?

This is where shorting stock becomes a big, big problem. Should the price go up, the hedge fund is now responsible to pay for the loss. Let’s go back to the example above.

• Borrow 1 share and sell it for $100
• Market price goes up to $150
• Hedge fund must buy it for $150 and loses $50 in addition to the $100 they gained in the first sale.

Here is what the subreddit people are attempting to do by forcing these hedge funds to lose money. With stock shorts, there is no limit on the losses. As the stock price is driven ever higher, the hedge funds lose more and more money when their short position comes due and they are forced to buy it back at a loss. For example, if they borrowed and sold 1000 shares at $3 (1,000 * 3 = $3,000) and stock price goes up to $300 (1,000 * 300 = $300,000), when they are forced to buy it back because the lender wants it back, they are forced to pay $297,000 (in addition to the $3,000 they gained by selling it initially) to cover the cost of buying that stock at its current price. Because hedge funds buy these low priced “in danger” company’s stock, they bet that the stock price will go down. This proves that there is no cap on losses when shorting.

Because of the market forces with the wallstreetbets subreddit, this very large group of people have worked together (colluded) to ensure the price goes up to an extremely high price… one that forces the hedge fund to cash out and lose money (conspire) and also force the stock price higher so those who got in first can make a lot of money (market manipulation to an advantage).

Collusion, SEC and DOJ

Here’s where this situation becomes a problem in the same way as the Capitol Hill mob. Social media allows people to post anything they want and discuss whatever is on their mind. It’s very freeing, but it can also be equally damning. In this case, both the SEC regulators have a reason to go looking in much the same way as the DOJ went looking for Capitol Hill mob participants.

People participating in the wallstreetbets subreddit have left breadcrumbs to their person. Meaning, by writing into that thread, it gives the SEC regulators a way to track down who you are, where you are and whether you participated. For those not living in the United States, the DOJ might not be able to do much. However, for those who are in the United States, the DOJ can lay claim on you.

Collusion and conspiracy isn’t taken lightly. In this specific case, the wallstreetbets subreddit had the ability to push the GME stock from less than $10 to over $300 in about a week. That’s definitely market manipulation. If using this subreddit to tell everyone hold or sell or buy, that definitely manipulates the market and because all people are doing it at once can be seen as a form of collusion and market manipulation. Manipulating the market to gain an advantage is illegal. Doing it using collusion makes that collusion illegal. On top of that, attempting to force a bad outcome on someone else is considered conspiracy.

Penalties

Let’s understand now what the penalties for collusion are:

Most criminal antitrust prosecutions involve price fixing, bid rigging, or market division or allocation schemes. Each of these forms of collusion may be prosecuted criminally if they occurred, at least in part, within the past five years. Proving such a crime does not require us to show that the conspirators entered into a formal written or express agreement.

https://www.justice.gov/atr/price-fixing-bid-rigging-and-market-allocation-schemes

 

From the above DOJ’s web site, we can see that market division or allocation schemes may be prosecuted criminally. Further, the DOJ doesn’t have to show that the conspirators entered into an agreement. The word conspirators is the noun form of conspire. Also, because it states “Most” to open this paragraph, it means the DOJ is open to other forms, not just those listed.

Definition of conspire:

(of events or circumstances) seem to be working together to bring about a particular result, typically to someone’s detriment.

Oxford English Dictionary

 

In this case, the conspiracy is to bring down the hedge funds by forcing them to lose money. That definitely wreaks of conspiracy. At the same time, the conspirators gain a market advantage by driving up the price to make money.

Let’s go back to that DOJ article from above and describe what the penalties actually are:

Enacted in 1890, the Sherman Act is among our country’s most important and enduring pieces of economic legislation. The Sherman Act prohibits any agreement among competitors to fix prices, rig bids, or engage in other anticompetitive activity. Criminal prosecution of Sherman Act violations is the responsibility of the Antitrust Division of the United States Department of Justice.

Violation of the Sherman Act is a felony punishable by a fine of up to $10 million for corporations, and a fine of up to $350,000 or 3 years imprisonment (or both) for individuals, if the offense was committed before June 22, 2004. If the offense was committed on or after June 22, 2004, the maximum Sherman Act fine is $100 million for corporations and $1 million for individuals, and the maximum Sherman Act jail sentence is 10 years. Under some circumstances, the maximum potential fine may be increased above the Sherman Act maximums to twice the gain or loss involved.

https://www.justice.gov/atr/price-fixing-bid-rigging-and-market-allocation-schemes

 

That means that anyone who is found to have participated in this scheme, which should be readily apparent by reading comments on that subreddit, may be liable for $1 million for EACH violation and up to 10 years in prison. The fine could be well more than this if the gain from the market advantage ended up more than the fine itself.

Participation?

If you participated in this, don’t think that the Department of Justice can’t find you. They most certainly can. Think about all of the people they have found from the mob on Capitol Hill. The DOJ can subpoena reddit for the IP address used, then trace it back to your ISP also with a subpoena, then trace it back to the household where that IP resided at that moment in time, then send someone to the home. It’s only a matter of tracking the specific person who posted on reddit which can be easily done by reviewing the devices in the household (via warrant confiscation). Yes, they can confiscate your devices including your phone.

If the SEC regulators determine collusion and conspiracy were involved (and it looks more and more likely), then every individual who participated may find themselves in court, fined at least $1 million, have a felony on their record and may face up to 10 years in prison.

The hedge funds may or may not get their money back. The government could distribute the collected fines to the hedge funds to help offset their losses. However, the hedge funds may also be able to bring their own lawsuits against each individual separately should the SEC find foul play in this situation. That means that in addition to the DOJ’s own penalties, the hedge funds may also have legal recourse against every individual who participated.

Social Media

When participating in such actions, social media is not your friend. It holds onto and remembers everything you say and do. Because you volunteered that information to that social network, you gave up the right to the privacy of that data by posting it. That means that you brought the wrath down upon yourself by participating.

Investing and Collusion

Investing alone with no participation in the subreddit thread may not be seen as collusion by the SEC. People have the right to buy and sell stocks at any time. So long as they’re buying and selling stocks on their own and those sales cannot be traced back to participation in a wider collusive conspiratorial effort, then it shouldn’t be considered collusion or conspiracy. Though, you might still be called or visited if you bought into GME stock and have been determined to have visited reddit or Twitter or discussed anything about this situation.

However, those people who can be definitively traced to both bumping the stock price up AND participating in the subreddit to affect others to “do the same”, particularly with regards to conspiring against the hedge funds, these people may be brought up on charges of collusion, conspiracy and market manipulation.

If you’re reading this article and you’ve participated, deleting your posts may not protect you. If your post has lived for more than 24 hours on reddit or Twitter, it’s very likely on a backup that the DOJ can request. Deleting the post from the interface may not be enough to prevent the DOJ from finding your involvement.

Just Starting

The SEC investigation into collusion, conspiracy and market manipulation is just beginning. The SEC and DOJ will take their time before they start tracking down individuals and arresting them. Just as it has taken weeks to track people down to arrest the mob on Capitol Hill (which is still ongoing), it might take weeks or months to track down everyone involved in the GME market manipulation. Don’t think you’re safe if the DOJ hasn’t visited you yet. The DOJ isn’t under any time constraint to round up and charge individuals in any specific time frame. They will do it on their time, which could be months or even years later.

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