Misconceptions related to the GME debacle

1. “It’s illegal to have short interest above 100% of float.” While the SEC has regulations that prevent “naked shorting”, it is possible to get to >100% short interest without naked shorting.
2. “Melvin Capital still holds a short position in GME.” While Melvin Capital stated publicly that they closed their short position, many people online have claimed that Melvin Capital lied about their position. While we cannot definitively know their position, lying about their position in hopes of the stock declining would be considered securities fraud. No proof of Melvin Capital lying has surfaced at this time.
3. “Citadel is short GME.” Large institutional investors are required by law to disclose their positions once a quarter through a 13-F filing to the SEC. As of their November 16 filing, Citadel Advisors — the parent of other Citadel funds such as Wellington and Global Equities — was long 111,805 shares in GME. Allegations seem to come from Justin Kan’s now-deleted Tweet, but no evidence has been provided for these allegations.
4. “Short interest in GME is still above 100%.” A website showing the top shorted stocks has been making rounds online as evidence that GME short interest is still over 100%. However, it’s worth noting that FINRA regulations only require short interest to be reported twice a month. While some firms may release more frequent results, it’s not clear how up to date this calculation is. And while it’s totally possible for the interest to be above 100% still, this is largely speculation.
5. “Melvin Capital is/was short ~140% of the float for GME.” While it is true that GME’s short interest was around 140% of the float, it’s important to note that Melvin Capital was not the only firm short GME. While 13-F filings don’t disclose net short positions, it’s incredibly unlikely that Melvin Capital was the only fund with a large short position in GME. We know that Melvin Capital lost 30% on a $12.5 billion portfolio — or $3.75 billion. Based on S3 Research’s findings, short sellers lost over $5 billion on GME.
6. “Citadel and Citadel Securities are the same firm.” In the discussion of possible conflicts of interest, many have conflated “Citadel” and “Citadel Securities.” While the firms are very connected — having been founded by Ken Griffin and sharing certain resources — they are in fact two distinct businesses separated by a “Chinese Wall”. Citadel consists of a hedge fund, and is also the organization that bailed out Melvin Capital. Citadel Securities, on the other hand, is a market maker that is associated with handling 40% of Robinhood’s order flow. While it’s not crazy to expect some amount of interaction between the two firms, it’s worth noting that Citadel Securities is headed by a different CEO. Further, this “Chinese Wall” is enforced by the SEC in firms that include both a hedge fund and market making arm. Finally, it’s worth noting that as a market maker, Citadel Securities stands to make profit off of increased volume and volatility in GME, rather than the reverse; thus, it would be in the best interest of Citadel Securities to have GME continue to be traded on retail platforms.
7. “Citadel/the White House told Robinhood to block buying GME.” This stems from a Reddit post claiming to be a Robinhood employee. The author never substantiated their claims (even at the request of the subreddit’s moderators, who subsequently locked the post). The author has now been suspended from Reddit for unclear reasons. However, even if we choose to believe this post there are still several issues. Firstly, the author claimed to overhear the conversation, but Robinhood is based in California which was still enforcing its lockdowns until early this week. Thus, it’s very likely that Robinhood was still “work from home.” Luckily, a much simpler explanation already exists: the DTCC (the central body in charge of settling trades in the US) raised collateral requirements for trades due to high volatility and Robinhood (as well as other brokerages) could not afford the new requirements. As a result, Robinhood rushed to raise money via credit lines in order to allow enabling buys again.
8. “The White House press secretary’s husband works at Citadel.” A number of users online have suggested that the White House press secretary, Jen Psaki, is married to a portfolio manager at Citadel named Jeff Psaki. Despite the similar names, she is actually married to another politician named Gregory Mecher.
9. “Payment for order flow = front-running.” Michael Lewis’ Flash Boys brought the practice of front-running to national attention. In his book, he discusses the high-frequency trading (HFT) industry extensively and ties it into the front-running practice, suggesting that much of HFT involves using user’s orders to guess how a stock will move and profit off of it. In effect, front-running would involve a firm seeing a huge order for, say, GME and then purposely buying GME before, knowing that the stock will rise when the larger order executes. This practice has been illegal in the US since the 1980s, though courts have found a number of violations. On the other hand, payment for order flow (PFOF) is a legal practice in which a brokerage (like Robinhood or Fidelity) offers a market maker (like Citadel Securities or Virtu) the chance to match a trade before it’s routed to the exchange (usually NYSE or Nasdaq). This is practiced around the board, and SEC regulations require that the market maker always match or beat the national best bid/offer (NBBO). That is, if Robinhood sells your order to Citadel, then the worst price you can possibly get is the price on Nasdaq/NYSE. Note that PFOF does not involve selling any other information (including your current positions). While poor matching in PFOF has led to fines, the claim that PFOF = front-running is completely unfounded and no evidence exists in its favor.
10. “Robinhood could’ve just blocked all GME trading.” While this sentiment has been expressed a lot online, Robinhood’s decision to allow closing positions made sense. Robinhood has been caught with their pants down during high volatility periods where users couldn’t close their positions. Users rightfully complained about losses incurred by being unable to sell stocks before they plummeted. Some have claimed that Robinhood’s reasoning for only allowing selling and not buying was meant to stop GME’s rise. Based on their statements, the intention here seemed to be on “closing positions” rather than “selling” here, though we can’t know for sure since Robinhood does not allow shorting on its platform. However, other platforms that allow shorting like Interactive Brokers adopted similar restrictions. Although I can’t find any specifics on how DTCC calculates the requirements online, it would make sense to only request collateral when opening new positions.
11. “All hedge funds/Wall Street are suffering from this.” There is this sentiment online of “us vs. them” or “WSB vs. Wall Street.” People participating in the buying of GME seem to believe that their impact on Wall Street is immense. This could not be further from the truth. On a typical day, the US equities market moves about ±1%. With a total market cap of $50 trillion, the market sees fluctuations of approximately $500 billion on an average day (and about triple that on 10% of days). Over the past week, GME has fluctuated less than $20 billion. Make no mistake, this type of fluctuation is unprecedented and worth discussing for many in the industry. At the same time, most of Wall Street is not exposed to GME and has seen no impact from this. The amount of fluctuations in GME (and other low-cap stocks) will hardly make a dent in the overall market. Beyond that, many institutional investors are actually making money off of GME right now (even more so than those shorting it!).
12. “What WSB did was 100% legal.” As with many of the misconceptions above, the answer is closer to “we don’t know.” The activity of WallStreetBets is controversial at best, and in many ways resembles traditional pump-and-dump scams. As in a traditional pump-and-dump, people with large positions in GME (a small-cap stock) convinced others to buy into the hype. This also often involved misleading information (such as incorrectly citing the short interest, exaggerating the valuation of GameStop, and trying to convince people that GME was bound to hit insane price targets). While WSB regulars may have been aware of what parts were meant to be misleading, many retail investors have been duped into thinking that GME performance was a sure fact. In reality, most WSB users probably agree that there is no reason a company like GME should be valued upwards of $20 billion despite its massive losses. The interesting part of this case — and what many interpreted to be the financial industry scared of this event — was the distributed nature of the pump-and-dump. While traditional scams could be easily prosecuted by being tied to a single party, it’s unclear how the SEC will treat a distributed push to raise the stock’s value. Most in the financial industry would agree that the real victims here will be retail investors who did not understand the risks of their trades, but there is fear that a lack of prosecution would allow this behavior to happen again.
13. “I am entitled to money by investing in GME.” Many have argued that Robinhood’s conduct caused losses in their investments. To me, this indicates that people believed that their GME holdings were meant to go up, and have only dropped because of Robinhood’s interference. However, it’s quite obvious that GME was not going to go up forever and that the high stock price was influenced by artificially pumping the price up (note: I am not claiming that this was illegal). Without any inherent reason for the price to go up so quickly, the price is certain to eventually go down. In all likelihood, most GME-holders will not sell their shares until the price drops far lower than the current price and triggers panic selling. I suspect that the SEC will not attempt to treat Robinhood’s behavior as causing losses here because it will only cause lost potential gains, and there is no proof that those potential gains would have ever happened. Instead, it can nearly be guaranteed that losses will eventually occur.
14. “The facts are already in.” We are still very early in this debacle. As WSB users have pointed out, the short squeeze probably hasn’t happened (or at least ended) yet. And, obviously, most retail traders haven’t closed their positions in GME either. While we’re watching panic buying right now, it’s a guarantee that we’ll see the reverse some time in the future. As it stands, GME is not poised to grow to a $20 billion valuation and that will be reflected in the company’s future earnings. As GME-holders gradually come to this conclusion or decide that the hype has died down, the stock price is bound to fall. Unfortunately, many people purchased the stock at incredibly high prices and are unlikely to make it out unscathed. I suspect that the reporting we see in a few weeks will not reflect the same information we see today.

I’m sure that many readers will wonder why I wrote this. Firstly, it’s worth disclosing that I have (in the past) been employed in the financial industry. With that said, I have found the majority of the discourse on this issue to be completely nonsensical. In my opinion, there are legitimate arguments to be made about issues in the financial industry and I do think that firms like Melvin Capital deserve to see losses for their overly risky behavior. I think that Robinhood has made huge mistakes in their PR and that they have proven that they are currently incapable of running a stable stock-trading platform. However, much of the discussion has been muddied with blatant disinformation and this will harm future investigations into the events. The SEC is not going to prosecute many of the claims that “Reddit detectives” have pushed because they are so far from the truth. Millions in taxpayer money and regulator’s time will be wasted on wild-goose chases into conspiracy theories that could’ve been rejected by Occam’s razor. After the resources dry up, we are likely to see no discussion of the real issues uncovered. If you are interested in seeing prosecution go through, I urge you to focus on what can be proven in a court of law and to avoid wanton speculation.