In January 2021, GameStop’s stock dropped 16 percent after the company’s holiday sales were 27 percent below expectations. (Matt Perez, Forbes). Demonstrating further evidence of declining business performance, GameStop was scheduled to close 1,000 retail store fronts and lay off 14% of its staff by March 2021 due to the coronavirus pandemic and the trend toward online shopping. (Matt Perez, Forbes; Lauren Gray, Yahoo). Institutional investors capitalized on the company’s poor performance by short selling GameStop’s stock, expecting it to continue to fall. (Juliet Chung, Wall Street Journal). Short sellers are investors who borrow shares of stock from a financial institution to sell on the market with the hope of buying them back later at a lower price. (Adam Hayes, Investopedia). Investors profit from the difference between the price of the shares borrowed and sold and the price of the shares purchased and returned. Id.

WallStreetBets, a subreddit community of retail investors, took notice of the large short positions and bought large amounts of GameStop stock to squeeze hedge funds, like Melvin Capital, out of their short positions. (Juliet Chung, Wall Street Journal). The rush to buy shares triggered a sharp increase in GameStop’s stock price forcing investors to cover their shorts by buying GameStop stock back at the inflated price to avoid margin calls on their accounts. Id. At the same time, other investors saw the increase, shorted more GameStop stock, and bought long to cover their shorts. (Jon Quast, The Motley Fool). Taking longer positions effectively drove up the stock price again, pushing another round of bearish investors into margin calls. Id. This resulted in huge losses for institutional investors such as Melvin Capital, Point 72, and Citadel. (Deborah D'Souza, Investopedia). In total, all short sellers lost $5.05 billion on their bets against GameStop.Id.

GameStop’s short squeeze was just one in a long line of stocks impacted by sharp volatility due to a conflict between Wall Street short sellers and internet investors bubbles, including Virgin Galactic Holdings, Inc.; Workhorse Group, Inc.; AMC Networks, Inc.; and Bed Bath & Beyond, Inc. (Philip van Doorn, MarketWatch). Twitter posts by WallStreetBets argued that large investment firms were colluding by publishing scripted research and sharing short sale strategies to manipulate markets and guarantee winning bets. (WallStreetBets, Twitter). Such claims by WallStreetBets caught the attention of Congress, the Department of Justice (“DOJ”), and the Securities and Exchange Commission (“SEC”). (Katia Porzecanski, Tom Schoenberg, Bloomberg). Not only is the DOJ investigating over 30 investment and research funds for collusion and market manipulation, but the SEC has also announced new rules for institutional investors with large short positions. Id.

The SEC’s focus on short sellers is overdue. Congress officially tasked the SEC with increased scrutiny of short sales through the enactment of the Dodd-Frank Act after the 2008 financial crisis. (Gary Gensler, SEC.gov). The SEC released proposed rules in February 2022 that will require institutional investment managers with large short positions to make monthly disclosures to the SEC if the new rule is adopted. (SEC.gov). The definition of institutional investment managers includes trusts, banks, broker-dealers, corporations, pension funds, insurance companies, and investment advisors. Id. However, not all short sellers are impacted by the proposed rule. Id. For SEC reporting issuers, only institutional investment managers that have “investment discretion” over a gross short position of $10 million or more during a calendar month or have a monthly average gross short position in a security of 2.5 percent or more of shares outstanding are required to submit the monthly disclosures. Id. For non-reporting issuers, the threshold is reduced to include institutional investment managers that have a short position of $500,000 or more at the close of any settlement during the month. Id. Finally, the data to be reported includes the security, the month reported, the issuer, the gross short position, the dollar value of the shorted shares, and whether the gross position is fully, partially, or not hedged. Id. The SEC’s reports will make aggregate daily and monthly data on specific securities available to the public so that the public is more informed as to the behavior of large short positions. Id.

From an institutional perspective, the new rules pose two main concerns. First, some institutional investment managers may be concerned that making this information publicly available will make them more susceptible to short squeezes like GameStop. Id. The SEC, however, assures institutional investment managers that only aggregate information will be published. Id. Any information that could reveal the identity of the manager is subject to confidential treatment. Id.Second, the SEC acknowledges industry concerns that monthly disclosures will require information gathering and additional compliance oversight that does not currently exist. Id. However, the SEC maintains that the high reporting threshold mitigates cost concerns. Id. The $10 million short position threshold is high enough to include only substantial positions, while excluding smaller short selling strategies from oversight. Id. The SEC argues that this cutoff gives regulators and the public the insight needed to understand institutional short selling behavior while limiting compliance costs to financial institutions. Id.

Market participants and short sellers, in general, will benefit from the increased transparency. Information on hedged positions may provide insight into how investors view certain stocks. Id. Daily reporting of gross short positions will provide context to market participants into how shorted positions are being closed out, how call and put options are being exercised, and about secondary offering transactions. Id. The data will provide regulators with additional information to investigate abusive market manipulation techniques associated with short selling. Id. For example, managers with very large short positions have historically used “bear raids” to illegally manipulate stock prices. Id. A bear raid is when managers collude to spread false information on social media or news outlets to make sure the stock they sold short declines in value. (Cory Mitchell, Investopedia). SEC oversight could deter managers and alert regulators when such activity is happening. (SEC.gov).

However, it is unclear as to how effective the new SEC rules on short sell disclosures will be. When viewed through the lens of the GameStop case study, it is unlikely that SEC data would have helped investors in real time since the stock increased and decreased so quickly. Aggregating, de-identifying, and publishing disclosures takes time, and disclosure data may be stale by the time it is finally available to the public. (Jessica B. Magee, Scott Mascianica & Javan Porter, Holland & Knight). The current proposed rule says that the SEC will release the disclosures within 30 days of the end of the reporting month. Id. For context, GameStop stock jumped from $17.69 on January 8 to $325 on January 29. By the time the SEC would have released the January positions at the end of February, the stock would have already dropped to between $40.59 and $101.74. Further, posting aggregated hedge information may provide insight, but it is insufficient to glean a meaningful understanding of sophisticated trading strategies. Id. Finally, the proposed rules only impact a select few large institutional investment Managers. It does nothing about the online investor groups on Reddit that have also been accused of market manipulation. I would not be surprised if WallStreetBets sees this rule as a gaslight to subdue their rogue crowd investment techniques that effectively cost Wall Street $5 billion.