How an Investment Group on Reddit Can Return Democracy to Stock Markets

533

By Dara Albright, Dara Albright Media

America was established on the doctrine of freedom. One of its many founding liberties grants citizens the right to invest in and profit from the ingenuity of its fellow citizens. Stock markets are vehicles to facilitate this right. 

Stock markets were created to foster capital formation so that businesses could flourish while individuals participate in their growth. Although stock exchanges were not originated for gamblers to bet against companies for personal gain, market speculation is by no means an illicit activity. Nor is it without its benefits. Speculation happens to bring enthusiasm to markets which in turn drives the very capital formation that fuels innovation and job creation.

Neither is there anything iniquitous in taking risk. Risk is as essential to investing as it is to the advancement of mankind. Neither markets nor humanity could progress without it. If it weren’t for risk, there wouldn’t be any entrepreneurs to gift the world with innovation and supply economies with jobs.

Markets rooted in democracy are not brought down by speculation nor risk. Unduly blaming both does nothing but safeguard the true causes of free market demise: injustice and corruption. History has proven time and time again that ignoring reality by manufacturing faux culprits does not resolve problems, it only exacerbates them.

The most stunning display of misplaced culpability was witnessed on Wall Street last week. It began when a number of small investors, congregating in a Reddit chat group, started vigorously “crowdbuying” stock in public companies – most notably: GameStop ($GME) – which they believed were undervalued and possessed abnormally high and unjustifiable short interest ratios. Because there were far more shares borrowed than exist in the float (a mathematical impossibility without shenanigans), shorts got squeezed, causing multiple hedge funds to suffer billions of dollars in losses.

Instead of scrutinizing abusive shorting, which for decades has been devastating retirement portfolios, destroying businesses and stymieing job growth, the government came to the hedge funds’ rescue by announcing plans to “investigate” members of the Reddit group. At the same time, Robinhood, an online trading platform for micro-investors, immediately halted its customers from purchasing these stocks. In doing so, Robinhood helped provide those hedge funds, caught in the short squeeze, with a chance to cover their short positions at far more advantageous prices. 

To be clear, it is not illegal to discuss investment opportunities in an open forum. Nor is it unlawful to purchase shares in publicly-traded stocks cited in public discussions. It was not as though these “Redditors” were trading on insider information. Insider Trading is indeed a punishable offense – unless, of course, it is being perpetrated by a member of congress.

While there was no obvious crime committed by the Redditors, it is yet to be known whether the same can be said of others involved in this remarkable story. Abusive short sale practices, including certain naked short sales (selling stock without borrowing or arranging to borrow the securities within the allotted time to make delivery to the buyer) as well as short sales effected to manipulate the price of a stock, most definitely constitute illegal activities.

Although certainly unethical, it will be left up to a court of law to determine the legality and constitutionality of prohibiting buy orders from one class of investors while permitting them from another class.

The tension presently unfolding in the markets will not soon fade, and certainly not without a dramatic sea change. This is not merely a conflict between bulls and bears or longs and shorts. It isn’t even really a clash amongst Redditors and Hedgies. Rather, it is a revolt against a centralized financial system that has become gradually less democratic through the increasing implementation of unjust securities regulations that restrict small investors and businesses from the same opportunities to access capital as the nation’s financial, political and corporate elite.  

For decades, Wall Street fat cats have been exploiting inequitable securities regulations, using them to mercilessly invent new market manipulation schemes that would guarantee themselves larger and larger investment profits in exchange for taking on less and less risk.

Below are just two of many examples of biased securities regulations that have not only caused irreparable damage to both small investors and emerging businesses, but unequivocally contributed to last week’s market upheaval.

  1. THE ACCREDITED INVESTOR RULE: An accredited investor is an individual or a business entity that is entitled to the privilege of unfettered access to investment opportunities due to their income, net worth, asset size, governance status or professional experience. Essentially, the accredited investor rule prohibits investors with lesser means from investing in non-registered securities, such as pre-IPO growth companies, while granting institutional and high net worth investors unconstrained ability. This unfair practice forces the “retirement saving masses” to serve as the “exit strategy” to the financially privileged. Over the years, I have written extensively about this rule, continuously questioning its constitutionality. The following example demonstrates just how abhorrently unjust this rule truly is.  

In December 2011, when UBER was valued at $346.5 million (a little less than the mean market capitalization of IPOs in 1996), it raised a private Series B venture capital round of $43.8 million from Jeff Bezos, Goldman Sachs, Menlo Ventures and a few other members of the financial elite. UBER ultimately went public, 8 years later, at a valuation of $82.4 billion and thereby providing the small number of its Series B investors with 23,680% in appreciation. That is over $82 billion in wealth, received by a select few, that 25 years ago would have been dispersed across the retirement accounts of millions of Americans. To give this some perspective, $82 billion is 122,978,993% more than the GDP per capita in the United States and more than the GDP of most countries on this planet. Hence, this one deal, alone, netted a mere handful of investors more money than the annual Gross Domestic Product of 67% of the world’s nations representing over 1.44 billion people![1]  

  • THE SEC’S ALTERNATIVE UPTICK RULE (RULE 201): Adopted in 2010, the alternative uptick rule was a well-intentioned rule designed to restrict short sellers from further driving down the price of a stock that has dropped more than 10 percent in one day. However, abusive shorters found a way to manipulate this rule for personal gain – all at the expense of emerging businesses and small investors. In recent years, the alternative uptick rule has been exploited by abusive shorters to destroy Reg A+ offerings, a type of public financing that was designed to enhance small business capital formation which had been impeded by increasing regulatory burdens and the exorbitant costs associated with conducting a conventional IPO. Because there is no “prior trading day” when a company goes public, the 10 percent circuit breaker is never triggered, thereby allowing IPOs to theoretically be shorted to zero. This loophole has made small companies (the ones that go public without the muscle of influential underwriters such as Goldman Sachs or JP Morgan) a prime target for shorters and manipulators who begin attacking these small caps, on day one, without any regard to fundamentals. Their assaults have made it nearly impossible for smaller cap companies to thrive in the public markets from the very second they begin trading. Through these unprovoked small cap assails, abusive shorters are not only crushing companies, they are literally stealing appreciation from small unaccredited investors.

Regulators can readily bring justice back to the financial markets by amending the aforementioned rules. They could start with removing the government’s role in determining one’s personal risk tolerance by eradicating the accredited investor rule altogether and allowing everyone – regardless of income, net-worth or professional status – access to the very same investment opportunities.

Additionally, regulators can easily resolve illicit short selling practices by moving all short sale reporting to the blockchain. This would keep accurate tabulation of short interest ratios which would preclude the same shares from being shorted in multiplicate. This would not only prevent a repeat of last week’s market turmoil, it would significantly enhance small business capital formation and ultimately lead to more trust in the public markets, job growth and stronger retirement returns.

In fact, these two changes, alone, could help thwart a looming retirement-induced economic crisis that, without interference, is eventually going make the 2008 financial meltdown look like the roaring twenties.

If preventing a retirement crisis of unimaginable proportions isn’t enough incentive, perhaps regulators should consider that despite the significant financial angst Redditor Bulls have caused hedge funds in the last few days ($15 billion in losses and counting), these Redditors represent just a tiny subsection of disenfranchised Wall Street outsiders who are no longer willing to sit idly by while market manipulators and abusive shorters destroy emerging businesses and retirement accounts with impunity. Accordingly, failure to re-democratize public stock markets has the potential to turn last week’s small-scale “redditor rebellion” into a full-blown revolution.

It is not difficult to predict the victor of a market revolution occurring amidst the rise of decentralized finance (DeFi). Spoiler Alert: it is democracy that will win.

I look forward to discussing all of this market drama as well as ways to monetize fintech achievement and regulatory shifts in my new podcast, DWealth Muse.


[1] The International Monetary Fund


Dara Albright is President of Dara Albright Media, a recognized fintech advisory firm that helps investors, businesses and conventional financial services providers capitalize on fintech innovation and related regulatory shifts.