GameStop, Overstock and Barry Minkow: Justice in the Short Sale Squeeze?

January 29, 2021
Stock market ups and downs graphic with titling, by Nicole Westbrook

To most, the GameStop frenzy reeks of market manipulation of some sort and investors are calling for justice. We’ve seen this before. 

By Nicole Westbrook.

Four weeks ago, GameStop’s stock (GME) was trading around $18 per share. Four trading days later, the price doubled. This week it doubled two more times and by Wednesday’s close, the stock was trading up to $347.51. Large hedge funds were acquiring recklessly large short positions in GameStop. We’ve seen this activity before, investors being duped by the reckless short selling of greedy investors with Overstock and Barry Minkow, and where the end result, litigation, illuminated the justice in the short sale squeeze.

When a large amount of a stock is shorted, a cycle can be perpetuated that drives the price higher. In GameStop, which was heavily shorted, the stock price began to rise. As the short sellers saw the price rise, they started dumping their bets and buying enough GameStop stock to cover their positions. The more stock that was purchased, the higher the price went. As the price climbed, the frenzied short sellers continued dumping shares – buying and buying, raising the price, in an endless loop. The short sellers got squeezed.

The volatility created what appear to be unprecedented steps in the market. Robinhood Markets, a trading app that became wildly popular in the wake of the pandemic as individuals had more time to trade and perhaps were looking for ways to make a buck, on Thursday, January 28, 2021, prevented its traders from buying GameStop (and other stocks) – though selling the stock remained available. Rumors are swirling that many of the other large Wall Street investment groups were likewise preventing their traders from purchasing GameStop. Trading on GameStop was not halted – if it was “halted,” the stock could neither be sold nor purchased. Worse, it appears that the small retail traders were prevented from purchasing GameStop while the large hedge funds and other select groups remained able to purchase the stock.

Is it fair? Does Robinhood have the contractual right to stop the purchase of a stock? Were the other large investment groups likewise involved in preventing small retail traders from purchasing GameStop stock in favor of allowing the large hedge funds to cover their short positions? Was Robinhood itself in financial peril due to the volatility and had no choice but to shut down trading? Did the others have the same issue – reaching out to their lenders for hundreds of millions (or billions) of dollars in lines of credits to stop circling the drain.

To most, the GameStop frenzy certainly reeks of market manipulation of some sort and investors are calling for justice. Similar calls led in 2007 to Overstock.com filing a lawsuit against Goldman Sachs and Merrill Lynch accusing them of intentionally depressing the price of its stock by engaging in naked short sales. The Complaint defined naked short selling as “selling short shares that the seller does not have and does not borrow to make delivery.” Overstock.com claimed that the naked short selling had the effect of plummeting Overstock’s stock price from over $70 a share early in 2005 to under $20 a share late in 2006.

Overstock alleged that Goldman profited through loan fees charged for the short positions, interest on margin accounts, transaction fees, and also shorting the stock itself. Overstock argued “selling but failing to deliver actual shares issued by Overstock [had] the effect of generating a virtually unlimited supply of Overstock shares for sale.” Overstock.com’s then-CEO, Patrick Byrne, crusaded not only against the fraud he believed was being perpetrated on Overstock and its investors, but also against the practice and lack of oversight in the system. Many feel his outrage went unheard by the feds in control of the system.

In 2006 and 2007, Barry Minkow, who was previously jailed for founding a Ponzi scheme, ZZZZ Best, was accused of a practice termed “short and distort,” whereby he and cohorts allegedly took short positions in stocks. Then, Minkow would release a damaging report about the company to drive the stock price down. Minkow allegedly made large sums of money from shorting multi-level marketing companies Herbalife and USANA before releasing damaging information about the companies to the public and authorities. As the price of the stock fell on bad news, Minkow purchased to cover his positions and profited while the other investors lost out.

In 2011, Minkow was sentenced to five years in prison and over half a million dollars in restitution for conspiring to commit securities fraud for his participation in a scheme to manipulate the stock price of Lennar Corporation. Minkow admitted to making false and misleading statements about improprieties in Lennar’s financial reporting and business structure and attacking the personal character of Lennar’s management.

The Press Release from the United States Attorney’s Office for the Southern District of Florida read: “beginning in January 2009, Minkow used the Internet, press releases, e-mail communications, Youtube.com videos, and the U.S. mail to broadcast false and misleading statements about Lennar, with the intent of artificially depressing Lennar’s stock price. Minkow then used his relationship with federal law enforcement agencies to report false allegations of criminal conduct purportedly committed by Lennar and its management. Once Minkow confirmed that his allegations had successfully induced law enforcement to open a criminal investigation, Minkow used that knowledge and information to trade Lennar securities for his own benefit.”

The GameStop saga looks like a David and Goliath story, where little David is being hamstrung by higher lobbies from trading on the stock while Goliath is relying on his friends to ensure his survival despite his financial recklessness. But the story is not over. The courts will certainly be called upon to weigh in on the side of David and the hope is that justice, blind to money, prevails.

Nicole Westbrook, litigates complex business matters, and is a trial instructor and frequent writer on legal issues. Reach Nicole at nwestbrook@joneskeller.com.

This information is not intended as legal advice. Readers should seek specific legal advice before acting with regard to the matters addressed above.