Securities Regulation.

• Author: Van Doren, Peter

Securities Regulation * "Gamestonk: What Happened and What to Do about It," by James Angel. SSRN Working Paper no. 3782195, February 2021.

Speculative activity surrounding the stock of the video game retailer GameStop has been in the news. The firm's share price exploded from $18.84 at the end of 2020 to a high of $483 on January 28, 2021, before collapsing to under $60 in early February.

Gamestops are found in traditional shopping malls, which means high lease costs for a retailer that faces growing competition from internet-distributed games. Institutional investors, including prominent hedge fund Melvin Capital, shorted GameStop because they concluded the future of such a business is doomed and that its stock price was overvalued. Shorting stock (borrowing shares and selling them now in the belief that they can be purchased for less in the future when they need to be returned) is a useful and important activity that appropriately disciplines stock market optimism.

According to media accounts, GameStop stock was involved in what is termed a "short squeeze." Retail investors using venues that do not charge commissions, like E-Trade and Robinhood, purchased GameStop shares in a David-versus-Goliath battle against the institutional shorts. The squeeze results from the fact that those who short the stock must eventually buy it to return the borrowed shares to their original owners. If enough investors buy shares, the shorts must compete against them to buy stock at an increased price to return the borrowed shares. Melvin Capital had to raise $2.75 billion to close out its failed short bet on GameStop.

This paper, by Georgetown finance professor James Angel, examines possible reforms of Securities and Exchange Commission rules regulating the shorting of securities in light of the GameStop events.

The manner in which the Internal Revenue Service treats the realization of capital gains from shorting inefficiently prolongs the time period over which stock shorting occurs. The IRS generally taxes stock trades when a position is closed out and the profit or loss is realized. This makes sense when cash is received when a stock is sold. In a successful short sale, however, the short seller has received the cash long before the position is closed out as a result of the daily collateral adjustment that occurs in the stock lending market. The current tax treatment induces those who short never to close out the position, and thus short sellers have...