Large institutional investors were of the view that the stocks of the company would go down on the basis of misconceptions and poor fundamentals. Therefore, numerous investors of large institutions bet on falling of the price and thus pooled in lots of investment. Consequently, with the medium of social media, news spread in the air, and thus a large number of small retail investors also pooled in their investments in the stocks. The price went up by 1500% and 140% of the stocks were short sold and thus a short squeeze was created.
In India, many eyes are betting if such a situation could occur in India too. However, the answer to such inquiries is no. This is due to the stringent regulations imposed upon by Securities & Exchange Board of India which have been discussed below in detail:
In India, the shares of traders are kept in a Demat account and thus the broker cannot use the said shares for the purpose of lending. On the other hand, in the US lending of shares is allowed and the brokers lend shares of the traders. The lending in stocks in India is done through an exchange platform known as Stock Lending and Borrowing Mechanism (SLBM). However, SLBM is not used popularly by Indian retail investors. Reason being that the income to be lent as stocks are qualified as income from other sources under the Income Tax Act, 1961 (Section 56-59), and thus an income tax return is required to be filed and audited as a pre-step to the filing of ITR.
Thus, the Demat account impregnates the shares by kicking out the broker’s high or low in the market. The shares of a trader remain unaffected by the broker’s risk. By such restrictions in lending, situations like the Gamestop fiasco cannot occur as lending is the pivot of such funds.
The core game of Gamestop frenzy was short selling. In short selling, a broker sells stocks on behalf of the investor and when the price goes down, the broker buys back the shares and returns to the investor. In this case, the profit of the broker is the price difference between he sold the shares and the buy back.
Rules for short selling were issued by SEBI vide its circular MRD/DoP/SE/Dep/Cir- 14 /2007on Dec 24, 2007.In India short selling is quite of a task since the stocks cannot be held for a long time and have to be squared off (buy back) at the end of one trading session followed by auction if there is a failure on the part of the investor to buy back the stocks.There is a high risk involved in short selling in India since if the price of the stock does not go down or increases then the investor would lose its money. Generally, short selling is done for those stocks which the investor believes to be overpriced and expects that the price would go anytime soon.
In the USA, it is common and easy to manipulate stock prices especially in hedge funds. For example, a large investor starts selling off a stock that it owns and other investors start buying it taking the stock price to a steep low and then the large investor would buy back the stocks at low prices.
SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 1995 provide for the prohibitions against manipulating market prices of shares. Regulation 4 specifically deals with such prohibition and provides that no person should take part in artificial raising or depressing the price of securities; indulge in any act, which is calculated to create a false or misleading appearance of trading on the securities market;indulge in any act which results in reflection of prices of securities based on transactions that are not genuine trade transactions; enter into a purchase or sale of any securities, not intended to effect transfer of beneficial ownership but intended to operate only as a device to inflate, depress, or cause fluctuations in the market price of securities; pay, offer or agree to pay or offer, directly or indirectly, to any person any money or money’s worth for inducing another person to purchase or sell any security with the sole object of inflating, depressing, or causing fluctuations in the market price of securities.
Regulation 13 provides that the Securities Board may initiate action for suspension or cancellation of registration of an intermediary holding a certificate of registration under section 12 of the Act after conducting an investigation under Section 11 of the Regulation.
Kanika Sharma is student at NLU Nagpur, now intern in Taxscan.
