GameStop fiasco has Chanos defending short-sellers in Washington

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Prominent short-seller James Chanos has been lobbying White House economic aides not to put curbs on the controversial trading practice that has come under fire in recent weeks following the Robinhood trading frenzy, FOX Business has learned.

Chanos, according to a source with direct knowledge of the matter, pressed White House aides on the importance of short selling, where traders make money if a company’s stock declines in value and often do so by pointing out problems with its underlying finances and business. It’s unclear if the White House was persuaded by his pitch, this source said.

Chanos is a major Democratic Party fundraiser and a close friend of President Biden. The person said he did not speak to Biden directly about the matter.

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A White House spokesman didn’t return a call for comment; Chanos declined to comment for this story.

In a short sale, the trader borrows stock, sells it immediately, hoping to repay the borrowed funds when the stock declines thus pocketing the difference. Conversely, short-sellers lose money when they are forced to repay the borrowed shares by purchasing stock at higher prices.

Short selling has long been a controversial practice in a market where most investors hope that their stock holdings rise in value. While many investors hate short sellers, who often tout their negative research on stocks, regulators at the Securities and Exchange Commission, also known as Wall Street’s Top Cop, have defended the practice. SEC officials say short-sellers like Chanos provide the market with analysis that counters the overwhelming amount of investor touting of penny stocks and other speculative investments.

But shorting has come under fresh scrutiny following the recent Robinhood trading frenzy. Hordes of small traders snapped up shares of heavily shorted stocks, such as AMC, Blackberry and GameStop, in an attempt to drive up shares and cause massive losses among short-sellers.

The results produced what’s known as a “short squeeze,” where many hedge funds that were betting against these companies’ shares lost significant amounts of money. The squeeze forced one such fund, Melvin Capital, to seek additional capital from outside investors.

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The controversy erupted when Robinhood responded to the squeeze by limiting the buying of these stocks for a period of time, angering many of its customers who claimed the trading platform was protecting its hedge fund clients who were losing money. For example, Citadel Investments purchases so-called order flow from Robinhood, matching buyers and sellers and allowing the firm to charge zero commission to its trading customers. A separate hedge fund run by Citadel’s chief executive Ken Griffin invested $2 billion in Melvin.

Both Robinhood and Citadel vehemently denied there was any link between the investment and the trading halt on the stocks, reiterating as much during Congressional testimony last week.

Robinhood chief executive Vlad Tenev cited a weakening capital position to settle the immense volume of trades for the need to put a lid on the buying of these stocks. But that hasn’t stopped the attacks against short sellers. Barstool Sports chief and day trader Dave Portnoy has repeatedly attacked Tenev for effectively ending the short squeeze and costing people like himself who were long the frenzy-related stocks to lose big bucks.

On Tuesday, Portnoy browbeat Tenev during a scheduled online debate.

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Now some members of Congress are weighing limits on the practice. Last week’s House Financial Services Committee hearing discussed the practice that its chairwoman, Maxine Watters called “predatory.”

Fearing possible new regulations, Chanos is attempting to get in front of lawmakers' efforts.

Chanos, who runs Kynikos Associates, has been credited with uncovering some of the biggest stock frauds in recent years, including the Enron scandal. He has had notable misses as well; Chanos’ heavily shorted electric vehicle maker Telsa, earning him the enmity of Tesla founder Elon Musk for criticizing the company’s vehicles and finances and once calling Tesla a “walking insolvency.”

Chanos has been forced to dramatically scale back his short position in Tesla as shares continued to rise and the firm overcame production problems. That said, late last year Musk conceded that the car maker was indeed on the brink of bankruptcy during the rollout of its Model 3 vehicle.

Meanwhile, Chanos is said also to have taken aim at a proposal by Tenev of Robinhood to changes the period of time it takes brokers to complete or “settle” stocks. Currently regulatory agencies mandate a two-day settlement period, known as T+2. Tenev argues that the longer T+2 time frame caused Robinhood to curtail trading in the frenzy-related stocks or face the possibility that it would run out of cash it needed to put up to settle trades. If trades settled immediately, Robinhood would not have halted the trading because it would have had enough cash to meet its capital requirements.

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But Chanos told White House economic aides that the two days are needed to make sure trades are processed correctly and because it allows short sellers to locate stocks to borrow before shorting them. If shares were immediately settled, traders wouldn’t be able to locate stocks, he is arguing. So called T+Zero would essentially end short selling, he said.

That might be good for Robinhood’s business model – the firm is built on buying of stocks including penny stocks and doesn’t allow short selling. But it would deprive the market and many small investors of research that shows problems with companies’ finances, Chanos said, according to the person with direct knowledge of the matter.

Stocks — including GameStop, AMC and others at the heart of the trading frenzy — were heavily shorted based on research that showed their business models were on shaky ground. GameStop traded as high as $500 a share during the frenzy but has recently dropped. Yet on Wednesday shares spiked once again, surging 104% to $91.71 in late day trading after its CFO announced he will depart next month.

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A GameStop spokesman didn’t return a call for comment; a Robinhood spokesman had no comment.