Breaking Down Short Ladder Attacks Amid the WallStreetBets Escapade

Hedge funds and investors shorting stocks is nothing new. Major market players have been practicing it for more than a century. In 1929, short sellers were actually blamed for the stock market crash that prefaced the Great Depression.

A short ladder attack is a very intentional maneuver that requires highly detailed planning. Historically, it has helped funds grow their assets under management more rapidly. However, in instances like the GameStop fiasco, it can backfire with a little help from retail investors.

A short ladder attack has multiple moving parts. The process starts when a firm or fund takes on a sizable short position in a stock. From there, they will do what they can to lower the stock's value. Since they are using a short sell to bet against a stock (instead of investing in a stock in the hopes that the value increases), they make money when the stock's value shrinks.

In some instances, a fund might put a company into bankruptcy. If bankruptcy does happen, hedge funds celebrate because they never have to transfer their counterfeit shares (which are used for shorting stocks) into real shares. Also, capital gains taxes become a moot point.

Companies use other hedge funds and brokers to pull the stock's value down by pulling out of their positions.

It isn't a surprise that the targeted stocks include GameStop ("GME" on the NYSE), AMC Entertainment ("AMC" on the NYSE), and Bed Bath & Beyond ("BBBY" on the Nasdaq). All three of these companies are operating under difficult circumstances and a changing economic mindset (like the switch to all-virtual gaming, e-commerce shopping, and at-home streaming). It makes sense that these companies were targeted by the hedge funds seeking a short attack. 

While they might be malicious, short attacks aren't wholly illegal. However, there can be illegal attempts to drive a stock's price down below its true asset value. This includes market manipulation in the form of bribing people to avoid a company's offering or producing slander about a company to keep it from being profitable. If a fund is charged with an act of interference like this, they won't be charged with a "short attack" per se, but rather manipulating the market in a monopolistic way (which would result in an antitrust trial).

The SEC does hold restrictions on abusive short sales that operate in this fashion.

In the late 1600s, the Amsterdam Stock Exchange was a meeting ground for bear pools. This form of market manipulation led to "bear raids to exert maximum selling pressure," according to the SEC. 

In the early 1700s, a similar event occurred surrounding the London Stock Exchange. Following this, the British parliament prohibited short selling by law in 1734 (the law was ultimately repealed in 1860 and officially authorized in 1893).

In the U.S., the SEC has its own restrictions. It's safe to assume that the restrictions will be tightening following the 2021 response to hedge fund shorts.