There's a lot of confusion in the market about what a short seller is: Dan David

Wolfpack Research founder Dan David joins Yahoo Finance Live to discuss the risks to the overall market as the GameStop and Reddit-fueled saga continue, and why he thinks regulation is the wrong move.

Video Transcript

MYLES UDLAND: All right, let's stay on this topic and think a bit more about what it means for market structure, where we go from here in terms of regulation, how short sellers think about events like this. Dan David joins us now. He's the founder over at Wolfpack Research. And Dan, I'm just curious, as someone who likes to play on the short side of the market, how you've looked at the last couple weeks of-- Andrew left getting chased out of dodge on this thing and the narrative around shorts that has kind of developed as a result of this.

DAN DAVID: Well, I think there's a lot of confusion in the market about what a short seller is, the difference between a long short fund and possibly short activist. And I really don't think the Reddit rebellion or army cares. I think what they saw, and what really doesn't get described, is that there are some very sophisticated people on that chat board. And they saw a setup with GameStop that showed, hey, look, there's really only 4 million shares we need to push around, and show 70 million shares in the flow.

But between what insiders own and passive investments who aren't going to sell, they're, in fact, the ones loaning out the shares. And when they loan out those shares, short seller sells it to the market, creates a synthetic share. That's how you get to the 140%. And we're seeing that contract as that happens right now. And the stock's going down. But when you have a situation where you can really just have to push around four million shares, it's quite a different thing.

As this thing opens up and there's 10, 20, 30, 40 million shares that are free trading, maybe not locked up and passive or with insiders, they're not going to be able to do that. So that's what happened.

MYLES UDLAND: And I guess, Dan, this also gets to a question about the way the market has changed as a result of passive flows, which I think for the average consumer are a positive thing. But the dynamic you're outlining is that liquidity just doesn't really exist in the way that it seems to exist, even in pretty big names. I mean, GameStop wasn't a penny stock. It's still a couple billion market cap. And the shares that are actually able to trade in large names still don't amount to all that much.

DAN DAVID: Yeah, I mean, look, you look at GameStop and it was a speculative bet. I mean, at 20 bucks it still is. It's brick and mortar and it's not doing great as a healthy business unless they completely morph themselves and a Hail Mary. So you've got to ask yourself-- I'm asking myself-- why are Vanguard, Fidelity, Blackrock, all these passive institutions taking up 70% of the shares in GameStop before all of this started. And really it's because of the liquidity that we're throwing at the market. I mean, $5 trillion just this last year with maybe another $2 trillion on the way. I mean, putting this in some perspective, Myles, I mean, taking dollar for dollar stacked on top of each other, $7 trillion will take you to the moon and back physically.

So what does money mean anymore when you're throwing that kind of liquidity at the market? These passive investments have to invest in everything. They are invested in massive frauds that I see out there today. Some that have been called out this year, and they're still going up because money has to be thrown at the market. And it's not going to be put in the bank. Because at a cost of living of 2%, and you maybe get 1% at the bank, you're losing 1%.

So the government has set it up so the only place to put our money is the stock market. That's where it's going. What's very dangerous about these passive investment vehicles is you're right, they don't sell until they do. And when they do, that is a very, very serious situation. And I'm not sure how we're going to put a stop to it. Well, I am sure [AUDIO OUT]. That's what we do.

BRIAN SOZZI: Dan, who do you think is selling GameStop this morning? And what do you think the trigger point was?

DAN DAVID: Well, the shortage is coming down, is definitely part of the trigger point. And you have to understand that many of these passive investment vehicles are like a Robinhood platform. They're free. If you are in this passive investment, it's free. But you have to know that we make money lending shares. So being in GameStop for that reason made a lot of sense to these free passive investments, free to the end user, because they made enormous fees on GameStop. The borrow rate was huge.

And they get in these tightly held stocks for that reason. And as they start to unwind, that's going to be the reason this thing comes down. Because there's just more in there in the flow. And there's not enough money in that Reddit room to start pushing around a stock like that. And I heard somebody say before that, look, if you're in this at $15 or $20, you're still really happy at $150, where it's sitting here today. I don't know. I mean, I think a lot of people that are-- whatever they're in it for and they see it at $450 and now it's down to $150, they're like, I missed it. I better get out now while I still get a very good profit. And I think that's part of the momentum. Momentum up, momentum down.

JULIE HYMAN: Hey, I just finally want to ask you, you know, Myles mentioned that Andrew left a few minutes ago, who was a well-known short seller. Definitely not a mainstream Wall Street guy. But he said, I'm not going to be doing short selling research anymore. What kind of mail are you getting? I should say email, what kind of email, what kind of comments are you getting? What is it like? What's your mindset right now as an activist short seller?

DAN DAVID: Well, I mean as an activist short seller, and the distinction being that we come out publicly and we talk about what we're shorting. I'm usually shorting something that's a fraud. And we've always gotten threats and online mail. It's really ratcheted up this past week. I've had no position in GameStop. Long or short, I have not been in it at all. And I got threatened every day last week. And I mean, literally, that's just from my family. So I'm not even talking about other people sending stuff in.

It's pretty awful out there. I would ask this, that if anybody's going to follow through on that, please do it before I finish shoveling my driveway, not after. Because this is ridiculous.

MYLES UDLAND: All right, well, Dan, we'll let you get out there and at least start the process of thinking about digging out down there in the Philly Metro area. I know they got hit pretty hard as we did up here. Dan David of Wolfpack Research. Dan, always great to get your thoughts. Thanks so much for joining the show this morning. I know we'll talk soon.

DAN DAVID: Thanks, Myles. Good to be back.