Naked Short Selling - Prohibited Trading Activity
What is Naked Short Selling?
Naked short selling is an illegal trading activity that occurs when a stock is sold short on the market without ever borrowing any shares. In a normal trading transaction, the broker will provide the required shares in real-time or acquire them shortly thereafter to ensure there are shares on hand for the short position. The end result of naked shorting is the price of the security is pushed lower by "fictitious" shares being sold on the open market. This type of manipulation leads to bear raids that pushes prices to extremes and creates volatile moves in the market.
Tracking Naked Short Selling
Tracking naked short selling can be extremely difficult. Since the short position is never opened, there is no buyback to close the position. So, the trade is categorized as "having failed" to deliver and there is virtually no way of knowing who initiated the naked short. This allows an unlimited number of sales orders to flood the market thus disrupting the normal supply and demand balance for the security.
Naked shorting would not be possible without brokerage firms who allow the shorting of stocks that are not on the easy to borrow list, which leads to short sales for which the broker can not support. As a result of the 2008 credit crisis the SEC finally admitted that naked shorting is a problem. The SEC has now begun to place even further limits on short selling by amending the Regulation SHO rules to require short sellers to deliver securities a minium of three days later. Many politicians are now pushing to have broker dealers be required to deliver the borrowed security on the actual settlement date.