Naked Short Selling

Imagine, if you would, if you had the ability to sell something to someone else
that you did not own. I am not talking about a person employed as a sales
professional, who rightfully earns a commission by selling the product or
service of their employer, but someone who represents owning something but in
fact doesn’t, then sells it to another person at a price below market value,
hoping that starts a chain of events which would lower the overall market value
of that product or entity, thereby giving the seller the chance to retroactively
profit from selling something he or she did not own.

Does that sound confusing and complicated? It should, because it is and it goes
on in millions of daily transactions in stock exchanges all over the world.

It’s called naked short selling and while it is supposed to be illegal in the
United States, many companies have pointed to the practice as the reasons they
have had difficulty raising capital or in some cases, have failed altogether.

Naked short selling is the practice of short-selling a financial instrument
without first borrowing the security or ensuring that the security can be
borrowed, as is conventionally done in a short sale. When the seller does not
obtain the shares within the required time frame, the result is known as a “fail
to deliver”.

Naked shorters will sell securities or stocks they do not own, in the hope the
price drops, after which they can buy the shares at the lower price and profit
from the difference. To further add to the conundrum, unscrupulous manipulators
will employ people to bash a stock on internet message boards, attempting to
create a wave of panic selling, further enabling the naked short seller to do
what they do…profit from an illegal transaction.

But how, you may ask, if it is illegal, does it continue to happen? It’s because
“Regulation SHO” which was enacted in 2005, requires only that broker-dealers
“have grounds to believe” that shares will be available for a given stock
transaction, and that delivery takes place within a limited period of time.

My question is, what constitues “grounds to believe”?

This week in Europe, the European Commission has submitted proposals to
safeguard financial markets from naked short sellers. If enacted, naked
short-sales of shares and government bonds would be limited and some
over-the-counter derivatives trades would be forced through clearinghouses.

It is a very controversial issue as some believe this is a destructive and
despicable practice, while others deny it happens at all.

In the US, the laws against it already exist, they just need to be better
enforced.

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