Naked short sale
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In a "naked" short sale, the seller does not borrow or arrange to borrow the securities in time to make delivery to the buyer within the standard three-day settlement period. As a result, the seller fails to deliver securities to the buyer when delivery is due (known as a "failure to deliver" or "fail").
Failures to deliver may result from either a short or a long sale. There may be legitimate reasons for a failure to deliver, such as human or mechanical error or processing delays. They can also result from naked short selling, as when market makers sell short thinly traded, illiquid stock and then have difficulty obtaining those securities when it is time to deliver them.
Naked short selling is not necessarily a violation of the federal securities laws or the Commission's rules. In certain circumstances, naked short selling contributes to market liquidity. For example, broker-dealers that make a market in a security generally stand ready to buy and sell the security on a regular and continuous basis at a publicly quoted price, even when there are no other buyers or sellers. Thus, market makers must sell a security to a buyer even when there are temporary shortages of that security available in the market. This may occur, for example, if there is a sudden surge in buying interest in that security, or if few investors are selling the security at that time. Because it may take a market maker considerable time to purchase or arrange to borrow the security, a market maker engaged in bona fide market making, particularly in a fast-moving market, may need to sell the security short without having arranged to borrow shares. This is especially true for market makers in thinly traded, illiquid stocks such as securities quoted on the OTC Bulletin Board, as there may be few shares available to purchase or borrow at a given time.[1]
Abusive naked short sales are transactions in which the trader intentionally fails to deliver the shares for settlement.[2]
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References
- ↑ Division of Market Regulation, Key Points About Regulation SHO. Securities and Exchange Commission. Retrieved on September 17, 2008.
- ↑ SEC Announces Aggressive New Short-Selling Rules. Traders Magazine. Retrieved on September 17, 2008.
