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Short-Selling Vs. Naked Short-Selling: An Explanation (Matt Taibbi in Rolling Stone)

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He's got the definition

He's got the definition wrong.

There's nothing wrong with naked short selling, as long as the shares are delivered within the three-day settlement period. The problem is failure to deliver, called "fails."

It helps market liquidity if a broker is allowed to sell shares short without having borrowed them first. But he MUST either borrow them or buy-in in a reasonable amount of time. In theory, if a broker cannot locate the shares to borrow within the standard three-day delivery window, he is supposed to "buy in." In other words, he's supposed to buy the shares on the open market.

But there is a loophole that allows brokers to play hot-potato with the "fails" and never borrow the shares or buy in. In effect it's counterfeiting shares. There's no excuse for the feds to allow it, except for the fact that there are so many counterfeit shares circulating now that calling them in would crash the market - more thieves that are "too big to fail."

There's a list of "fails" called the REG SHO list. After a certain number of days on the list, the shorts legally are required to buy in. But they flaut the law by buying from from a co-conspirator who sells the shares short, and then HE fails to deliver. Round and round they go. Stocks can stay on the REG SHO list with "buy-in imminent" for years. On top of that, real old fails were excluded from the regulation in a "grandfather" clause.

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"Fully half the quotations found on the internet are either mis-attributed, or outright fabrications." - Abraham Lincoln

First: Is the buyer aware that the seller does not...

actually have the shares?

If so then no harm no foul, otherwise I'd say that short selling should constitute fraud.

And second: I agree they ought to close the loophole.
Simple fix-- You're suspended from the market for failing to deliver; repeat offenders are banned from the exchange for life. That and short sellers should have to take physical possession of the stocks they shorted by the time their grace period expires-- no more kick the can.

Nope. The buyer does not

Nope. The buyer does not know. The "fail" even has voting rights. If the stock pays a dividend, whoever is charged with the fail has to pay it. The buyer has no way of knowing. If he did, it would not matter. He is not harmed specifically. Every shareholder is harmed through dilution, just as with counterfeiting.

Ĵīɣȩ Ɖåđşŏń

"Fully half the quotations found on the internet are either mis-attributed, or outright fabrications." - Abraham Lincoln