Naked short selling, or naked shorting, is the practice of selling a stock short, without first borrowing the shares or ensuring that the shares can be borrowed as is done in a conventional short sale. When the seller does not obtain the shares within the required time frame, the result is known as a "fail to deliver". However, the transaction generally remains open until the shares are acquired by the seller or the seller's broker, allowing a trade to occur when the order is filled.[1]
In the United States, naked short selling is covered by various SEC regulations which, as of September 2008, prohibit the practice.[2] In 2005, "Regulation SHO" was enacted to curb the practice, requiring that broker-dealers have grounds to believe that shares will be available for a given stock transaction, and requiring that delivery take place within a limited time period.[3][4] As part of its response to the crisis in the North American markets in 2008, the SEC issued a temporary order restricting fails to deliver in the shares of 19 financial firms deemed systemically important.[5] Effective September 18, 2008, amid claims that aggressive short selling had played a role in the failure of financial giant Lehman Brothers, the SEC made permanent and expanded the rules to remove exceptions and to cover all companies.[6][7]
Some commentators have contended that despite regulations, naked shorting is widespread and that the SEC regulations are poorly enforced, although the SEC has denied these claims. However, the SEC and others have also defended the practice in limited form as beneficial for market liquidity. Its critics have contended that the practice is susceptible to abuse, can be damaging to targeted companies struggling to raise capital, and has led to numerous bankruptcies.[6][2] Other commentators contend that naked shorting is more of a potential than a real problem, and have criticized the SEC for dealing with an issue that is tangential at best.