Bill Cara

Abusive naked short selling: a persistent market concern

January 4, 2024

In our markets, short-selling has always been a topic of debate. While I view it as a mechanism for price discovery and market efficiency, I know short-selling is also a tool for manipulation and abuse. One form of short selling, known as naked short selling, has always been a serious concern.

Naked short selling occurs when a trader sells a security without first borrowing it or ensuring it can be borrowed. This practice can lead to the sale of shares that do not exist, creating artificial supply and driving down the stock’s price.

This tweet reminded me of the problem:

In March 2005, the Senate Banking Committee presented evidence to the SEC Chair that one investor intending to prove his case bought 111% of a publicly traded company’s issued and outstanding shares. In the following two days, despite no shares being available for borrowing by short-sellers, there were 50 million shares traded in that stock.

SEC rules are now stricter, but is there no longer an abusive short-selling problem?

When a trader sells an Exchange-Traded Fund or a 2, 3, or 4x leveraged ETF, are all the shares borrowed? I doubt that, but the truth is I don’t know the answer, and I am concerned.

Securities regulators may listen to some of our concerns, but unfortunately, they are quite passive in their oversight. So, as market participants, we should be on the lookout for cases of naked short-selling and bring examples to their attention.

If there is one thing I learned in the past 50 years, it’s that our friendly bankers are always on the hunt for profit regardless of how they make it. It’s up to the public to be the advocate for market transparency and fairness.