Naked Short Selling
Short selling securities without first borrowing or locating shares to deliver, creating a risk of settlement failure.
What is Naked Short Selling?
Naked short selling is the practice of selling securities short without first borrowing the shares or confirming that they can be borrowed—creating a short position that may fail to deliver at settlement. In a standard (covered) short sale, the seller borrows shares before selling them and must return them later. In naked short selling, no such borrowing occurs, resulting in a 'failure to deliver' if the seller cannot obtain shares by the settlement date. In the United States, naked short selling in equity markets is largely prohibited under SEC Regulation SHO (adopted in 2005), which requires broker-dealers to locate shares before executing a short sale and imposes close-out requirements for persistent failures to deliver. Despite the prohibition, some naked short selling persists through loopholes in market maker exemptions. Critics argue that unchecked naked shorting can artificially depress stock prices; defenders note that market maker exemptions are necessary for liquidity provision.
Example
During the 2008 financial crisis, the SEC issued emergency orders temporarily banning short selling in nearly 800 financial stocks and took additional steps to limit naked short selling after concerns arose that coordinated short selling was accelerating the decline of financial institution stocks. These actions were among the most aggressive market interventions in SEC history.
Source: SEC — Regulation SHO