But market makers like Knight have an exemption from naked short selling restrictions, on the grounds that they use the practice to maintain liquidity in markets. For example, if there’s high demand for a stock, the market maker can fill orders even if it doesn’t have the shares available.
As the Securities and Exchange Commission explains, “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 often occurs in thinly traded stocks, like penny stocks.
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