It boils down to selling "AIR" shares or shares that these big market makers do not own.
Naked short selling, or naked shorting, is the practice of short-selling a tradable asset of any kind without first borrowing the security or ensuring that the security can be borrowed, as is conventionally done in a short sale. When the seller does not obtain the shares within the required time frame, the result is known as a "failure to deliver". The transaction generally remains open until the shares are acquired by the seller, or the seller's broker settles the trade.[1]
Short selling is used to anticipate a price fall, but exposes the seller to the risk of a price rise.
In 2008, the SEC banned what it called "abusive naked short selling"[2] in the United States, as well as some other jurisdictions, as a method of driving down share prices. Failing to deliver shares is legal under certain circumstances, and naked short selling is not per se illegal.[3][4][5] In the United States, naked short selling is covered by various SEC regulations which prohibit the practice.[6]
Critics, including Overstock.com's Patrick M. Byrne, have advocated for stricter regulations against naked short selling. In 2005, "Regulation SHO" was enacted, 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.[4][7]
As part of its response to the crisis in the North American markets in 2008, the SEC issued a temporary order restricting short-selling in the shares of 19 financial firms deemed systemically important, by reinforcing the penalties for failing to deliver the shares in time.[8] Effective September 18, 2008, amid claims that aggressive short selling had played a role in the failure of financial giant Lehman Brothers, the SEC extended and expanded the rules to remove exceptions and to cover all companies, including market makers.[2][9]
Some commentators have contended that despite regulations, naked shorting is widespread and that the SEC regulations are poorly enforced. 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][10] However, other commentators have said that the naked shorting issue is a "devil theory",[11] not a bona fide market
issue and a waste of regulatory resources.[12]
The basic form of short selling is selling stock that you borrow from an owner and do not own yourself. In essence, you deliver the borrowed shares. Another form is to sell stock that you do not own and are not borrowing from someone. Here you owe the shorted shares to the buyer but "fail to deliver." This form is called naked short selling. These short sales are almost always done only by options market makers because they allegedly need to in order to maintain liquidity in the options markets. However, these options market makers are often the brokers or large hedge funds, who abuse the options market maker exemption. (For more, see How To Work Around A Market Maker's Tricks.)
