Please Note: this article is related to the act of selling shares short without covering them, and is not in any way related to the act of selling Call options on the options market
Naked Short Selling is a controversial act of placing sell orders on the stock market in an instrument, without first borrowing the actual shares to sell to the buyers; commonly, when you short-sell, your broker/principal will acquire the shares from a holding facility and then sell these borrowed shares for you, thus ensuring that the buyer is receiving real shares in the company. It has been criticized for being a device of depressing stock prices.
However, large hedge funds, usually through the act of abusing trust, will order the sale of a number of shares into the market, without being able to back these up with real shares, thus effectively writing an IOU to the buyer for the shares, meaning that the buyer himself is now technically not actually in ownership of a portion of the company, effectively equivalent to selling counterfeit shares in many respects.
Consequences[]
As a result of large businesses being able to do this, they can continually sell to the market, selling nothing but thin air to buyers, eventually resulting in a FTD (Failure to Deliver) meanwhile the price of the stock has been significantly impacted with the naked short continually writing the IOU equivalents.
This action is illegal, and the Reg SHO list is kept to list all companies with a naked short size of greater than 0.5% of the number of shares issued by the company.
Criticism[]
Critics of naked shorting have emphatically asserted that the practice constitutes a major scandal on the stock market, and that "hundreds if not thousands of companies" have been victimized by the practice. Some critics have contended that there is a "massive stock counterfeiting" conspiracy, with one vocal critical, Overstock Inc. Chief executive officer Patrick Byrne, maintaining that there is a "Sith Lord" behind naked shorting machinations; a claim that has been met by widespread derision.
However, critics of naked short-selling have failed to produce evidence in support of their arguments. That and the "Sith Lord" and "stock counterfeiting" claims, have hurt the credibility of the anti-naked-shorting movement
Purpose[]
The purpose of the shorting is for the firm to continually bring the price down to the point of squeezing buyers out of that security, thus allowing them to cover their position for a profit, without having even been operating at cost in the first place. Similarly, with small companies, they can send them into bankruptcy and thus make a full profit on this effectively illegal action.
Reaction[]
The SEC implemented the Reg SHO to track stocks that are being shorted in this manner, although many complain that this is impotent and has not actually stopped the Hedge Funds from doing something that was already illegal in the first place, resulting in many calling for harsh penalties being instated upon those who violate this law, although at current, nothing is being done (allegedly).