In the finance world, naked shorting is a practice that is often shrouded in controversy. It occurs when investors sell shares of a stock they do not own and have not borrowed. Critics charge that naked shorting can be used to drive down a company’s stock price, while proponents argue that it is an essential part of the free market system. Let’s take a closer look at this practice and see the arguments on both sides.
What Is Naked Shorting?
Naked shorting is the illegal practice of selling a security that the seller does not own and has not borrowed. This type of short selling can be used to manipulate a security’s market price and create artificial supply and demand.
How Does Naked Shorting Work?
To engage in naked shorting, a trader must first sell a security they do not own. The trader then hopes to repurchase the same security at a lower price so they can profit from the difference. To do this, the trader must find someone willing to accept their stake. Once the trade is complete, the trader must find someone willing to sell them the security at a lower price.
Why Is Naked Shorting Illegal?
Naked shorting is illegal because it creates artificial supply and demand in the market, which can lead to market price manipulation. Additionally, naked shorting can make a false impression of market activity, which can mislead investors and lead to losses.
Who Can Be Charged With Naked Shorting?
Anyone who engages in naked shorting can be charged with securities fraud. This includes traders, brokers, and investment banks. Individuals can face up to 20 years in prison and/or fines of up to $5 million if convicted.
What Are Some Examples of Naked Shorting Cases?
There have been several high-profile cases of naked shorting in recent years. In 2008, Goldman Sachs was accused of naked shorting during the subprime mortgage crisis. In 2010, Deutsche Bank was fined $12 million for naked shorting during the financial crisis. And in 2012, UBS was fined $14 million for naked shorting during the European debt crisis.
What Are Some Risks Associated With Naked Shorting?
There are several risks associated with naked shorting, including market price manipulation, artificial supply and demand, and false impressions of market activity. Additionally, naked shorting can lead to losses for investors if they purchase securities based on incorrect information about market activity.
Should Naked Shorting Be Banned?
There is much debate on whether or not naked shorting should be banned. Critics argue that naked shorting is a form of securities fraud that can lead to market manipulation and investor losses. Proponents say that naked shorting is an essential part of the free market system and should not be regulated.
What Is the SEC’s Position on Naked Shorting?
The SEC has taken a tough stance on naked shorting, issuing several fines in recent years. In 2008, the SEC issued an emergency order banning the naked shorting of financial stocks. And in 2010, the SEC adopted new rules requiring traders to own the securities they are selling before selling them.
What Is the Bottom Line?
Naked shorting is a controversial practice that is often shrouded in secrecy. It occurs when investors sell shares of a stock they do not own and have not borrowed. Critics charge that naked shorting can be used to drive down a company’s stock price, while proponents argue that it is an essential part of the free market system. Let’s take a closer look at this practice and see the arguments on both sides.