Shorting a stock is borrowing an available share to sell it short or at a lower share price. But what is a naked short?
Definition: Naked Shorting
Naked shorting is an illegal practice of short selling shares that have not been confirmed to exist.
Naked shorting began at the same time of short selling becoming popular. Normally when shorting a stock an investor needs to confirm that shares are available to short sell before shorting. Due to various loopholes in the rules and discrepancies between paper and digital trading the practice still continues today.
The practice of naked shorting was banned by the SEC after the 2008 financial crisis when a high volume of shorts were placed on financial institutions. However, stocks still become victims of naked short selling.
In January of 2020 when GameStop stock was surging online investors pointed out that the stock was shorted over 100 percent of all the available shares. The short percentage was as high as 140 percent. Many online users questioned how this was possible if naked shorting is illegal.
What this means is that 40% of the shares that were shorted did not even exist to borrow. There is an ongoing investigation concerning how this was allowed to happen. With the investigation, it is possible that corrupt investors may be penalized.
Although naked shorting may cost other investors losses, investors that are caught naked shorting are not strongly penalized. Many of them will pay a small fine if caught.
This debacle began a movement by retail investors for reform in the practice of short selling a stock. They have encouraged the SEC and Federal Government to place stronger restrictions on the practice.
”So let me get this straight, GameStop stock was being illegally naked short sold and it was allowed to happen?”
“Wall Street Bets, we need to complain about naked short selling.”
“Why don’t large investors have to play buy the rules? Why are they allowed naked short selling?”