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Legal issues around naked short sales

On Behalf of | Sep 23, 2021 | White Collar Crimes

Short selling essentially means betting against a stock. With short selling, an investor is hoping to profit when a stock loses money. This is legal, provided that the short seller has access to the shares of stock. Investors in Oklahoma should be aware that sometimes, unscrupulous brokers and dealers will attempt to short stocks they don’t have access to. The shares may not even really exist. This is an illegal practice called naked short selling.

Understanding naked short selling

Naked short selling is a practice that has been illegal since the mid-2000s. However, it’s still possible for unscrupulous people to engage in naked short selling. It can still be accomplished because of lags and discrepancies between paper and electronic recording systems.

The SEC continues to uncover cases of naked short selling and prosecute them. In May of 2021, they brought a case against a broker-dealer who allegedly misclassified over 95% of a hedge fund’s short sale orders. Short selling is a complex and risky maneuver in and of itself. In order to legally short a stock, an investor must borrow a stock, sell it, then buy it back. Next, they return it to the original owner who loaned it to them. It’s advised that individual investors steer clear of this. Even professionals have lost large amounts by attempting to short a stock.

Naked short selling falls into the category of white-collar offenses. White-collar crimes are defined as non-violent crimes involving fraud and committed for the purpose of making money. Naked short selling qualifies as a fraud because there’s a lie at the heart of it: no one involved can even establish the shares exist. In the case brought by the SEC in May, for example, the broker-dealer was not able to produce the shares for settlement dates.

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