I normally have a lot of respect for the Clusterstock blog. They have witty and sarcastic commentary bringing the reader’s attention to events that matter to the markets. This article about naked short-selling, written by John Carney and found here, however, disappoints me because I believe he misses the point.
Mr. Carney’s argument that naked short-selling, the practice of selling shares that you haven’t bothered to borrow in the first place, is ok rests on his claim that whether or not the seller has the shares is irrelevant because the amount of shares that are net short is no different than regular shorting. This is wrong.
Firstly, by eliminating the need to search for shares to borrow, naked shorting can happen a lot quicker, which raises volatility. We may only be talking about a matter of minutes, but if thousands of these transactions are happening at any one time, this can make a huge difference. Secondly, it can create a scramble to find the shares the shorter needs to close out the position, and if there are not enough available, the investor who thought he had bought an amount of shares from the shorter is screwed. This creates dissatisfaction in the market, to the disservice of all. Finally, by not disclosing their position, the number of net Shorters can increase dramatically as they can have multiple “claims” on the same shares, which can amplify the effect of the short interest and possibly cause a run on the stock.