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Regulation of Naked Short Selling

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Publication Date: March 2005

Publisher(s): Library of Congress. Congressional Research Service

Series: RS22099

Topic: Banking and finance (Commodity exchanges)

Abstract:

Short sellers borrow stock, sell it, and hope to profit if they can buy back the same number of shares later at a lower price. In effect, a short sale is a bet that a stock's price will fall. A short sale is said to be "naked" if the broker does not in fact borrow shares to deliver to the buyer. When executed on a large scale, naked short sales can equal a large portion of total shares outstanding, and can put serious downward pressure on a stock's price. Critics of the practice characterize it as a form of illegal price manipulation. The Securities and Exchange Commission (SEC) recently adopted rules designed to control short selling abuses, but calls for further restrictions on the practice continue. This report describes the mechanics of short selling, summarizes the new SEC rule, and analyzes the impact of short selling in the marketplace. It will be updated if events warrant.