Traditional short selling involves selling securities or other investment instruments the seller does not actually own, and then subsequently repurchasing them to cover the sale within the standard three-day settlement period (“T+3”). “Naked” short selling or “naked” shorting occurs when the seller does not actually borrow the security or ensure the security is even available to be borrowed.
If the seller or the seller’s broker-dealer fails to deliver the shares within the requisite T+3 settlement period, then a “failure to deliver” occurs.
While “naked” short selling does not necessarily violate SEC rules or federal securities laws, Regulation SHO outlines general requirements designed to curb abusive “naked” short selling. Rule 204 requires self-clearing broker-dealers to close out “failure to deliver” positions by purchasing or borrowing securities of like kind and quantity within one business day following the settlement date (“T+4”).
Additionally, Rule 201 requires trading centers to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent the execution or display of a short sale at an impermissible price once a stock has experienced a price decline of at least 10% in one day.
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