Naked Short Selling
A form of fraud where the perpetrator profits while lowering the price of a target stock
- Naked short selling is an illegal form of trading where a trader short-sells a stock or other security without first borrowing or having possession of the security. This means they are selling securities that they don’t actually have.
- Hedge funds and other market participants might do naked short selling if the perceived risk of doing so is less than the expected return on investment from doing so.
- Oftentimes, perpetrators of naked short selling are able to avoid negative consequences by concealing their efforts and closing out of the trade before being noticed.
Following the Sneeze of January 2021, many GME investors began to investigate and discuss what exactly was going on in the stock market to have caused this peculiar event.
It didn't take very long for the hive mind to point towards naked short selling as one of the necessary culprits. After all, how could it be that the reported short interest of a stock could exceed the number of shares of that stock that officially exist? In the case of GME, in January 2021, analytics firm S3 Partners reported a short interest of 141%.
During these social media discussions, there was often a great amount of doubt surrounding naked short selling; many social media users explicitly denied the existence of naked short selling.
The very idea of naked short selling sounds absurd, selling something you don't have. Was it even a real thing? How prevalent was it in the stock market? To what degree was naked short selling involved in creating the conditions that led to the GME sneeze?
- Mainstream financial outlets like CNBC, Bloomberg, and Reuters often emphasize that direct evidence of large-scale naked short selling of GME has not been conclusively proven
- Outlets covering the GME saga frequently mention retail investors' community-driven narratives about naked short selling, "synthetic shares," and dark pools. While some platforms portray these as conspiracy theories or exaggerations, others acknowledge the lack of transparency in market mechanics that fuels these beliefs
Here is a clip recorded on April 23, 2021 from the miniseries Gaming Wall St, released March 3, 2022, in which a market participant admits to using naked short selling to make profits, and emphasizes that the problem is ubiquitous:
"Folks I know who are still in the industry have been telling me, ‘I wouldn’t advise you to talk about it.’ But I think they’re all living in a fake world.
I used to illegally naked short sell stocks every day. Every day. As long as I was collecting commissions. And the bank did not care.
The client sends an order electronically, and all you do is click on the order, go to execute; it’ll pull up a little box, you type in anything you want, and you just hit ‘OK.’ You don’t ask questions. You appreciate the order, and if that involves shorting a stock naked, you do it anyway.
Because management essentially tells you, ‘Just create the business. Anything on the back side, we will deal with.’
So you’re collecting money on the front, you collect money on the back, and you actually have zero risk. The clients never see that.
All the prime lenders—they all do it. Consistently."
Naked short selling is an open secret of the stock market. It is real, it is prevalent, it is widely known about, yet rarely talked about in the mainstream media and enforcement against it rarely occurs.
It is difficult to prove because it is behavior that is perpetrated covertly by market participants that possess the ability to do so while evading detection and consequences.
When GME shareholders began investigating the peculiarity of GME in the aftermath of the sneeze of January 2021, the discovery of naked short selling played an important role in investors' understanding of what is otherwise a mysterious and unclear story. Many GME shareholders continue to have the assumption that GME has been naked short sold to some extent, perhaps to a very large extent.
