The GameStop Mess Exposes the Naked Short Selling Scam

At the House Financial Services Committee hearing last week on the GameStop debacle, there was an elephant in the room: naked short selling.

Short selling, effectively betting that a stock will go down, involves a trader selling shares he does not own, hoping to buy them back at a lower price to make money on the spread. The trader is supposed to locate (or have a “reasonable belief” he can locate) or borrow the shares in brokerage accounts, and then transfer them to the buyer within two days. This accounts for as much as 50 percent of daily trading.

Naked short selling is when the trader does not find those shares to deliver. It’s costly to big hedge funds to locate hard-to-borrow shares. So prime brokers, who carry inventory of stocks for high-volume short sellers, simply lie about the borrows, to assist their favorite clients.

It’s a scam central to the stock trading system, enabled by the Securities and Exchange Commission (SEC), the market regulator, and the Depository Trust and Clearing Corp. (DTCC), the stock clearinghouse, to benefit the big players. The SEC has long been run by revolving-door officials who move between it and Wall Street trading houses and law firms. DTCC is owned by the prime brokers, such as Goldman Sachs, JPMorgan, and Citi, and run in their interests.

It’s a scam central to the stock trading system, enabled by the Securities and Exchange Commission, the market regulator.

At the House hearing, Rep. Nydia Velazquez (D-NY) asked about the dangers of short selling. “GME [GameStop] sold short 140 percent. Why isn’t that manipulation?” She meant that short sellers sold 40 percent more shares in GameStop than existed. They were phantom shares that didn’t exist but that were posted in buyers’ accounts as “entitlements.” The buyers have no idea they don’t have real shares. They can sell and even loan those digital entitlements.

In other words, large numbers of “locates” or “borrows” were fake, making the shorts “naked.” Why does it matter? Because naked short selling causes the number of shares in the market to increase, which normally makes their value drop; more shares equals less value. And it can massively disrupt the market, as GameStop showed.

Rep. Andy Barr (R-KY) backed up Velazquez. “We are interested in naked shorting. How do you make sure you are first locating to borrow?” Rep. Ed Perlmutter (D-CO) asked if sellers were in a naked position.

Source: The American Prospect

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