Securities law is complicated. And because it’s so complex, it’s not always easy to know whether a given stock trade is legal or illegal. These questions of legality most often involve different types of insider trading, but they also commonly occur with the practice known as “short selling.”
When Short Selling Is Legal
The United States is something of an anomaly in that most other countries outlaw nearly all forms of short selling. This is likely because short selling involves traders selling stocks that they don’t actually own.
Put simply, in a short sale, a trader anticipates that the price of a stock is about to drop and then sells borrowed (or soon to be borrowed) shares of that stock. The trader doesn’t actually own the stock at the time of the sale—someone else does.
Once the stock drops in price, the trader then buys the shares back and returns them to their owner, keeping the difference in sales and buying prices as a profit.
Obviously, short selling is risky as it hinges on accurately predicting how the price of a stock will fluctuate. This is also likely why it is illegal in most other countries. The above scenario is completely legal in the United States, however—unless one of the factors detailed below complicates things.
Factors Making Short Selling Illegal
Naked short selling occurs when the trader hasn’t actually bothered to borrow the stock to be sold, or at least confirmed that he or she will be able to borrow it. Instead, the trader makes an empty trade with nothing to actually sell.
In a bear raid, a group of traders undertake a smear campaign against a targeted stock after selling borrowed shares. Their goal is to temporarily drive down the price of the stock, thereby allowing them to buy the borrowed shares back at a lower price, effectively creating the conditions of a short sale.
Short selling can also overlap with insider trading. If a trader’s knowledge of a coming drop in a stock’s price is based on insider information, then short sales based on that information will constitute securities fraud.
Report Illegal Short Selling to the SEC
As a form of securities fraud, illegal short selling is of high interest to the Securities and Exchange Commission (SEC). If you blow the whistle and the SEC launches a successful investigation that recovers sanctions in excess of one million dollars, you could be rewarded.
Contact Meissner Associates for a free, confidential tip evaluation to determine if you’ve encountered illegal short selling and how the SEC might react. Just complete the form below or give us a call at 1-866-764-3100 to get started.