End of Naked Shorting? Will Pigs Finally Fly?

American investors have been taken for a trillion-dollar ride by naked short sellers, in what could turn out to be the biggest financial regulatory scandal in North American history.

While what is now an all-out war on naked short sellers intensifies, there is a new flashpoint on the front line–a potentially devastating ruling targeting those who are alleged to make illegal naked short selling possible: The Facilitators: bankers and brokers.

When things get naked, the regulatory environment becomes riddled with compliance holes. With a naked short, the short seller is selling shares it doesn’t own and has made no arrangements to buy. That means the seller cannot cover or “settle” in this instance. More profoundly, it means they are selling ghost shares that simply do not exist without their further action. The ability to sell an unlimited number of non-existent shares in a publicly-traded company gives a short seller the ultimate power: To destroy and manipulate a company’s share price at will.

Following the 2008/2009 financial crisis, naked short selling was classified as illegal in the United States, though that labeling has done nothing to thwart this lucrative game.

What makes the September ruling so impactful is this: Without the big banks and financial institutions’ complicity, this highly destructive form of naked short selling could never happen. Instead, they actively facilitate the destruction of shareholder value.

However, as Barkley points out, the SEC does not publish FTDs (failures-to-deliver) of U.S.-issued securities traded and settled abroad (including Canada). This means a significant number of FTDs are never accounted for, essentially creating a naked free-for-all.

The judge’s ruling categorically means that going forward, big banks and financial institutions won’t just be fined for not actively closing shorts, they could be held liable for what so far has been an estimated trillion dollars in losses to retail investors, companies and the U.S. government.

“Brokers can no longer claim that they are not liable for their customers’ trading activities because they are only following their directions. A broker can now be held primarily liable under the federal securities laws when they recklessly fail to monitor, detect and prevent the manipulative or fraudulent trading of their customers,” Warshaw Burstein said in a statement following the judge’s September 29 ruling.

“This decision is a clear and unambiguous warning to broker-dealers that unless they fulfill their gate-keeper responsibilities of monitoring their customers’ trading they can be held primarily liable for their client’s manipulative conduct,” the law firm added.