2.7.6. Naked Short Selling and the Locate Requirement
A short sale can be covered or naked. A naked short sale occurs when a short seller does not borrow or arrange to borrow the securities in advance of selling them. By contrast, borrowing the securities first and then selling them is called a covered short sale.
Naked short selling is riskier than covered short selling. If a naked short seller cannot borrow the securities in time to deliver them by T + 2, the result is a fail-to-deliver. When many sellers choose to naked short sell a stock, the result can be a large number of fails-to-deliver, which could potentially drive down the price of the stock.
Naked short selling is legal in and of itself. But it is illegal if used to deliberately manipulate the market. It is also illegal if the seller deceives anyone involved in