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Short selling is a perfectly legitimate practice. It involves traders borrowing shares and then selling them, hoping the price will drop so that they can repurchase the shares at a discount, return them to the lender, and pocket the difference. In “naked” short sales, traders do not borrow or purchase stock before they sell it. They simply sell what they do not have – phantom stock. You probably can imagine how easy it is for someone to suppress the price of a security if they are able to swamp a market with artificial supply.
In 2005, "Regulation SHO" was enacted, requiring that broker-dealers have grounds to believe that shares will be available for a given stock transaction, and requiring that delivery take place within a limited time period. As part of its response to the crisis in the North American markets in 2008, the SEC issued a temporary order restricting short-selling in the shares of 19 financial firms deemed systemically important, by reinforcing the penalties for failing to deliver the shares in time. Effective September 18, 2008, amid claims that aggressive short selling had played a role in the failure of financial giant Lehman Brothers, the SEC extended and expanded the rules to remove exceptions and to cover all companies, including market makers.
Meanwhile, there is strong evidence that the markets for U.S. government debt have also come under attack. The first naked short selling assault on U.S. Treasuries was launched in September 2001, at the time of Al Qaeda’s attacks on the World Trade Center and the Pentagon. In the months and weeks before the 9-11 tragedy, a daily average of $1.5 billion worth of U.S. government bonds failed to deliver. On the days immediately before 9-11, the daily failures to deliver soared to an astounding average of $1.5 trillion and continued to rise in the days after the attacks.