WASHINGTON D.C. (CN) – In an effort to stop those trying to cash in on a diving market, the Securities and Exchange Commission adopted three new rules Wednesday to crack down on naked short selling where the seller sells stock without having it in hand.
First, short sellers must deliver securities within three days of the sale. Penalties for breaking the rule were included.
Also, Options market makers, whose role is to buy when demand is low and to sell when demand is high to ensure balance of the market, are no longer exempt from the three day delivery rule.
Finally, short sellers must not lie about their intentions to deliver the securities.
Short selling is the legal practice of borrowing shares and selling them with the expectation that the value will drop. The borrower, who is required to return the shares to the original owner, then buys the shares back after the values have fallen and returns the devalued shares.
If the share value has fallen, the short seller walks away with a net gain. If the value of the share climbs, the short seller must buy them back at the higher price, and suffers a net loss.
Naked short selling happens when a short seller illegally sells stock he hasn’t borrowed and therefore fails to deliver the stock to the buyer.
The new rules took effect Thursday.