User:PouponOnToast/arb

Illegal naked short selling is fraud. It is the creation of a sale transaction, for which the buyer's funds are taken, but no product is delivered. Apologists for the practice seek to introduce a number of straw man arguments, none of which address the core fraud in the practice, which as noted before, is illegal in all but a few instances - such as market maker exemptions.

It is difficult to argue with a straight face that there are benefits for the market to be had by defrauding investors, however that doesn't stop the perpetrators of the practice from advancing arguments supporting the practice. Some common arguments are that naked short selling is good for the market, as it can be used to combat other fraudulent activity, such as pump and dump schemes, where promoters pump a stock's value above fair value. It is simple to see the logical fallacy here, as it really argues that one fraud can be countered by allowing a different fraud - the "two wrongs make a right" fallacy.

Another canard that is floated by apologists for the illegal variant is that it increases liquidity, which is an argument that says that by increasing the amount of fraud, you increase the amount of trading, which increases the ability to buy and sell easily, and decreases spreads. Again, this argues for allowing investors to be defrauded, as the benefits to an efficient market in trading these frauds are supposed to outweigh the damage from the fraud itself.

Current legal naked shorting rules allow brokerages to make large profits doing "bona-fide market making" while stock markets are falling. The market maker exemption to the rules governing the practice is intended to allow market makers to naked short sell on a very temporary basis, in order to increase liquidity and stabilize markets. When this practice extends for more than a few days, it too crosses over from the legal variant, to the illegal variant - fraud.