Skip to main content
Law Related

Naked Short Selling, How to Moon, and Case Study!

By July 14, 20214 Comments


Hello and welcome to Legal “No” Briefs – I am attorney Jeremy Hogan and we will call this the Naked and Short edition of Legal Briefs, not because I am naked or short but because we are talking about what Naked Short selling of a stock is and more importantly, how you – yes you – can turn the tables on the hedge funds that ARE naked and short, and Moon!

I love that graphic – so old school.

Tomorrow I will be present at the SEC vs. Ripple hearing but today we are go going to go over what naked short selling is, why it’s bad, the legalities of it all and how YOU can turn it on its head and make some moon – instead of the hedge funds and yes, we are talking about AMC, Overstock – exactly. And then stick around to the end and we will do a case study of a stock – GTII that is apparently heavily naked shorted and talk about the super things the company is doing to try and trigger the short squeeze.  Let’s go!

That still brings a tear to my eye all these years later.

Welcome back and now the legal disclaimer: Look at me. Don’t take anything I say as legal or financial advice. I can barely tie a tie – kinda like the U.S. soccer team. (get it?)  This video is what we call Edu-tainment. I am not an investment advisor and you need to get investment advice elsewhere. (Was that enough disclaimer?)

Ok, so first, there is something called short selling which is a legal form of speculative investing. It’s when someone borrows a share of stock from a broker, sells them to someone else – for example for $10,  and some time later “closes” their position by buying the shares at market price – for example at $5 and returning them to the lender.  The short sellers profit is the difffference between what they bought and sold for – in our example they borrowed it from a stock broker, sold it for $10 and then bought the same amount later for $5 and returned it to the stock broker – pocketing the $5 . 

They make money when the stock goes down. And it’s a legit thing to do. Maybe Too Legit. 

Thank you Hammer.

So there’s short selling but then there’s also something called “Naked” short selling and that is a completely different story.

No, not that kind of story and not that kind of “Naked”. 

“Beaver Creek” Nudist Ranch. Well played.

In any case, we are not talking about some old hedge fund guys running around naked while trading stocks.  It’s much more messed up than that.

Somehow, and we don’t need to get into too much detail how this is possible, but somehow a hedge fund or similar entity can short a stock without actually borrowing real shares of  the stock or at least making concrete arrangements to come into possession of the stock.  Basically they get the stocks without paying for them. How can this happen?? You might ask. Well, the truth is that the broker or whichever party is supposed to obtain the stock “bends the truth” a little as we say, and then there is a failure to deliver the stock and you are left with shares of a stock  that exist on paper but aren’t part of any stock issuance.  This leads to their being more shares of stock out there than actually exist.  Yes, this actually happens! Believe it or Not. And innocent stock purchasers are left buying shares of stock that don’t really exist.

And if you don’t believe me, just think back to 2020 and what happened with Gamestop.

In the case of Gamestop, short sellers or actually naked short sellers sold 40 percent MORE shares of Gamestop stock than actually existed.  You can call them Phantom Menace Shares because they are a menace to our equity markets and don’t really exist..kinda like Jake Loyd’s career after Phantom Menace.

Poor kid.

Which takes me back to Gamestop. Remember a short seller wants the price to go down and by putting phantom shares into the marketplace, the naked shot sale seller can cause the price to drop. But the short seller has almost unlimited risk because the price can theoretically go up an unlimited amount and the short seller still has to cover the purchase – or pay for the stock to the broker when it’s time to close the short position.

And what happens is that IF the price rises instead of drops, the short sellers will be forced to either cover (buy the shares of the stock and give them back to the stock lender) OR  risk losing more and more money as the price rises. And in a normal stock with a lot of short sellers, the price of the stock will rise as shorts cover, it’s called a short squeeze, but in a stock with a lot of NAKED short sellers, the increase in price is even more dramatic because the Naked Shorts didn’t have to pay for the shares so there are usually much more shorts shares involved.

But what if the Naked Short Seller says “the price has increased,” I’m just going to walk away and not cover. This happened in the past and the buyers of the Phantom Shares like me and you were left with …nothing.  SO the new SEC Rules, Rule 204 requires that “Brokers and dealers that are participants of a registered clearing agency take action to close out failure to deliver positions.”

In other words, if the Naked Short doesn’t cover, the stock broker must step in and cover.   And that is great for the retail purchaser because they can’t be left out in the cold.

Now, a  naked short squeeze can happen very very quicly and here’s what it looked like in early 2021 with Gamestop.

In late 2019 a group of retail investors, mostly young people, took notice of the amount of naked short sellers messing around with Gamestop and decided to force them to sell and when all that retail money along with a LOT of hedge fund money that jumped onboard went into Gamestop, you can see in January 2021 what happened.  The price started at $4 before this chart then up to $17.50 and rose slowly into January but by January 21 the damn broke as the shorts realized they were in trouble and there you see it go up to over $350 in just 5 trading days .

Great for the Reddit crowd who made this happen.  Not so good for the Naked Shorts. 

But for every Gamestop, there are of course hundreds of Naked Short Sellers out there making a killing and you might be thinking “Surely, this can’t be legal?” And before 2005 it was frowned on but legal.  That changed with the Regulation SHo in the U.S. in 2005.  And here it is in all its glory straight from the SEC:

Regulation 203 (1) and (2) requires stock brokers to have “reasonable gounds” that is can deliver the stock that is ostensibly being shorted.  AND Rule 204 basically says that the stock broker, if it can’t deliver the stock, must ITSELF basically cover the short position.

SO how is possible that this is still happening?  Well, the bottomline is that the rules are only as good as how they are enforced and unfortunately there has not been a lot of enforcement in this area and the limitation to civil penalties can make it worth the risk for certain people.

A Naked Short that gets away with it can make millions of dollars – capital M.  And the results of getting caught – well, here’s one:

“The SEC order finds that (there was a violation of 203(a)(1) …and must …) pay a penalty of $250k.

And there you can see why the practice persists.

And now that you know the basics here is an actual case study from about 10-15 years ago involving a company called Sedona and this is a video from Judd Bagley’s channel which I strongly recommend you watch. In the Sedona situation, Sedona was the company, Rhino was the hedge fund that was attacking the company with Naked short shares, and Refco was the stock brokerage. Watch this:

And there you have it. This is actually happening still. All the time.

SO, now that you hopefully understand what Naked Short Selling is and why it happens – why could this be important to you? The reason it’s become important is because is that the Gamestop short squeeze got a lot of attention and has brought the practice to public light and also has shown people that the tables can be turned on the bad guys.  In other words, if you can get the price of the shorted stock to increase, you can force  a cover and the price can rise dramatically – in the case of Gamestop – almost 100times. 100 times.

Still love it.

But here’s the problem.  Naked short selling is illegal and so there’s no easy way to know it’s going on.  No one who is breaking the law tells you about it on Twitter and because a stock is sold by literally hundreds of brokers, there’s no way even for the company who issued the stocks to sit down and count them all and figure out that they issued a million shares and now there are 1.5 million shares floating around on exchanges.  

No, naked shares are hidden and sometimes hidden very well and it’s finding the Naked Shorts and triggering the squeeze where the secret juice is.

SO let’s talk about a stock that’s heavily naked short and that stock is Global Tech industries Group – GTII and it’s an over the counter stock.

GTII is a small tech company and tech companies and small pharmaceutical companies are the perfect targets for naked short sellers or really any short seller.  The naked shorts can really depress stock price and sometimes even force the company into bankruptcy – which of course is wonderful for the short seller.

As an example, this screen shot is from just before we shoot this video and look at how easy it was to drop the price of GTII almost 9% on almost no volume. 

I found out about GTII on a VPN while surfing the dark web cuz I’m cool like that  – just kidding, a friend told me about it but you can just look on Reddit or Twitter or I think even Google. Seems everyone knows another Gamestop nowadays but that is the name of the game because even figuring out whether a company has been naked shorted is really a matter of experience and educated guessing.

So with GTII the best educated guess is that the total naked shorted shares are somewhere in the 70-80 million share range which might not sound crazy until you see that the company only ever issued like 240 million shares in total.

And this seems to jibe with the info from which we can see here how much the short volume is with GTII and how it almost perfectly matches regular selling volume to keep the price repressed.

But what’s really interesting here is what the company is doing about it.  A naked shorted company doesn’t really have a good way to prove that naked short sellers have attacked it because it has no ability to count total shares – including the “phantom” shares.  So what GTII did was it announced that it would give everyone who owns the stock another issuance of stock at a certain price. Very smart.  The idea is that when the price goes above the issuance price you would have all the shareholders asking for their shares of stock and that number would be requests corresponding to 330  million shares of stock  – when the total number of shares should be only  240 million.  Boom – you have the proof of the Phantom shares.  The problem GTII had with this is that shareholders had a hard time getting the warrants transferred.

Which led to this news release from the company trying to help shareholders figure it out.

And here’s where things get even more interesting because apparently the warrants were not being transferred so the company merged with another company which, wait for it, which company is specializing in tokenizing fine art on a blockchain. Two things I’m interested in – coming together. Love it.

And why is that super interesting?  Because GTII intends to give its tokenized crypto fine art to shareholders as a kind of digital warrant – in other words, they will distribute the tokenized ownership of the artwork to all shareholders upon request.  This  solves the problem of relying on third parties to transfer the warrants because when the digital fine art tokens are distributed, the shareholders can come straight to the company to apply for their extra shares and the company will be able to get an accurate count of the TRUE number of outstanding shares INCLUDING the Phantom shares and with that information they can take the information to the SEC and – it should be game over for the Naked Short seller and then – Boom, it’s time for the Stock brokers to cover…and Moon.

So, will digital Picasso beat our naked short seller?

Or will the Phantom shares remain – out of focus.

Stay tuned to find out.  But what an interesting battle going on behind the scenes in any case.

And That’s all I have for you today. Remember when it comes to investing always do your own research, time really is money and no one values your limited time on this earth as much as you do.  Thanks for watching.

Join the discussion 4 Comments

Leave a Reply