When a short position is opened in the stock market how does the brokerage know whether the trader has actually borrowed the shares or not?

  • 2
    See JoeTaxpayer's answer to your other question. If your broker is involved, he is responsible to the other brokerage for delivering the shares that you have sold short, and you owe your broker the shares. If you are opening a short position without a broker, the broker on the other side of the transaction will have to trust you on the matter, right? Assuming he didn't fall off the turnip truck this morning, would he be willing to give you money for shares not yet delivered to him? – Dilip Sarwate Jun 30 '12 at 18:06
  • +1 Dilip, for turnip truck reference. Indeed, a broker won't take a risk on a small client. – JTP - Apologise to Monica Jun 30 '12 at 21:17
  • Not yet -1, but the premise of this question seems flawed. How do you open a position without using a brokerage? Are you a member of the exchange? How did you enter your trade? – sdg Jul 4 '12 at 22:07
  • @sdg I agree with you. The brokerage would of course know whether the trader has borrowed the shares, as the broker needs to have them in order to sell them for the trader! We need some further clarification/ motivation to be able to answer this question, I think. – Ellie Kesselman Jul 5 '12 at 0:32

Brokerage firms are required to report the number of shares being shorted. This information is reported to the exchange (NYSE of NASDAQ) and is made public. Most financial sites indicate the number of shares being shorted for a particular stock. The image below from Yahoo finance shows 3.29 million shares of CMG were being shorted at the close of 9-28-2012. This is over 12% of the total outstanding shares of CMG.

CMG shares shorted

For naked short selling additional information is tracked. If the brokerage is unable to borrow shares to deliver before the settlement date of a short sale then the transaction is recorded as fails-to-deliver. No money or shares are exchanged since the brokerage is unable to deliver the shares that were agreed upon. A large amount of fails-to-deliver transactions for a stock usually indicates an excessive amount of naked shorting. When investors and brokerage firms start to aggressively short a stock they will do so without having borrowed the shares to sell. This will result in a large amount of naked short selling. When there are a large number of naked short sellers not all the sellers will be able to borrow the necessary shares before the settlement date and many fails-to-deliver transactions will be recorded.

The SEC records the number of fails-to-deliver transactions.

The table below summarizes the fails-to-deliver transactions from 1-1-2012 through 9-14-2012 (data obtained from here). The “Ext Amount” column shows the total dollar value of the transactions that failed ( i.e. Fail Qty * Share price ). The “Volume” column is the total number of shares traded in the same time period. The “% Volume” shows the percentage of shares that failed to deliver as a percentage of the total market volume.

The table orders the data in descending order by the quantity of shares that were not delivered. Most of the companies at the top of the list no longer exist. For many of these companies, the quantity of shares that failed to deliver where many multiples of the number of shares traded during the same time period. This indicates massive naked short selling as many brokerages where unable to find shares to borrow before the settlement date.

More information here.

fails to deliver by qty

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