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From the wiki article on naked short selling

It is not clear whether this practice is illegal ,or only limited to hedge funds and institutions.

I say this because at least my discount brokerage does not allow naked short selling. Do retail investors engage in this activity?

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    This depends on jurisdiction. What country are you asking about? – littleadv Feb 8 '14 at 0:10
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In the United States, according to Regulation SHO, failure to deliver is forbidden to traders and their agents except by mistake.

Market makers are permitted to fail to deliver, but the exchanges for which they make will not permit them to trade for long if the liabilities are unhedged because this will expose the exchange to solvency risk.

An intentional failure to deliver by a normal market participant or its agent is a violation of securities law and is considered fraud.

Failure to deliver is common with securities undergoing trade volume well in excess of their respective averages because it is difficult to maintain proper settlement & clearing at such high speeds. The failures are usually quickly resolved after a security has calmed.

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