The penny stock world often attracts investors looking for the big score. They’ve heard stories of investors buying Xerox or IBM when they first went public and were at very low prices. A few decades later early investors were multi-millionaires. But the penny stock world also is full of risky companies and some outright scams. This is a very long piece. But if you have the patience it’s an interesting tale of an experienced investor who lost money in a penny stock (after having huge profits on paper) and spent years searching for the reasons it tanked.
But in naked short selling, you don’t even borrow the stock. You sell additional, phantom shares. This is even more likely to drive down the price than regular shorting, because suddenly the supply is larger but the demand is the same. “I can think of a number of stocks where the shares on the short exceeded the shares ever issued by the company,” said Alabama Securities Commission Director Joseph Borg. “You can’t do that unless it’s naked.”
Naked short selling is, not surprisingly, illegal in most circumstances.
But market makers like Knight have an exemption from naked short selling restrictions, on the grounds that they use the practice to maintain liquidity in markets.