Opinion ID: 4425534
Heading Depth: 2
Heading Rank: 1

Heading: Short Selling

Text: ¶ 9 A brief overview of the trading practice known as short selling helps understand Plaintiffs’ allegations. 5 Short selling is best characterized as a “sell high, buy low” strategy. Alexis Brown Stokes, In Pursuit of the Naked Short, 5 N.Y.U. J. L. & BUS. 1, 3 (2009). If everything goes according to plan, an investor, suspecting that the price of a stock will decrease, borrows the stock, sells it, waits for the price to decline, purchases the stock at the lower price, returns the stock to the lender, and “pockets the difference in price as profit.” Id. Typically, the investor will borrow the stock from a brokerage firm, and the borrowed stock originates from the firm’s own inventory, the margin account of other brokerage firm clients, or another lender. U.S. SEC. & EXCH. COMM’N, KEY POINTS ABOUT REGULATION SHO, https://www.sec.gov/investor/pubs/regsho.htm (last visited August 7, 2019). Short selling is a lawful trading practice in many instances. Id. But short selling is illegal when used to manipulate the price of a stock. Id. ¶ 10 In a typical transaction, the seller has a three-day settlement period to deliver the stock to the buyer. U.S. SEC. & EXCH. COMM’N, NAKED SHORT SALES, https://www.sec.gov/answers/ nakedshortsale.htm (last visited August 7, 2019). In a naked short sale, the investor identifies a stock that she suspects is overvalued and likely to decrease in price, then sells shares of the stock that she does not own or has not borrowed and does not intend to own or borrow, thus creating phantom shares of the stock. Id.; Stokes, supra ¶ 9 at 6. Because the seller does not own or possess the shares she sold, she cannot deliver the securities within the settlement period. U.S. SEC. & EXCH. COMM’N, KEY POINTS ABOUT REGULATION SHO, https://www.sec.gov/investor/pubs/regsho.htm (last visited _____________________________________________________________ 5 “Because this is an appeal from a grant of a motion to dismiss, we construe the facts in the light most favorable to . . . the nonmoving parties.” Bylsma v. R.C. Willey, 2017 UT 85, ¶ 4 n.2, 416 P.3d 595. . 4 Cite as: 2019 UT 44 Opinion of the Court August 7, 2019). This is known as a “failure to deliver” or “fail”—the securities equivalent of an “IOU.” Stokes, supra ¶ 9 at 7; U.S. SEC. & EXCH. COMM’N, KEY POINTS ABOUT REGULATION SHO, https://www.sec.gov/investor/pubs/regsho.htm (last visited August 7, 2019). ¶ 11 The Depository Trust and Clearing Corporation (DTCC) records the fails. The DTCC is “a financial services company that clears and settles securities trades and provides custody of securities.” Stokes, supra ¶ 9 at 6. The DTCC eliminates the need for exchanging paper stock certificates and provides an efficient and safe trading mechanism for buyers and sellers. Id. ¶ 12 This system allows a transaction to occur, and all monies to be paid, before delivery of the stock occurs. Id. Broker-dealers and banks credit the shares to the buyer before delivery. Id. at 7. If the seller does not deliver the shares, a fail occurs, but the buyer still possesses the purchased shares. Id. This can result in an artificial oversupply of the stock. Id. When the market is flooded with the chimerical shares, the stock price usually falls. Id. The SEC heavily regulates naked short selling, and its legality is confined to limited circumstances. U.S. SEC. & EXCH. COMM’N, KEY POINTS ABOUT REGULATION SHO, https://www.sec.gov/investor/pubs/ regsho.htm (last visited August 7, 2019). Plaintiffs allege that Defendants’ trading practices ventured outside of these limited circumstances and into the realm of illegal activity.