Market makers are allowed to be temporarily naked short because it's required for them to do the job they're supposed to do - provide liquidity. A market maker can sell short if they don't have any stock because they will almost certainly be buying it soon after. There's no evidence that any market makers are abusing this privilege with GameStop.

Yeah; it's not exactly what I'd called "unlimited shorting"; all of the pre-borrow and closeout requirements from Regulation SHO apply ... plus, as you say, the market maker exception is specifically there to stabilize markets by providing liquidity in the face of sudden rushes to buy.

I guess one man's price stabilization is another man's market manipulation.

It also needs to be mentioned that the entire business of MMs is to capture the spread by buying at the bid and selling at the offer. As such, they are passive market participants who will only transact if someone executes a marketable order against one of their resting orders. This means, they can only be as (naked) short as someone else is willing to buy from them. But they are also not interested in having directional exposure and will go to great lengths in order to balance their inventory.

The idea that MMs would somehow use their privilege to actively sell massive amounts of non-existent shares into the market in order to manipulate the price downwards is preposterous. That is literally the opposite of their business model and such activity would certainly be flagged by regulators.

Right - the entire Volcker reporting framework would instantly reveal anything of that nature.

Honestly it feels like a lot of the conspiracy theories around these meme stocks are based on reading a lot into a very narrow slice of regulatory text without any real understand of the whole.

This poster knows what they're talking about. The market making exception is there to prevent liquidity completely evaporating as it did during the flash crash. It's not there to encourage them to bend the rules -- it's to compel them to trade when it might be unprofitable.

Every trade has to be marked correctly, whether it's short with a physical locate or short on a riskless principal basis. Equity swaps trade and are marked as riskless principal trades (ie. they're fully hedged positions and the short position is the market maker's aggregate short position). That information gets aggregated at client level and reported to regulators.

After Dodd Frank equity swaps and rehypo became even more heavily restricted. Swaps go through a clearing house and rehypothication was basically dead the last time I worked in the industry (though that might have changed).

I'm 99% sure that the speculation about the "elites" and their sinister role in GME's trading activity is simply caused by booking errors and/or aggregation mistakes.

I think it's also worth pointing out that when selling short (naked or not), there's a big difference between adding liquidity and taking liquidity, and market makers are primarily (if not exclusively) in the business of adding liquidity.

If you're taking liquidity (i.e. "I want to sell right now"), you're directly applying downward price pressure to the market, by removing shares from the buy side.

If you're adding liquidity ("I'm selling, but I'm waiting for a buyer"), that's likely to have much less (if any) effect on the price.

> a market maker engaged in bona fide market making, particularly in a fast-moving market, may need to sell the security short without having arranged to borrow shares

It's literally called the "madoff rule" and the "madoff exemption" because he's the one that pushed the SEC to allow it.

https://www.sec.gov/investor/pubs/regsho.htm