The Naked Shorting on ETFs in the Modern Economy

Abstract

Executionary naked shorting, or cellar boxing, is a form of manipulation found within the stock market. To combat naked shorting, the SEC adopted Regulation SHO. Regulation SHO also includes the threshold list which publishes the securities that have an excessive amount of fails. Exchange-traded funds are relatively new securities that trade like stocks. Richard Evans, University of Virginia, (2019) found that around 1% of ETFs are failing at any given time. Additionally, many ETFs are always found on the threshold list. This study analyzes the effects naked shorting has on ETF behavior during a recessionary and calm period. A data analysis was performed on the Regulation SHO threshold list appearances and the French-Fama-Carhart 4 Factor Model was used on the ETFs with the most severe naked shorting cases. The ETF market was affected by the recession, but I found that it recovered very quickly. Additionally, the FFC 4 Factor model revealed that momentum was neither negative nor significant, indicating that cellar boxing does not take place in the modern ETF market. The FFC 4 Factor model also revealed that the only consistently significant factor was the market risk premium, indicating that ETFs fail simply because of the market conditions. I show how executionary naked shorting is not pervasive in the modern ETF market.