Fails to Deliver: The Hidden Indicator of Market Manipulation

Short selling is a common trading practice where an investor borrows shares to sell them, hoping to buy back later at a lower price. In normal circumstances, short selling can contribute to healthy markets by adding liquidity and aiding price discovery. However, problems arise when short selling becomes abusive. Tactics like naked short selling – selling shares without ever borrowing them – can flood the market with phantom shares and distort prices. This form of manipulative shorting is illegal under U.S. securities laws. Everyday investors should be aware of the red flags that may indicate abusive short selling (such as naked shorting or coordinated “short and distort” campaigns) and know what tools to use to spot suspicious activity.

Legitimate vs. Abusive Short Selling

It’s important to distinguish regular short selling from abusive practices. In a legitimate short sale, a trader must borrow (or have a broker locate) actual shares before selling them short. The trader pays interest or fees to borrow those shares and must eventually buy back and return them. Legitimate shorts are part of normal market function – for example, hedge funds often short stocks they believe are overvalued or to hedge other positions, and such activity is subject to strict rules and margin requirements. Under normal conditions, this kind of short selling is a healthy mechanism that adds liquidity and efficiency to markets.

Abusive short selling, on the other hand, involves breaking or evading the rules to put undue downward pressure on a stock. The chief example is naked short selling, which means selling shares short without ever borrowing or intending to borrow the shares for delivery. In naked shorting, the seller fails to deliver the shares at settlement – essentially selling “made-up” shares that don’t exist in the tradable float. By removing the cost and effort of borrowing, naked shorting allows potentially unlimited short selling in a stock and can overwhelm the market with artificial supply. This concentrated selling can drive a company’s stock price down sharply without any fundamental reason. U.S. regulators outlawed naked short selling after the 2008 financial crisis and implemented Regulation SHO to clamp down on such abuses. Reg SHO requires broker-dealers to “locate” shares beforehand and to close out any failure-to-deliver positions within a prescribed time frame, especially for stocks that show signs of excessive delivery failures (more on this shortly). In summary, selling a stock short with a valid borrow and honest intent to deliver is legal and often sound practice – but selling shares you never borrow (naked shorting) or manipulating the market with false rumors (“short and distort”) crosses the line into abusive territory and market manipulation.

Red Flags of Abusive Short Selling

What clues might tip off an average investor that a stock is potentially under an abusive short selling attack? Here are a few major red flags to watch for:

• Unusually High Short Interest: A dramatic spike in short interest or an extremely high short interest ratio can signal potential trouble. Most stocks typically have a relatively small percentage of their float sold short (often single-digit percentages). When short interest climbs into double digits, it reflects heavy bearish bets – if the float reaches 10% or higher sold short, some market professionals consider it a red flag. In extreme cases, short interest has even exceeded the total shares available – for example, GameStop’s short interest famously reached around 140% of its float in early 2021. Such outsized short positions may indicate not only strong negative sentiment but possibly aggressive or unconventional shorting practices. While a high short interest alone isn’t illegal (GameStop’s case involved legally borrowed shares, which later led to a massive short squeeze), a sudden surge in short interest especially without clear reason could merit closer scrutiny. It’s wise to monitor published short interest reports (discussed below) for any shocking jumps or persistently large short positions on a stock you own.
• Persistent Fails-to-Deliver and Threshold List Appearance: Another hallmark of possible naked short selling is a pattern of settlement failures – when trades aren’t being delivered properly. If short sellers don’t deliver shares within the standard settlement period (now T+2 in the U.S.), those trades become fails-to-deliver (FTDs). A few isolated FTDs can happen for benign reasons, but persistent, large fails are a warning sign. In fact, the SEC’s Regulation SHO monitors this through the daily “threshold securities” list. A stock gets on the threshold list if it has significant fails-to-deliver for five consecutive settlement days (at least 10,000 shares and at least 0.5% of the outstanding shares failing to deliver) . Being on the threshold list suggests someone has sold shares they didn’t properly borrow, as such settlement failures may be indicative of improper naked short selling. For example, AMC Entertainment (a favorite of retail traders) remained on the NYSE threshold securities list for multiple days in mid-2021, which exposed potential naked shorting activity in the stock according to observers. Investors can look up if a stock is on the threshold list via exchange websites or FINRA – a prolonged stay on this list is a red flag. However, it’s important to note that not all fails-to-deliver are nefarious. Regulators caution that settlement fails can occur for technical or benign reasons and are not automatically proof of naked shorting or wrongdoing. So, while a high level of FTDs is a clue worth investigating, it should be considered alongside other factors.
• Sharp Price Declines on No News: If a stock’s price is plunging sharply without any negative news, earnings miss, or fundamental change to justify the sell-off, it could be experiencing a short-driven “bear raid.” Abusive short sellers sometimes attempt to drive prices down rapidly to create panic. The SEC noted during the 2008 financial crisis that “unbridled” short selling contributed to sudden price declines in financial stocks that were “unrelated to true price valuation”. In other words, the selling pressure was decoupled from the companies’ real condition. A classic sign is when a stock free-falls on rumors or fear alone. In such scenarios, heavy shorting may be accompanied by negative rumors or social media/blog attacks about the company (the so-called “short and distort” tactic where false bad news is spread to amplify the down move). For a vigilant investor, a rapid price drop in your stock on no apparent news should prompt you to check other indicators: Has short interest spiked recently? Is the stock showing up on any threshold lists or experiencing big fails-to-deliver? A convergence of these signs strengthens the case that manipulative short selling might be in play rather than just normal market trading.

Tools to Spot Suspicious Short Activity

Fortunately, there are public data sources and tools that everyday investors can use to investigate the above red flags. Here are some key resources to help spot and verify potential abusive short selling:

• Short Interest Reports (FINRA & Exchanges): Official short interest data is published twice a month in the U.S., giving a snapshot of the total open short positions in each stock. FINRA collects short interest from brokerage firms around mid-month and end-of-month and makes the data available for free on its website. The stock exchanges (like NYSE and Nasdaq) also publish these reports (often accessible via their websites or market data pages). By checking these reports, you can see what percentage of a company’s float is sold short and if that number is rising quickly. For example, if you notice a stock’s short interest jumped from 5% of float to 20% in one reporting period, that’s a significant spike worth digging into. Consistently high short interest relative to peers or to the stock’s own history can indicate a potential concerted short attack (or at least a high conviction bet against the stock). Keep in mind short interest reports are bimonthly snapshots, not daily figures, but they are a solid starting point to gauge if unusual short positioning is present. (Many financial news sites and brokerages also republish short interest percentages for stocks – just ensure the source is using the official FINRA/exchange data.)
• Fails-to-Deliver Data and the Threshold List: The U.S. SEC publishes Fails-to-Deliver reports on its website, detailing the aggregate FTDs for all stocks, updated semi-monthly (with a slight delay). These reports can be dense raw data, but they let investors confirm if a company has many shares failing to settle. An easier way to monitor settlement issues is via the daily Reg SHO Threshold Securities List mentioned earlier. Each exchange (NYSE, Nasdaq, etc.) posts its threshold list daily (often in an online report), and FINRA also provides this information. If you suspect a stock is under naked short selling pressure, check whether it’s appearing on the threshold list and for how long. A stock that persistently remains on the list day after day is a red flag (since under Reg SHO rules, brokers are supposed to close out fails in threshold securities after 13 settlement days at most). Continual presence on the list could merit asking why fails are not being closed out. Using these tools, investors in volatile stocks like AMC have famously tracked FTD numbers and threshold status to substantiate claims of naked shorting. Again, context is key: a few days on the threshold list might resolve, but an extended stay or repeatedly landing on it is a sign of chronic delivery failures. By accessing SEC and exchange data, vigilant investors can verify whether unusual fails-to-deliver coincide with price drops or high short interest in the stock.
• News, Filings, and Other Market Indicators: In addition to short-specific data, keep an eye on qualitative signs. Unsubstantiated negative news stories or social media posts emerging in tandem with heavy short selling can indicate a coordinated “short and distort” campaign. If you see a sudden flood of negative rumors about a company that lacks factual basis, combined with anomalously high short selling activity, it’s a red flag for manipulation. In suspected cases, company management may even speak out or reach out to regulators – for instance, AMC’s CEO publicly noted the firm’s extended threshold list status and contacted the NYSE and FINRA to scrutinize trading of AMC shares. Such developments can often be found in news articles, company press releases, or even CEO tweets. While these aren’t “tools” you log into like the FINRA or SEC data, staying informed through financial news can tip you off to possible abusive short tactics in the stocks you follow. Always cross-reference sensational claims with the hard data (short interest, FTD reports, etc. as above) to separate internet buzz from reality.

Real-World Examples of Abusive Short Selling Signs

To put these concepts into perspective, let’s look at a few historical examples where abusive short selling was widely suspected, and identify what red flags were present in each case:

Overstock.com (Mid-2000s)

Overstock.com, an online retailer, became one of the most famous battlegrounds over naked short selling. In 2005–2007, Overstock’s management (led by CEO Patrick Byrne) believed the company’s stock was being manipulated by naked shorts. Indeed, Overstock accused major brokers of intentionally failing to deliver shares for short sales – essentially enabling naked short selling that drove its share price down. The signs were striking Overstock’s stock price plunged from over $70 in early 2005 to under $20 by late 2006 during the alleged short attack. The company claimed that by selling and not delivering shares, short sellers created a “virtually unlimited supply” of phantom Overstock shares for sale, exerting constant downward pressure on the price. In other words, classic naked short tactics were blamed – large fails-to-deliver and an outsized short position that seemingly overwhelmed natural demand.

Overstock fought back with lawsuits. While the legal saga was protracted (and eventually settled years later), this case put a spotlight on how persistent delivery failures and huge short interest can ravage a stock’s value. It also led to increased regulatory focus; by 2008–09, the SEC cracked down on naked shorting more broadly, in part due to situations like Overstock’s. For investors, Overstock’s story is a cautionary tale: if you see your stock’s short interest soaring and hear credible reports of large fails-to-deliver, those are serious red flags – exactly the kind Overstock pointed to in accusing Wall Street firms of abuse.

Lehman Brothers and the 2008 Financial Crisis

During the 2008 financial crisis, several big financial institutions saw their stock prices collapse, and short sellers were widely blamed for worsening the panic. Lehman Brothers, Bear Stearns, and others were under genuine financial strain due to bad assets, but there were signs that aggressive (and potentially abusive) short selling accelerated their demise. For example, Bear Stearns in March 2008 suffered a run on the bank amid reports that short sellers were spreading negative rumors to drive its stock down. This “short and distort” dynamic – shorting the stock heavily while fomenting fear – was suspected to have contributed to Bear’s fire-sale collapse. Similarly, Lehman Brothers’ stock plunged precipitously in 2008, and regulators later noted that shorting had become “unbridled,” causing sudden price declines unrelated to fundamentals. In response, the SEC took extraordinary measures: in September 2008 it temporarily banned all short selling in nearly 800 financial stocks to halt what it called “aggressive short selling” and restore calm. Regulators also issued emergency rules against naked shorting in financials around that time.

The Lehman episode underlines a key red flag: a free-fall in stock price without proportional news can indicate a bear raid. If a normally stable stock is plummeting and you hear only whispers of “liquidity issues” or other rumors, there may be a concerted short seller attack at work. It’s a difficult scenario for a retail investor to navigate, but being aware of the possibility is important. Notably, in the Lehman case, short interest had been building on financial stocks and fails-to-deliver spiked for some firms during the turmoil. The government’s aggressive intervention was a signal that officials believed short sellers were abusing the situation. For today’s investors, Lehman’s lesson is to watch for steep, rumor-fueled selloffs – they might indicate manipulation. And remember that in extreme cases, regulators can and will step in (as they did by banning short sales) when they suspect that manipulation is undermining market integrity.

AMC Entertainment (2021–2023)

AMC Entertainment became a high-profile example in recent years amid the “meme stock” saga, where retail traders battled hedge funds shorting certain stocks. Many AMC shareholders believed the stock was the target of abusive short selling and possibly millions of “synthetic” shares created by naked shorts. What were the red flags? For starters, AMC’s short interest was very elevated during 2021 (often above 20% of the float, which is high for a large company) and the stock experienced wild price volatility. More tellingly, AMC appeared multiple times on the SEC’s Threshold Securities List – including a stretch in mid-2021 where it stayed on the list for over two weeks straight, and again for an extended period in early 2023. Being on the threshold list so long implied persistent fails-to-deliver, supporting the idea that some short sellers might not be delivering shares (a sign of naked shorting). In fact, AMC’s CEO Adam Aron publicly acknowledged the unusual volume of FTDs and said the company asked regulators to investigate the trading in AMC stock. Retail “ape” investors on forums diligently tracked SEC FTD data showing spikes of failed deliveries in AMC and pointed out the disparity between the massive trading volume and the relatively small float of legitimate shares – suggesting some trades involved phantom shares. While definitive proof of illegal naked shorting is hard to come by (AMC’s CEO himself cautioned that they had no confirmed evidence of “fake or synthetic shares”), the combination of threshold list status, high short interest, and unexplained price swings kept suspicions high.

For an average investor, the AMC story highlights how you can use publicly available info to flag something odd: noticing your stock on a regulatory list for settlement issues and seeing consistently high short interest should prompt questions. AMC’s saga also shows the importance of distinguishing between normal shorting and possible manipulation – short sellers did have fundamental reasons to bet against AMC (a troubled theater chain during a pandemic), but the extent and mechanics of the shorting raised eyebrows. In the end, AMC’s share price was buoyed in 2021 by a massive short squeeze rally (fueled by retail buying), illustrating the risk that short sellers themselves face when their trades become too crowded. For retail investors, the takeaway is to remain alert: if you suspect an organized short attack, verify the data (short interest %, FTDs) and don’t rely solely on internet chatter. The AMC case shows both the power of collective investor awareness and the challenges in conclusively proving abuse.

Conclusion

Abusive short selling can pose a real threat to market fairness and to individual investors’ portfolios. By understanding the red flags – from abnormal short interest levels, to heavy fails-to-deliver and threshold list appearances, to sudden price drops on no news – you can better spot when a stock might be under manipulative pressure. Armed with tools like FINRA’s short interest reports and the SEC’s fails-to-deliver data, you have ways to verify if those red flags are indeed present. It’s important to approach this analytically: none of these indicators alone guarantees wrongdoing, but together they can paint a suspicious picture that warrants caution (and sometimes regulatory attention).

Above all, know the difference between legitimate short selling and abusive tactics. Short selling isn’t evil – it’s a valid part of the market that, when done by the rules, helps correct overvalued stocks and provides liquidity. But when short selling crosses into rule-breaking – such as naked shorting that floods the market with phantom shares or spreading false information to tank a stock’s price – it becomes harmful to ordinary investors and companies alike. The cases of Overstock, Lehman, and AMC show that abusive short selling has happened in various forms, but also that these activities eventually come to light. Regulators have ramped up oversight since the 2000s, and retail investors today are more educated and vigilant about market manipulation than ever before.

By keeping an eye on the data and staying informed, you can protect yourself. If you suspect your stock is a victim of an abusive short campaign, consider raising the issue in a constructive way – sometimes company management or regulators will act if they see enough evidence. In the meantime, diversify your investments to mitigate the impact of any one stock’s drama. Knowledge and vigilance are your best defense. Spot the warning signs, verify the facts, and you’ll be better positioned to navigate a market where, thankfully, the fair players far outnumber the abusive few.