The issue in Merrill Lynch v. Manning is whether state law claims alleging that the “naked” short selling at issue in this case violated state law must be heard in federal court.
In a short sale, a short seller identifies a security he or she believes will decline in value, borrows some of those securities from a broker and sells them. When the securities decline in value he or she rebuys them and makes a profit.
In a “naked” short sale the seller doesn’t borrow the securities in time to deliver them to the buyer—to manipulate the security’s price or to avoid borrowing costs. While “naked” short selling isn’t per se illegal under federal law, some schemes may violate federal antifraud law and Security and Exchange Commission (SEC) rules.