Well, I can say how location works.
Exchange Act Regulation SHO, Rule 203(b)(1) and (2) collectively create for broker-dealers what is referred to as the “locate requirement.” It says, in brief, that before a broker-dealer executes a short sale (whether for the broker’s account or for a customer), the broker-dealer must document that it can locate the shares and deliver them before the settlement date. The broker-dealer can complete its locate obligation by borrowing the shares ahead of time, entering into an arrangement to borrow the shares ahead of time, or having reasonable grounds to believe that the shares can be borrowed ahead of time. The “reasonable grounds” is often found by finding the security on an “easy to borrow” list maintained by a prime broker (other than the one doing the short). Those are basically lists of large, liquid stocks wherein the prime broker reports to market participants, “I have millions of these shares available to lend if you just ask.” For other stocks, the locate requirement can by fulfilled by documenting with a prime broker or other reliable source that they have the shares to lend. For more thinly-traded or heavily-shorted stocks, the locate requirement can be fulfilled by making an arrangement with a stock lending agent.
The locate requirement is intended to prevent naked short selling by making the broker find the stock it intends to short before it effects a short sale. Yes, there is an exception for bona fide market making by the broker. But that exception does not apply to short sales that the broker effects for its customers nor does it apply to any manipulative trades for the broker’s (more properly here, dealer’s) own account, which are not bona fide market making.
Regulation SHO, Rule 204 imposes on brokers a close-out requirement to deliver the securities on the settlement date. If the broker can’t deliver the securities, it must close out the fail to deliver. For a short sale, that means by the end of the next business day. Again, this prevents the problem of a naked short sale just sort of hanging our forever.
Yes, some of this stuff is complicated. Believe it or not, there are many people who understand it. You don’t need to dismiss the rules because you don’t understand them.