A few things. Being short stock does not make it "naked". That is a term that typically applies to being short a derivative, usually a call, without a collar or underlying to cover. Even still, being short stock is mitigated by posting an "Initial Margin Requirement". Thats a balance that needs to be met to keep the position open. This is posted with the exchange or with the broker, depending on the institution's organization. That is also fulfilled with the value of other long stock, thus the fundamental building block for a long/short equity fund. Even if we assume these hedge funds were short calls without any hedges, that is still not illegal. Even a "qualified investor", ie someone with enough capital and experience, can have portfolio margin that allows them to carry naked short calls by posting portfolio margin. If that goes against you, then you need to continue to post more margin to carry the position. So... naked shorts are not illegal.