Crashing the Stock occurs when the price is getting away from the shorts, or when it is time to knock the price down so short positions can be covered at a profit.
The short mindset relative to trades that are going bad is entirely different from a long investor. A long investor typically will cut his losses by reducing his position in a stock that is moving away from him. The short reacts differently. It is important to remember that so long as the stock price is remaining flat or dropping, the short has little net investment. Further he has access to a virtually unlimited supply of shares that are “free” as long as he can keep the price from going up.
A recent case involves an emerging technology company that was allegedly being shorted by a group of B tier shorts that included a west coast brokerage firm. The broker had a million share short position with an estimated short price of $11. Despite 60-90% of the daily sells being short, the stock price had increases to $18, putting the broker upside down by $7 million. A “crash” of the stock was implemented, and, in a matter of days, drove the price down to $13. The regional broker contributed an estimated additional 250,000 short shares to help drive the price down. At the end of the crash, he was short 1.25 million shares, but was only upside down $2 per share, or $2.5 million on his position. By throwing more shares at a position going bad, he was able to improve his position. Eventually, continued massive shorting in the face of very good company news, saw the price drop to $9/share, putting the shorts in the money.
The shorts do this repeatedly and eventually drive the long buyers out, then they may cover some of their open positions or take profit out by marking to market. Rarely do they get caught out with this strategy.
One of the more flagrant crashes involved CROX in December, 2007. The company manufactures a line of quirky casual footwear that caught on with the American public and small investors, who bought the stock in droves. The stock split and climbed almost exponentially during the summer and fall of 2007, despite being shorted heavily the whole time. By December, the stock price was $75 and the shorts were seriously upside down. At that point CROX had 80 million shares issued and a typical daily trading volume of 3-4 million shares, which included significant short selling.
On Dec.1, 2007, CROX released quarterly earnings that were in line with guidance but were 2¢ short of “Street expectations”. The shorts crashed the stock on this supposed bad news. In a single trading day sixty million shares traded — almost all counterfeit. The shorts, by the sheer volume of their selling and buying, took complete control of trading, aided by the abolition of the up tick rule (The SEC recently dropped the rule that short shares could only be sold on up ticks, thereby allowing shorts to pile on massive quantities of shares very quickly). They dropped the stock price from $74 to $47 in a matter of hours.
This huge volume was probably the result of short down laddering. At the end of the day, the shorts sold (say) fifty million short shares, but if they were buying from themselves and covering open short positions, they ended up with a relatively small net increase in the number of short shares in their portfolio. They profited on all trades that day as they dropped the price $27 and they may have improved the value of their remaining portfolio by $27/share. Because they covered many short shares before the trades settled, there were few fails-to-deliver created.
So long as the short shares sold fit into one of many loophole exemptions and fails-to-deliver are not created, the enforcement agencies don't seem to view this overt manipulation as illegal, or chose not to prosecute them.