The one that involves only two participants is called "naked short selling". That's the one that is illegal. I would like to see the SEC enforce their own regulations for a change.
As far as I know it was banned while back. So naked short-selling is outside of the uptick rule proposal. SEC should leave alone not naked short-selling because it's identical to long-selling and it's not up for regulation.
It is not just market makers that are able to short without borrowing. Although they, the market makers, should be able to short without borrowing only in the course of "bona fide" market making activities as the SEC puts it. And those short positions should be closed forthwith and not be allowed to stay on the books indefinitely. It is absurd when more shares are sold short than exist, but apparently it happens! I understand that the European markets are much better at requiring delivery, perhaps we should just follow there model.
Washington, D.C., Sept. 11, 2009 â The Securities and Exchange Commission will hold a roundtable about securities lending and short sale issues on September 29 and September 30. http://sec.gov/news/press/2009/2009-196.htm