When a security transaction (e.g. a purchase or sale of securities) is not completed according to the terms to the contact the parties have certain rights and responsibilities to remedy the failed transaction. For example, if a seller fails to deliver securities to a buyer, the buyer has the right to “buy-in,” or purchase, the securities in the open market, and pass any additional costs in connection with the purchased securities (e.g. a higher share price) to the failing seller.
There are rules, however, that dictate when and how a buy-in can occur. These rules are drawn from FINRA’s Uniform Practice Code Rule 11810 as well as the SEC’s Rule 204. Below is a chart explaining how these rules interact and apply.
Rule | Scenario | Consequence | Note |
| FINRA’s Uniform Practice Code Rule 11810 and Threshold securities under Reg SHO | A customer (that is not a clearing firm) fails to deliver securities sold in accordance with a securities contract (an agreement to sell). Threshold Security: A security where there is a fail to deliver at a clearing firm of 10,000 shares or more for five consecutive days. SROs update the threshold security list daily. | Fails to delivery by customers or in threshold securities must be bought-in 10 business days after settlement (or 13 days after trade date). | These rules should be considered when a non-clearing customer (e.g. a retail customer) fails to deliver securities.Example: Bob sells 100 shares of IBM, if he fails to bring those securities to his broker-dealer, the firm will buy-in Bob 10 days after settlement (or 13 days after trade date). |
| SEC Rule 204 (short fails). Technically, this rules applies to both short and long fails, but there is an exception that applies to all long fails (see next row). | A member of National Securities Clearing Corporation (“NSCC”) (i.e. a clearing firm) has a short fail to deliver (i.e. a seller does NOT own the sold shares and plans to borrow them to make deliver them on settlement). | NSCC clearing firms must close out (buy-in) the short fail to deliver before trading begins on T+4. | Example: A NSCC clearing firm accepts a short sell order must deliver the securities to the buyer on settlement (T+3), if the short seller has not delivered the securities on T+3 the clearing firm must buy-in the short seller before trading begins on T+4. |
| SEC Rule 204 (long fails) | A member of NSCC (i.e. a clearing firm) has a long fail to deliver (i.e. the seller owns the shares sold). | NSCC clearing firms must close out (buy-in) the short fail to deliver before trading begins on T+6, and provide notice to the failing seller of the buy-in on T+4 before noon) | An exception in SEC Rule 204 provides for the additional two days for failed long sales.Example: A NSCC clearing firm accepts a long sell order must deliver the securities to the buyer on settlement (T+3), if the long seller has not delivered the securities on T+3 the clearing firm must buy-in the short seller before trading begins on T+6, with notice to the failing party on T+4 before noon. |
A related rule deals with sell-outs, which occurs when a buyer of securities fails to pay for the purchased securities. The sell-out permits the selling party to sell the securities in the best available market and charge any losses incurred (e.g. a lower sale price) to the failing party.
Rule | Scenario | Consequence | Note |
| FINRA’s Uniform Practice Code Rule 11820 | A customer places an order to buy securities but does not have the funds to purchase the securities on settlement. | The selling party, who was not paid for the securities, can sell the securities on T+4, and must provide notice to the failing buyer on the day of the sell-out by 6 PM that day. | A buyer who fails to pay for securities on settlement, does not get any additional time to pay, and the seller can sell the securities immediately in the market on T+4. |
Knopman Notes
Candidates should understand the consequences of failing to complete a securities transaction, including both for regular customers (the longer 10 business day after settlement time-frame) and for clearing firms (e.g. member firm to member firm) the shorter T+6 for long fails and T+4 for short fails.
Relevant Exams
Series 7, Series 24, Series 65, Series 66, Series 79
