“Fail to deliver” is a situation in the stock market in which a broker/dealer that has sold securities fails to deliver them to the purchasing broker/dealer by the transaction’s settlement date. Its counterpart, on the purchaser’s side of the transaction, is a “fail to receive.” Taken together “fails,” or "failed trades" as they are known, are a violation of U.S. securities industry regulations. They can present serious risks to the financial system if of sufficient size, including broker/dealer and market failure, as well as artificially depressing securities' prices. Penalties and procedures to be followed in the event of “failed” trades are set out by the U.S. Securities Exchange Commission (SEC) according to securities law.
U.S. securities industry regulations require that transactions be completed by settlement and clearance of the securities and associated funds within a specified number of business days after the transaction date. Known as the settlement date, this varies with the type of security. Stock market transactions, for example, are settled on a “T+3” basis, which means that the broker/dealer on the sell side must deliver the shares to the buy-side broker/dealer on the third business day following the transaction date. A “fail to deliver” occurs when the sell-side broker/dealer does not deliver the securities as of that date. In the U.S. the vast majority of securities are settled and cleared through an independent, third-party agency, the Depository Trust Company or its subsidiary, the National Securities Clearance Corp.
“Fail to deliver” and “fail to receive” transactions pose problems and risks to the proper functioning of the securities and capital markets. A domino effect may result in which a succession of “failed” trades across broker/dealers can lead to market failure in one or more securities and possibly the firms themselves. This occurred in the 1960s and resulted in significant customer losses, as well as the collapse of broker/dealer firms, because a crisis of faith and trust in their ability to honor their fiduciary and financial obligations ensued. Attempting to prevent a repeat of such circumstances, legislators passed amendments to the Securities Exchange Act, which included the adoption of net capital requirements for broker/dealers and additional protection for their investor customers.
Furthermore, “fail to deliver” transactions may be associated with margin trading and naked short selling. If of sufficient size, short sales that “fail to deliver” create a “phantom” overhang in supply of the shares of a company and can artificially depress the price of that company’s stock. Hence, the U.S. Congress and the SEC have instituted procedures and penalties to be followed in the event of “fail to deliver-fail to receive” transactions.
