What does “Fail to Deliver” Mean? Overview & 7 Facts

If you have used an e-commerce shopping cart, you understand what it means when an order fails to deliver. Failure, like most things, is not always negative. It could be that the package was too large, or you could be receiving a defective product. This blog discusses the consequences of “fail to deliver.” 

What does “Fail to Deliver” Mean?

In the stock market, fail to deliver occurs when a broker/dealer that has sold shares fails to deliver them to the purchasing broker/dealer by the settlement date. On the buyer’s side of the transaction, the corresponding document has been returned as undeliverable.

Overall, failures, also known as failed transactions, constitute a violation of U.S. securities industry standards. If of sufficient magnitude, they can pose significant threats to the financial system, such as broker/dealer and market failure as well as artificially depressing securities prices.

What does "Fail to Deliver" Mean?

In accordance with securities law, the Securities and Exchange Commission (SEC) of the United States establishes sanctions and procedures to be followed in the event of unsuccessful trades.

Examples of “Fail To Deliver”

Consider a scenario in which you have agreed to acquire an asset on April 26 and will receive delivery on April 27. You agreed to sell the property to another investor on April 27 for more than you paid. You make payment for the asset on April 26, but it was not delivered on April 27.

The situation is made worse by the fact that the investor you intended to sell to did the same thing you did, and the investor they intended to sell to intended to conduct a naked short sale.

According to the SEC, short sales and naked short sales are not prohibited, as they contribute to market liquidity in certain situations.

Gamestop (GME) stock is a recent example of underperformance. On January 28, 2021, more than one million Gamestop shares with an average price of $347.51 failed to deliver.

Prior to two weeks ago, the share price of Gamestop increased from $20 per share to $22 per share as retail investors from Reddit and other websites purchased the company. Some investors, according to the SEC, attributed delivery difficulties to naked short selling.

How Does “Fail To Deliver” Work?

As stated previously, “fail to deliver” is the failure to provide the agreed-upon assets or payments. However, the reasons for a failed delivery are not so straightforward to explain.

In the majority of cases, an entity “fails to deliver” because of circumstances beyond its control; however, it may also fail because it failed to account for and mitigate the risks of any potential scenarios that could prevent it from fulfilling its obligations.

Failure To Deliver Causes

Frequent causes of delivery failure are processing errors or delays. After removal from the Securities and Exchange Commission (SEC) failure list, it is anticipated that the delivery will settle within a few days. The party accountable for the delivery failure may be penalized.

Regulation SHO violations are prosecuted by Financial Industry Regulatory Authority (FINRA).

There may be instances of non-delivery in all types of investment contracts. The SEC adds that a long sale could also result in a failure to deliver. However, short sales are the most common cause.

What does "Fail to Deliver" Mean?

The SEC tracks daily delivery failures and publishes the information on its website. The agency’s published data reveals the total net balance of undeliverable shares on any given day.

For instance, Ferroglobe PLC (GSM) was included on the SEC’s list of underperforming companies in February 2022. For 11 February 2022, the entry is:

SETTLEMENT DATE CUSIP SYMBOL QUANTITY (FAILS) DESCRIPTION PRICE
2022021 G33856108 GSM 538 FERROGLOBE PLC ORD SHS (GBR) 6.86

Ferroglobe PLC listed several reasons why it was unable to submit its annual report (Form 20-F). Included are the following:

  • The global effect of COVID-19
  • The historical cyclical nature of the metals industry
  • Variations in pricing and demand on the market Faulty equipment
  • Capability to acquire or renew licenses

It is difficult to determine why a company underperformed because trade secrets, corporate practices, and a number of other internal issues are not required to be disclosed. To alleviate investor concerns, the company may provide an explanation for what transpired.

What It Means for Individual Investors

Individual investors are rarely affected by delivery difficulties. Individuals are prohibited from engaging in naked short selling due to SEC regulations requiring brokers to locate stocks prior to individual transactions.

You may be on the other side of a naked short (i.e., the buyer who is not supplied shares), but in the vast majority of cases, you will be made whole within a few days.

What does "Fail to Deliver" Mean?

If you are concerned about naked short selling or receiving phantom shares from a naked short seller, the majority of brokers will agree, for a fee, to provide you with the actual share certificate.

Consequence  Of “Failed to Deliver”

Failure to deliver and failure to accept transactions pose obstacles and threats to the normal operation of the securities and capital markets. A domino effect may occur if a string of failed broker-dealer transactions causes the collapse of the market for one or more securities and possibly the businesses themselves.

This occurred in the 1960s and resulted in significant client losses and the demise of broker/dealer businesses due to a crisis of faith and trust in their ability to fulfill fiduciary and financial obligations.

In an effort to prevent a recurrence of these conditions, the Securities Exchange Act was amended to include net capital requirements for broker-dealers and enhanced investor protections.

Failed-to-deliver transactions may be associated with leveraged trading and naked short selling. Short sales that fail to deliver create a phantom overhang in the supply of a company’s shares, which can artificially lower the stock price of that company.

The U.S. Congress and the SEC have consequently enacted procedures and penalties to be implemented in the event of fail to deliver fail to receive transactions.

Regulations of the US Securities Industry on “Fail to Deliver”

Regulations governing the U.S. securities industry mandate settlement and clearing of securities and related funds within a specified number of business days following the transaction date. Depending on the type of security, the settlement date differs.

What does "Fail to Deliver" Mean?

For instance, stock market transactions are settled on a T+3 basis, which means that the broker/dealer on the selling side must deliver the shares to the broker/dealer on the buying side on the third business day following the transaction date.

A failure to deliver occurs when the sell-side broker or dealer misses the deadline for delivering the securities. The Depository Trust Company or its subsidiary, the National Securities Clearing Corp., settle and clear the vast majority of securities in the United States.

Conclusion

“Failure to deliver” refers to a failed transaction in which the broker failed to deliver the securities to the buyer. “Failure to deliver” and “failure to receive” transactions pose problems and risks to the securities and capital markets’ efficient operation.

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Pat Moriarty
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