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 SHOA 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 11820A 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

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Written by Dave Meshkov
Dave's mission (and job: Managing Director of Course Design) is to make FINRA exam training engaging, approachable, and dare he even say, enjoyable. Having trained and coached over ten thousand students to exam success he knows how to present complex subjects in memorable and understandable ways. Prior to joining Knopman Marks in 2011, Dave practiced bankruptcy law at Weil, Gotshal & Manages and served as a law clerk in a the Southern District of New York Bankruptcy Court working on the General Motors and Lehman Brothers bankruptcies. Building on his legal expertise and training allows him to keep all our courses updated with the latest legislative and rule-making changes. Dave currently trains for the Securities Industry Essentials (SIE) exam and the Top-Off Series 6, 7, 24, 57, 63, 65, 66, 79, 86, 87, and 99 exams. He also delivers executive one-on-one training and shares his passion for learning outside of work as a ski instructor and yoga teacher. Dave graduated magna cum laude from Fordham Law School, and cum laude with a BA from the University of Pennsylvania.