Failure to deliver is when one party of a financial transaction does not follow through on their end of the deal. Even experienced investors can have this happen to them.
So, how does failure to deliver happen, and how does it affect you as an investor? Learn exactly what failure to deliver is, how it works, and what it means for you.
Definition and Examples of Failure To Deliver
“Failure to deliver” is the phrase used by the investing community when one party in a transaction doesn’t follow through with their side of an investment contract or transaction. Generally, it happens when shares or funds aren’t delivered to the buyer or seller on the settlement date.
Naked short sales and selling an asset without borrowing it first are two of the leading causes for failures to deliver. In the case of naked short sales, a failure to deliver can have a compounding effect.
For example, imagine that you arranged to purchase an asset on April 26 and take delivery of it on April 27. You then contracted to sell it to another investor on April 27 at a higher price than you paid. On April 26, you pay for the asset, but on the 27th, the other party did not deliver it. What makes it compound is that the investor you were going to sell to did the same thing you did, and the one they were selling to was also going to use it in a naked short sale.
Short sales and naked short sales are not illegal; the SEC says that in some circumstances, they help bring liquidity to the market.
A recent example of failure to deliver focused on Gamestop (GME) shares. On January 28, 2021, more than one million Gamestop shares with an average price of $347.51 failed to deliver. Gamestop’s share price had risen from $20 per share two weeks earlier as retail investors from Reddit and other websites bought into the stock. According to the SEC, many investors blamed the failures to deliver on naked short selling.
How Does Failure To Deliver Work?
As explained previously, failure to deliver is not delivering the agreed-on assets or funds. However, the causes of a failure to deliver are not so easy to explain. In most cases, an entity fails to deliver because of circumstances out of its control; it might also fail because it didn’t account for and reduce the risks of any scenarios that might keep it from fulfilling its obligations.
Failure To Deliver Causes
Failure to deliver often happens due to errors or processing delays. In these instances, the delivery is expected to settle in the next few days when it’s removed from the Securities and Exchange Commission (SEC) failure list. The party that failed to deliver might be fined for the failure.
The Financial Regulatory Authority (FINRA) is the entity that works to prosecute failures to deliver under Regulation SHO.
You might see instances of failure to deliver among investing transactions of any kind. The most well-known causes are short sales; however, the SEC notes that a failure to deliver can also happen on a long sale.
The SEC tracks daily failures to deliver and publishes the data on its website. The data reported by the agency represents the aggregate net balance of shares not delivered on a particular day.
For example, Ferroglobe PLC (GSM) was on the SEC’s failure to deliver list for February 2022. Its entry for Feb. 11, 2022, is:
|SETTLEMENT DATE||CUSIP||SYMBOL||QUANTITY (FAILS)||DESCRIPTION||PRICE|
|2022021||G33856108||GSM||538||FERROGLOBE PLC ORD SHS (GBR)||6.86|
Ferroglobe PLC listed many reasons it could fail to deliver on its annual filing (Form 20-F). Among these reasons are:
- COVID-19 pandemic impacts
- Historic cyclicality of the metals industry
- Swings in market price and demand
- Equipment failures
- The ability to renew or acquire permits
Trade secrets, company processes, and several other internal factors are not required to be reported, so it may not be easy to figure out why a company failed to deliver. However, the company may publish why it happened to ease investors’ concerns.
What It Means for Individual Investors
For the most part, individual investors aren’t affected by failures to deliver. Individuals can’t perform naked short selling because SEC regulations require brokers to locate shares before individual transactions.
It’s possible you could be on the other end of a naked short (i.e., the buyer who isn’t delivered shares), but in most cases, you’d be made whole in a few days.
If you’re worried about naked short selling or being delivered phantom shares that don’t exist from a naked short seller, most brokers will offer to send you the physical share certificate for a fee.
- Failure to deliver is when one party of a stock transaction doesn’t deliver their part.
- For the buyer, this means the cash; for the seller, it means the stock.
- Naked short selling is one cause of failure to deliver, but many others exist.
- Many failures to deliver are cleared within a few trading days.
U.S. Securities and Exchange Commission. "Key Points About Regulation SHO," Section II.
U.S. Securities and Exchange Commission. "Staff Report on Equity and Options Market Structure Conditions in Early 2021," Page 18.
U. S. Securities and Exchange Commission. "Staff Report on Equity and Options Market Structure Conditions in Early 2021," Page 29.
Financial Regulatory Authority. "FINRA Fines Cantor Fitzgerald $2 Million for Regulation SHO Violations and Supervisory Failures."
U.S. Securities and Exchange Commission. "Fails to Deliver Data." Click February 2022, first half, download text file.
Ferroglobe PLC. "Form 20-F," Pages 1,2.