Definition and Examples of Delivery Failures
“Delivery failure” is the term used in the investment community when one party in a financial transaction fails to fulfill its side of the deal. This typically occurs when shares or funds are not delivered to the buyer or seller on the settlement date.
naked short selling and selling assets without borrowing them first are prominent causes of delivery failure. In the case of naked short selling, delivery failure can have a cumulative effect.
For example, imagine you purchased an asset on April 26 and took delivery 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 fails to deliver it. What makes it cumulative is that the investor you were going to sell to did the same thing you did, and the person they were selling to would also have used it for naked short selling.
Note: Short selling and naked short selling are not illegal. The U.S. Securities and Exchange Commission (SEC) says that in some cases, they help provide liquidity to the market.
How Does Delivery Failure Work?
As explained earlier, delivery failure is the failure to deliver the agreed-upon assets or funds. However, the reasons for delivery failure are not easy to explain. In most cases, the entity fails to deliver due to circumstances beyond its control; it may also fail because it did not account for and mitigate the risks of any scenarios that might prevent it from fulfilling its obligations.
Reasons for delivery failure:
Delivery failure usually occurs due to errors or delays in processing. In these cases, delivery is expected to be settled in the few days following removal from the SEC’s failure list. The party that failed to deliver may face fines for the failure.
Note: The Financial Industry Regulatory Authority (FINRA) is the entity that pursues delivery failure cases under Regulation SHO.
You may see delivery failures in investment transactions of any kind. The most well-known reasons are short selling; however, the SEC indicates that delivery failure can also occur in long selling scenarios.
The U.S. Securities and Exchange Commission tracks daily delivery failures and publishes the data on its website. The data provided by the agency represents the net total of shares that were not delivered on a given day.
For example, Ferroglobe PLC (GSM) was on the delivery failure list for February 2022. Its entry for February 11, 2022, is:
Settlement Date CUSIP Symbol Quantity (Failure) Description Price
2022021 G33856108 GSM 538 FERROGLOBE PLC ORD SHS (GBR) 6.86
Ferroglobe PLC reported several reasons that could lead to delivery failure in its annual report (Form 20-F). Among these reasons are:
– Historical volatility in the metals industry
– Volatility in market price and demand
– Equipment failures
– Ability to renew or obtain permits
Company secrets and operations and other internal factors do not need to be reported, so it may not be easy to determine why the company failed to deliver. However, the company may disclose the reason for the failure to alleviate investor concerns.
What Does This Mean for Individual Investors?
Most often, individual investors are not affected by delivery failures. Individuals cannot engage in naked short selling because SEC regulations require brokers to locate shares before individual trades.
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You may be on the other side of a short sale (i.e., the buyer who has not been delivered the shares), but in most cases, you will be compensated within a few days.
If you’re concerned about naked short selling or the delivery of nonexistent phantom shares from a naked short seller, most brokers will provide you with a physical share certificate for a fee.
Sources:
– U.S. Securities and Exchange Commission (SEC)
– Financial Industry Regulatory Authority (FINRA)
– Ferroglobe PLC
Source: https://www.thebalancemoney.com/what-is-failure-to-deliver-5221740
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