Fail To Deliver

A principal is training a new associate on settlement terminology and is asked to explain the difference between a "fail to deliver" and a "fail to receive," and which party may initiate a buy-in procedure. What is the correct explanation?

1. A.A fail to deliver and a fail to receive describe the identical situation from two different firms' perspectives, and either party may initiate a buy-in.Wrong. While the two terms describe the same underlying settlement failure from each side, only the party owed delivery may generally initiate the buy-in.
2. B.A fail to receive occurs when the selling firm does not deliver securities, and the seller may initiate a buy-in against itself.Wrong. A fail to receive is the buying firm's failure to receive, not the selling firm's failure to deliver, and a firm doesn't buy in against itself.
3. C.A fail to deliver is the selling firm's failure to deliver; a fail to receive is the buying firm's resulting failure to receive, and it is generally the buyer who may initiate the buy-in.Correct. The buyer facing a fail to receive is generally the party who may initiate a buy-in against the non-delivering seller.
4. D.Only a clearing corporation, and never either firm directly, may ever initiate a buy-in procedure.Wrong. The party owed delivery may itself initiate a buy-in; it is not limited exclusively to a clearing corporation.

Why: A fail to deliver occurs when the selling firm does not deliver securities it sold; a fail to receive occurs when the buying firm does not receive securities it purchased. It is generally the party owed delivery — the buyer facing a fail to receive — that may initiate a buy-in against the party that failed to deliver.

A principal supervising one trading desk identifies and closes out a fail to deliver in a security caused by her desk's short sale activity. She is unaware that a different desk at the same broker-dealer also has an outstanding fail to deliver in the identical security, which remains unresolved. What should she recognize about the firm's Rule 204 close-out obligation?

1. A.The obligation is fully satisfied once each individual desk closes out the fails that its own activity caused.Wrong. The obligation runs to the firm as a whole, so a fail from another desk in the same security remains unresolved at the firm level.
2. B.The close-out obligation runs to the firm as a whole for the security, so the firm must also confirm whether the other desk's fail remains unresolved.Correct. Rule 204's close-out obligation applies at the firm level, not separately to each desk.
3. C.The obligation only extends firm-wide if the two desks are formally organized as a single aggregation unit.Wrong. The firm-wide close-out obligation applies regardless of how the desks are organized for aggregation unit purposes.
4. D.The obligation is resolved as long as the desk that most recently caused a fail addresses it.Wrong. Resolving the most recent fail doesn't address an earlier, still-outstanding fail from a different desk in the same security.

Why: The close-out obligation under Rule 204 applies to the broker-dealer as a whole with respect to its fails to deliver in a security, not separately to each individual desk; a principal addressing only her own desk's fail without confirming whether the firm has other outstanding fails in the same security has not necessarily satisfied the firm's overall obligation.

A customer's account has an outstanding, unresolved fail to deliver from a recent short sale in a particular security. Before that fail is addressed, the same customer places another short sale order in the identical security, and the representative processes a routine locate without any added scrutiny given the unresolved fail. A principal reviewing the account is asked whether this is adequate. What should she conclude?

1. A.The principal should apply added scrutiny to the new locate given the account's unresolved fail in the same security, rather than treating it as routine.Correct. An existing unresolved fail in the same security and account is a red flag warranting added scrutiny of a new locate.
2. B.No added scrutiny is needed, since each short sale order's locate is evaluated independently of the account's recent history.Wrong. The account's recent, unresolved history in the same security is directly relevant context for evaluating a new locate.
3. C.Added scrutiny is needed only if the customer's new order is larger in size than the one that caused the original fail.Wrong. The order's relative size isn't what triggers the need for scrutiny; the unresolved fail itself is the red flag.
4. D.Added scrutiny is needed only after a second fail to deliver actually occurs in the account.Wrong. Waiting for a second fail before applying scrutiny defeats the purpose of using the first fail as an early warning sign.

Why: An account with an existing, unresolved fail to deliver in a security presents a heightened risk that a routine locate for a new short sale order in that same security and account may not reflect a genuinely reliable borrow; the principal should apply added scrutiny to confirm the new locate is well-founded rather than treating it as routine.

A firm outsources its locate function entirely to a third-party vendor. When a fail to deliver results from a short sale where the vendor's locate turned out to be unreliable, the firm's principal treats the vendor's error as relieving the firm of its own close-out obligation under Rule 204. What is the concern with this view?

1. A.The view is correct, since the vendor's error caused the fail and therefore bears responsibility for addressing it.Wrong. Causation by a vendor's error does not shift the firm's own regulatory close-out responsibility.
2. B.The view is correct as long as the firm's contract with the vendor specifically disclaims the firm's liability.Wrong. A private contractual disclaimer between the firm and its vendor does not alter the firm's own regulatory obligations.
3. C.The view is correct only if the vendor is itself a registered broker-dealer.Wrong. The vendor's registration status doesn't change that the firm's own close-out obligation remains its own.
4. D.Outsourcing the locate function to a vendor does not shift the firm's own close-out responsibility, which remains the firm's regardless of a vendor's error.Correct. The firm's regulatory responsibility for close-out remains its own despite outsourcing the locate function.

Why: Outsourcing the locate function to a third-party vendor does not shift the broker-dealer's own regulatory responsibility for compliance with Regulation SHO, including the close-out obligation for a resulting fail to deliver; the firm remains responsible regardless of a vendor's error.