What is a Fail?

In common trading terms, a fail occurs if a seller does not deliver securities or a buyer does not pay owed funds by the settlement date. Through a stock exchange, this occurs if a stockbroker does not deliver or receive securities within a specified time after a security sale or a security purchase. When a seller cannot deliver the contracted securities, this is called a short fail. If a buyer is unable to pay for the securities, this is called a long fail.

Technical analysts also use the term fail, but this is typically related to a failure of the price to move in an anticipated direction after a breakout or following a specific catalyst. This may be called a fail but is more commonly called a failed break or false breakout.

Key Takeaways

  • A fail is when a buyer fails to deliver funds or a seller fails to deliver an asset by the settlement date.
  • Depending on the market, settlement is supposed to occur within T+1 to T+3 days.
  • The most common reasons for a failed transaction are an inability to pay, not owning the asset to deliver, or mismatching, late, or missing information.

Understanding a Fail

Whenever a trade is made, both parties in the transaction are contractually obligated to transfer either cash or assets before the settlement date. Subsequently, if the transaction is not settled, one side of the transaction has failed to deliver. Failure to deliver can also occur if there is a technical problem in the settlement process carried out by the respective clearing house.

Presently, firms have one to three days after the date of a trade to settle transactions, depending on the market. Within this time frame, securities and cash must be delivered to the clearing house for settlement. If firms are unable to meet this deadline, a fail occurs. Settlement requirements for stock, options, futures contracts, forwards, and fixed-income securities differ.

Subject to change, as the settlement process continues to become more efficient, stocks settle in T+2 days. That means they settle two days after the transaction (T) date. Corporate bonds also settle in T+2 days. Options settle in T+1 days.

Fail is also used as a bank term when a bank is unable to pay its debt to other banks. The inability of one bank to pay its debt to other banks can potentially lead to a domino effect, causing several banks to become insolvent.

Why Do Trades Fail?

The cause of a failed trade could be one of three main reasons.

  • Mismatches with instructions, late instructions, or missing instructions. Sometimes buyers and sellers disagree on exactly what is to be delivered (specifications). This generally happens where the parties disagree on whether the delivered item meets the agreed upon specifications. This is more likely to occur in the over-the-counter (OTC) market where specifications are not formalized like on an exchange.
  • The seller does not have the securities to deliver. The seller must either own or borrow securities to deliver.
  • The buyer does not have sufficient resources, such as cash or credit, to make payment.

Failing to pay for purchases creates a risk to the buyer's reputation that may impact its ability to trade in the future. Failing to deliver also hurts the seller's reputation and may impact how and with whom they can trade in the future.

Failing to deliver securities could create a chain reaction. During the financial crisis of 2008, failures to deliver increased significantly. Similar to check kiting, where someone writes a check but has not yet secured the funds to cover it, sellers did not surrender securities when they were supposed to. They delayed the process to buy securities at a lower price for delivery as the price rapidly and dramatically fell. Regulators still need to address this practice as fails continue to occur.

The Securities and Exchange Commission (SEC) publishes a "Fails-to-Deliver" report twice per month containing information on transactions that failed.

An Example of a Fail to Pay Fail to Deliver

Failures to deliver can occur when a short sale isn't properly secured or borrowed prior to the sale taking the place. Assume a trader shorts Company XYZ, but the broker didn't make sure they actually had borrowed the shares.

To short, there must also be a buyer buying the shares. The buyer then expects delivery of those shares. But if the shares haven't been borrowed, then there are no shares to give the buyer. The seller can't deliver. This is a short fail.

On the flip side, a buyer may fail to deliver funds when buying. This could happen if they have the funds in their account when the trade is taken, but they then lose a bunch of money through a number of other margined trades. Because of the losses they don't have enough capital to cover the cost of their purchases.

This could happen as some margin violations are often not noticed or flagged until the end of the trading day. While margin rules are in place to protect investors, it is possible that an unexpected sharp and adverse price move could leave a trader with less capital than they need to settle the transactions they have taken. If funds aren't available to buy the asset they purchased, they have failed to pay. This is called a long fail.