Close-Out Requirements for Various Products

A fail does not cancel the contract. The Uniform Practice Code gives the buyer a buy-in and the seller a sell-out, and each runs on its own notice clock. Several products and situations bypass the notice steps entirely, and knowing which ones is most of this topic.

When Is a Buy-In Available, and Where Does the Rule Not Reach?

A securities contract that has not been completed by the seller according to its terms may be closed by the buyer not sooner than the third business day following the date delivery was due, in accordance with the rule.

The rule then names five situations it does not reach.

• Exchange or clearing agency buy-ins. Where the contract is subject to the buy-in requirements of a national securities exchange or a registered clearing agency, those requirements apply instead.
• Exempted securities. Transactions in securities exempted under the Securities Exchange Act.
• Municipal securities. Transactions in municipal securities as the Securities Exchange Act defines them.
• Redeemable investment company securities. Transactions in redeemable securities issued by companies registered under the Investment Company Act; provided, however, that the rule does apply to secondary market transactions between members in a security issued by a registered investment company classified as a unit investment trust.
• Direct participation programs. Transactions in Direct Participation Program securities.

The investment company exception limits its own carve-back in a second sentence. Redemption of securities directly by the trustee of the unit investment trust are not transactions between members for purposes of that subparagraph.

Exam Tip: Gotchas

• The third business day is a floor, not a deadline. The buyer may close the contract not sooner than the third business day following the date delivery was due, so there is no stated last day by which the buyer must act.
• An exchange or clearing agency buy-in requirement displaces this rule entirely. Where one applies, the buyer follows that body's requirements rather than the Uniform Practice Code steps.

How Is a Buy-In Notice Given, Received and Answered?

Written notice of buy-in shall be delivered to the seller at its office not later than 12:00 noon Eastern Time (ET), two business days preceding the execution of the proposed buy-in.

"Written notice" includes an electronic notice through a medium that provides for an immediate return receipt capability. The rule gives an open example list of such media: facsimile transmission, a computerized network facility, or the electronic functionality of a registered clearing agency.

The buyer carries a records duty on the other side of that notice. Confirmation of receipt of the buy-in notice by the seller shall be maintained with the notice as part of the buyer's books and records.

A seller that does not accept the notice must send a signed, written response to the buyer stating its rejection by no later than 6:00 p.m. ET on the date of issuance of the notice. Where the seller sends no such signed written response by that time, the notice shall be deemed to have been accepted.

The seller also has a right to test the claim, even after the notice is deemed accepted. Prior to the proposed effective date of the buy-in, the seller has a right to request proof of fail obligation from the buyer, and the buyer shall deliver such proof to the seller prior to such date.

Two limits then sit on the buyer.

• A ceiling on the buy-in. In no event shall a buyer be entitled to a buy-in that exceeds the liability of a seller under an unsettled securities contract because of the seller's failure to reject the notice.
• A bar on execution. A buyer may not execute a buy-in notice to the extent the buyer fails to deliver the proof of fail obligation in accordance with that paragraph.

Notice travels down the chain as well. It shall be redelivered immediately by the receiving party to other parties from which the securities involved are due, in the form of a re-transmitted notice.

A re-transmitted notice received by a member shall be delivered to subsequent parties not later than 12 noon ET on the business day preceding the time and date of execution of the proposed buy-in, and the time specified for delivery in it shall not be prior to the time specified in the original notice.

Each party receiving a re-transmitted notice is subject to the same books-and-records duty and the same rejection, acceptance and proof provisions; provided, however, that the written response goes to the party from which that notice was received, not to the party that started the chain.

Where a notice, or a re-transmitted notice, is given for less than the full amount of securities due, it shall not be for less than one trading unit.

Exam Tip: Gotchas

• The re-transmitted notice leaves its recipient less lead time than the original. The original goes out by 12:00 noon ET two business days before execution. A re-transmitted notice must reach subsequent parties by 12 noon ET on the business day preceding execution.
• The proof of fail obligation is a duty on the buyer, not merely a right of the seller. The seller may request it, and the buyer shall deliver that proof before the proposed effective date, or it may not execute to that extent.
• Silence from the seller is acceptance. Absent a signed written rejection by 6:00 p.m. ET on the date of issuance, the notice is deemed accepted, subject to the ceiling on the buyer's entitlement.

What Must Every Buy-In Notice Say?

Every notice of buy-in, including a re-transmitted notice, shall state four things: the date that the contract will be closed out, the quantity and contract value of the securities covered by the contract, the settlement date of the contract, and any other information deemed necessary to properly identify the contract to be closed out.

The notice shall state further that unless delivery is effected at or before 3:00 p.m. ET on the "effective date" of the notice, the security may be bought in on the date specified for the account of the seller.

Each notice shall also state the name and telephone number of the individual authorized to pursue further discussions concerning the buy-in.

Exam Tip: Gotchas

• The contact detail is part of the required content. A notice carrying the dates, quantity and value but no named individual with a telephone number does not meet the rule.
• The 3:00 p.m. ET warning belongs on the notice itself. It is a statement the notice must carry, which is separate from the seller's own delivery duty at that same hour.

How Is a Buy-In Stopped or Executed?

A seller that has received a buy-in notice, or a re-transmitted notice, and that has not rejected or stayed the notice, shall deliver the securities to the issuing party at or before 3:00 p.m. ET on the effective date, unless otherwise agreed to by the issuing party prior to execution and that seller having notified the issuing party that it has physical possession of the securities.

A stay works differently from delivery. Where the issuing party is notified by a seller, prior to the execution of the buy-in, that some or all of the securities, but not less than one trading unit, are in the seller's physical possession and will be promptly delivered, the order to buy in shall not be executed with respect to those securities.

The member that initiated the original order shall accept and pay for those securities, if delivered promptly. If they are not promptly delivered, the seller that stated they would be shall be liable for any resulting damages.

Execution is the other branch. On failure of the seller to effect delivery in accordance with the notice, or to obtain a stay, the buyer may close the contract by purchasing all or part of the securities necessary to satisfy the amount requested in the notice. Securities the seller delivers after receipt of the notice shall be considered as delivered pursuant to it.

Delivery of the requisite number of shares stated in the notice, or execution of the buy-in against the seller, will also operate to close out all contracts covered under re-transmitted notices issued pursuant to the original notice.

One case breaks that chain closure. Where a re-transmitted notice is sent before the delivery or execution but not received until after it, the member that sent the notice may, unless otherwise agreed, promptly re-establish, by a new sale, the contract with respect to which the notice was sent.

Two further branches complete the picture. A buy-in may be executed by a member from its long position and/or from customers' accounts maintained with that member.

For transactions where the buyer is a customer other than another member, upon failure of a clearing corporation to effect delivery in accordance with a buy-in notice, the contract must be closed by purchasing for "cash" in the best available market, or at the option of the buyer for guaranteed delivery, for the account and liability of the party in default.

Across all of those branches, members must be prepared to defend the price at which the buy-in is executed relative to the current market at the time of the buy-in.

Exam Tip: Gotchas

• A stay needs physical possession of at least one trading unit. Notice that the securities are in transit or in transfer does not stay the order; it triggers the separate seven-day extension set out under What Happens When a Buy-In Is Not Completed?
• A late delivery still counts against the notice. Securities delivered by the seller after receipt of the buy-in notice are treated as delivered pursuant to it, so the buyer cannot ignore them.
• A promise of prompt delivery carries liability if broken. The seller that stated the securities would be promptly delivered is liable for any resulting damages where they are not.

What Extra Buy-In Options Exist for Unit Investment Trust Securities?

Buy-in execution options in addition to the general ones may be available where the buyer wishes to buy in contracts made for unit investment trust securities.

• Substituted securities by agreement. The buyer may by mutual agreement accept from the seller, in lieu of the seller's obligation under the original contract, which shall be concurrently canceled, the delivery of unit investment trust securities comparable to those originally bought in quantity, quality, yield or price and maturity, with any additional expenses or additional cost of acquiring the substituted securities borne by the seller.
• Forced repurchase. Where the buyer's general options are not available and the buyer and seller cannot agree on the substitution, the buyer may require the seller, for the seller's own account and liability, to repurchase the unit investment trust securities on terms that require the seller to bear the burden of any change in the market price from the original contract price, with accrued interest.

That second option is spelled out in both directions. Where the current market price is higher than the original contract price, the buyer may require repurchase at the current market price. Where it is lower, the buyer may require repurchase at the original contract price, with accrued interest.

Exam Tip: Gotchas

• The forced repurchase is a fallback, not a first choice. It opens where the general buy-in options are unavailable and the parties cannot agree on the comparable-securities substitution.
• The repurchase price always disadvantages the defaulting seller. A higher market means repurchase at the market; a lower market means repurchase at the original contract price.

What Happens When a Buy-In Is Not Completed?

Where a buy-in is not completed on the day specified in the notice, or as that date may be extended under the rule, the notice shall expire at the close of business on the day specified in it. The contract survives; only the notice dies.

A reconfirmation and pricing period cancels a pending notice outright. Where a buy-in notice for a reconfirmation eligible security is pending during a reconfirmation and pricing period and one or more members are participating in a reconfirmation and pricing service, that buy-in notice shall be canceled.

Written notice of cancellation must be received by the non-participating member prior to the original or extended date of execution, and failure to provide that notification may result in an execution. A new notice of buy-in may be issued no earlier than the first business day following the final reconfirmation and pricing settlement date.

The buyer also carries a duty while a notice is outstanding. Prior to the closing of a contract on which a buy-in notice has been given, the buyer shall accept delivery of the securities called for by the contract.

That duty carries a proviso on a partial delivery: the portion remaining undelivered when the buyer proposes to execute is not an amount which includes an odd-lot which was not part of the original transaction.

Securities in transit force an extension rather than a stay. Before the closing, the buyer may receive from the seller written or comparable electronic notice stating that the securities, except for those securities due from a depository, are in transfer, in transit, being shipped that day, or due from a depository, and giving the certificate numbers.

On that notice the buyer must extend the execution date of the buy-in for a period of seven calendar days from the date delivery was due under it.

Upon request of the seller, an additional extension of seven calendar days may be granted by the Committee due to the circumstances involved.

Exam Tip: Gotchas

• The first seven-day extension is mandatory and the second is discretionary. The buyer must extend on a compliant securities-in-transit notice. The Committee may grant a further seven calendar days on the seller's request.
• The certificate numbers are part of the trigger. A notice that the securities are in transfer without giving the certificate numbers does not meet the paragraph.
• An expired notice does not end the contract. The notice expires at the close of business on the day it specified, leaving the underlying obligation and the right to issue a fresh notice intact.

What Notice Follows an Executed Buy-In?

The party executing the buy-in shall, immediately upon execution but no later than 6:00 p.m. ET on the date of execution, notify the party for whose account the securities were bought as to the quantity purchased and the price paid.

That notification shall be in written or electronic form having immediate receipt capabilities. Where that written medium is not available, the telephone shall be used for same-day notification, and written or similar electronic notification having next day receipt capabilities must also be sent out simultaneously.

In either case, formal confirmation of purchase shall be forwarded to the party entitled to receive it not later than 9:30 a.m. ET on the following business day after the execution.

Notification also runs down the chain. It shall be given to succeeding parties to which a re-transmitted notice was issued, using the same procedures. And if a re-transmitted buy-in is executed, it will operate to close out all contracts covered under the re-transmitted notice.

Money moves on two separate clocks. Statements of resulting money differences, if any, shall also be provided immediately.

Any money difference resulting from the closing of a contract, or from the re-establishment of a contract as provided in the rule shall be paid not later than 3:00 p.m. ET on the business day after the settlement date of the executed buy-in, to the member entitled to receive it.

Exam Tip: Gotchas

• The statement of money differences and the payment run on different clocks. The statement is provided immediately. The money itself is paid by 3:00 p.m. ET on the business day after the executed buy-in's settlement date.
• The telephone fallback does not replace the writing. Where the immediate-receipt medium is unavailable, the firm telephones and simultaneously sends written or electronic notification with next-day receipt capability.

When May a Contract Be Closed Out Without Prior Notice?

Three separate routes skip the notice steps here, and each turns on a different fact. A fourth, where the liability notice procedures are not used as the rule provides, sits under How Does the Liability Notice Route Work? below.

Cash and guaranteed-delivery contracts. Contracts made for "cash," or made for or amended to include guaranteed delivery on a specified date, may be bought in without notice during the normal trading hours on the day following the date delivery is due on the contract. Otherwise the ordinary notice-through-extension procedures apply, and in all cases the executed-buy-in notification is required. Buy-ins executed under that paragraph are for the account and risk of the defaulting broker-dealer.

A ruling by an exchange or the Committee. Where a national securities exchange makes a ruling that all open contracts with a particular member, which is also a member of FINRA, should be closed out immediately, or any similar ruling, members may close out contracts as directed by the exchange.

The Uniform Practice Code Committee has its own trigger, and it runs on either of two findings. The first is that it ascertains that a court has appointed a receiver for any member because of its insolvency or failure to meet its obligations.

The second is that it ascertains, based upon evidence before it, that a member cannot meet its obligations as they become due and that such action will be in the public interest. On either finding the Committee may, in its discretion, issue notification that all open contracts with that member may be closed out immediately.

Within the meaning of that paragraph, to close out immediately means two things: buy-ins may be executed without prior notice of intent to buy in, and sell-outs may be executed without making prior delivery of the securities called for.

All close-outs under this paragraph, whether on an exchange ruling or a Committee notification, shall be executed for the account and liability of the member in question, and notification of all close-outs shall immediately be sent to that member under the Uniform Practice Code's confirmation provisions, at least thirty minutes before the close-out.

Exam Tip: Gotchas

• A cash contract buy-in runs the day after delivery is due, not the third business day. That timetable belongs to contracts made for cash or carrying guaranteed delivery on a specified date, and the executed-buy-in notification is still required.
• An immediate close-out still carries a thirty-minute notice. Notification goes to the member in question at least thirty minutes before the close-out, even though no prior notice of intent to buy in is needed.

How Does the Liability Notice Route Work?

The first branch reaches a contract for warrants, rights, convertible securities or other securities which have been called for redemption, are due to expire by their terms, are the subject of a tender or exchange offer, or are subject to other expiring events such as a record date for the underlying security.

Where the expiration date is the settlement date of the contract or later, the receiving member may deliver a Liability Notice to the delivering member as an alternative to the close-out procedures in the notice-through-notification paragraphs.

For the whole rule, "expiration date" means the latest time and date on which securities must be delivered or surrendered, up to and including the last day of the protect period, if any.

Transmission runs on two routes. Where the parties are both participants in a registered clearing agency that has an automated service for notifying a failing party of the liability attendant to a failure to deliver, the transmission must be accomplished through that automated notification service.

Where the parties are not both participants in such a clearing agency, the notice must be issued using written or comparable electronic media having immediate receipt capabilities, and must be sent as soon as practicable but not later than two hours prior to the cutoff time set forth in the instructions on a specific offer or other event, in order to obtain the protection the rule provides.

A second product branch carries its own clock. It reaches a contract for a deliverable instrument with an exercise provision where the exercise may be accomplished on a daily basis, and where the settlement date of the contract to purchase the instrument is on or before the requested exercise date.

There the receiving member may deliver a Liability Notice no later than 11:00 a.m. ET on the day the exercise is to be effected. Notice may be redelivered immediately to another member but no later than noon ET on the same day.

That branch carries the same two transmission routes, the automated service where both parties are participants and immediate-receipt media where they are not, but it states no two-hour deadline. Where the contract remains undelivered at expiration and has not been canceled by mutual consent, the receiving member shall notify the defaulting member of the exact amount of the liability on the next business day.

In all cases, members must be prepared to document requests for which a Liability Notice is initiated.

Two consequences follow. Where the delivering member fails to deliver the securities on the expiration date, it shall be liable for any damages which may accrue.

A Liability Notice delivered in accordance with the rule is itself the receiving member's notification of the existence of a claim for damages, and all claims for such damages shall be made promptly.

And where those procedures are not utilized as provided under the rule, contracts may be bought in without prior notice, after normal delivery hours, on the expiration date, for the account and risk of the defaulting member.

The close-out requirement for a fail to deliver in an equity security runs on its own separate deadlines under the Regulation SHO close-out rule, which is covered in the unit on handling and executing short sales.

Exam Tip: Gotchas

• The two-hour deadline belongs to only one of the two branches. Where the parties are not both on a clearing agency's automated notification service, the expiring-event branch requires notice as soon as practicable and not later than two hours before the cutoff time for the specific offer or other event. The daily-exercise branch states no such deadline.
• The automated route is mandatory where both parties can use it. Where both are participants in a clearing agency with an automated liability-notification service, the notice must go through that service.

When Can a Security Be Reclaimed or Returned?

"Reclamation" means a claim for the right to return or the right to demand the return of a security which has been previously accepted. Securities presented for delivery on a transaction and for a valid reason refused shall, within the meaning of the reclamation rules, be deemed a rejection.

A properly executed Uniform Reclamation Form must accompany securities on reclamation or return. A security reclaimed or returned without one may, at the option of the receiving broker, be sold out under the selling-out rule, however, in no event later than three business days after receipt of the receiving broker or its agent.

Timing and settlement of a reclamation are stated separately. A security with an irregularity having been delivered may be returned or reclaimed between the hours established by rule or practice in the community where the delivery or reclamation is to be made.

When a security is returned or reclaimed, the party who originally delivered it shall immediately give the party returning it either the security in proper form for delivery in exchange for the security originally delivered, or the money amount of the contract.

In the latter case, unless otherwise agreed, the party to whom the security is returned shall be deemed to be failing to deliver the security until a proper delivery is made.

Two irregularity classes carry fixed windows.

• Minor irregularities. Reclamation for an irregularity which affects only the currency of the security in the market shall be made within 15 days from the day of original delivery, except that, where the security is issued under the jurisdiction of a foreign country, the period is 45 days from the day of original delivery.
• Wrong form of certificate. Reclamation by reason of the fact that a form of certificate was delivered which was not a good delivery, but which is exchangeable without charge for a certificate which is a good delivery, shall be made within 15 days from the day of original delivery.

Three other classes run on a separate rule and a much longer clock. Reclamation in each of them shall be within 30 months after the settlement date of the contract.

• Irregular delivery. Reclamation by reason of the fact of an irregularity in the delivery of a security. That term includes, among other things, wrong, duplicate, misdirected or over-deliveries and delivery of unit investment trust securities having the incorrect payment option.
• Transfer refused. Reclamation by reason of the fact that a specific certificate tendered in settlement of a contract has been presented for transfer and transfer thereof has been refused by the transfer agent.
• Lost, stolen or confiscated securities. Reclamation by reason of the fact that a security is lost or stolen or confiscated.

The running of that 30-month period shall not be deemed to foreclose a member's rights to pursue its claim via other open avenues, including but not limited to the FINRA arbitration procedure.

Called securities have no window at all. Reclamation by reason of the fact that a security was delivered after publication of notice of call for its redemption may be made without limit of time, and such security may be returned to the party who held it at the time of that publication.

That open-ended right carries one exception. It shall not apply when an entire issue is called for redemption, or when the security involved was dealt in specifically as a "called" security.

Exam Tip: Gotchas

• A foreign-jurisdiction security triples the minor-irregularity window. The base period is 15 days from the day of original delivery, and it becomes 45 days where the security is issued under the jurisdiction of a foreign country.
• The called-securities right is unlimited in time but not unlimited in scope. It falls away where the entire issue was called or where the security was dealt in specifically as a called security.
• A missing reclamation form opens a sell-out with an outer limit. The receiving broker may sell out at its option, in no event later than three business days after receipt by that broker or its agent.

When May a Seller Sell Out?

The selling-out rule is the seller's remedy, and it opens on two facts together: failure of the buyer to accept delivery in accordance with the terms of the contract, and the absence of a properly executed Uniform Reclamation Form or the equivalent depository generated advice for depository eligible securities meeting the reclamation rule's requirements.

On those facts the seller may, without notice, sell out in the best available market and for the account and liability of the party in default all or any part of the securities due or deliverable under the contract.

Notice follows execution rather than preceding it. The party executing a sell-out shall, as promptly as possible on the day of execution, but no later than 6 p.m. ET, notify the broker-dealer for whose account and risk the securities were sold of the quantity sold and the price received.

That notification shall be in written or electronic form having immediate receipt capabilities, and a formal confirmation of the sale shall be forwarded as promptly as possible after the execution of the sell-out.

Exam Tip: Gotchas

• A sell-out needs no prior notice at all. The seller may sell out without notice, and the notice duty runs after execution, by 6 p.m. ET on the day of execution.
• The absence of a reclamation form is part of the trigger. The seller's right arises on the buyer's failure to accept delivery and the lack of a properly executed form or the equivalent depository advice.

What Standing Duties Does the Buy-In Rule Impose?

Two duties do not attach to any single transaction.

• A staffed desk. Members shall have a buy-in section or desk adequately staffed to process and research all buy-ins within the required time frames of the rule.
• Accrued securities. Securities in the form of stock, rights or warrants which accrue to a buyer shall be deemed due and deliverable to the buyer on the payable date, and any such securities remaining undelivered at that time shall be subject to the buy-in procedures.

Two pieces of supplementary material adjust the mechanics at the edges.

• Early market closures. For purposes of the notice-content paragraph and the seller's delivery paragraph, on an announced early closure of the market upon which the security subject to the notice is traded, members may take the action required by those paragraphs not earlier than one hour prior to the announced early closure of that market.
• Securities delivered after execution. Where securities have been delivered by the seller after the buy-in order has been placed by the party effecting the buy-in, the securities may be returned to the seller if the buy-in was executed in accordance with the rule before it could reasonably be cancelled by the initiating party.

Exam Tip: Gotchas

• The right to return a late delivery is conditional on a compliant execution. The buy-in must have been executed in accordance with the rule before it could reasonably be cancelled, so a buy-in run outside the rule leaves the buyer holding the securities.
• Accrued stock, rights and warrants have their own due date. They are deemed due and deliverable on the payable date, and anything undelivered then is exposed to the buy-in procedures.

What Should You Check on Exam Day?

• Confirm the buyer waited until the third business day following the date delivery was due, unless the contract is cash or guaranteed delivery, which runs the day after delivery is due.
• Read the notice clocks separately: original by 12:00 noon ET two business days ahead, re-transmitted by 12 noon ET the business day before, rejection by 6:00 p.m. ET on the issue date.
• Distinguish a stay, which needs physical possession of at least one trading unit, from a securities-in-transit notice, which forces a seven calendar day extension.
• On an expiring event, check whether both parties are clearing agency participants with an automated liability-notification service; that route is mandatory when available.
• On a reclamation, name the irregularity class: minor irregularities 15 days (45 for a foreign-jurisdiction security), wrong form of certificate 15 days, irregular delivery, refused transfer and lost, stolen or confiscated securities 30 months after settlement, called securities no limit.