Quick Answer
A settlement fail does not cancel the trade; the contract stays binding and is resolved through a buy-in (seller fails to deliver) or sell-out (buyer fails to pay). A separate 10-business-day rule forces a firm to buy in its own customer on an undelivered long sale, distinct from the inter-dealer buy-in timeline and from the DK process for trade-comparison disputes.
Even with modern book-entry systems, settlement failures occur. Understanding what happens when a seller does not deliver securities or a buyer does not pay is frequently tested on the exam.
Fail to Deliver / Fail to Receive
- A fail to deliver occurs when the selling broker-dealer does not deliver securities by settlement date
- A fail to receive occurs when the buying broker-dealer does not receive securities by settlement date
- A fail does not cancel the contract; the trade remains binding
- The remedy is through buy-in or sell-out procedures, not cancellation
Exam Tip: Gotchas
- A fail to deliver does not cancel the trade. The contract is still binding, and the remedy is a buy-in or sell-out, not cancellation.
Buy-In Procedures
When a seller fails to deliver, the buyer may initiate a buy-in to obtain the securities from another source.
Timeline
| Step | Timing |
|---|---|
| Delivery was due | Settlement date (T+1) |
| Earliest buy-in execution | 3 business days after delivery was due |
| Written notice of intent | Must be delivered by 12:00 PM ET at least 2 business days before buy-in execution |
The inter-dealer buy-in is the buyer's option once the 3-business-day floor has passed; the close-out rule sets no fixed number of days by which it must be completed.
Cost Allocation
- If the buy-in price is higher than the original contract price, the failing seller is liable for the difference
- The buyer purchases the securities at the current market price and bills the difference to the seller
- If the buy-in price is lower, the buyer simply acquires the securities more cheaply
Exam Tip: Gotchas
- The failing seller pays the difference if the buy-in price is higher. The buyer does not absorb the cost.
- Buy-in notice must be given by 12:00 PM ET at least 2 business days before execution.
Customer Buy-In: The 10-Business-Day Rule
A different close-out applies when the failing party is the firm's own customer on a long sale (the customer sold securities they own but did not deliver them):
- If a broker-dealer has not obtained the securities from the customer within 10 business days after the settlement date, the firm must buy the customer in (purchase like securities to close out the position)
- This is a firm-versus-customer close-out, distinct from the inter-dealer buy-in above
- The rule is suspended for exempted securities (U.S. government and municipal obligations), so it applies to equities
Exam Tip: Gotchas
- The 10-business-day close-out is the CUSTOMER buy-in under the SEC customer protection rule, not the inter-dealer buy-in timeline. If a customer sells long stock and fails to deliver within 10 business days of settlement, the firm buys them in.
Sell-Out Procedures
When a buyer fails to pay, the seller may initiate a sell-out.
- The seller may sell the securities and hold the failing buyer liable for any loss
- If the securities sell for less than the original contract price, the buyer owes the difference
- Mirror image of the buy-in process, but triggered by the buyer's failure to pay
Don't Know (DK) Notices
A DK notice is sent when one party to a trade does not recognize or agree to the terms of the transaction.
- Used during the trade comparison process
- Governed by FINRA's trade-comparison rules and corresponding exchange rules
- If a party receives a comparison and does not recognize the trade, they must send a DK notice promptly
- Unresolved DK'd trades may result in cancellation or arbitration
Common DK scenarios:
- Wrong quantity or price on the comparison
- Trade was never agreed to
- Account number mismatch
Exam Tip: Gotchas
- DK notices are about trade comparison disputes, not settlement failures. A DK means one party does not recognize the trade at all.
Extensions of Time for Payment (Regulation T)
Under Regulation T, payment in a cash account is due by settlement date (T+1), with an outside deadline of T+3 (settlement + 2 business days).
What Happens When a Customer Doesn't Pay
| Step | Action |
|---|---|
| Payment not received by T+1 | Firm may request an extension |
| Extension request | Filed with a self-regulatory organization (SRO) such as FINRA or an exchange |
| Extension denied / no payment | Firm must liquidate the position |
| After liquidation | Account is frozen for 90 days |
The 90-Day Account Freeze
- During the freeze, the customer can still trade but must deposit cash in advance of any purchase (not after)
- This is a penalty for failure to pay on time; the customer loses the ability to buy now and pay later
- Also known as a freeriding violation if the customer bought and sold a security before paying for the original purchase
Exam Tip: Gotchas
- The 90-day freeze does not prevent trading. The customer can still buy, but must deposit cash in advance before placing the order (not after).
- A freeriding violation triggers the freeze: buying and selling a security before paying for the original purchase.
What Should You Check on Exam Day?
- A fail never cancels the trade. The remedy is always a buy-in or sell-out, never contract cancellation.
- Keep the three timelines distinct: the inter-dealer buy-in (earliest execution 3 business days after delivery was due, notice by 12:00 PM ET at least 2 business days before), the customer buy-in (10 business days after settlement, suspended for exempt securities), and Reg T's cash-account payment deadline (T+3 outside limit, then a 90-day freeze).
- Do not confuse a DK notice (a trade-comparison dispute over whether the trade happened at all) with a settlement fail (the trade is agreed, but delivery or payment did not occur).