The Immobilization and
Dematerialization of Equity
Securities
(or “Dude, where’s my stock certificate?”)
Public Companies Subgroup Meeting
June 13, 2006
Background - How Shares are Held
1. In “street name”
–
Securities held in the name of a broker or another nominee
(such as a financial institution or depository), instead of the
shareholder
•
•
Non-Objecting Beneficial Owners (NOBOs) and Objecting
Beneficial Owners (OBOs) make up the entire street name
universe
– “Objecting” refers to the shareholder’s decision of whether
to allow disclosure of ownership data and personal
information about the shareholder
Cede & Co. is the nominee name for The Depository Trust
Company (DTC) (often used interchangeably)
2. In “registered name”
–
Portlnd2-4497402.1
Ownership registered directly on the books of the issuer WITH
a physical certificate personally held by the shareholder
Background - How Shares are Held
(cont’d)
3.
Though a direct registration system (DRS)
– Ownership registered directly on the books of the issuer or its
transfer agent WITHOUT a physical certificate personally held
by the shareholder
•
•
Portlnd2-4497402.1
Note that the term “DRS” is commonly used to refer both to the
Direct Registration System implemented by the Depository Trust
Company, as well as the general concept of book-entry electronic
direct registration programs
As of the date of this presentation, the Depository Trust
Company’s Direct Registration System is the only existing direct
registration program
What are Immobilization and
Dematerialization?
• Immobilization
– “any circumstance where an investor does not receive a
physical certificate upon the purchase of shares or is required
to physically deliver a certificate upon the sale of shares”
– aka “Book-Entry Ownership” (evidence of ownership
maintained on issuer’s or broker/dealer’s books)
• Examples include “street name” ownership and the Direct
Registration System (DRS)
• Dematerialization (DEMAT)
– “the process of eliminating physical certificates as a record of
security ownership, or where ownership of the security exists
only as an accounting record”
Portlnd2-4497402.1
The Hub of the Securities Industry’s
Infrastructure
• Depository Trust & Clearing Corporation (DTCC)
– Holding company that supports five main subsidiaries, including the
Depository Trust Company (DTC) and National Securities Clearing
Corporation (NSCC)
– DTCC provides custody and asset servicing for more than two
million securities issues from the United States and 100 other
countries and territories. In addition, DTCC is a leading processor
of mutual funds and insurance transactions, linking funds and
carriers with their distribution networks
– In 2005, the value of securities settled through DTCC subsidiaries
exceeded $1.4 quadrillion.
• (that’s “1.4” followed by 14 zeros)
– As of December 31, 2005, DTCC showed a balance sheet of over
$19.3 billion.
Portlnd2-4497402.1
The Hub of the Securities Industry’s
Infrastructure (cont’d)
•
Depository Trust Company (DTC)
– A limited-purpose trust company that immobilizes securities for brokerdealers and banks, completes the book-entry delivery of those securities,
and does all of the “back office” tasks required to provide centralized,
automated processing
– Focuses on immobilization to reduce paperwork
– In 2005, DTC processed 263 million book-entry deliveries, with a total
value of $148.2 trillion
•
National Securities Clearing Corporation (NSCC)
– A central counterparty that provides centralized clearance, settlement and
information services for virtually all broker-to-broker equity, corporate bond
and muni bond, exchange-traded funds and UIT trades in the U.S.
– Focuses on multilateral netting to reduce paperwork (all payments settle to
a single dollar figure owed to or from NSCC)
– In 2005, NSCC netted 6.6 billion transactions, with a total value of
$130.7 trillion
Portlnd2-4497402.1
Who is Behind the DEMAT Movement?
• Securities Industry Association (SIA)
– Established in 1972 through the merger of the Association of
Stock Exchange Firms (1913) and the Investment Banker's
Association (1912)
– A 501(c)(6) non-profit with over 600 SIA members (including
investment banks, broker-dealers, and mutual fund companies)
• Other supporters:
–
–
–
–
–
Portlnd2-4497402.1
The Depository Trust Company (DTC)
National Association of Securities Dealers (NASD)
Securities Information Center (SIC)
Securities Transfer Association (STA)
American Society of Corporate Secretaries (ASCS)
Four Reasons SIA Loves to Hate
Physical Certificates
1.
More costly than electronic book-entry
•
A March 2003 SIA “Physical Securities Cost Analysis” reported the
following primary costs of supporting physical certificates (on an
annualized basis):
•
•
•
•
•
2.
Less safe than electronic book-entry
•
3.
Broker/dealer and Custodian bank costs $48,548,000
DTC Costs = $86,290,000
Securities Information Center (SIC) operating costs = $5,400,000
Surety Bond cost to replace lost certificates = $49,400,000
Transfer Agent service costs = $45,000,000
• TOTAL = Over $234.6 million per year
Physical certificates vulnerable to loss, theft, acts of God, etc.
Less convenient than electronic book-entry
•
Trades commonly not executed until physical certs are delivered and
verified; a problem in fast-moving markets
Portlnd2-4497402.1
Four Reasons SIA Loves to Hate
Physical Certificates
4.
They’re one of the main obstacles to SIA’s goal of achieving
Straight-Through Processing (STP)
–
–
–
–
The stated objective of the SIA Straight-Through Processing (STP)
Physical Securities Subcommittee is to eliminate the use of physical
certificates in the industry.
STP, as defined by the Securities Industry Association (SIA), is “the
process of seamlessly passing financial information to all parties
involved in the transaction process, spanning the investment manager
decision through to reconciliation and statement production, without
manual handling or redundant processing in real-time.”
Note that STP is NOT synonymous with the goal of T+0 or T+1 settlement;
STP can work within existing T+3 settlement framework
But STP cannot be implemented industry-wide until book-entry ownership
(street name or DRS) becomes the default rule
Portlnd2-4497402.1
Benefits of Dematerialization (as
viewed by SIA)
• To investors
– Increased portability (easy to move shares between transfer
agents and brokers)
– Increased trading flexibility; sale proceeds distributed faster
– Reduces lost or stolen certificates and replacement fees
– Eliminates risk associated with catastrophic events
– Timely notification and immediate receipt of many corporate action
entitlements
– Removes opportunity for fraudulent presentation of previously
cancelled certificates
– Less assets escheated to the state; annual DRS statements
are mailed, which generates address updates
Portlnd2-4497402.1
Benefits of Dematerialization (cont’d)
• To issuers
– Amount of benefit depends on the size of the shareholder base,
frequency of transactions, transfer agent fee structure, and other
factors
– In general, the costs associated with printing, safeguarding and
issuing certificates, processing lost certificates and the potential
costs of processing corporate actions will be dramatically reduced
– Minimizes risk of fraudulent presentation of previously cancelled
certificates
– Corporate action processing for certificated securities is 6 times
greater than for book-entry securities
– Transfer agent servicing costs of $45 million per year could be
eliminated, with savings flowing to issuers and shareholders
Portlnd2-4497402.1
What Securities are DRS-Eligible?
• Generally, the securities that may be made eligible for DTC’s
book-entry delivery service are those that:
– Have been registered under the ’33 Act, or
– Are exempt from registration pursuant to a ’33 Act exemption that
does not involve transfer or ownership restrictions, or
– Are eligible for resale pursuant to Rule 144A or Reg S (and
otherwise meet DTC’s eligibility criteria)
• For issues and securities that are NOT DRS-eligible (such as
restricted equity securities, collateralized shares, private
placements and limited partnerships) DTC offers the Networking
For Equities (NFE) program
– Differs from DRS in some important respects, the primary
difference being the broker/dealer has custody and control over the
asset
Portlnd2-4497402.1
Endgame – DRS for Public Companies
•
SIA has been spearheading the following initiatives
–
To require the NYSE, Nasdaq and AMEX to:
1. Require DRS as a listing standard
2. Encourage listed companies to exercise their ability to cease issuing
physical certificates
3. Allow a simple board resolution to eliminate physical stock certificates
4. Allow issuers to charge shareholders a fee when a physical stock
certificate is requested
–
–
Portlnd2-4497402.1
To encourage the SEC to develop regulatory initiatives to establish
book-entry ownership as the standard
To lobby state legislatures to change laws that require issuers to
make physical certificates available to shareholders
SIA’s Progress Toward the DEMAT and
DRS Goals
1.
Lobbying activities:
–
–
–
–
Portlnd2-4497402.1
June 2004 - only seven jurisdictions still required corporations incorporated therein to
provide physical certificates to shareholders upon request (Arizona, California,
Delaware, Louisiana, Maine, Missouri and Puerto Rico)
August 2005 – Delaware, Louisiana and Missouri enacted new laws allowing
companies incorporated therein to issue uncertificated securities
Delaware HB 150 provides:
Section 2. Amend Section 158, Title 8, Delaware Code, by deleting the third
sentence thereof in its entirety and substituting in lieu thereof the following:
“Every holder of stock represented by certificates shall be entitled to have a certificate
signed by, or in the name of the corporation by the chairperson or vice-chairperson of
the board of directors, or the president or vice-president, and by the treasurer or an
assistant treasurer, or the secretary or an assistant secretary of such corporation
representing the number of shares registered in certificate form.”
As of 2006, only Arizona and Puerto Rico still have laws requiring corporations
incorporated therein to issue physical stock certificates upon request.
SIA’s Progress toward the DEMAT and
DRS Goals (cont’d)
2.
•
Exchange activities:
NYSE
–
In 2002, Section 501.01 of the NYSE Listed Company Manual was
amended to provide:
“The Exchange does not require that a listed company send stock certificates to a
record holder with respect to a stock distribution if …the company's stock is included
in a direct registration system, operated by a securities depository, and available for
Exchange-traded stocks.”
–
On May 31, 2006, the NYSE filed a proposed rule change to require that
all listed securities become eligible under a “direct registration system
operating by a clearing agency…that is registered with the Commission”
•
Portlnd2-4497402.1
Note that participation is not required– only eligibility
SIA’s Progress toward the DEMAT and
DRS Goals (cont’d)
2. Exchange activities (cont’d):
– Nasdaq:
•
•
•
•
–
AMEX:
•
Portlnd2-4497402.1
Marketplace Rule 4350(l) allows an issuer to establish a Direct Registration
Program for its shareholders so long as the issuer, directly or through its transfer
agent, participates in an electronic link with DTC.
On May 31, 2006, Nasdaq filed a proposed rule change to require that all listed
securities become eligible under a “direct registration system operating by a
clearing agency…that is registered with the Commission”
Note that participation is not required– only eligibility
Also, the proposed rule expressly DOES NOT call for the elimination of physical
certificates
On May 31, 2006, Amex proposed to add new Rule 778 to its Rules and new
Section 135 to its Company Guide to require that certain listed securities
become eligible for a Direct Registration System operated by a securities
depository.
Bottom Line
• The immobilization and dematerialization of equity
securities is well underway
• Direct Registration System (DRS)-eligibility of equity
securities as a listing standard is on the horizon
• Issuers should conduct a self-assessment to
determine whether DRS is right for them, and if so,
begin to chart a path for the move to DRS
– SIA has published handy checklists, questionnaires, sample
bylaws, etc.
Portlnd2-4497402.1
Selected Online Bibliography
•
•
•
•
•
•
•
SIA Securities Industry Immobilization & Dematerialization Implementation
Guide
– http://www.sia.com/stp/pdf/SIADematerializationImpGuide.pdf
2004 SEC Concept Release on Dematerialization
– http://www.sec.gov/rules/concept/33-8398.htm
NYSE proposed rule change to require DRS-eligibility as a listing standard
– http://www.sec.gov/rules/sro/nyse/2006/34-53912.pdf
AMEX proposed rule change to require DRS-eligibility as a listing standard
– http://www.sec.gov/rules/sro/amex/2006/34-53911.pdf
Nasdaq proposed rule change to require DRS-eligibility as a listing standard
– http://nasdaq.complinet.com/file_store/pdf/rulebooks/NASDAQ-2006-008.pdf
Delaware HB 150
– http://www.state.de.us/corp/hb150.pdf
List of Issuers offering DRS
– http://www.dtcc.com/nomorepaper/industry/paperless_companies.html
Portlnd2-4497402.1