Friday, August 25, 2006
U.S. a Step Closer to Eliminating Paper Stock Certificates
FROM SECURITIES INDUSTRY NEWS
August 21, 2006
PAGE ONE
Direct registration affects first-time listers in '07
By Chris Kentouris, Senior International Editor
August 21, 2006 - The U.S. is taking a cue from some foreign markets to cut back on paper stock certificates in circulation. Effective Jan. 1, companies listing for the first time on the New York Stock Exchange, Nasdaq Stock Market, American Stock Exchange and NYSE Arca will have to be eligible for a direct registration system (DRS), operated by the Depository Trust & Clearing Corp. (DTCC), that will enable certificateless transfers. Existing issues would have to permit DRS by Jan. 1, 2008.
"This may not be dematerialization," says John Panchery, VP and managing director of operations and technology at the Securities Industry Association (SIA), referring to the term for removing paper in securities ownership. "But it's the closest we have come to going paperless for several years." In a direct registration system, corporations know exactly who their underlying shareholders are because they are on the books of an issuer or its transfer agent under their own names rather than the name of a financial intermediary, also known as nominee or street name. Shares in DRS-held accounts can be moved among brokers and transfer agents electronically.
However, an estimated 85 percent of stock investors have their certificates in street name. By contrast, all U.S. government securities are now issued in paperless form, as are more than 98 percent of corporate and municipal debt securities. Only in August 2005 did Delaware, where over half of U.S. issuers are incorporated, eliminate its requirement that issuers offer certificates upon request. Arizona followed suit in April, leaving Puerto Rico as the only U.S. jurisdiction still requiring certificates to be issued.
"We have been lobbying the Big Board and other exchanges to require issuers to adopt the DRS option since 2004, but it was not until changes in state legislation that we could move forward," says Lawrence Morillo, managing director of Bank of New York's Pershing clearing division and head of the SIA's operations, legal and regulatory committee.
Issuers, transfer agents and broker-dealers have their work cut out to prepare for DRS. Issuers need to notify their shareholders, and some may have to change their bylaws. Transfer agents will have to participate in the DRS Profile service of DTCC's Depository Trust Co. (DTC) subsidiary. Agents complain they do not have the technological wherewithal to do so and are not certain that they can pass along the costs to smaller issuers that use them. However, larger agents see an opportunity.
"We wouldn't have any capacity issues in adding to the number of DRS accounts we process," says Kevin Brennan, managing director and head of new business development at Bank of New York. "But there has been a mixed response from clients--larger ones view it as making it easier for investors, while some smaller ones haven't focused on the upside." Brennan says that about 150 of BNY's 550 clients, representing a third of 17 million total shareholders, offer the DRS option.
Not a New Idea
Broker-dealers have been advocating dematerialization since 1995 when the Securities and Exchange Commission moved to reduce the settlement cycle from five days to three. Wanting to preserve their business, the transfer agent community, which is paid by issuers based on the number of registered accounts, lobbied for the DTC to create the DRS option the following year, and with its introduction in 1996, broker-dealers began offering it. But today, these firms' sales forces will need to be trained to advise shareholders of the option. "Broker-dealers typically tell investors about street name ownership; it's the default mechanism," says Panchery. The SIA is now modifying its two-year-old guide on dematerialization to incorporate the DRS option.
"We don't charge issuers for registered certificated shareholders or shareholders holding DRS accounts any differently," says Charles Rossi, VP of Computershare, the biggest U.S. transfer agent. "The goal is to streamline the process for investors and transfer agents." Of the 23 million shareholders serviced by Computershare, 14.5 million have DRS shares.
"More and more companies are considering going paperless because they know it's safer, less expensive and more convenient for investors," says Joseph Trezza, DTCC's VP of asset services. "And a new generation of investors takes electronic registration for granted. They don't want stock certificates. They want a DRS statement saying they own X number of shares in a given corporation." He questions why some smaller transfer agents see DRS as onerous "because we've had small transfer agents in Fast [Fast Automated Securities Transfer] and DRS for some time now."
There are 1,217 issues currently DRS-eligible. Trezza expects that to increase by 9,000 by January 2008. The New York-based depository is also anticipating that 250 more transfer agents will be joining the roster of 130 participating in DTC's Fast, a prerequisite to DRS. Fast allows transfer agents and DTC to avoid movement of certificates between each other for registered shareholders by crediting and debiting accounts electronically.
The DRS option exemplifies what has become known as immobilization--the other side of the dematerialization coin. Both make paperless transactions possible, but dematerialization does away with paper certificates entirely. Share ownership is represented by electronic entries in the central securities settlement system. In immobilization, certificates remain in vaults and investors can receive the documents on demand.
International Urgency
Some U.S. corporate issuers are also offering dematerialized shares, but typically that has resulted from a corporate reorganization or initial public offering. Elsewhere, Sweden, France, Australia and New Zealand have dematerialized, and the U.K., Irish, Belgian and Dutch regulators and market participants are discussing how to do so. Last year, the European Securities Forum, a trade association representing securities professionals, advocated direct registration for U.K. investors, and the U.K.'s Institute of Chartered Secretaries and Administrators and Ireland's Dematerialization Implementation Group (DIG) recently called for complete dematerialization. About 9 million of the 12 million private investors in the U.K. hold certificates.
"The consensus of the group is that dematerialization should be pursued as a matter of priority by the Irish equity market," says Brian Healy, director of trading and regulation for the Irish Stock Exchange and head of DIG. "There is a growing realization that a system using paper share certificates is outdated and inefficient compared to a fully electronic means of holding and settling shares."
Healy expects changes to the Irish Companies Act to allow for dematerialized holdings by the end of this year. With transactions on both the Irish Stock Exchange and the London Stock Exchange settled by the Crest depository, Ireland should synchronize its dematerialization efforts with the U.K.
According to Healy, dematerialization is made more necessary because of Euroclear's efforts to consolidate the operating platforms of its five markets onto a single system by 2009. Those platforms service the U.K., Ireland, France, Belgium, the Netherlands and Euroclear Bank, the international central securities depository.
"Ireland needs to keep its securities market at the forefront of international best practice, and the implementation of dematerialization is an important contributor to timely, efficient and cost-effective settlement for retail investors," says Healy. "In addition, if other countries serviced by Euroclear implement fully dematerialized systems, it will become an expensive option to retain a paper settlement system."
In Belgium, effective Jan. 1, 2008, new bearer shares cannot be issued in certificate form. By 2013, all securities will be dematerialized--meaning that 45 million certificates weighing some 620 tons will be recalled and destroyed, says Stephane Bernard, CEO of Euroclear Belgium, the country's central securities depository.
In the U.S., the SEC has historically been reluctant to mandate full dematerialization, but in 2004 it requested industry comment on a number of issues to promote shorter settlement times and straight-through processing, including how to reduce the number of paper certificates in circulation. According to SIA research based on 2002 data, the securities industry spends $250 million a year to process physical certificates--a cost ultimately borne mostly by investors. Aside from costs, there are risks, as evidenced during the Sept. 11, 2001 disaster when the whereabouts of thousands of certificates were temporarily unknown.
Many investors don't know they have to replace certificates if they are lost, and replacement fees to cover the surety bond for lost securities can be 3 percent of the current market value of the shares. According to the Securities Information Center, which tracks lost and stolen certificates, $8.7 billion worth of certificated securities were reported lost in 2005. As a result, investors spent $261 million on surety bonds to have their shares replaced.
Early Dematerializers
Over two-dozen companies have dematerialized, New York-incorporated AT&T being the largest. In 2002, in announcing a one-for-five reverse split, the company required shareholders to go the electronic route. (Since its takeover by SBC Communications last year, certificates are allowed.) Corporate actions--such as mergers and restructurings--often involve the issuance of new shares, which historically required new certificates. The SIA has estimated that it costs issuers with 100,000 registered investors $1 million more to issue certificates resulting from a corporate action than book-entry registration.
Others that have gone paperless in recent months are Intel Corp., mutual fund company Nuveen Investments, Chevron Corp., Federated Department Stores, NCR Corp., RadioShack Corp. and US Airways.
While issuers can save plenty by not printing certificates, another aspect of going paperless is investor convenience. Intel, a Computershare client, went to dematerialization for new investors as of last August in large part due to concerns over lost certificates. Existing investors could still hold on to certificates. "Some of our executives and shareholders had difficulties selling their shares when their certificates were lost, so we decided there were merits to dematerialization," says Douglas Stewart, senior attorney for Intel.
From a corporate governance perspective, not only do DRS issuers know who their investors are--not a bad idea in the case of a takeover or proxy battle--but they can communicate with them directly rather than through intermediaries. Such a stance is advocated by some issuers that also want to save proxy mailing fees charged by banks and brokerages. Most financial firms outsource the work to Automatic Data Processing, whose fees are set by the NYSE.
"Financial intermediaries feel that the shareholder is their investment customer, while corporations see the same shareholder as their owner," says Geoff Loftus, VP of the Society of Corporate Secretaries & Governance Professionals. "Corporations still might decide to do their mailings through ADP, but at least they would have direct access to their owners."
August 21, 2006
PAGE ONE
Direct registration affects first-time listers in '07
By Chris Kentouris, Senior International Editor
August 21, 2006 - The U.S. is taking a cue from some foreign markets to cut back on paper stock certificates in circulation. Effective Jan. 1, companies listing for the first time on the New York Stock Exchange, Nasdaq Stock Market, American Stock Exchange and NYSE Arca will have to be eligible for a direct registration system (DRS), operated by the Depository Trust & Clearing Corp. (DTCC), that will enable certificateless transfers. Existing issues would have to permit DRS by Jan. 1, 2008.
"This may not be dematerialization," says John Panchery, VP and managing director of operations and technology at the Securities Industry Association (SIA), referring to the term for removing paper in securities ownership. "But it's the closest we have come to going paperless for several years." In a direct registration system, corporations know exactly who their underlying shareholders are because they are on the books of an issuer or its transfer agent under their own names rather than the name of a financial intermediary, also known as nominee or street name. Shares in DRS-held accounts can be moved among brokers and transfer agents electronically.
However, an estimated 85 percent of stock investors have their certificates in street name. By contrast, all U.S. government securities are now issued in paperless form, as are more than 98 percent of corporate and municipal debt securities. Only in August 2005 did Delaware, where over half of U.S. issuers are incorporated, eliminate its requirement that issuers offer certificates upon request. Arizona followed suit in April, leaving Puerto Rico as the only U.S. jurisdiction still requiring certificates to be issued.
"We have been lobbying the Big Board and other exchanges to require issuers to adopt the DRS option since 2004, but it was not until changes in state legislation that we could move forward," says Lawrence Morillo, managing director of Bank of New York's Pershing clearing division and head of the SIA's operations, legal and regulatory committee.
Issuers, transfer agents and broker-dealers have their work cut out to prepare for DRS. Issuers need to notify their shareholders, and some may have to change their bylaws. Transfer agents will have to participate in the DRS Profile service of DTCC's Depository Trust Co. (DTC) subsidiary. Agents complain they do not have the technological wherewithal to do so and are not certain that they can pass along the costs to smaller issuers that use them. However, larger agents see an opportunity.
"We wouldn't have any capacity issues in adding to the number of DRS accounts we process," says Kevin Brennan, managing director and head of new business development at Bank of New York. "But there has been a mixed response from clients--larger ones view it as making it easier for investors, while some smaller ones haven't focused on the upside." Brennan says that about 150 of BNY's 550 clients, representing a third of 17 million total shareholders, offer the DRS option.
Not a New Idea
Broker-dealers have been advocating dematerialization since 1995 when the Securities and Exchange Commission moved to reduce the settlement cycle from five days to three. Wanting to preserve their business, the transfer agent community, which is paid by issuers based on the number of registered accounts, lobbied for the DTC to create the DRS option the following year, and with its introduction in 1996, broker-dealers began offering it. But today, these firms' sales forces will need to be trained to advise shareholders of the option. "Broker-dealers typically tell investors about street name ownership; it's the default mechanism," says Panchery. The SIA is now modifying its two-year-old guide on dematerialization to incorporate the DRS option.
"We don't charge issuers for registered certificated shareholders or shareholders holding DRS accounts any differently," says Charles Rossi, VP of Computershare, the biggest U.S. transfer agent. "The goal is to streamline the process for investors and transfer agents." Of the 23 million shareholders serviced by Computershare, 14.5 million have DRS shares.
"More and more companies are considering going paperless because they know it's safer, less expensive and more convenient for investors," says Joseph Trezza, DTCC's VP of asset services. "And a new generation of investors takes electronic registration for granted. They don't want stock certificates. They want a DRS statement saying they own X number of shares in a given corporation." He questions why some smaller transfer agents see DRS as onerous "because we've had small transfer agents in Fast [Fast Automated Securities Transfer] and DRS for some time now."
There are 1,217 issues currently DRS-eligible. Trezza expects that to increase by 9,000 by January 2008. The New York-based depository is also anticipating that 250 more transfer agents will be joining the roster of 130 participating in DTC's Fast, a prerequisite to DRS. Fast allows transfer agents and DTC to avoid movement of certificates between each other for registered shareholders by crediting and debiting accounts electronically.
The DRS option exemplifies what has become known as immobilization--the other side of the dematerialization coin. Both make paperless transactions possible, but dematerialization does away with paper certificates entirely. Share ownership is represented by electronic entries in the central securities settlement system. In immobilization, certificates remain in vaults and investors can receive the documents on demand.
International Urgency
Some U.S. corporate issuers are also offering dematerialized shares, but typically that has resulted from a corporate reorganization or initial public offering. Elsewhere, Sweden, France, Australia and New Zealand have dematerialized, and the U.K., Irish, Belgian and Dutch regulators and market participants are discussing how to do so. Last year, the European Securities Forum, a trade association representing securities professionals, advocated direct registration for U.K. investors, and the U.K.'s Institute of Chartered Secretaries and Administrators and Ireland's Dematerialization Implementation Group (DIG) recently called for complete dematerialization. About 9 million of the 12 million private investors in the U.K. hold certificates.
"The consensus of the group is that dematerialization should be pursued as a matter of priority by the Irish equity market," says Brian Healy, director of trading and regulation for the Irish Stock Exchange and head of DIG. "There is a growing realization that a system using paper share certificates is outdated and inefficient compared to a fully electronic means of holding and settling shares."
Healy expects changes to the Irish Companies Act to allow for dematerialized holdings by the end of this year. With transactions on both the Irish Stock Exchange and the London Stock Exchange settled by the Crest depository, Ireland should synchronize its dematerialization efforts with the U.K.
According to Healy, dematerialization is made more necessary because of Euroclear's efforts to consolidate the operating platforms of its five markets onto a single system by 2009. Those platforms service the U.K., Ireland, France, Belgium, the Netherlands and Euroclear Bank, the international central securities depository.
"Ireland needs to keep its securities market at the forefront of international best practice, and the implementation of dematerialization is an important contributor to timely, efficient and cost-effective settlement for retail investors," says Healy. "In addition, if other countries serviced by Euroclear implement fully dematerialized systems, it will become an expensive option to retain a paper settlement system."
In Belgium, effective Jan. 1, 2008, new bearer shares cannot be issued in certificate form. By 2013, all securities will be dematerialized--meaning that 45 million certificates weighing some 620 tons will be recalled and destroyed, says Stephane Bernard, CEO of Euroclear Belgium, the country's central securities depository.
In the U.S., the SEC has historically been reluctant to mandate full dematerialization, but in 2004 it requested industry comment on a number of issues to promote shorter settlement times and straight-through processing, including how to reduce the number of paper certificates in circulation. According to SIA research based on 2002 data, the securities industry spends $250 million a year to process physical certificates--a cost ultimately borne mostly by investors. Aside from costs, there are risks, as evidenced during the Sept. 11, 2001 disaster when the whereabouts of thousands of certificates were temporarily unknown.
Many investors don't know they have to replace certificates if they are lost, and replacement fees to cover the surety bond for lost securities can be 3 percent of the current market value of the shares. According to the Securities Information Center, which tracks lost and stolen certificates, $8.7 billion worth of certificated securities were reported lost in 2005. As a result, investors spent $261 million on surety bonds to have their shares replaced.
Early Dematerializers
Over two-dozen companies have dematerialized, New York-incorporated AT&T being the largest. In 2002, in announcing a one-for-five reverse split, the company required shareholders to go the electronic route. (Since its takeover by SBC Communications last year, certificates are allowed.) Corporate actions--such as mergers and restructurings--often involve the issuance of new shares, which historically required new certificates. The SIA has estimated that it costs issuers with 100,000 registered investors $1 million more to issue certificates resulting from a corporate action than book-entry registration.
Others that have gone paperless in recent months are Intel Corp., mutual fund company Nuveen Investments, Chevron Corp., Federated Department Stores, NCR Corp., RadioShack Corp. and US Airways.
While issuers can save plenty by not printing certificates, another aspect of going paperless is investor convenience. Intel, a Computershare client, went to dematerialization for new investors as of last August in large part due to concerns over lost certificates. Existing investors could still hold on to certificates. "Some of our executives and shareholders had difficulties selling their shares when their certificates were lost, so we decided there were merits to dematerialization," says Douglas Stewart, senior attorney for Intel.
From a corporate governance perspective, not only do DRS issuers know who their investors are--not a bad idea in the case of a takeover or proxy battle--but they can communicate with them directly rather than through intermediaries. Such a stance is advocated by some issuers that also want to save proxy mailing fees charged by banks and brokerages. Most financial firms outsource the work to Automatic Data Processing, whose fees are set by the NYSE.
"Financial intermediaries feel that the shareholder is their investment customer, while corporations see the same shareholder as their owner," says Geoff Loftus, VP of the Society of Corporate Secretaries & Governance Professionals. "Corporations still might decide to do their mailings through ADP, but at least they would have direct access to their owners."
