It’s an unfortunate rule of thumb that when something brings benefits in one area it often causes problems in another. So it is with the move to T+3 in the US.
Certainly, when the big day arrives on June 7 there will be a few teething problems, but the general perception seems to be positive. A move to clearance and settlement three days after a trade will reduce the risk to clearing firms, their participants and investors; and it will keep the US at the forefront of international competitiveness. But what of the longer-term downside from the corporate perspective which has been ignored by many companies?Brokerage firms have seized on the move to T+3 as a chance to persuade more retail customers to hold securities in ‘street-name’ (nominee) accounts. That involves the owner maintaining a security interest in an account with their broker (or other intermediary). Shares are held indirectly, with the owner not being identified to the issuer. This differs from direct ownership options when the shareholder is recorded on the books of the issuer and is easily identifiable.
According to the transfer agents industry, the brokers have not just been casually suggesting that clients switch from direct form holding – they have been out there aggressively pushing the case. From the brokers’ viewpoint, of course, it makes good sense to keep it all under one roof. With the assets linked to the broker the power lies with them. More commissions, straight fees, and exit fees to move to another broker are just some of the lucrative benefits on offer.
When the moves to T+3 were first being developed, the retail brokerage industry began to argue that the elimination of certificates was a prerequisite for a shortened settlement period as physical delivery of certificates would become nigh on impossible. Indeed, street-name ownership was cited as the only alternative in the new environment and was only rejected when, following the objections of transfer agents, issuers and investors, the SEC dictated that those investors who wanted certificates should be able to obtain them.
Not surprisingly the brokers’ claims did not sit well with these interested parties. Forced street-name accounts lead to a decrease in the portability of investments for share owners and less ability to negotiate commissions. Moving between brokers becomes more complicated and time-consuming. And retail investor relations becomes complicated and expensive when the company has no knowledge of who is holding shares and can only communicate with shareholders by using the non-objecting beneficial owner process.
Back in 1989 the US working committee of the International Group of Thirty established a direct registration subcommittee to identify alternatives to certificates for the retail investor. Two options were presented for public comment: the investor registration option (IRO) for those wishing to remain direct owners; and depository based book-entry record-keeping for indirect holding in street name with financial intermediaries. The latter option was not supported by the intermediaries and was dropped, while an IRO implementation committee was formed to proceed with the former.
Sponsored by the Securities Transfer Association, the Corporate Transfer Agents Association and the American Society of Corporate Secretaries, the IRO committee has developed a programme covering two main concepts – asset record-keeping by the issuer, and related services companies may wish to offer to their shareholders. At the base level, IRO is issuer-direct book-entry with the option for shareholders to request a certificate from the company or transfer agent if they wish – satisfying the requirements of the SEC. The IRO proposal foresees a situation whereby corporate issuers provide a non-negotiable transaction advice as the record of ownership, instead of a certificate. The IRO committee expects that many companies which establish issuer-direct book-entry programmes will also offer shareholders a variety of services such as the buying and selling of shares directly through the transfer agent.
With endorsement from the SEC in December last year, transfer agents have been given the green light to implement the so-called open availability programmes for their corporate clients, allowing investors to purchase shares directly from the company. Several companies have been quick to establish their own programmes but, considering the impending move to T+3 and the retail brokers’ approach, the number remains woefully small.
James Volpe, vice president at First Chicago Trust Company and director of the IRO implementation committee, cannot understand the slow move to implement the IRO concept. Volpe and members of his committee have been trudging the corporate issuer byways, hammering the message home. ‘I have made dozens of national, regional and one-to-one presentations this year and lost,’ he says. ‘Most attendees have little knowledge of how the company and its shareholders are affected by the combination of the T+3 mandate and the aggressive, retail broker drive to asset accumulations. Once there is an appreciation of this perspective, the implementation of an open availability programme is not far behind.’
The lack of concern on the part of corporates certainly seems strange considering the benefits of nurturing direct links with shareholders. Volpe points to the fact that shareholders tend to vote early and in line with management recommendations. ‘The IRO service continues to keep the issuer close to the owner of the company without interjecting a third party,’ he says. ‘It saves money for the issuer, in that it is less expensive to communicate with shareholders held on a company’s books. And directly registered investors provide valuable additional support for many companies – both as customers and as an important voice in regulatory issues.’
From the shareholders’ perspective there are also significant advantages to the investor registration option. Investors gain freedom of choice by being able to purchase or sell shares through a broker or through the transfer agent direct service plan. It may also prove cheaper for investors to hold directly on the issuer’s books as they are not tied to transaction fees, commissions and the other broker benefits.
Thomas O’Hara, chairman of the National Association of Investors Corporation, laments the fact that companies have been slow to take up direct registration options. ‘We’ve made our members aware of the change and expressed the opinion that they’d be better off in a direct relationship with the company,’ says O’Hara. ‘But the brokers are putting on a very strong campaign for holding shares in street form. The weakness of that option – and it’s a sizeable one – is that we have many brokers in this country going bankrupt. Although they may be insured it still means that our members’ assets could be tied up for a long time.’
O’Hara believes that many companies have just not given the issue the attention that it deserves and that they will pay the price when the move to T+3 occurs. ‘A lot of companies are hesitant to create any ill-will with the broking community but they are not doing themselves many favours in the long run. There’s not a lot more we can do about it apart from inform our members of the situation.’
Of course, throughout all this the retail brokerage industry is being portrayed as a nasty ogre greedily herding investors into street name accounts and gathering the spoils that go along with it. But this is far from the case, according to Ben Edwards, chairman and CEO of retail brokers AG Edwards. In fact, retail brokers have consistently argued against the move to T+3, saying that the compression of the settlement period offered retail investors little reward, higher transaction charges and less mobility.
Edwards says transaction risk could be cut in other ways than simply reducing the gap between trade day and settlement, for example by creating an escrow fund at a central location. The main complaint of the brokerage industry is the difficulty of receiving funds from the client before settlement and the resulting likelihood of having to pay interest while waiting for payment.
With moves afoot by the SEC to shorten the settlement period even further in the next few years – to the point where settlement occurs on trade day – the problem will be exacerbated. Edwards believes that many small broking firms will be forced out of business as the bigger ones soak up the extra cost rather than passing it on in transaction charges. ‘If you have to settle on trade date it’s impossible to receive payment in time and some firms are going to be forced to charge interest accordingly,’ says Edwards. ‘We don’t want to do that but we don’t want to absorb the extra costs either. It’s going to cost the brokerage industry millions of dollars and will end up pushing assets into the hands of the big banks and investment firms. Some firms which offer a lot of proprietary products are encouraging clients into street name accounts so what they lose on the float they recoup on the products. That puts the specialised investment boutiques at a serious disadvantage.’
But the fear of brokers pushing clients into nominee accounts is not peculiar to the US. ProShare, the organisation for wider share ownership in the UK, recently expressed alarm at the prospect of brokers promoting nominee status among their retail clients as the UK’s own settlement period is reduced to T+5 this June to cut transaction risk for institutions. Surprise, surprise. Another case of benefits for some and problems for others.
