There is no area of the securities business which offers more opportunity for reducing costs as well as exposure to the kind of disruption which resulted in loss to customers during the 1969-1970 period, than the improvement and modernization of the systems for clearing, settlement, delivery and transfer of securities. It was the archaic method of achieving this simple objective which nearly drowned the financial community in a tidal wave of uncontrolled paper.* The aftermath of this "tidal wave"-financial disaster for individuals and brokerage houses-forced the financial industry to adopt emergency, temporary measures and to seek a permanent solution for the evidence of transfer of private capital. Since that time, committees and study groups, both government and private, have proposed interim and permanent solutions. The proposals have one solution in common: the elimination of the stock certificate must be the ultimate goal. We, at The First National Bank of Boston, propose that now is the time for ultimate solution. We are convinced that a Transfer Agency Depository System is the only system so far proposed which can effectively solve the problems by gradual elimination of the stock certificate. It is, furthermore, a system which can function efficiently and effectively with the current depository systems. This feature makes the changeover from current procedures less radical than it otherwise might be. Despite the crisis of 1968 and the lessons presumably learned, the stock-transfer business is still conducted through the issuance, possession, transfer, and cancellation of stock certificates. The number of steps involved in this process is overwhelming; the steps themselves are tedious, repetitive, and offer innumerable opportunities for error. The already involved process is further burdened by the transactions ancillary to stock transfer and ownership-payment of dividends, tax forms, proxies, annual meetings, splits, mergers, etc. The flow chart on page 10 is a discouragingly realistic presentation of twentieth-century stock-transfer methods. *Securities Exchange Commission. Study of Unsafe and Unsound Practices. p. 57 This situation is made even more complicated by the fact that in the majority of transactions the only purpose of the stock certificate is to provide the transfer agent with information for the registration of the transfer. The stock certificate, while it does not prove ownership by itself, does require issuing, inspection, registration, cancellation, storage, etc., and invites large-scale theft, fraud, and unauthorized manipulation as little or no verification is made as to ownership when certificates are used as collateral. The members of the financial industry and the general public are all too aware of these facts and the subsequent problems. Changes must be made in the method of transferring and recording ownership of securities if the business is to remain in the private sector. To this end, the return of public confidence is imperative. Immobilization of the stock certificate, followed by its gradual elimination must, therefore, be the objective for all concerned. A Transfer Agent Depository (TAD) as conceived by The First National Bank of Boston provides both the system and the method for attaining this end. The Transfer Agent Depository system is one which provides all of the advantages of certificates while eliminating the disadvantages. The individual clearly owns his securities. He receives a statement within a few days after the trade is settled as opposed to waiting weeks for certificates to be delivered to him. This statement clearly shows his ownership of shares in the company as well as historical information. It describes each transaction and reflects whole shares held in certificate form and whole shares held by the transfer agent in book form as well as any fractional shares which may be held by the transfer agent as a result of dividend reinvestment or cash investments by the individual. A lender has bona fide collateral by assignment, and the broker's problem of fails is minimized. Under TAD, the certificate is immobilized at the point of origin (with the transfer agent) because it is not physically issued. Transfer of ownership is achieved by computerized bookkeeping, and records are maintained and updated on a computer file. A stock certificate may still be issued, however, if and when insisted upon. Up-todate TAD files allow lenders to verify their protected positions, thus making certificates valueless in case of theft. The TAD system may be effectively used by corporations, banks, transfer agents, brokers, and individual shareholders. The benefits are impressive: For the corporation • Reduced costs-mail insurance, certificate, registrars' fees • More direct lines of communication with stockholders • Substantial reduction in clerical processing costs For banks, brokers, and transfer agents • Substantial reduction in clerical processing costs • Speedier issuance and transfer processing • Losses through fraud and theft will virtually disappear with immobilization and elimination of the stock certificate • Reduction in audit requirements because of elimination of • Requirements for costly vault space will be greatly reduced • Substantial elimination of fails and dividend claims For the stockholder • Protection from loss of certificates and illegal manipulation • Reliable collateral for loans • Better communication with corporations for information on annual meetings, splits, mergers, new issues, etc. • Up-to-date statements showing the status and activity of his account ⚫ More rapid securities transactions • Elimination of safekeeping of his stock certificates • No tying up of his securities due to broker failure The flow chart on page 11 illustrates the working of the TAD system and is an interesting contrast to the flow chart of current procedures on page 10. The TAD system would work as described in the following paragraphs. Buying Customer/Broker Transactions The basic procedure for placing a buy order will not change from current practice. The customer places his order to buy with his broker. The broker transmits the order to the market place where the trades are matched. He confirms the trade price, amount due, number of shares purchased, date, commission, etc., to his customer. The broker prepares a trade confirmation ticket with the CUSIP number, price, amount due, number of shares, registration and/or delivery instructions, which is then sent to a clearing house or a central/regional depository for comparison and processing. Selling Customer/Broker Transactions The basic procedure for placing a sell order is essentially the same as it is at present. A difference occurs when a customer does not have his shares in certificate form. In such a case, the broker may contact the transfer agent directly for confirmation of ownership or, when his knowledge of the customer's holdings is sufficient, he may proceed with the processing of the sell order. When the order is complete, the broker sends the trade detail and transfer-debit instructions and guaranteed stock power to the clearing house for matching to the corresponding buy detail. Borrower/Lender Transactions Under TAD, when a shareholder wishes to use his securities as collateral for a loan, he provides an assignment of interest, stock power, and/or hypothecation agreement to the lender. The assignment of interest is forwarded to the transfer agent who verifies ownership, places escrow (stop) restrictions against the account, and forwards statements to both the borrower and the lender. When a loan is repaid, the lender notifies the transfer agent. The escrow restrictions are removed from the file, and statements are sent to both parties. A stolen certificate thus cannot be assigned as collateral without the real owner and the lender being informed immediately by means of TAD statements. The Function of the Clearing House Under the proposed TAD system, the functions of the clearing house are quite simple and efficient. Each clearing house will prepare a special contract sheet or transfer authority sheet for each security to show, by CUSIP number, the total number of shares purchased and sold by each broker, by broker numbers. Individual customers will be shown in a similar manner. Transfer agents receive copies of these transfer authority sheets or computer tapes for each corporation they represent. Transfer procedures are both simpler and more accurate because the transfer authority sheets are balanced and proved at the clearing house, as well as by the brokers when they check money settlements. If certificates are involved in a sale, the broker sends them to the clearing house with the transfer instructions. The clearing house forwards the certificates to the transfer agent for cancellation, and book shares are recorded in the purchaser's name, unless he specifically requests certificates. The Function of a Central or Regional Depository The Central Certificate Service as it now exists, or regional/ national depositories being proposed, can function within the Transfer Agent Depository system. The purpose of such depositories should be simply a bookkeeping service. The depositories would deposit issues directly with the transfer agents and receive statements of holdings by issue on a daily basis. This is not a change in procedure but one which is in current use. We are told that IBM acts as transfer agent depository for Merrill Lynch. Each day, Merrill Lynch sends certificates received to IBM and is issued a statement of holdings. When an individual requests a certificate, Merrill Lynch sends registration instructions and a stock power to IBM. An immediate transfer is made from Merrill Lynch's nominee to the individual without the necessity of having a debit certificate. The Function of the Transfer Agent When the transfer agent receives a transfer authority, he prepares (by data processing) "statements" reflecting the increases and/or decreases to the specific accounts and mails them to both the buying and selling stockholder or to his broker. This statement is similar to a mutual fund statement or a no passbook savings account notice. It provides a final audit verification and notification to buyers and sellers that the transaction has been properly executed. When certificates are registered in broker, street name, or even nominee name, the processing is the same as for individual accounts. The TAD system allows brokers to deposit certificates with the transfer agent and enables them to order out certificates or to transfer book shares from an existing balance account. This results in almost instant transfers. Such a processing method will gradually eliminate the need for brokers to handle certificates in the routine course of trading activities. Possibilities for loss or theft are thus further eliminated. At present the Transfer Agent Depository is a composite of theory and practice. It is not only an ultimate solution but a live working system that is gaining acceptance from various organizations. The Federal Reserve system of book-entry transfers of government debt obligations is a certificateless Transfer Agent Depository. The mutual fund industry has for several years systematically eliminated the need for a certificate and has been very successful in doing so. In fact, 95 percent of mutual fund shareholders in 1960 held certificates; today only 10 percent request certificates at time of purchase. The expanding number of Dividend Reinvestment Programs for major corporations, expanding because shareholders are demanding it of the corporations, dispels a great deal of the theory that "Aunt Minnie" will not give up her certificates. AT&T's program, with probably the largest number of such "Aunt Minnie" shareholders, is extremely successful. Under this program, rather than receiving dividend checks directly, the stockholder authorizes automatic reinvestment of dividends through a bank with trust powers. The shareholder receives a statement showing his holdings, not a certificate. In fact, AT&T has received thousands of requests from shareholders to deposit their certificates and provide a statement, which tends to discredit the "shareholders-demand-certificates" belief. Other major corporations with Dividend Reinvestment Programs have had similar experience. |