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The Immobilization and Dematerialization of Equity Securities (or “Dude, where’s my stock certificate?”) Public Companies Subgroup Meeting June 13, 2006.

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Presentation on theme: "The Immobilization and Dematerialization of Equity Securities (or “Dude, where’s my stock certificate?”) Public Companies Subgroup Meeting June 13, 2006."— Presentation transcript:

1 The Immobilization and Dematerialization of Equity Securities (or “Dude, where’s my stock certificate?”) Public Companies Subgroup Meeting June 13, 2006

2 Portlnd 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” –Ownership registered directly on the books of the issuer WITH a physical certificate personally held by the shareholder

3 Portlnd 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 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

4 Portlnd 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”

5 Portlnd 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.

6 Portlnd The Hub of the Securities Industry’s Infrastructure (cont’d) Depository Trust Company (DTC) –A limited-purpose trust company that immobilizes securities for broker- dealers 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

7 Portlnd 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: –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)

8 Portlnd 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): 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 2.Less safe than electronic book-entry Physical certificates vulnerable to loss, theft, acts of God, etc. 3.Less convenient than electronic book-entry Trades commonly not executed until physical certs are delivered and verified; a problem in fast-moving markets

9 Portlnd 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

10 Portlnd 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

11 Portlnd 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

12 Portlnd 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

13 Portlnd 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 –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

14 Portlnd SIA’s Progress Toward the DEMAT and DRS Goals 1.Lobbying activities: –June 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.

15 Portlnd SIA’s Progress toward the DEMAT and DRS Goals (cont’d) 2. Exchange activities: NYSE – In 2002, Section 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” Note that participation is not required– only eligibility

16 Portlnd SIA’s Progress toward the DEMAT and DRS Goals (cont’d) 2.Exchange activities (cont’d): –Nasdaq: 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 –AMEX: 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.

17 Portlnd 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.

18 Portlnd 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/ htm NYSE proposed rule change to require DRS-eligibility as a listing standard –http://www.sec.gov/rules/sro/nyse/2006/ pdf AMEX proposed rule change to require DRS-eligibility as a listing standard –http://www.sec.gov/rules/sro/amex/2006/ pdf Nasdaq proposed rule change to require DRS-eligibility as a listing standard –http://nasdaq.complinet.com/file_store/pdf/rulebooks/NASDAQ 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


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