Transfer Agents, Brokers, DTC Debate SEC’s Proposed Rules

The Securities and Exchange Commission’s decision to overhaul the rules governing transfer agents has prompted a debate among shareholder recordkeepers on the one hand and broker-dealers and their allies on the other.

It could easily take up to a year for any new requirements to take effect, However, transfer agents for equities and investment funds are starting to get worried about just how far the SEC is willing to go to revise an antiquated set of regulations which date back to 1977. Those rules never specifically addressed investment fund transfer agents who have been exempt from the basic turnaround, processing and recordkeeping rules governing their equity brethren. So far, investment fund transfer agents have relied on best practice when interpreting what they believe are unclear SEC guidances.

The agency’s new recommendations were issued on December 22, 2015, in two separate documents — an advanced notice of proposed rulemaking (ANPR) and a concept release — requesting comments within 60 days. Initially transfer agents objected to the short timetable given the dozens of questions they were asked to address. and the agency extended the deadline. The SEC is expected to issue a second more detailed rulemaking proposal for further comment.

Although few individual firms dished up their opinions, the Investment Company Institute (ICI) and the Securities Transfer Association (STA) vigorously argued against going overboard with costly, ineffective rules. The ICI acknowledged that transfer agents for registered investment funds need their own set of new rules, but didn’t come up with any specifics. Broker-dealers, represented by the Securities Industry and Financial Markets Association (SIFMA), do want the SEC to oversee some of the fees they are charged by equity transfer agents, but oppose any regulatory oversight of their own services for the beneficial owners of investment fund accounts. Broadridge Financial Solutions, the world’s largest proxy distributor, was the most vocal among the respondents in asking the SEC to more closely regulate some of the activities of equity transfer agents. Depository Trust & Clearing Corp., the US market infrastructure for clearance and settlement, also threw in its two cents about the need for transfer agents to be more closely monitored.

While transfer agents are the providers of administrative services to investors on behalf of corporations and investment funds, others such as broker-dealers, Broadridge Financial and DTC also have a stake in the game. Broker-dealers and banks often act as sub-transfer agents servicing shareholders who bought their stake in mutual funds through them. Transfer agents for mutual funds don’t know who those investors are because their shares are held in the name of these financial intermediaries. Broadridge owns a transfer agency business, which mainly processes proxy materials and votes on behalf of investors holding their shares through broker-dealers and banks that outsource their proxy operations to the technology giant. DTCC operates the FAST system, which stock transfer agents must join to make shares of the corporate issuers they service eligible for the depository’s direct registration system. That is the system allowing investors to keep shares in their own names on the books of transfer agents without holding any certificates.

“Given the timing and length of the concept release and the fact there were relatively few specifics in the ANPR, transfer agents decided not to expend their scarce resources to prepare lengthy individual comment letters,” says Tim Johnson, a partner with Reed Smith in Pittsburgh who specializes in transfer agents and investment funds. “They still have another shot at the apple when actual rule proposals come out, but their ability to frame the discussion about this and important regulatory change will be somewhat more diminished at that point than it was with this release.” His wish list: the SEC will resolve the interpretative difficulties faced by investment fund transfer agents with the current rules and provide a way for them to access the information they need to oversee subtransfer agents.

Although transfer agents of investment funds and equities equally objected the SEC’s suggestions, they also provided comments on some specific issues related to their  different services and conditions. Transfer agents of investment funds are concerned with how much the SEC wants them to monitor the activities of subtransfer agents, while transfer agents of equity accounts asked the SEC to curb what they consider to be the DTC’s overreaching policies.

More Disclosure

Transfer agents of investment funds and equities register with the SEC on Form TA-1 and file Form TA-2 annually. However, the SEC now wants them to fork over far more information which transfer agents don’t want to do. Transfer agents oppose the SEC’s suggestion that it might require them to reveal the identities of their clients, all direct and indirect conflicts of interest, and their annual financial statements. The reason: the disclosure won’t help protect investors who don’t rely on any the work of transfer agents to influence their investment decision. Even worse, revealing more data could harm transfer agents.

The notion that transfer agents reveal the fees they charge issuers naturally generated angst.. “Such disclosure will put into the public domain confidential and proprietary information that is competitively sensitive,” says David Blass, general counsel of the Investment Company Institute in Washington, D.C. “Because the services a mutual fund agent provides to mutual funds and their shareholders will differ in scope and quality from fund to fund, this information will not appear as valuable to the Commission because it would not be the proverbial comparing of “apples to apples” based solely on fees. Likewise, in citing the unique characteristics of each agreement, Charles Rossi, chairman of the STA’s advisory committee in Hazlet, New Jersey, says revealing any information in the agreement would “be closely reviewed by issuers and each transfer agent’s competitors and distort the competitive relationships among industry participants and are contrary to the purpose of the Exchange Act. They would make publicly available proprietary confidential business information and thus be anti-competitive.”

Reg SCI and Asset Segregation

When it came to the SEC’s recommendations on stricter operating rules for transfer agents, the SEC’s ideas about how client securities and funds should be safekept and how transfer agents should monitor their cybersecurity and business continuity drew the most attention. The STA’s Rossi agrees that the SEC could require transfer agents to have written policies and procedures on how they safeguard client funds, but urges the SEC not to impose the same ones applicable to broker-dealers. Unlike broker-dealers, transfer agents have not been responsible for fraud and billions of dollars in shareholder losses. What’s more, transfer agents do not extend margin, hold inventory of securities for trading, lend customer securities or finance their operations with leverage. “While we fully support the Commission’s goals, any effort to advance those goals through rule-making should be narrowly tailored,” says Rossi.

Broadridge came up with more specific recommendations for the SEC such as requiring transfer agents to hold issuer and security funds in special segregated accounts at unaffiliated banks, as well as asking the bank for a written acknowledgment letter when opening issuer/security holder fund accounts. Its rationale: the SEC’s current transfer agent rules do not prescribe specific standards or requirements for how transfer agents should protect funds and securities. “This regulatory gap creates risks including that in the event of transfer agency insolvency, client funds could be treated as funds of the transfer agent,” says Charles Callan, senior vice president of regulatory affairs for Broadridge in Edgewood, New York.

The ICI and STA urged the SEC not to require transfer agents to follow a one-size fits all prescriptive approach governing how transfer agents prevent cybersecurity threats and ensure business continuity in case of unforseen natural or man-made disasters. However, Callan counters that transfer agents should follow the best practices outlined in Regulation SCI. That regulation requires clearing agencies, national securities exchanges and other “SCI entities” to establish written policies and procedures to ensure their core systems have levels of capacity, integrity, resiliency, availability and security adequate to maintain operational capacity. However, SIFMA sided with transfer agents in urging the SEC to require minimal guidelines for cybersecurity protection, but not impose the uniform policies of Reg SCI. Transfer agents are not core market utilities and their continuous operation is needed in fair and orderly markets, argues Thomas Price, managing director for SIFMA in New York.

Overseeing Subtransfer Agents

Investment funds and broker-dealers were equally concerned about how investment funds should monitor the activities of subtransfer agents, but for different reasons. The ICI questioned just how transfer agents could oversee the service levels of banks and broker-dealers for beneficial owners of mutual funds without having the legal authority to to ask for more information. “Until such time as the Commission requires mutual funds to obtain or requires intermediaries to provide the information funds need to oversee the subaccount services financial intermediaries provide to the fund shareholders, some funds will lack the leverage necessary to obtain such information and this will be a challenge for them,” says the ICI’s Blass. However, he didn’t ask the SEC to change the omnibus account structure used by broker-dealers, nor did he specify just what data should be obtained.

SIFMA’s Price was quick to encourage the SEC to retain the status quo. That is, broker-dealers should not be required to give up the names of beneficial shareholders in mutual funds to mutual fund transfer agents. The SEC should also not ask broker-dealers serving as sub-accounting agents to register as transfer agents and be subject to the same rules. “When performing sub-accounting services, broker-dealers act as securities intermediaries and perform activities in a broker-dealer capacity, not a transfer agency capacity,” says Price. “Also, a broker-dealer performs sub-accounting activities on behalf of its customers and entitlement holders, not on behalf of issuers as required by the definition of transfer agent under the Exchange Act.”

However, SIFMA is interested in seeing the SEC to regulate the fees that some equity transfer agents charge broker-dealers when the broker-dealers ask for “DRS transfers” or for the transfer of shares held on the books of DTC through its direct registration system to the books of broker-dealers. Such transfers often occur when investors want to sell-shares they originally held with transfer agents in their own names through broker-dealers.

The STA’s Rossi counters that the DRS fees are modest and commercially reasonable based on the work transfer agents have to do. But that’s not what SIFMA thinks. “DRS fees may be viewed as creating a barrier to the prompt and accurate transfer of securities,” says Price. His rationale: if broker-dealers don’t pay the fees, transfer agents can and do refuse to transfer the shares. The only alternative broker-dealers have is to pay even higher fees to have the shares transferred by the Depository Trust Company (DTC), the depository subsidiary of DTCC. Broadridge’s Callan agrees with Price noting that Broadridge doesn’t charge broker-dealers DRS fees except in unusual circumstances such as when processing is hindered due to insufficient data.

Curbing DTC’s Role

While equity transfer agents might not want the SEC to more rigorously control their activities, they do want the agency to pay closer attention to the rules the DTC imposes on transfer agents that want to join the depository’s FAST program. In doing so, the DTC has overstepped its bounds, says Rossi who urged the SEC to adopt a rule prohibiting the DTC from implementing any rules that are in addition or contrary to the SEC’s. Calling the DTC a “monopoly” for essential services, he says that its standards for membership in FAST are not fully transparent and not applied uniformly. DTC has even delayed access to its FAST program to many issuers in the over-the-counter markets, thereby requiring them to hold their shares in certificated form. Such a scenario, argues Rossi, will only hamper the US’ move to a two-day settlement cycle in 2017.

However, Daniel Thieke, DTC’s general manager for settlement and asset services, insists that DTC is not acting in a “quasi-regulatory” role. The DTC’s requirements for transfer agents do not contradict the SEC’s rules for transfer agents and are necessary to fulfill the depository’s role of promoting and protecting the safe and accurate settlement of securities transactions. In fact, the SEC should make some of the depository’s requirements for transfer agents participating in its FAST program applicable to all transfer agents. Those include daily rebalancing of positions, insurance coverage, notifying DTC when terminating or initiating service, and notifying DTC when securities are lost.

Thieke took his argument once step further saying that the SEC should require transfer agents to follow more rigorous rules on managing cybersecurity and business continuity threats, submit audited financial reports and follow the SEC’s recommendations for required terms in written agreements. Transfer agents participating in the DTC’s FAST program should be held to additional disclosures in their contracts with issuers, says Thieke. Not only should the agents outline their relationships and obligations to DTC, but they should also be required to agree they will inform the SEC, issuers, and DTC when transfer agents experience any systems disruptions or other problems that materially affect the transfer of securities.

Likewise, issuers should also be required to acknowledge that the FAST agent’s last confirmation of the transfer agent’s balance with DTC is “binding” upon the issuer. The reason, says Thieke: there have been limited cases where discrepancies between the books of the issuer and transfer agent have forced the DTC to cease all book-entry services for an issue, because the validity of a transfer agent’s balance with DTC and/or shares outstanding were called into question.