SEC Exams 2025: T+1 Post-Mortem?

T+1 settlement isn’t over for the US Securities and Exchange Commission.

Chief compliance officers at US fund management firms and broker-dealers must be prepared to show how they are meeting the challenge of a one-day settlement cycle, otherwise known as T+1 settlement,  if requested by an examiner from the SEC next year. The onus appears to be greater for broker-dealers than fund managers because the two critical rules to meet T+1 settlement require them to make operational changes. However, the SEC won’t let fund managers off the hook entirely if they are to blame for settlement fails. The US, Canada and Mexico, moved to a one-day settlement cycle from two days on May 28, 2024, while the UK and European continent are considering following in 2027.

First published in 2023, the SEC’s annual examinations priorities list allows fund managers and broker-dealers to know the key areas the Division of Examinations will focus on the following year. Tucked on Page 13 of the SEC’s October 2024 exam alert for 2025 was a brief mention that one of the areas in which the regulatory agency will address next year is the financial industry’s level of compliance with its regulations requiring T+1 settlement . The laundry list also includes the use of artificial intelligence, customer protection for cryptoassets, and meeting fiduciary obligations.

For broker-dealers, Rule 15c6-1 sets out the requirement for T+1 settlement. Rule 15c6-2 requires broker-dealers involved in the allocation, confirmation, and affirmation (ACA) process to have written agreements and procedures designed to complete affirmation by the end of the day a trade is executed or T+0. They must also enforce those agreements and procedures.

For fund managers the changes to their books and records requirement means they will just have to document when the ACA process or delivery and receipt of post-trade instructions occurs. They aren’t legally obligated to make the necessary operational changes to accommodate T+1 settlement the way broker-dealers are, but the SEC won’ take kindly to recordkeeping errors. “SEC examiners may view compliance with the new books and records requirement as binary,” says David Adams, an attorney with the law firm of Mintz in Washington, D.C. “Outsourcing the recordkeeping process doesn’t let the fund manager off the hook if information is missing.”

In touting the US’ shift to a one-day settlement cycle, Depository Trust & Clearing Corp., the Investment Company Institute, and Securities Industry and Financial Market Association in a September joint press release cited an average 95 percent same-day affirmation rate and a 2.12 percent fail rate in July 2024 for trades processed through the National Securities Clearing Corp.’s continuous net settlement system. The fail rate rose to 3.31 percent for trades not processed through CNS. A subsidiary of DTCC, NSCC clears transactions in US equities, municipal and fixed-income securities transactions while sister company Depository Trust Company settles the trades– transfers cash and securities to the right counterparty bank and broker-dealer members listed as the account holders on its books.

Same-day affirmation means the details of the trade were affirmed by a fund manager on the date it was executed. However, the DTCC’s figures won’t be the SEC’s litmus test for success. Instead, the SEC’s definition for broker-dealers is subjective. “The SEC won’t penalize a broker-dealer if it doesn’t meet the DTCC’s benchmarks, but a broker-dealer must show it has the right policies, procedures and technology in place to meet same-day affirmation,” says Ken Joseph, director of the US regulatory practice at global consultancy Kroll in New York.

Allocation refers to a fund manager’s dividing a block trade among multiple funds while confirmation refers to a broker-dealers acknowledgement of the trade details to a fund manager. The final step of affirmation means that the fund manager agrees with the broker-dealer’s confirmation. The higher the rate of affirmation on trade date the higher the likelihood a trade will settle on time. Settlement instructions — meaning where to transfer cash and securities on settlement date– must also be accurate.

Unlike their European counterparts, US fund managers and broker-dealers don’t have to pay any indirect or direct fines based on the number of settlement fails for which they are responsible. There is no US equivalent to the European Union’s Central Securities Depository Regulation requiring European securities depositories to charge penalties to their member banks and broker-dealers for not settling their trades on time. Nonetheless, the SEC could fine US fund managers and broker-dealers based on poor policies and procedures if the lapses are egregious enough. Alternatively, the regulatory agency could issue a deficiency letter which means the firm needs to correct its operational deficiencies before the next SEC exam.

The first question an SEC examiner will likely want answered from a broker-dealer’s CCO is whether the firm has automated its post-trade communications process and is monitoring it counterparties.
“The SEC will want to know why a settlement fail took place and who was responsible– the firm or its counterparty,” says Joseph. “It might even be the custodian bank’s fault.” Custodian banks, which typically send settlement instructions to broker-dealers on behalf of fund managers, are outside of the SEC’s purview, but fund managers must monitor them as part of their oversight of outsourced functions.

It is imperative that a broker-dealer present an SEC examiner with a strategy of how it will prevent settlement fails. The SEC could also inquire about what the broker-dealer did after a settlement fail occurred–aka the escalation process. “The SEC will want to know whether the fail to settle was flagged for escalation by the operations department,” says Joseph. The problem would ultimately find itself at the desk of the managing director or senior executive in charge of operations, followed by the compliance department if it can’t be solved or is repeated. Presumably, a broker-dealer will also present the SEC strategy for how it will avoid settlement fails in the future.

“Although chief compliance officers are the ones meeting with the SEC’s examiners, operations directors at broker-dealers will likely be doing most of the day-to-day work meeting the T+1 requirement,” says Wayne Aaron, a partner with the law firm of Katten Muchin Rosenman in New York. “Operations directors are the ones who must implement their firms’ written supervisory procedures and based on those procedures monitor the affirmation rate and take action if it declines before the problem hits the compliance desk.”

Operations managers at five US broker-dealers contacted by FinOps Report say they are keeping close tabs on their settlement fail rates and trying to meet, if not exceed, the July figures cited by DTCC.  Although some Wall Street giants such as BNY and Blackrock have publicly touted their operational savviness in meeting a one-day settlement cycle, operations managers at other financial firms who spoke with FinOps Report acknowledge that some glitches remain. Late allocations and affirmations are just one of the causes for settlement fails. Among the other reasons operations managers cited are not recalling lent securities on time and incorrect settlement instructions sent by custodian banks to broker-dealers. Settlement fail rates for fixed-income trades are anecdotally higher than for equities. Cross-border transactions are also higher than for domestic, based on what brokerage operations executives tell FinOps Report, because of time-zone differences and foreign currency exchanges.

The tradeoff to a low US settlement fail rate appears to be higher overhead for broker-dealers– paying for extra US operations staff working extra hours to accommodate US and foreign clients. Foreign fund managers are also being encouraged to pre-fund their cash accounts and to hold securities with US financial firms to ensure cash and securities are quickly available for settlement.

Compliance directors at fund management firms could feel the heat from the SEC. “Evidence of delivery of allocations, receipt of confirmations, and delivery of affirmations such as timestamps will be necessary to show they were completed on trade date,” says Mintz’s Adams who specializes in fund management law. Fund managers may be asked why the ACA process was not completed on the day of the trade, particularly if a series of settlement fails has occurred. “Timely allocations appear to be a critical part of the post-trade communications process for achieving T+1,” says Adams. “A broker-dealer might not be able to send confirmations quickly enough, if allocations are delayed.”

A fund manager which isn’t on the SEC’s initial radar could face an unwanted visit from an examiner if it is found to be the cause of a broker-dealer’s repeated settlement fails. Late allocations could open a Pandora’s box to other inquiries. “If the fund manager has delayed its allocation process, the SEC examiner could start checking into whether the firm has other operational deficiencies,” says Katten Muchin’s Aaron who also co-chairs its broker-dealer practice. “One of the reasons for delayed allocations could be cherry-picking how securities are divided among underlying fund clients to give some clients preferential treatment.”

Regardless of the reason for failed settlements and the culprit, the SEC’s examiner will be looking to answer one key question, according to Aaron. “Did the fund management firm or broker-dealer make reasonable attempts to prevent settlement fails is the question,” he says. “The SEC isn’t looking for perfection.”

Of course, it will be up to the SEC’s examiner to interpret what reasonable means. “Hopefully, the SEC will give fund managers and broker-dealers a few exam cycles to adjust to the T+1 settlement cycle,” says Adams. However, fund managers and broker-dealers can’t afford to be remiss. Adams’ final words of advice: Don’t tell an examiner “I don’t know what happened.” The motto should always be to have an explanation for what went wrong and to have a solution to prevent the glitch from reoccurring.