FDIC supervised financial institutions that conduct
securities transfer activities in the trust department have adopted the Statement of
Principles of Trust Department Management, which requires the Trust Department to
implement adequate internal controls. Even for those institution's that do not
conduct transfer agent activities in a Trust Department, the implementation of an effective
system of internal controls is an essential element in ensuring the satisfactory and
efficient performance of securities transfer activities. While not specifically
required by SEC rules and regulations, except for required controls protecting funds
related to securities transferred, it is difficult to envisage effective compliance with
SEC operational requirements without effective internal controls. Therefore, part of
the Board's responsibility to ensure compliance with applicable rules and regulations
includes the maintenance of an effective internal control environment. In effect,
the adoption and implementation of a system of internal controls appropriate for the
volume and complexity of securities transfer activities represents a standard industry
practice.
In the context of securities transfer activities, a
system of internal controls comprises methods and techniques designed to prevent and
detect errors, omissions and irregularities in the processing of securities transfers, to
ensure the accuracy and integrity of the books and records relating to securities transfer
activity, to protect funds related to securities transfer (e.g. funds for dividend and
interest payments) and to provide for the physical protection of both blank and cancelled
securities certificates. In addition, effective internal controls promote
operational efficiency and facilitate compliance with applicable laws and regulations.
Controls Governing the Processing of Securities
Transfers
The issuance, transfer and cancellation of securities
involves complex legal considerations. Transferring recorded ownership of a security
from one person to another is effected by the delivery of the security accompanied with a
proper assignment by the appropriate person. In the case of book-entry only issues,
the transfer is initiated by an instruction by the appropriate person. An instruction is
an order to the issuer of a book-entry security requesting the transfer, pledge or release
from pledge of a book-entry security. For example, a Stock Power or a Bond Power is
a form used to instruct the transfer of ownership of a security from the registered
owner to a third party. Stock and Bond Powers are frequently used to instruct the
transfer of book-entry securities, or in those cases where the back of the securities
certificate is not used for endorsement. It is important to note that for the purposes of
the Uniform Commercial Code (UCC) an "issuer"
means a person on whose behalf transfer books are maintained, i.e., the registered transfer
agent.
The transfer agent acts on behalf of the security
issuer and verifies that all the legal requirements for the transfer are satisfied. For
the most part, the legal requirements governing securities transfers are contained in
Article 8 of the UCC. Section 8-208 of the Code states:
(1) a person placing his signature upon a security as
authenticating trustee, registrar, transfer agent or the like warrants to a purchaser for
value without notice of the particular defect that:
- the security is genuine; and
- his own participation in the issue of the security is
within his capacity and within the scope of the authorization received by him from the
issuer; and
- he has reasonable grounds to believe that the security
is in the form and within the amount the issuer is authorized to issue.
A transfer of ownership which does not satisfy all
the legal requirements, or a transfer based on an improper endorsement, results in
liability for the transfer agent for any damages caused by the improper transfer.
Similarly, processing errors that result in the overissuance of securities potentially
make the transfer agent liable for purchasing and retiring shares in the amount that the
shares were overissued. Therefore, controls designed to ensure that presentors of
securities for transfer are authorized to request the transfer of ownership, that the
endorsements provided are genuine and accompanied by appropriate documentation and that
the details of the transfer agree with the transfer agent's existing records are
essential for controlling the risk of improper transfer.
Appropriate Person
An endorsement of a certified security in registered form is
made when the appropriate person signs on it, or on a separate document, an assignment or
transfer of the security or a power to assign or transfer it, or his signature is written
without more on the back of the security. Section 8-308 of the UCC defines
appropriate persons as:
For certificated securities, i.e., securities represented by a
printed certificate, the appropriate person is the person specified on the certificate or
by a special endorsement to be entitled to the security. A special endorsement
specifies to whom the security is to be transferred, or who has the power to transfer it.
A special endorsement contrasts with an endorsement in blank, which is an
endorsement to bearer. An endorsement in blank may be converted into a special
endorsement.
For uncertified securities, essentially securities in
book-entry form, the appropriate person is the registered owner, if the security is not
subject to a registered pledge. If subject to a registered pledge, the appropriate
person is the registered pledgee.
In addition, the following are defined as appropriate
persons:
- if the person designated is described as a fiduciary but is no
longer serving in the described capacity, either that person or his successor;
- if the persons designated are described as more than one person
as fiduciaries and one or more are no longer serving in the described capacity, the
remaining fiduciary or fiduciaries, whether or not a successor has been appointed or
qualified;
- if the person designated is an individual and is without
capacity to act by virtue of death, incompetence, infancy, or otherwise, his executor,
administrator, guardian, or like fiduciary;
- if the persons designated are described as more than one person
as tenants by the entirety or with right of survivorship and by reason of death all cannot
sign, the survivor or survivors;
- a person having power to sign under applicable law or
controlling instrument; and
- to the extent that the person designated or any of the
foregoing persons may act through an agent, his authorized agent.
The UCC clarifies that "whether the person signing is
appropriate is determined as of the date of signing and an endorsement made by or an
instruction originated by him does not become unauthorized for the purposes of this
Article by virtue of any subsequent change of circumstances.
When the appropriate person is a fiduciary the Code states
that the "failure of a fiduciary to comply with a controlling instrument or with the
law of the state having jurisdiction of the fiduciary relationship, including any law
requiring the fiduciary to obtain court approval of the transfer, pledge, or release, does
not render his endorsement or an instruction originated by him unauthorized for the
purposes of this Article."
Consequences of Unauthorized Endorsements or
Instructions
A transfer agent that registers the transfer of a certificated
security upon an unauthorized endorsement or registers the transfer, pledge, or release of
a book-entry security upon an unauthorized instruction must, upon demand, issue a like
security to the true owner, or for a book-entry security restore the true owner's recorded
ownership, unless doing so would result in an overissuance of the security. If an
overissuance would result, then the true owner of the security may:
- If an identical security which does not constitute an
overissuance
is reasonably available for purchase, compel the transfer agent to purchase the security
for him; or
- If an identical security is not available
for purchase, recover from the transfer agent the price that the true
owner or the last purchaser paid for the security, along with interest
from the date that the true owner makes the request.
An important point to note is that neither the true owner of a
security nor the transfer agent can recover the improperly transferred security from a
person who purchased the security for value and without notice of adverse claims. An
"adverse claim" includes a claim that a transfer was or would be wrongful or
that a particular adverse person is the owner of or has an interest in the security.
The true owner, and the transfer agent as subrogee, may
recover a security from any person who was not entitled to receive it, i.e., a person who
did not acquire it for value or who acquired it with knowledge of adverse claims.
Signature Guarantees
In view of the potential liability that a transfer agent
assumes when securities are transferred on the basis of improper endorsements, i.e.,
endorsements or instructions provided by persons other than the appropriate person(s),
institutions need controls designed to prevent the unauthorized transfer of securities for which
the institution serves as transfer agent. One control that is almost universal among
transfer agents is the requirement that a signature guarantee accompany all endorsements.
Article 8-312 of the UCC governs signature,
endorsement and instruction guarantees.
The guarantor of a signature of an endorser of a securities
certificate warrants that at the time the security certificate or documents related
thereto were signed:
- the signature was genuine;
- the signer was an appropriate person to endorse; and
- the signer had the legal capacity to sign.
The guarantor of a signature of the originator of an
instruction warrants that at the time of signing:
- the signature was genuine;
- the signer was an appropriate person to originate the
instruction if the person specified in the instruction as the registered owner or
registered pledgee of a book-entry security was, in fact, the registered owner or
registered pledgee. The guarantor of the signature provides no guarantee that the
signer is in fact the registered owner or registered pledgee;
- the signer had the legal capacity to sign; and
- the taxpayer identification number, if any, appearing on the
instruction as that of the registered owner or registered pledgee was the taxpayer
identification number of the signer or of the owner or pledgee for whom the owner was
acting.
Specially guaranteeing the signature of the
originator of an instruction to transfer provides the warranty, in addition to the
signature warranties provided, that:
- the person specified in the instruction as the registered owner
or registered pledgee of the uncertificated security will be the registered owner or
registered pledgee; and
- the transfer, pledge, or release of the uncertificated security
requested in the instruction will be registered by the issuer free from all liens,
security interests, restrictions, and claims other than those specified in the instruction
The guarantor of an signature does not otherwise warrant the
rightfulness of a particular securities transfer, pledge, or release. Guaranteeing
the endorsement of a securities certificate, rather than just the signature on the
certificate, warrants the rightfulness of a particular transfer in all respects.
Guaranteeing an instructions similarly warrants the rightfulness of a particular transfer,
pledge or release in all respects. Note: notarization of a signature by a Notary
Public does not qualify a signature guarantee.
Transfer agents may require a signature guarantee as a
condition for processing a securities transfer. Transfer agents, however, may not
require a special signature guarantee or a guarantee of endorsement or instruction as a
condition for processing the transfer, pledge or release of a security.
The guarantor is liable to any person dealing with the
security in reliance on the warranties provided by the guarantor. The transfer agent
can seek to recover any losses resulting from a breach of the warranties given from the
guarantor.
Medallion Guarantees
A person or organization providing a signature guarantee
promises to reimburse the transfer agent for losses that result if the endorser's
signature is not genuine, if the endorser is not an appropriate person to endorse, or
lacks the legal capacity to endorse a certificate or make a transfer instruction. As
a result, transfer agents were often reluctant to accept signature guarantees from persons
or organizations whose financial ability to honor its guarantees was not well established
or otherwise in doubt. In response, Medallion signature guarantee programs (so
called due to the medallion stamp that is placed next to the signatures being guaranteed)
were established. The organization sponsoring a medallion signature program
guarantees the financial performance of the individual guarantors participating in the
program. Transfer agents accepting signature guarantees issued under a medallion
program greatly reduce the risk of loss from signature guarantors failing to honor
signature guarantees.
Although a transfer agent may accept a signature guarantee
from any person or organization, it has become an industry practice to accept signature
guarantees only from participants in a medallion signature guarantee program. The
SEC, which has established rules governing transfer agents' acceptance of signature
guarantees, discussed below, permits registered transfer agents to reject signature
guarantees from guarantors that are not participants in an SEC approved medallion program.
As described below, the Securities Transfer Association, a trade organization for
transfer agents, runs two medallion signature guarantee programs, the STAMP and SEMP
programs. The New York Stock Exchange runs another program, MSP.
- STAMP - Securities Transfer Agents Medallion Program.
This program is open to all eligible guarantors which includes commercial banks, credit
unions, savings associations, trust companies and broker-dealers.
- SEMP - Stock Exchanges Medallion Program. This program is
open to members of the American, Boston, Midwest, Pacific and Philadelphia stock exchanges
and clearing and trust companies.
- MSP - New York Stock Exchange Inc. Medallion Signature Program.
This program is open to all members of the New York Stock Exchange.
SEC Requirements for Signature Guarantees
The SEC does not require registered transfer
agents to require signature guarantees as a condition for processing securities transfer
requests. Rather, the SEC permits registered transfer agents to require a signature
guarantee as a condition of effecting a securities transfer, as does the UCC, and allows
transfer agents to limit signature guarantees to guarantors that participate in an
approved signature guarantee program, i.e. one of the Medallion programs described above.
A registered transfer agent may process securities without a signature guarantee;
may require a signature guarantee for every transfer; or may process some transfers
without a signature guarantee for some transfers and require a signature guarantee for
others.
SEC Regulation 17 C.F.R. §240.17Ad-15, Signature Guarantees,
basically requires that, in deciding to accept or reject a signature guarantee, registered
transfer agents must treat eligible guarantor institutions or class of institutions
equitably. The SEC implemented Rule 17Ad-15 in response to the discriminatory
treatment that many registered transfer agents practiced with respect to the signature
guarantees of savings associations and credit unions. In the past, transfer agents
routinely accepted signature guarantees from broker-dealers and commercial banks, but
normally rejected the signature guarantees of savings banks, savings and loan associations
and credit unions. Under Rule 17Ad-15 an Eligible
Guarantor Institution means:
- Banks;
- Brokers, dealers, municipal securities dealers, municipal
securities brokers, government securities dealers and government securities brokers:
- Credit Unions;
- National securities exchanges, registered securities
associations, clearing agencies; and
- Savings associations.
It should be noted that all of the eligible guarantor
institutions may participate in one of the medallion signature guarantee programs.
Standards and Procedures for Signature Guarantees
All registered transfer agents are required to have the
following:
- Written standards for the acceptance of guarantees of
securities transfers form eligible guarantor institutions; and
- Procedures, including written guidelines where appropriate, to
ensure that those standards are used in determining whether to accept or reject guarantees
from eligible guarantor institutions
The transfer agent's standards and procedures may not treat
eligible guarantor institution's inequitably, or result in the rejection of a guarantee
from an eligible institution because it falls into one on the categories of eligible
guarantor institution listed in Rule 17Ad-15.
Written policies and standards are required of all
registered transfer agents, even those that do not require signature guarantees.
Rule 17Ad-15 provides, however, that a transfer agent is in
compliance with the standards and procedures requirements if the transfer agent:
- Rejects signature guarantees from guarantor institutions that
do not participant in a signature guarantee program; or
- Accepts signature guarantees from eligible guarantor
institutions that, at the time the guarantee is issued, is an participant in a
signature guarantee program.
Since all eligible guarantor institutions may participate in a
medallion guarantee program, accepting signature guarantees only from program participants
does not result in inequitable treatment. As a result, it has become an industry
practice to accept signature guarantees only from medallion program participants.
The term "signature guarantee program" is defined in
Rule 17Ad-15 as a program which the transfer agent determines accomplishes the following:
- Facilitates the equitable treatment of eligible guarantor
institutions; and
- Promotes the prompt, accurate and safe transfer of securities
by:
- Adequately protecting the transfer agent against risk of
financial loss in the event persons have no recourse against the eligible guarantor
institution; and
- Adequately protects the transfer agent against the issuance of
unauthorized guarantees.
Rule 17Ad-15 provides for a transition period for transfer
agents who change their written Signature Guarantee policies to include a signature
guarantee program requirement. For six months following such a change in policy, a
transfer agent may not reject a requested transfer because the signature guarantee was
from a guarantor institution that does not participate in a signature guarantee program
unless the transfer agent provides 90 days written notice of its intent not to accept
signature guarantees form non-participating guarantor institutions.
It is important to note that Rule 17Ad-15 prohibits the
inequitable rejection of signature guarantees based solely on the basis of type or class
of eligible guarantor institution. A transfer agent may reject a signature guarantee
from an eligible guarantor institution for reasons not solely related to the type or class
of eligible guarantor institution that issued the guarantee. A transfer agent may
reject a signature guarantee for the following reasons:
- For reasons unrelated to acceptance of the guarantor
institution, such as:
- the transfer of the security would be wrongful;
- a signature is believed to have been forged;
- the transfer would violate laws requiring the collection of
transfer taxes;
- the transfer agent has knowledge that the security to be
transferred is subject to adverse claims;
- The person acting on behalf of the guarantor institution is not
authorized by that institution to act on its behalf, provided that the transfer agent
maintains a list of people authorized to act on behalf of that guarantor institution;
- The eligible guarantor institution is neither a member of a
clearing corporation or maintains net capital of at least $100,000.
Therefore, a transfer agent's signature guarantee policy may
address individual considerations not related to the type of eligible guarantor
institution, such as those listed above. While not required, written signature
guarantee policies may provide for some non-medallion guarantees, such as those from
Federal Reserve Banks and the Depository Trust Company. Also, while the signature
guarantee requirement is accepted industry practice, transfer agents may decide to waive
signature guarantee requirements limited circumstances, such as:
- Small transfers;
- The securityholder requesting the transfer is well-known to the
transfer agent or has a well-established business relationship (e.g. loans or deposits)
with the transfer agent;
- For military personnel stationed overseas and unable to utilize
an eligible U.S. guarantor.
Upon request, a registered transfer agent must, within three
business days, provide the requesting party a copy of its signature guarantee policies and
procedures. The transfer agent must keep a copy of its signature policies and procedures
in an easily accessible place.
Rejection of Signature Guarantees
A transfer agent may reject a signature guarantee from an
eligible guarantor institution only if the signature guarantee fails to satisfy the
transfer agent's written signature guarantee policies and procedures, e.g. if the
guarantee is from a non-medallion program participant and the transfer agent's policy
allows only for medallion program participant guarantees.
When a registered transfer agent rejects a signature because
it does not satisfy the transfer agent's written standards and procedures, the transfer
agent must notify both the presentor of the security to be transferred and the guarantor
of the presentor's signature of the reasons for the rejection. Notification must be
made within two business days. The transfer agent may notify the guarantor by
telephone, fax, or ordinary mail. The transfer agent may notify the presentor by
returning the rejected item to the presentor.
Registered transfer agents are required to maintain and retain
records relating to rejected signature guarantees. The transfer agent's records must
include:
- the date the item was rejected;
- the reason for the rejection;
- the identity of the guarantor; and
- whether the guarantor failed to meet the transfer agent's
standards and procedures.
The records must be retained for three years following the
date the signature was rejected.
Liability for Unreasonable Rejection of Signature Guarantees
Section 8-401 of the UCC requires transfer agents to register
the transfer, pledge or release of a security presented to the transfer agent if:
- the security is endorsed or the instruction was originated by
the appropriate person or persons;
- reasonable assurance is given that those endorsements
or instructions are genuine and effective:
- the transfer agent has no duty as to adverse claims or has
discharged the duty;
- applicable laws relating to the collection of taxes have been
satisfied; and
- the transfer, pledge, or release is in fact rightful or is to a
bona fide purchaser.
The transfer agent is liable to persons presenting
certificates or transfer instructions for losses resulting from any unreasonable delays in
registration or from a failure or refusal to register the transfer, pledge, or release.
In view of this liability, registered transfer agent should implement sufficient internal
controls to ensure that securities transfers are not delayed by the rejection of
acceptable signature guarantees. One example of an appropriate internal control is to have
an appropriate level of transfer agent management review all rejected signature guarantees
and any related follow-up thereto.
Controls Over the Overissuance of Securities
A transfer agent that transfers a security to a purchaser for
value warrants that the number of shares or, in the case of bonds, par value of bonds is
within the amount of securities the issuer is authorized to issue. When an issue of
securities exceeds the amount that the issuer has the corporate power to issue, an
overissuance has occurred. Recall that it is the express duty of the stock registrar
to verify that the transfer of a security or securities does not result in an
overissuance. See
Stock
Registrar or
Bond Registrar. A
transfer agent that effects a transfer of securities that causes an overissuance risks
having to buy-in the amount of securities overissued if the overissuance can not otherwise
be eliminated.
Internal controls designed to prevent the overissuance of
securities include procedures as elementary as verifying that the number of shares, or the
par value of bonds, issued in a transfer match the number of shares, or par value of
bonds, presented for transfer. Any differences should be adequately explained and
reconciled before completing the transfer. Simply put, before making an item
available, the transfer agent (registrar) should confirm that an overissuance of
securities will not result, i.e. that the number of shares, or par value of bonds, agree
with the amount authorized to be issued. For such procedures to be effective,
transfer agents need to post securities transfers to its related records in a prompt and
accurate manner. Adequate reconcilement practices are needed to ensure that
securities transfer records, such as control books and master securityholder lists,
continue to be accurate and promptly updated. As described in greater detail below,
the SEC has implemented regulations governing the prompt posting of transfer agent
records, the resolution of out-of-proof conditions and the duty to buy-in the amount of
overissued securities, as well as required reporting when such events occur.
Prompt Posting of Securities Transfer Related Records
Failure to promptly post changes in certificate detail
increases the risk that out-of-proof conditions will occur and remain outstanding, with
the related risk that an overissuance of securities may occur due to inaccurate
recordkeeping.
SEC Rule 17Ad-10 requires recordkeeping transfer agents to promptly post securities
related transactions to transfer agent related records. A "recordkeeping transfer agent" is the registered
transfer agent that maintains and updates the master securityholder file (See below). A
recordkeeping transfer agent contrasts with a "named
transfer agent", which is a registered transfer agent engaged by a securities issuer
to act as transfer agent, but that engages a service company to perform some or all of the
named transfer agent's duties. A "service
company" is defined as a registered transfer agent engaged by a named transfer agent
to perform transfer agent functions for the named transfer agent.
Securities related records that must be posted promptly are: Master
securityholder file - The master securityholder file is the official list of individual
securityholder accounts. For mutual funds, the master securityholder file may
consist of multiple, but linked, automated files. Transfer agents must promptly post
certificate detail to the master securityholder file. Certificate detail consists of:
- The certificate number, except for uncertificated securities;
- The number of shares for equity securities or the principal
dollar amount for debt securities;
- The securityholder's registration;
- The address of the registered securityholder;
- The issue date of the security;
- The cancellation date of the security;
- In the case of redeemable securities of investment companies
(i.e. mutual funds), an appropriate description of each debit and credit (e.g. purchase
or sale); and
- Any other identifying information about securities and
securityholders the transfer agent reasonably deems essential to its recordkeeping
system for the efficient and effective research of record differences.
Note: A "file" includes both
automated and manual records.
If the security to be transferred or redeemed contains
certificate detail that is different from the certificate detail on the master
securityholder file, then a "record difference" has occurred, see below. In
such a case, the recordkeeping transfer agent must post a credit to the master securityholder file, i.e. record the new certificate detail in the master securityholder
file. The corresponding debit, i.e. cancellation of certificate detail from the
master securityholder file, however, shall be recorded in a subsidiary file, e.g. suspense
account, until the record difference is resolved. Once posted to a suspense account,
the transfer agent must be diligent in its effort to resolve the record difference, and,
once resolved, must promptly debit the master securityholder file. Recordkeeping
transfer agents must maintain a record of all certificate detail deleted, i.e. debited,
from the master securityholder file for six years following the date the certificate
detail was debited.
Certificate detail must remain posted on the master
securityholder file until a debit to a securityholder's account is
appropriate.
Transfer agents must maintain accurate master securityholder files for the securities for
which it is the recordkeeping transfer agent. Transfer agents that assume the maintenance
and updating of master securityholder files from predecessor transfer agents, establish a
new master securityholder file for an issue or convert from a manual to an automated
system must carry over the existing certificate detail.
- Control book - The control book
is the record or any other document that shows the total number of shares (in the case of
equity securities) or the principal dollar amount (in the case of debt securities)
authorized and issued by the issuer. A recordkeeping transfer agent must maintain a
current and accurate control book for each issue of securities. Changes to the
control book require written authorization from a duly authorized agent of the issuer.
- Subsidiary files - A
subsidiary file is any list or record of accounts, securityholders or certificates
detailing debits and credits that have not been posted to the master securityholder file.
Subsidiary files must be current and accurate.
Prompt Posting Criteria
SEC Rule 17Ad-10 requires the posting of applicable records within the following
timeframes:
- Recordkeeping transfer agents that have qualified as exempt
transfer agents must post applicable records within 30 calendar days;
- Recordkeeping transfer agents that transfer only own-bank,
parent holding company or affiliated company securities and that use a batch posting method
must post applicable records within ten business days;
The SEC considers a batch posting system to be one in which
posting is done daily to a front-end subsidiary file, with less frequent batch updating to
master securityholder files.
- All other recordkeeping transfer agents must post applicable
records within five business days. Securities transferred or issued prior to record
date, but posted after the record date, must be posted as of the record date.
The timeframes detailed above do not apply to recordkeeping
transfer agents' posting of mutual fund transfers. The timeframes refer to the
number of days following the issuance, purchase, transfer or redemption of a security.
In those cases where the recordkeeping transfer agent receives certificate detail
for posting from a "co-transfer agent", the timeframes commence on the date when
the recordkeeping transfer agent receives the records from the co-transfer agent. A "co-transfer agent" is registered transfer agent
that transfer securities, but does not maintain and update the master securityholder file.
Co-transfer agents are required to dispatch or mail a record of debits and credits
for each security transferred or issued within two business days of transfer or issue,
except when the transfer or issue occurs with five business days of record date, which
must be dispatched or mailed to the recordkeeping transfer agent daily. When a
recordkeeping transfer agent inquires of a con-transfer agent concerning records that the
co-transfer agent was required to dispatch or mail to the recordkeeping transfer agent,
the co-transfer agent must respond to the recordkeeping transfer agent within five
business days of receipt of such inquiries.
Failure to Promptly Post
Recordkeeping transfer agents that fail to meet prompt posting
requirements must immediately report such failure to its appropriate regulatory agency,
along with a report stating the measures that are, have been, or will be taken to correct
the recordkeeping transfer agent's failure to promptly post required records.
SEC Rule 17Ad-11 requires such reports when a recordkeeping transfer agent has any
debits or credits for securities transferred, purchased, redeemed or issued that remain
unposted for more than five business days after the date when the debits and credits were
required to be posted to the master securityholder file or to a subsidiary file. A
copy of such reports must be retained for at least three years, the first year in an
easily accessible place.
Aged Record Differences
A "record
difference" occurs when either:
- The total number of shares or total principal dollar amount of
securities in the master securityholder file does not equal the number of shares or
principal dollar amount in the control book; or
- The security transferred or redeemed contains certificate
detail different from the certificate detail currently on the master securityholder file
and where the difference cannot be resolved immediately.
An "aged record difference" is a record difference
that has existed for more than thirty calendar days. Subject to certain criteria,
SEC Rule 17Ad-11 requires recordkeeping transfer agents to report aged record
differences to issuers and to the appropriate regulatory agency.
Whether aged record differences must be reported depends on the aggregate market
value of the aged record differences and the issuer capitalization. Different
reporting thresholds apply to required reports to interested parties than to required
reports to the appropriate regulatory agency.
Reports to Issuers
Recordkeeping transfer agents must report to
issuers aged record differences that, as of the end of each month, exceed the thresholds
detailed in the table below.
$5 Million or Less |
$50,000 |
$100,000 |
Greater than $5 Million but less than $50 Million |
$250,000 |
$500,000 |
Greater than $50 Million but less than $150 Million |
$500,000 |
$1,000,000 |
Greater than $150 Million |
$1,000,000 |
$2,000,000 |
Issuer capital is the market value of the
issuer's authorized and outstanding equity securities. For an issuer of municipal
securities issuer capital is the market value of all debt issues for which the transfer
agent performs recordkeeping functions. The market value of debt securities is
determined by reference to the control book and current market prices.
Aged record differences are aggregated for all
securities of a particular issuer, and not across all issuers.
Thus, to determine if an aged record difference must be reported, the aggregate of
aged record differences for a particular issuer is compared to the capitalization of that
issuer.
Recordkeeping transfer agents must report aged record
differences to the following parties:
- The official performing corporate secretary functions for the
issuer of the securities for which the aged record difference exists;
- For municipal securities, the chief financial officer of the
issuer of the securities for which the aged record difference exists;
- The named transfer agent, if the recordkeeping
transfer agent
acts as a service company.
Note: A recordkeeping transfer agent that transfers only its
own securities does not have to report aged record differences to issuers, but does have
to make the required reports to regulatory agencies.
A named transfer agent engaged by an issuer to maintain and
update the master securityholder file must report aged record differences to the
following:
- The official performing corporate secretary functions for the
issuer of the securities for which the aged record difference exists;
- For municipal securities, the chief financial officer of the
issuer of the securities for which the aged record difference exists;
The reports must be made within 10 days of the end of the
month in which the aged record difference exists. A report must be sent for each
month in which a record difference exists. The required reports must
contain the following information:
- The reasons for the aged record difference; and
- The steps being taken or to be taken to resolve the aged record
difference.
Reports to Appropriate Regulatory Agencies
Recordkeeping transfer agents must report to the appropriate regulatory agency aged record differences that, as of the
end of each calendar quarter, exceed the thresholds detailed in the table below.
$300,000 |
5 or fewer |
$500,000 |
6-24 |
$800,000 |
25-49 |
$1,000,000 |
50-74 |
$1,200,000 |
75-99 |
$1,400,000 |
100-499 |
$1,600,000 |
500-999 |
$2,600,000 |
1,000-1,999 |
An additional $1 million for each
additional 1,000 issues |
The reports must be made within 10 days of the
end of the calendar quarter in which the aged record difference exists. A report
must be sent for each calendar quarter in which a record difference
exists. The required reports must contain the following information:
- The reasons for the aged record difference; and
- The steps being taken or to be taken to resolve the aged record
difference.
Reports must be retained for at least three years, the first
year in an easily accessible place.
Buy-Ins
When a registered transfer agent causes a physical
overissuance of securities and can not recover the physical certificates that created the
overissuance, the transfer agent must purchase securities in an amount equal to the
overissuance. Essentially, the transfer agent "buys-in" the amount of
securities overissued in order to return the number of shares, or par value of bonds,
to the authorized amount, as documented in the control book. Buy-ins are only
required when: 1) there has been a physical overissuance of securities, as opposed to an
out-of-proof condition with respect to book-entry securities; and 2) the registered
transfer agent's acts, of omission or commission, caused the physical overissuance. A
transfer agent is not required to buy in a physical overissuance caused by a predecessor
transfer agent.
For example, a physical overissuance of securities might
result from:
- the transfer of securities subject to an existing stop-transfer
order. See Lost, Stolen or Missing Securities;
- errors in which the number of shares, or par value of bonds,
represented by a newly issued certificate exceeds the number of shares, or par value of
bonds, represented by the corresponding certificate that was cancelled. Note
that the stock registrar or bond registrar has the duty to guard against such occurrences.
- errors in which the wrong class or series of security, e.g. the
conversion of debentures into preferred stock instead of common stock.
Note: A difference in
the amount of securities, representing either shares of stock or the face value of bonds,
actually issued and the amount of securities indicated by the control book as being
authorized gives rise to an "out-of-proof" condition. An out-of-proof
condition constitutes a record difference, but not all record differences represent an
out-of-proof conditions. In addition, an out-of-proof condition can represent an
underissuance of securities. Although an underissuance is not subject to buy-in
requirements, it represents a potential liability to the transfer agent. For
example, as a result of a transfer agent's failure to issue or record the proper number of
shares, or par value of bonds, a securityholder may not receive dividends, interest,
corporate distributions, redemptions or stock splits to which the
securityholder is
entitled, with the transfer agent potentially liable for the losses it has caused.
SEC Buy-In Requirements
SEC Rule 17Ad-10(g) requires registered transfer agents that have both caused a
physical overissuance of securities and know that an overissuance has occurred to buy-in
securities equal to the number of shares in the case of securities or the principal dollar
amount in the case of debt securities. The transfer agent must buy-in the securities
within 60 days of the date it discovers the physical overissuance. The transfer agent
"discovers" an overissuance when the transfer agent identifies the erroneously
issued certificate(s) and the registered securityholder(s).
Within the 60 day timeframe, the transfer agent must work
diligently to resolve the overissuance and recover the certificates involved. In the
following cases, however, the transfer agent does not have to buy-in physically overissued
securities:
- The transfer agent has obtained a letter from the holder of the
overissued certificates in which the holder confirms that the overissued certificates will
be returned to the transfer agent within 30 days. If the overissued certificates are
not returned within this 30 days period the transfer agent must immediately buy in the
overissued securities.
- The overissued certificates are covered by a surety bond
indemnifying the transfer agent for all expenses resulting from the overissuance.
The transfer agent is required, however, to act diligently in resolving the
overissuance
and recovering the overissued certificates.
Required Reports
Reports to Issuers
A transfer agent must report to issuers buy-ins executed
pursuant to SEC Rule 17Ad-10(g). Recordkeeping transfer agents must report as follows:
- The official performing corporate secretary functions for the
issuer of the securities for which the aged record difference exists;
- For municipal securities, the chief financial officer of the
issuer of the securities for which the aged record difference exists;
- The named transfer agent, if the recordkeeping
transfer agent
acts as a service company.
Note: A recordkeeping transfer agent that transfers only its
own securities does not have to report aged record differences to issuers, but does have
to make the required reports to regulatory agencies.
A named transfer agent engaged by an issuer to maintain and
update the master securityholder file must report buy-ins to the following:
- The official performing corporate secretary functions for the
issuer of the securities for which the aged record difference exists;
- For municipal securities, the chief financial officer of the
issuer of the securities for which the aged record difference exists;
Required reports must be sent within ten business days
following the end of the month in which the buy-in occurred. Named transfer agents
that have engaged a service company must send the report within ten days following the
date on which the named transfer agent receives a report from the service company that the
service company has bought in securities. SEC Rule 17Ad-10(c) requires co-transfer agents
to report buy-ins to the named fiduciary within three business days following the month in
which the buy-in occurred. The reports must contain the following information:
- The principal dollar amount of debt securities and the related
market value or the number of shares and related market value of securities that were
bought in. Note: Co-transfer agents are required to include this information in the report
they are required to make to named transfer agents;
- The party that executed the buy-in; and
- The reason for the buy-in. Note: Co-transfer agents are
required to include this information in the report they are required to make to named
transfer agents.
Reports to Appropriate Regulatory Agencies
Buy-ins must be reported to the appropriate
regulatory agency when the aggregate market value of all buy-ins
executed in a
calendar quarter exceeds $100,000. The information reported is the same as that
reported to issuers. Reports to the appropriate regulatory agency must be made
within 10 business days following the end of the calendar quarter in which aggregate
buy-ins exceeded $100,000.
Note: The market value of an issue is determined as of the
last business day on which market value information is available during the reporting
period.
Reports must be retained for at least three years, the first
year in an easily accessible place.
Safeguarding of Funds and Securities
SEC Rule 17Ad-12 requires registered transfer agents having custody or possession of
funds or securities related to transfer agent activities to assure that:
- Securities are kept and handled in a manner to reasonably
safeguard them from destruction, theft or other loss; and
- Funds are protected from misuse.
The regulations does not detail any specific internal controls
required for the protection of securities and funds held as a result of transfer agent
activities, but simply requires that the protection afforded to securities and funds must
be adequate in light of all facts and circumstances. Rule 17Ad-12 states,
however, that the cost of various safeguards and procedures and the degree of potential
financial exposure are two relevant factors in evaluating internal controls and procedures
governing the protection of securities and funds held as transfer agent.
Small transfer agents will normally require fewer and less
elaborate internal controls and procedures than larger, more complex transfer agent
operations. For example, a transfer agent that qualifies for the small transfer agent
exemption generally will have less sophisticated internal controls and procedures than a
transfer agent processing a large volume of items for various outside securities issuers.
Discussed in greater detail below are various internal control concepts that are
applicable to both large and small transfer agents.
Physical Security Controls
An effective control for preventing the misappropriation of
securities certificates and transfer agent related funds is the establishment of
controlled access to those areas of the institution where securities transfer activities
are conducted, including access to personal computers and other computer systems used to
process securities transfer activities. Controlled access can be via coded access,
special keys and badges or other means of preventing entry by and
identifying individuals
not authorized to enter areas where securities transfer activity is conducted. In
addition, fire proof filing cabinets and safes protect transfer agent records,
certificates and supplies from loss due to fire damage or other nature disasters, as well
as preventing misappropriation. To be effective, keys, combinations and codes to
file cabinets and safes must be effectively controlled at all times. Access to
vaults and safes should be subject to joint custody, i.e. two or more people are
accountable for access and thus required to be present when vaults and safes are accessed.
Access logs should be maintained and should identify the persons gaining access,
the reasons for accessing, and the assets or records accessed. Access codes and
combinations should be promptly cancelled or changed when individuals are no longer
employed with the institution or are no longer involved in securities transfer
activities.
Many small financial institutions with registered transfer
agent operations, however, lack the space for establishing a separate secure area for
securities transfer activity. For these institutions, the use of secure
storage areas,
such as vaults, safes and fireproof file cabinets, along with appropriate controls
thereto, will assume an even greater importance.
Segregation of Duties
One of the most fundamental methods of internal control is the
segregation of duties. The participation of two or more persons effecting the transfer of
a security causes the work of one to serve as proof for the accuracy of another.
Additionally, when two or more persons are involved in a process, the possibility of fraud
diminishes considerably. Ideally, duties should be arranged so that no one person
dominates any transaction from inception to termination. A single individual should
not be responsible for receiving and logging items presented for transfer;
canceling
certificates presented and issuing new certificates (or entering debits and credits in the
case of book-entry securities); and updating or reconciling related records. EDP service
center personnel should not initiate transactions or correct data except when such
activity may be required to complete processing in a reasonable period of time (if this
unusual situation arises, transactions should be approved by appropriate levels of
management at the data center and at the serviced institution). EDP systems should be
protected by password or other systems access controls and individual system operators
should be individually identified.
Often, small transfer agent operations lack the staff
necessary to implement a satisfactory segregation of duties. In such cases,
compensating controls should be implemented that will permit transfer agent
management and personnel to identify and correct errors and irregularities promptly.
For example, when a single employee dominates a transaction, the transaction can be
made subject to review by an independent employee.
When practicable, the planned and unannounced rotation of
duties can compensate for a lack of segregation of duties, in addition to being an
effective internal control in its own right. The rotation should be of sufficient duration
to be effective. Rotation of personnel, besides being an effective internal check, can be
a valuable aid in the bank's overall training program.
Vacation Policy
It is the FDIC's goal that all banks have a vacation policy
which provides that active officers and employees be absent from their duties for an
uninterrupted period of not less than two consecutive weeks. Such a policy is considered
an important internal safeguard largely because of the fact that the perpetration of fraud
of any substantial size usually requires the constant presence of the employee
perpetrating the fraud in order to manipulate records, respond to inquiries from
customers or other employees, and otherwise prevent detection. The benefits of such a
vacation policy may be substantially, if not totally, lost if the duties performed by an
absent individual are not assumed by someone else. In those cases where the bank does not
require a continuous absence, compensating controls, such as the rotation of personnel
among different duties or increased management review procedures, can constitute an
acceptable alternative to a vacation policy requiring a continuous two week absence.
Reconciliation Procedures
As previously discussed, one of the major functions of a
transfer agent is to transfer securities from a seller to a buyer after a purchase
transaction. Typically this takes place through the issuance of a new certificate to
the purchaser and the cancellation of the old certificate. With the growth of
uncertificated (i.e. book-entry) recordkeeping functions by transfer agents, an increasing
number of transactions are book-entry transfers. Moreover, the current securities
industry trend is towards a reduction in paper-based transaction flow, with greater
utilization of direct registration systems that rely on account statements instead of
negotiable certificates and automated links between securities depositories,
broker-dealers and banks. In the absence of physical securities certificates, the
integrity of a transfer agent's records, automated as well as paper based, is crucial.
Appropriate reconciliation procedures are an essential internal
control element in ensuring the integrity of transfer agent records and the reliability of
transfer agent recordkeeping systems. In addition, sound reconciliation procedures
promote compliance with SEC prompt posting requirements and the identification and timely
resolution of record differences. To be effective, reconciliations must be performed
at appropriate intervals by individuals independent of the maintenance of the records being
reconciled. Differences, errors and irregularities should be promptly investigated and
resolved. Reconciliations should be reviewed by an appropriate level of transfer agent
management, which should monitor the resolution of significant record differences.
Transfer agent related records and accounts that should be
reconciled periodically include control books, which should be reconciled to the
corresponding master securityholder file; ledgers, subsidiary ledgers and records related
to interest and dividend payment accounts; accounts related to dormant funds and unclaimed
property; inventories of blank securities certificates and interest/dividend checks.
Controls Over Securities Certificates
Unissued Securities Certificates
Transfer agents must protect and control the supply of bank
securities certificates that they hold in conjunction with the securities issues
transferred. The failure to control blank certificates could result in their being
used for fraudulent purposes such as fraudulently serving as collateral. With the exception of a reasonable working supply of blank
certificates, certificates should be kept in a secure location, such as a safe, vault or
locked file cabinet. Joint Custody of blank certificates further
strengthens the
effectiveness of controls over blank certificates, and is strongly recommended.
Working supplies of blank certificates should also be adequately controlled. The
use of blank certificates should be verified, and when pre-numbered or
numerically
sequenced certificates are used, with all breaks in numerical sequence adequately
documented. Blank securities certificates voided or spoiled should be adequately
documented and disposed of or controlled. The supply of blank securities
certificates should be inventoried periodically, with any discrepancies promptly
investigated and resolved.
SEC Rule 17f-1 was revised in 2004 to clarify
that all certificates from the time printed (and unissued) until destroyed
are covered by the rule. An unissued, but printed certificate,
includes the issuer's name, CUSIP number, certificate number, and
authenticating signatures. It does not have to include the
registrant's name, the number of units, or the counter-signature of the
transfer agent.
Cancelled Securities Certificates
When a bond is redeemed or the ownership of a stock or debt
security transferred, the corresponding security certificate is cancelled by the transfer
agent. For certificated securities, cancellation involves both a recordkeeping entry
on the transfer agents books and the physical alteration of the certificate itself.
Cancelled certificates must then be stored for not less than six years following the date
of cancellation. After six years cancelled certificates can be destroyed. See SEC Rule
17Ad-6(c) and 17Ad-7(d).
Refer also to Rule 17Ad-19.
The fraudulent use of cancelled securities certificates
presents significant problems and potential costs, not only to transfer agents, but also to
investors, creditors and broker-dealers. Securities certificates that have not been
properly cancelled can be used to defraud the public and financial institutions.
Stolen certificates that were not properly cancelled have been subsequently sold to
investors and used as collateral for loans. Examples of frauds involving the use of
cancelled securities certificates include:
- In a 1992 case, approximately $111 billion face amount of
cancelled bond certificates disappeared after being delivered from a transfer agent's
warehouse to a certificate destruction vendor. The certificates, representing many
well-known public companies, later began to resurface worldwide. A number of banks and
brokers as well as individuals were defrauded through sales of the cancelled certificates
for cash or through use of the cancelled certificates as loan collateral. The bulk of
these cancelled certificates still remain unaccounted for and continue to resurface in the
marketplace.
In this case the SEC brought an action against a transfer
agent for its failure to report stolen certificates pursuant to Rule 17f-1, 17 CFR
240.17f-1, and for its failure to safeguard securities in its possession pursuant to Rule
17Ad-12, 17 CFR 240.17Ad-12. The transfer agent agreed to pay a civil penalty of $750,000
and to cease and desist from future violations of Sections 17(f)(1) and 17A of the
Exchange Act and Rules 17f-1 and 17Ad-12 thereunder. See SEC v. Citibank, N.A.,
Civil Action No. 92-2833 (USDC, DC, 1992).
- In a similar 1994 case, approximately $6 billion face amount of
cancelled bond certificates disappeared after being delivered from a transfer agent's
record center to two certificate destruction vendors. The cancelled certificates, which
represented well-known companies, later began to circulate worldwide. Again, the bulk of
these cancelled certificates remain unaccounted for and continue to resurface in the
marketplace.
In 1994, the SEC and the OCC brought a joint action against a
transfer agent for its failure to report stolen cancelled certificates pursuant to Rule
17f-1 and its failure to safeguard securities in its possession pursuant to Rule 17Ad-12.
The transfer agent agreed to pay a civil penalty of $100,000 and to cease and desist from
future violation of Sections 17(f)(1) and 17A of the Exchange Act and Rules 17f-1 and
17Ad-12 thereunder. As remedial measures, the transfer agent also agreed to mark cancelled
certificates with the word "cancelled" and to adopt other safeguards. See The
Chase Manhattan Bank, Administrative Proceeding No. 3-8518. Securities Exchange Act
Release No. 34784 (October 4, 1994), 57 SEC Docket 2195.
- In another instance, cancelled certificates were stolen from a
transfer agent's shipping bags while in transit. The transfer agent regularly shipped
cancelled certificates from the West Coast to a New York bank for processing. The transfer
agent, however, did not record the contents of its shipments and, in effect, relied on its
processing agent to do its bookkeeping. When the shipping bags were stolen, neither the
transfer agent nor its processing agent realized that the certificates were missing. A
number of the certificates resurfaced more than a month after the theft in off-market
sales.
In 1994, the SEC and the OCC brought a joint enforcement
action against a transfer agent and found that the transfer agent had violated Section
17(f)(1) of the Exchange Act and Rule 17f-1 thereunder for failing to report the missing
securities to the Commission's Lost and Stolen Securities Program. The transfer agent
agreed to cease and desist from any further violations of Section 17(f)(1) and Rule 17f-1
thereunder and agreed to pay a $75,000 civil penalty. See Seattle-First National Bank,
Securities
The manner in which some transfer agents cancel
securities
certificates has contributed to the problem. Some transfer agents cancel
certificates by making pin-hole sized perforations which mark the cancellation date on the
certificate, along with the transfer agents initials. These
perforations, however,
were often so small as to be barely noticeable. In some instances, the
perforations
have been interpreted by some as authenticating the certificate, rather than as evidence
of the certificate's cancellation. In some cases, transfer agents have failed to
place any marking on the certificate to indicate that it had been cancelled. The potential
for such fraud has grown in recent years, as many corporate bond issues have been redeemed
many years prior to maturity, thereby increasing the volume of cancelled certificates that
could potentially be used in fraudulent schemes if they are not properly cancelled.
The processing of cancelled securities certificates can involve significant warehousing
costs, as they must be shipped, stored, safeguarded and tracked.
In view of the potential liability that securities transfer
agents confront when they cancel, transport and store securities certificates that have
been retired from circulation registered transfer agents should develop adequate policies
and procedures governing cancelled certificates. Canceling and retiring securities
certificates from circulation has been largely governed by industry practices.
However, in 2004, the SEC issued Rule 17Ad-19, which outlines the proper
procedures for cancellation.
In 1994 the Securities Transfer Association
(STA), the largest transfer agent trade association, adopted guidelines for dealing with
cancelled securities which calls for marking cancelled certificates with the word
"cancelled" and for security measures over the storage and destruction of
certificates. Examples of procedures governing the cancellation of securities
certificates include the following:
- Physically marking cancelled certificates in a manner that
clearly indicates that the certificate no longer represents a claim against the issuer.
The STA guidelines call for marking the certificates with the word
"Cancelled";
- Maintaining certificate information in a reasonably retrievable
manner, preferably electronically retrievable. Certificate information that should
be maintained includes:
- CUSIP number;
- Certificate number, with any prefix or suffix;
- Denomination;
- Registration;
- Issue date; and
- Cancellation date.
Note: In some instances where cancelled certificates were
stolen, the certificate information was of limited value in identifying the stolen
certificates because they were manual, rather than electronic, and the certificate
information was organized electronically by cancellation dates rather than by certificate
numbers. Thus, the necessary information could not be easily retrieved from the
transfer agents records.
- Maintaining controlled access to areas where cancelled
securities are stored. Controlled access generally means the
practice of permitting
only authorized personnel to areas where cancelled certificates are stored;
- Requiring that the physical transportation of cancelled
certificates be conducted in a secure manner and that a record of the CUSIP and
certificate numbers of the certificates transported be maintained. When cancelled
certificates are transported, the transfer agent dispatching the certificates should
receive notice that the certificates were delivered. In the case of non-delivery,
the transfer agent should investigate the circumstances regarding the non-delivery.
If the non-delivery is not resolved, the certificates transported should be reported to
the Securities Information Center as lost or missing securities. See SEC Rule
17f-1(c(2).
When a third-party servicer is used to physically destroy
certificates, a transfer agent may decide to have an authorized person witness the
physical destruction, or designate an outside party to do so. In any event, the
transfer agent should retain copies of all records relating to securities certificates
that have been destroyed.
With respect to small transfer agent operations, especially
those that limit securities transfer activity to own-institution or parent holding company
securities and with a relatively small volume of transfers processed, the number and
sophistication of procedures and controls over the cancellation, shipment and storage of
certificates will be less than what
is normally found in large, complex transfer agent operations.
Notwithstanding the size and complexity of transfer agent activity, the policies,
procedures and internal controls over cancelled securities must provide adequate
protection against the misappropriation and fraudulent use of securities certificates.
Controls Over Funds and Disbursements
SEC Rule 17Ad-12 requires adequate safeguards for the protection of all funds held
in connection with transfer agent activities. Transfer agents may hold considerable funds
related to its securities transfer activities; for example, funds for the payment of
dividends or interest to be paid to registered securities owners. In addition, it is not
unusual for transfer agents to hold considerable funds in conjunction with dividend
reinvestment programs, stock purchase programs and employee stock purchase programs.
Appropriate internal controls and procedures for the
protection of funds include the following:
- Controls over unissued dividend and interest checks.
Common procedures for controlling unissued checks include:
- Joint custody or dual control over blank dividend and interest
checks;
- Maintenance of blank checks in a secure location, such as vault
or safe;
- Use of prenumbered documents. Supplies of blank checks
should be inventoried periodically, with any breaks in the numerical sequence investigated
and explained;
- Working supplies of blank checks should be reasonable and
appropriately controlled;
- Controls over checks spoiled or voided during processing;'
- Returned mail procedures, see below.
- Maintenance of appropriate ledgers, subsidiary ledgers,
suspense accounts and other records relating to dividend and interest payments, as well as
funds held in conjunction with dividend reinvestment, stock purchase and employee stock
purchase plans. Ledgers, accounts and records should be:
- Reconciled periodically, see discussion on reconcilement
procedures elsewhere in this section;
- Audited periodically, see discussion on audits;
- Retained as required by applicable laws and regulations.
- Controls over dormant funds and unclaimed property. Dividend
and interest checks that remain uncashed or undelivered, as well as other funds and
property that remain unclaimed, are subject to state unclaimed property laws, generally
referred to as escheat laws. As a result, the holders of unclaimed, i.e. dormant,
funds are required to report such property to appropriate state authorities, and, after
the passage of a statutory timeframe to turn (escheat) unclaimed funds and property over
to state authorities. Internal controls and procedures over dormant funds and
unclaimed property should, at a minimum:
- Identify dormant funds and unclaimed property;
- Segregate dormant funds and unclaimed property from the funds
and property of the institution;
- Provide for the reporting of dormant funds and unclaimed
property in accordance with applicable laws; and
- Provide for the transfer of dormant funds and unclaimed
property (escheatment) to the appropriate authorities within established statutory
timeframes.
Rule 17Ad-12 does not mandate any particular internal
control or procedure. Rather, every transfer agent must implement internal controls
and procedures, that, "in the light of all facts and circumstances" protect
investor funds against misuse, e.g. embezzlement, misappropriation or misapplication.
In assessing the adequacy of internal controls, the cost of implementing various
internal controls and procedures should be evaluated in light of the volume of investor
funds held and the administrative complexity of handling such funds.
Mail Handling Procedures
Transfer agents both receive securities certificates for
transfer via the mails and dispatch securities certificates upon effecting transfer of
ownership. In addition, transfer agents receive and dispatch funds via the mails,
for example dividend checks mailed to owners of record and interest and dividend checks
mailed and later returned as undelivered. Therefore, the protection of securities
certificates and funds should include internal controls and procedures governing the
handling of securities certificates and funds received and transmitted via the mails.
Personnel who handle mail containing certificates or funds should be fingerprinted
as required by
SEC Rule 17f-2. As previously noted, 12 U.S.C. 1829 requires financial
institutions to take steps to avoid hiring an individual convicted of dishonest acts. So, transfer agents have a duty to ensure that those who handle securities
certificates and funds do not have a criminal history.
Ideally, two persons should be present when mail containing
certificates and funds is opened, much in the same manner that a bank controls the opening
of the bank's night deposit. Such a procedure lessens the risk of misappropriation
of certificates and funds before their receipt can be recorded. This is an important
consideration in view of the amount of time that may elapse before the nonreceipt of such
items is discovered. Moreover, adequate separation of duties should be implemented:
no single person should be responsible for receiving items via the mail, logging the
receipt of items received via the mail, processing the items and subsequently mailing or
otherwise disposition of them. Mail returned as undeliverable should not be returned
to and handled by those persons who dispatch certificates and funds via the mails, but
should be received by and investigated by persons independent of mailing certificates and
checks. Small transfer agent operations that lack the staff necessary to implement
adequate separation of duties governing the handing of mail should implement compensating
controls that are adequate for protecting securities certificates and funds received or
sent by mail from misappropriation or loss.
Lost Securityholders
A recordkeeping transfer agent's mail handling procedures
should include procedures for identifying and searching for lost securityholders.
SEC Rule 17Ad-17 requires recordkeeping transfer agents to search for a lost
securityholder's correct address and to maintain written procedures describing its
methodology for searching for lost securityholders. For the purposes of
Rule 17Ad-17, a
lost securityholder is:
- A securityholder to whom correspondence has been mailed to the
address contained in the master securityholder file and which correspondence has been
returned to the transfer agent as undeliverable; and
- The transfer agent has not received information concerning the
securityholder's new address.
A recordkeeping transfer agent, however, is allowed to re-send
undelivered correspondence to the lost securityholder within one month, in which case
the securityholder will be considered a lost securityholder, if the re-sent correspondence
is again returned as undeliverable. Recordkeeping transfer agents often use the
second mailing to test the possibility that the first return resulted from an error by the
postal service. Also, the transfer agent can attempt to obtain a current address by
requesting an address correction from the postal service. In the past, it has been
estimated that between 10 percent and 50 percent of second mailings were successful.
Recordkeeping transfer agents are required to conduct two database searches to find a lost securityholder's correct address. The two required database searches must be conducted without charge to the securityholder. The database search
must include one information database service. To qualify as an
information database service the following database service attributes are required:
- The database service contains addresses from the entire United
States;
- The database service contains the names of at least 50
percent of the
United States geographic areas;
- The database service contains the names of at least 50
percent of the
adult population of the United States;
- The database is indexed by taxpayer identification number or
name; and
- The database is updated at least four time a year.
However, any service or combination of services producing
results in locating lost securityholders comparable to the results produced by
database
services satisfying the above criteria, qualify as an information database service.
Consumer credit reporting agencies, credit bureaus, maintain
databases that satisfy the information database service requirements and are the most
likely information database service providers to be utilized by transfer agents.
Professional search firms may also satisfy the database requirements, and may employ more
extensive search techniques that can locate some securityholders that a credit bureau will
not locate. Professional search firms, however, usually charge the securityholder a
fee. A recordkeeping transfer agent may use a professional search firm that
satisfies the database requirements if the transfer agent pays the professional search
firm's fee, rather than passing the fee onto the securityholder. The cost of
database searches performed after the first two required searches can be passed onto the securityholder. So a recordkeeping transfer agent could use a professional search
firm for a third or subsequent search. A recordkeeping transfer agent is not
required to make a third search, only two are required.
The two required database searches must be conducted within
the following timeframes:
- Between three and twelve months of the securityholder becoming
a lost securityholder
- Between six and twelve months after the transfer agent's first
search
In the following cases, however, a recordkeeping transfer
agent is not required to search for lost securityholders:
- The transfer agent has received documentation of the
securityholder's death;
- The aggregate value of assets held in the securityholder's
account, including funds and securities held of record by the securityholder, is less than
$25; and
- The securityholder is not a natural person, for example, when
the lost securityholder is an estate. Securityholders which are not natural persons
are not easy to locate through the use of information databases services.
Note: The requirement to search for lost securityholders is not
limited to securityholders who receive dividend and interest payments. It also
applies, for example, to securityholders receiving only annual meeting materials, who in
the case that such materials are returned by the post office as undeliverable, become lost
securityholders under Rule 17Ad-17.
The funds and securities of lost securityholders may, after
the applicable statutory period, be subject to state unclaimed property and escheat laws,
and should be properly accounted for and controlled in order to ensure compliance
with applicable state laws.
Annual Meeting and Proxy Processing Services
Since recordkeeping transfer agents maintain complete and
accurate lists of the owner of record for each securities issue, the
transfer agent may be involved in
distributing corporate communications, such as the issuer's annual report and proxy
statements, as well as processing proxy votes. Annual meeting and proxy processing
services offered by transfer agents include:
- Compilation of record date listings of shareholders eligible to
vote;
- Broker search to determine the street name holders of the
issuer's stock;
SEC Regulation 240.14a-13, implementing provisions of the Shareholders Communication Act,
requires issuers to contact brokers, dealers, banks, and other entities that may hold
shares that are beneficially owned by other persons (i.e. street name holders) and, if
shares are beneficially owned by other persons, to determine the number of copies of proxy
materials, proxy statements, annual reports etc needed for distribution to beneficial
owners. The issuer is required to reimburse the brokers, dealers, banks and other
entities holding securities in street name for the cost of mailing or delivering the
materials to the beneficial owners of the issuer's stock. The issuer may opt to mail
annual meeting materials, proxies etc. to beneficial owners who agree, or do not object,
to disclosing their identities. Refer to the Shareholder
Communications Act and
related SEC regulations which are presented in greater detail in the Trust Examination
Manual.
- Fulfillment services for annual meeting materials, proxies etc.
As discussed above. once street name holding entities have been identified, the
issuer has the obligation to provide these materials for distribution via street name
holding entities to beneficial owners.
- Mailing services to registered holders. Registered
holders are listed directly on the master securityholder file of the issue, as opposed to
beneficial owners whose shares are registered in the street name of a broker, dealer, bank
or other entity.
- Tabulation services. The transfer agent receives votes
cast by shareholders, both from direct registrants and votes sent in by brokers, dealers
etc for beneficial owners, and tabulates the results.
Some larger transfer agents offer proxy solicitation services
in which the transfer agent assists the issuer in planning and organizing a proxy
solicitation campaign. Such services might include devising proxy vote
solicitation strategies; conducting a telephone campaign among registered holders and non-objecting
beneficial owners; soliciting banks, brokers, agents, institutions and large shareholding
individuals for votes; monitoring votes received to detect voting patterns among large
shareholders and institutions. A conflict of interest may be present when the transfer
agent both assists the issuer in a proxy solicitation and tabulates the proxies voted.
Transfer agents that provide annual meeting and proxy
processing services should implement appropriate policies, internal controls and
procedures to ensure the accurate and timely distribution of shareholder communications.
As noted previously, corporate communications returned as undeliverable by the post
office are subject to the SEC's lost securityholders rule, 17Ad-17.
When providing vote tabulation services, the transfer agent's internal controls and
procedures should provide for the adequate control and processing of proxies votes
received from direct registrants and street name holders returning votes cast by
beneficial owners of the issuer's stock. The tabulation of proxies should be
independent of all parties that have an interest in the outcome of the vote, and
procedures and internal controls should ensure an accurate tabulation of votes.
Tabulation of proxy votes should be independent of personnel providing proxy solicitation
services.
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