On March 18, 2011, the Securities and Exchange Commission proposed a new rule (the “Proposed Rule”) extending to brokers and dealers the requirement — currently applicable only to transfer agents — to search for lost securityholders. The rule also adds a new requirement that paying agents, including broker-dealers and investment advisers, send written notification to missing securityholders concerning checks that have not yet been negotiated after a specified period of time.
The Proposed Rule implements Section 929W of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which directs the SEC to revise Exchange Act Rule 17Ad-17 (“Transfer Agents’ Obligation to Search for Lost Securityholders”). The Proposed Rule also imposes related recordkeeping requirements on broker-dealers and other entities subject to the rule.
The Proposed Rule will be published in the Federal Register for a 45-day comment period. Firms would be required to comply with the rule one year after its adoption by the SEC. A brief summary of each of the material elements of the Proposed Rule is set forth below:
Search for Lost Securityholders
Under current Exchange Act Rule 17Ad-17, recordkeeping transfer agents must conduct specified database searches for “lost securityholders,” which generally means a securityholder for whom mail is returned as undeliverable.1 The Proposed Rule would apply these same database search requirements to brokers or dealers. While the text of the Proposed Rule refers in its first sentence to “each broker or dealer that holds customer security accounts,” the release states that the Proposed Rule would apply to all brokers or dealers. The release then expresses the SEC’s “preliminary belief” that as a “practical matter” only clearing brokers (as opposed to introducing firms) would have obligations under the amended rule. We hope that the SEC will clarify this ambiguity during the rulemaking process.
Brokers or dealers would be required to conduct two database searches in an effort to find correct addresses for lost securityholders: a first search between three and twelve months of a security holder becoming a lost securityholder2 and a second search between six and twelve months after the first search. The searches must be conducted using the securityholder’s taxpayer identification number or name, must use at least one “information database service” as defined in the rule and must be conducted without charge to the lost securityholder.3 These searches would not be required if the firm receives documentation that the securityholder is deceased, the value of assets in the securityholder’s account is less than $25 or the securityholder is not a natural person.4
Written Notice Regarding Non-Negotiated Checks
The Proposed Rule would add to Rule 17Ad-17 a new requirement that “paying agents,” defined broadly to include a broker, dealer, investment adviser, or any other entity that “accepts payments from the issuer of a security and distributes the payments to the holder of the security,”5 send a written notice to a “missing securityholder.” A missing securityholder is one who does not negotiate a check before the earlier of the paying agent’s sending the next regularly scheduled check or the elapsing of six months.
The written notice must state that the securityholder has been sent a check that has not yet been negotiated, and must be provided within seven months after the sending of the not-yet-negotiated check. The Proposed Rule specifically permits paying agents to send the written notice along with a check or other mailing. The notification requirement does not apply where the value of the non-negotiated check is less than $25.
In contrast to the definition of lost securityholder, “missing” securityholder status does not depend on mail being returned undeliverable but would include a securityholder with a valid current address who has not cashed a dividend check. A securityholder can, however, be both a lost and a missing securityholder at the same time. In such cases, firms might choose to conduct the first lost securityholder database search before the missing securityholder notice would otherwise be required.6
Finally, the Proposed Rule provides that the seven-month notification requirement imposed on paying agents has no effect on state escheatment laws. Accordingly, this requirement would not, by itself, shorten or extend the time periods used in state escheatment statutes to determine account dormancy.
Recordkeeping
Broker-dealers and other firms subject to the Proposed Rule would be required to maintain records to demonstrate compliance with the rule. Those records, which must be maintained for at least three years, the first year in an easily accessible place, must include written procedures describing the firm’s methodology for complying with the rule.
Conclusion
Broker-dealers, especially clearing or self-clearing firms, should consider the burdens or any other concerns posed by the Proposed Rule and whether they wish to provide comments to the SEC on those issues.
Please direct questions to any of the listed lawyers or to any other Bingham lawyer with whom you ordinarily work on related matters.
Matthew C. Applebaum, Partner, Broker-Dealer
matt.applebaum@bingham.com, 617.951.8488
David C. Boch, Partner, Broker-Dealer
david.boch@bingham.com, 617.951.8485
Amy Kroll, Partner, Broker-Dealer Group
amy.kroll@bingham.com, 202.373.6118
Roger P. Joseph, Practice Group Leader, Investment Management; Co-chair, Financial Services Area
roger.joseph@bingham.com, 617.951.8247
Edwin E. Smith, Partner, Financial Restructuring; Co-chair, Financial Services Area
edwin.smith@bingham.com, 617.951.8615
Tim Burke, Practice Group Leader, Broker-Dealer Group; Co-chair, Financial Services Area
timothy.burke@bingham.com, 617.951.8620
1 “Lost securityholder” under current Rule 17Ad-17(b)(2) means a securityholder “(i) To whom an item of correspondence that was sent to the securityholder at the address contained in the transfer agent's master securityholder file has been returned as undeliverable; provided, however, that if such item is resent within one month to the lost securityholder, the transfer agent may deem the securityholder to be a lost securityholder as of the day the resent item is returned as undeliverable; and (ii) for whom the transfer agent has not received information regarding the securityholder’s new address.” The Proposed Rule amends this definition to make it applicable to broker-dealers.
2 The terms “securityholder” and “lost securityholder” would likely include former customers under certain circumstances, such as when the firm mails the former customer a tax form or final account statement which is returned as undeliverable.
3 In 2000, three years after the adoption of Rule 17Ad-17, the Commission reported “anecdotal evidence” that current addresses were being found for “up to 60% of the lost accounts” for which database searches were conducted. Testimony Concerning Reuniting Securityholders With Their Investments Before the House Subcommittee on Finance and Hazardous Materials (October 4, 2000)
4 These are the same search requirements currently applicable to transfer agents. See Exchange Act Rule 17Ad-17(a)(1)-(3).
5 “Paying agent” would also include issuers, transfer agents, indenture trustees and custodians. In view of the definition of “paying agent” and the term “securityholder,” it appears that the written notice requirement would not apply with respect to non-negotiated checks that are not “payments from the issuer of a security.”
6 The term “lost securityholder” was adopted as part of Rule 17Ad-17 in 1997, while the term “missing securityholder” is used in the Dodd Frank Act provisions directing the SEC to adopt the paying agent requirements. The Proposed Rule retains the term “lost securityholder” in the existing provisions and uses the new term “missing securityholder” in the paying agent provisions. The rule proposal requests comment on whether this will be a cause of confusion. As noted above, however, they are different concepts.
This article was originally published by Bingham McCutchen LLP.