Industry’s “No-More-Paper” Drive Hits Stride in 2005; State Legislation Paves Way for Further Dematerialization
The financial services industry moved closer – a lot closer – in 2005 to its longstanding goal of “dematerialization” or eliminating paper, including paper certificates, from the securities processing cycle.
Over the past 12 months, for example, the number of certificates in DTCC’s vaults declined more than 12%, from 4 million in November 2004 to 3.5 million in November 2005, according to Kirk Matthews, DTCC product manager, Custody and Safekeeping.
The passage of landmark legislation updating state securities laws, the endorsement by major exchanges of electronic listing requirements, and the expansion of several DTCC programs that eliminate paper stock certificates and attachments all combined to make 2005 a year of significant accomplishments in the campaign to achieve greater elimination of paper in securities processing.
Delaware Law Change
Perhaps the most significant event in the campaign to dematerialize paper stock certificates by replacing them with electronic ownership records was Delaware’s decision in 2005 to update provisions of its corporate law that require the routine issuance of securities certificates. Under the new provisions, companies incorporated in Delaware no longer have to issue paper certificates for new shares, transfers or corporate actions.
“This was a major milestone in the national drive to eliminate paper stock certificates, because more than half of all publicly traded companies in the United States and almost 60% of the Fortune 500 are incorporated in Delaware,” said Jamie Balbo, DTCC managing director for Asset Services Product Management. “It will save investors and companies millions of dollars a year.”
Louisiana and Missouri also enacted similar legislation in 2005, leaving Arizona and Puerto Rico as the only jurisdictions that still require companies to issue paper stock certificates.
Many securities today – including corporate and municipal bonds, U.S. government securities, money-market instruments, futures, options and mutual funds – are issued and traded in a paperless, electronic format that allows for automated processing and safekeeping.
Paper stock certificates cost companies, investors, banks and brokers hundreds of millions of dollars each year to print, register, ship, examine, file and keep safe. The Securities Industry Association (SIA) estimates the annual cost of handling paper stock certificates to be $250 million or more.
Electronic ownership of securities is not only more economical, but also safer than holding physical certificates. Well over a million paper securities are reported lost, stolen or counterfeit each year, according to the Securities Information Center, which helps investors replace missing stock certificates.
Shortly after Delaware's law went into effect, a number of companies began issuing new equity shares only electronically. The list, which has grown to nearly 50 companies, includes some of the biggest names in the business world: Chevron Corporation, Federated Department Stores, Intel Corp., MetLife Inc., Microsoft Corp., Starbucks, United Parcel Service, and US Airways, according to Joe Trezza, DTCC vice president for Asset Services Product Management.
New Listing Requirement
Had the enactment of these state provisions been the only accomplishments in the campaign to eliminate paper certificates, 2005 would have been a banner year. But as the year was drawing to a close, several equally momentous events were taking place at the American Stock Exchange, New York Stock Exchange and Nasdaq Stock Market, where the governing bodies of these three organizations were discussing the possibility of making electronic stock ownership – through DTCC’s Direct Registration System (DRS) – a listing requirement for certain issues.
The number of DRS-eligible issues, which include corporate bonds and many other issues in addition to equities, surpassed the 1,000 milestone in 2005. But adoption as a listing requirement, followed by an expected Securities and Exchange Commission rule filing, would cause the number of DRS-eligible issues to skyrocket to 9,000 or 10,000.
DTCC continued to work with regulators and industry groups, including the SIA and the Securities Transfer Association, to eliminate certificate issuance for withdrawal by transfer (WT) processing.
In years past, when shares were sold, new certificates had to be issued to effect withdrawals by transfer. Today, the aim is to keep those shares that are already held in street name, or DRS, in electronic format. DTCC’s cooperative efforts with regulators and industry groups have begun to pay off.
“In recent months, requests for WTs in statement format climbed from 5% of all DRS-eligible WTs, which had been the norm for more than a year, to 17%,” said Trezza.
Another milestone was the introduction in the second half of 2005 of higher indemnity insurance coverage for transactions moving through the DRS Profile Modification process. Under the new program, transfer agents and others may opt for surety coverage of as much as $25 million per paperless transaction, thus easing processing constraints and reducing risk for all DRS users.
Restricted Securities Solution
While most types of equities are moving away from physical forms of ownership, one growing category remains paper-intensive. Restricted securities, which are used in executive compensation programs, private placements, and corporate mergers and reorganizations have become much more popular over the past few years.
One major reason is the change in accounting rules that require public companies to expense stock options on their balance sheets, thus lowering corporate profits. As a result, more companies are issuing restricted stock in place of stock options.
According to a recent analysis of proxy statements of 350 of the largest U.S. corporations by The Wall Street Journal and Mercer Human Resource Consulting, restricted securities as a percentage of total long-term incentive pay for chief executive officers (CEOs) nearly doubled over the past three years, rising from 12% in 2002 to 23% in 2004. A the same time, the use of stock options in the CEO pay mix plummeted, from 76% in 2003 to 57% in 2004.
To help participants streamline the process of restricted securities, DTCC introduced a new and more complete level of service within its Restricted Securities Family of Services. Called Total Processing Solution, the new service constitutes the top level in DTCC’s three-tiered Restricted Securities Family of Services, and it builds on the other two levels to provide a comprehensive service that lifts the “restricted legend” from restricted securities so that they may be traded.
Total Processing Solution is designed for firms with mid-to-high processing volumes and firms requiring a fully integrated restricted processing solution. It not only bundles together the options found in the Restricted Deposit Service and the Web Guide, but it also automatically supports the tracking of securities in the process of having their restrictions removed. At the same time, it maintains connections to other depository services, including Custody safekeeping. As a result, it offers additional functionality to support an end-to-end process to lift restrictions.
Other Programs to Eliminate Paper
In addition to these efforts to automate and streamline the flow of financial information, several other DTCC programs helped reduce the amount of paper associated with securities ownership:
- Paperless Legal Program: Working with industry members, DTCC expanded the Paperless Legal Program in 2005 to include 90% of the issues eligible for deposit at the depository. This program eliminates the cumbersome and costly handling of documentation for non-routine transfers, commonly referred to as legal transfers. Members of the Canadian Securities Transfer Association joined the program early in the fourth quarter. Looking ahead, DTCC plans to market the service to a number of large “issuer own” agents – companies that serve as their own transfer agents.
- Destruction of Non-transferable Certificates: DTCC’s depository subsidiary expanded its program of destroying non-transferable certificates – securities for which transfer services have not been available for at least six years. After shredding 13,000 certificates in 2004, the depository destroyed more than 75,000 in 2005. Most of these were equity certificates of companies that have become inactive or insolvent.
Participants have an incentive for seeing the certificates destroyed: they now face a surcharge of $5 per month for every non-transferable issue in DTC’s vault for which they have not relinquished their position. - Destruction of Paper Securities Registered in Street Name: In similar fashion, DTCC’s depository subsidiary continued its program of eliminating paper securities registered in street name by shredding more than 330,000 such certificates in 2005.
Reflecting the substantial decline in the use of paper certificates, in 2005 DTCC’s depository ended the Transfer Agent Drop Service that had provided firms outside New York City with a central location on Wall Street for depositing securities from banks, broker/dealers and shareholders – a vestige from the time when most securities were issued in physical form and transfer agents used messengers to deliver and pick up securities that had been traded. The depository continues to accept delivery of physical securities at its own New York City offices.
Another major thrust in 2005 was the “No More Paper” campaign to educate industry members and investors to the advantages of electronic stock ownership.
In addition to creating a Web site (www.dtcc.com/leadership/issues/nomorepaper/index.php) containing valuable industry and consumer information, DTCC “spread the word” by speaking at industry events, such as the SIA’s Annual Operations Conference, and by publishing educational articles in industry journals and consumer news media. @