Dematerialization and DRS: An Industry Update

By Edward C. Kelleher

"It's been a 30-year discussion." That's how Susan Petersen, special counsel, the Securities and Exchange Commission (SEC), characterized the move from the immobilization to the dematerialization of stock certificates in the securities industry at a recent seminar that JPMorgan Chase sponsored on this topic.

Held in January, the seminar attracted more than 500 professionals to the JPMorgan Chase auditorium in lower Manhattan - in person, on the telephone and online - who wanted to know about the latest developments in dematerialization and DTCC's Direct Registration System (DRS).

The SEC role
Petersen, who asked for feedback from the industry on dematerialization issues, spoke about the SEC's role in immobilization beginning in 1970s and over the next 30 years, including its 2004 concept paper that discussed new DRS initiatives for the industry.

Petersen prefaced her remarks with some historical perspective, noting that the United States "had a long tradition of certificates…they were first used to finance the American Revolution." At the same time, she added that the government and industry had long since recognized that paper certificates were "inefficient" and increased "risk."

Lawrence Morillo, managing director at Pershing LLC and chairman of the Securities Industry and Financial Markets Association's (SIFMA) Operations Legal and Regulatory Committee, pointed out the annual cost to the industry of issuing paper certificates. This now totals approximately $250 million to print and issue certificates, which includes $49 million annually to replace lost or stolen certificates. The additional cost to the industry from January through November 2006 was $8.6 million. Morillo said his firm had defaulted to DRS for eligible securities and recommended that other firms do the same as soon as possible.

DRS news
The update on DRS, which enables investors to register ownership of their shares electronically with either the issuing company or its transfer agents, was provided by Joseph Trezza, DTCC vice president, Asset Services.

DRS became a listing requirement for all major exchanges, including the New York Stock Exchange, NYSE Arca, Nasdaq and the American Stock Exchange, for new securities coming to market on or after January 1, 2007. All other securities must be DRS-eligible by January 1, 2008. Regional exchanges including Boston, Chicago and Philadelphia also have adopted the new listing requirement.

The number of issues expected to become DRS-eligible by 2008 will increase by about 9,000 this year, compared with 1,230 issues currently eligible. The number of new transfer agents that will join the DRS program is about 250, Trezza said, adding that these agents will need to become FAST agents, as well. (FAST is DTCC's Fast Automated Securities Transfer service that enables agents to provide electronic custody, transfer, deposit and withdrawal services.) Trezza urged underwriters to make sure their transfer agents are also FAST agents.

Possible delisting
If an issue is not DRS-eligible by the required date, DTCC is obliged to alert the exchange or market, said Trezza. "Penalties could range from a simple reprimand to a delisting of the issue."

Trezza pointed out that withdrawals-by-transfers (WTs) of securities from The Depository Trust Company, a DTCC subsidiary, have also been moving away from physical certificate withdrawals to DRS withdrawals. (Under DRS, the investor receives a statement of ownership rather than the physical certificate.)

In the first 11 months of 2006, 77% of the 19,774 WTs were in physical certificates versus 23% in DRS. This is more than double the DRS WTs in 2005, when 11% of 23,941 WTs were DRS transfers versus 89% in physical certificates. (The WT statistics are monthly averages.)

In 2007, the average volume of WTs in certificates is expected to drop by 22%, while the number of DRS WTs is expected to jump 50% over 2006 levels.

Cost also plays a role in WTs, Trezza said. For an average month in 2006, the cost of withdrawing a physical certificate came to $53.00; the cost of a DRS statement averaged just $5.92. Using these figures, he estimated that in 2006, the additional annual costs for WTs of physical certificates was $8.6 million.

DRS issues
Katie Sevcik, senior vice president and manager of operations at Wells Fargo Shareowner Services, and Kevin McCosker, vice president, Pershing LLC, provided an update on a list of projects the cross-industry DRS Working Sub-Committee has been dealing with. These include:

• Eligibility for the Issuer/CUSIP, the transfer agent and the broker/dealer.
• Information provided on DRS statements, DRS transaction advice and DRIP (Dividend Reinvestment Plan) statements.
• Details on moving shares from a DRS account to a broker or bank custodian and vice versa.

A question-and-answer session followed with Armando DiBiase, vice president, The Bank of New York, Donna Fremgen, vice president, Merrill Lynch, and William Robertson, vice president, JPMorgan Chase joining the other panelists to respond to questions. @

[To see the PowerPoint presentation of the dematerialization seminar, including a "frequently-asked-questions section," visit DTCC's No More Paper Web site at www.dtcc.com/nomorepaper, or www.sia.com/stp/pdf/DematPresRT011107.pdf.]