May 2008

Amendment to DTC FAST rule does little to calm storm

In late February 2008, the SEC released DTC's amended proposed rule change ("the amendment") for comment with a March 20, 2008 submission deadline.

Both the Securities Transfer Association of Canada (STAC) and the Securities Transfer Association (STA) believe that the amendment is one-sided - protecting DTC's business interests at the expense of transfer agents, and imposing additional costs and processes while prohibiting the transfer agents from charging the DTC for related fees. Instead, it is anticipated that such fees will be passed through transfer agents to their issuer clients. These costs and processes include the following:

• Insurance requirements - The amendment retains the substantial minimum coverage amounts of the previous version, levels that are not justified by DTC with any actual loss history or potential risk. For some agents, the minimum coverage amounts may exceed the value of DTC's securities on their books. While the amendment allows DTC to waive these levels, any such waiver would be at DTC's sole discretion.
• Physical balance certificate requirements - The amendment requires transfer agents to maintain and update a physical balance certificate for each FAST position, but it does not allow the transfer agent to charge DTC for its safekeeping. This adds unnecessary and costly work while increasing the chances that the balance certificate could be lost or destroyed. A book-entry position would provide DTC the same ownership rights without the costs and risks of safekeeping the paper.
• Audit requirements - The amendment requires that transfer agents provide an annual report from an external certified public accountant, attesting to the soundness of the transfer agent’s controls (in the form of an SSAE-10 or SAS-70 report) relating to FAST. These reports are in addition to the independent accountant’s audit of internal controls already required under Rule 17Ad-13 of the Securities Exchange Act of 1934. In the view of STAC, these additional reports are unnecessary and add substantial incremental expenses.
• Standard of care - The amendment absolves DTC from liability "for the acts or omissions of FAST Agents or other third parties, unless caused directly by DTC's gross negligence, wilful misconduct, or violation of Federal securities laws for which there is a private right of action." This means that if a broker-dealer or registered shareholder were to suffer a loss caused by an error at DTC in its interactions with a transfer agent, DTC would not be responsible.

As well as adding costs and obligations for transfer agents that solely benefit and protect DTC, the amendment also limits DTC's fee compensation exposure. STA, in its comment letter, strongly argued that it is more appropriate for DTC to pay for its own requirements than to pass them on to transfer agents and, ultimately, to issuers: "Based on the language of the Proposal, the DTC apparently expects transfer agents to provide such services (as well as other enhanced services that the DTC may mandate from time to time in its sole discretion) without compensation. This is clearly not acceptable to transfer agents and would not be allowed in any other commercial relationship. If one commercial party requests another to provide services to it, the service provider may decline to do so unless it receives acceptable compensation. If the DTC refuses to pay transfer agents for services rendered, transfer agents should be entitled to refuse to provide such services without the threat that the DTC could throw them out of FAST (thereby threatening their very existence)." STA continued, "The DTC may argue that transfer agents should simply pass these costs along to issuers, and indirectly their shareholders, but the STA maintains that neither of these parties should have to bear the cost of services provided to DTC. The DTC should not be permitted to require more and more from transfer agents without the discipline of bearing the cost for its demands."

SEC is now considering all comments received. Through its involvement in STAC and STA, CIBC Mellon will continue to monitor ongoing developments on this matter and will provide you with updates as more information becomes available.

By William Speirs, assistant vice president, product management stock transfer 

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Inform® is provided for general information purposes only and CIBC Mellon Trust Company, CIBC Mellon Global Securities Services Company, CIBC, The Bank of New York Mellon Corporation and their affiliates make no representations or warranties as to its accuracy or completeness. Readers should be aware the content of this publication should not be regarded as legal, tax, accounting, investment, financial or other professional advice nor is it intended for such use.