On February 15, 2023, the SEC adopted final rules shortening the standard settlement cycle from two business days (T+2) to one business day (T+1). A shorter settlement cycle will reduce the credit, market and liquidity risks in securities transactions. The SEC previously shorted the standard cycle from three days (T+3) to T+2 in 2017 (see HERE) and at that time, and in speeches and rule making agendas since then, has consistently indicated efforts to move to T+1.
In addition to shortening the standard settlement cycle, the new rules also shorten the standard settlement cycle for firm commitment offerings priced after 4:30 p.m. from four business days (T+4) to T+2. However, the rules do allow for underwriters and issuers to agree to an alternative settlement date, which is helpful in completing the numerous closing documents and processing steps that occur between the pricing and closing of deals.
The final rules will improve the processing of institutional trades by requiring a broker-dealer to either enter into written agreements, or establish, maintain, and enforce written policies and procedures that are reasonably designed to ensure the completion of allocations, confirmations, and affirmations as soon as technologically practicable and no later than the end of trade date. The final rules also require registered investment advisers to make and keep records of the allocations, confirmations, and affirmations for certain securities transactions. Further, the final rules add a new requirement to facilitate straight-through processing, which applies to certain types of clearing agencies that provide central matching services.
The compliance date for the new rules is May 28, 2024, the first business day following the Memorial Day weekend.
All securities trades involve a legally binding contract. In general, the “clearing” of those trades involves implementing the terms of the contract, including ensuring processing to the correct buyer and seller in the correct security and correct amount and at the correct price and date. This process is effectuated electronically.
“Settlement” refers to the fulfillment of the contract through the exchanging of funds and delivery of the securities. In 1993, Exchange Act Rule 15c6-1 was adopted, requiring that settlement occur three business days after the trade date (T+3). Delivery occurs electronically by making an adjusting book entry as to entitlement. One brokerage account is debited, and another is credited at the DTC level and a corresponding entry is made at each brokerage firm involved in the transaction. DTC only tracks the securities entitlement of its participating members, while the individual brokerage firms track the holdings in their customer accounts. Technology, of course, plays an important role in the process and ability to efficiently manage settlements.
There may be two brokerage firms between DTC and the customer account holder. Brokerage firms that are direct members with DTC are referred to as “clearing brokers.” Many brokerage firms make arrangements with these DTC members (clearing brokers) to clear the securities on their behalf. Those firms are referred to as “introducing brokers.” A clearing broker will directly route an order through the national exchange or OTC Market, whereas an introducing broker will route the order to a clearing broker, who then routes the order through the exchange or OTC Market.
The Dodd-Frank Act added a definition of, and responsibilities associated with, a “financial market utility” or FMU. Clearing brokers are FMU’s. FMU’s provide the actual functions associated with clearing trades through the DTC system. As part of that process, a division of DTC, the National Securities Clearing Corporation (“NSCC”), becomes the buyer and seller of each contract, netting out and settling all brokerage transactions each day, making one adjusting entry per day. The net entry debits or credits the brokerage firm’s account as necessary. When one of the counterparties in the process does not fulfill its settlement obligations by delivering the securities, there is a “failure to deliver.” Overall, failures to deliver are less than 1% of all transactions.
Likewise, a cash account is maintained for each brokerage firm, which is netted and debited and/or credited each day. These accounts can be in the billions. Clearing firms can either settle each day or carry their open account forward until the next business day. Because all transactions are netted out, 99% of all trade obligations do not require the exchange of money, which helps reduce some risk. NSCC’s role in this process is referred to as a central counterparty or CCP. This process is continuous.
Looking at the process from the top down, the CCP carries the risk that the clearing firm (or FMU) will not have the financial resources to perform its obligations. In turn, the clearing firms have risks from their customers, including introducing brokers, who in turn ultimately have risks from the individual account holders. The risks are compounded by changing values of the securities being traded, during the settlement process. The faster a trade settles, the lower the cumulative risk at each level of the process.
This is a very simplified high-level description of the process. Technically, the roles of DTC and its subsidiaries, CEDE and NSCC, as well as clearing agencies and introducing brokers involve a complex set of regulations, with different definitions, obligations and roles for the different hats the entities wear depending on the type of security being traded (stock, bond, etc.), how the security is owned (registered or beneficial), the form the security takes (paper or electronic), the market or exchange traded on (OTC Markets, NASDAQ…) and the entities and institutions involved (retail or institutional). For more on the U.S. settlement and clearing process, see HERE and HERE.
Exchange Act Rule 15c6-1
Exchange Act Rule 15c6-1(a) prohibits a broker-dealer from effecting or entering into a contract for the purchase or sale of a security, subject to certain exemptions, that provides for the payment of the funds or delivery of the securities later than the second business day after the contract (i.e., trade) date unless expressly agreed upon by both parties at the time of the transaction. The rule amendment shortens this time period to one business day.
Rule 15c-1(a) and (b) exempts certain securities including government and municipal securities, insurance products, commercial paper, limited partnership units that are not listed on an exchange or automated quotations system, and sales in a firm commitment underwritten offering that are priced after market close. The new rule amendments add security-based swaps to the exemption in paragraph (b). Subject to the exceptions enumerated in paragraphs (a) and (b) of the rule, the prohibition in paragraph (a) of Rule 15c6-1 applies to all securities.
The SEC is also amending Rule 15c-1(c) to shorten the settlement cycle for firm commitment offerings for securities that are priced after 4:30 p.m. ET to T+2, unless otherwise expressly agreed to by the parties at the time of the transaction. Previously, firm commitment offerings could rely on an extended T+4 settlement cycle.
Exchange Act Rule 15c-2 – Same Day Affirmation
The SEC has added Rule 15c6-2 to require that, where parties have agreed to engage in a securities transaction that is the subject of Rule 15c-1, with a relevant party (other than for exempted securities) the broker or dealer must have entered into a written agreement with the relevant party that requires the allocation, confirmation, affirmation, or any combination thereof, be completed as soon as technologically practicable and no later than the end of the day on trade date to achieve settlement in compliance with Rule 15c6-1(a).
This requirement can be complied with by establishing, maintaining and enforcing written policies and procedures reasonably designed to ensure the completion of the allocation, confirmation, affirmation, or any combination thereof, for the transaction as soon as technologically practicable and no later than the end of the day on trade date in such form as necessary to achieve settlement of the transaction.
New Rule 15c-2(b) sets forth the elements that such policies and procedures should include, to wit, that policies and procedures be reasonably designed to: (i) identify and describe any technology systems, operations, and processes that the broker-dealer uses to coordinate with other relevant parties, including investment advisers and custodians, to ensure completion of the allocation, confirmation, or affirmation process for the transaction; (ii) set target time frames on trade date for completing the allocation, confirmation, and affirmation for the transaction; (iii) describe the procedures that the broker-dealer will follow to ensure the prompt communication of trade information, investigate any discrepancies in trade information, and adjust trade information to help ensure that the allocation, confirmation, and affirmation can be completed by the target time frames on trade date; (iv) describe how the broker-dealer plans to identify and address delays if another party, including an investment adviser or a custodian, is not promptly completing the allocation or affirmation for the transaction, or if the broker-dealer experiences delays in promptly completing the confirmation; and (v) to measure, monitor, and document the rates of allocations, confirmations, and affirmations completed within the target time frames established under paragraph (b)(2) of the rule, as well as the rates of allocations, confirmations, and affirmations completed as soon as technologically practicable and no later than the end of trade date.
The rule does not define the terms “allocation,” “confirmation,” “affirmation,” and “end of the day on trade date,” as the SEC believes they are widely used and understood in the industry.
Exchange Act Rule 17Ad-27
The SEC has also established new Rule 17Ad-27 to establish new requirements for certain clearing agents acting as central matching service providers (CMSPs). The new rule requires: (i) a clearing agency that provides central matching services for transactions involving broker-dealers and their customers (i.e., CMSPs) to establish, implement, maintain and enforce policies and procedures reasonably designed to facilitate STP for transactions involving broker-dealers and their customers; and (ii) to submit certain reports to the SEC every twelve months.
The reports must describe: (i) the CMSP’s current policies and procedures for facilitating straight-through processing; (ii) the CMSP’s progress in facilitating straight-through processing during the twelve-month period covered by the report; and (iii) the steps the CMSP intends to take to facilitate and promote STP during the twelve-month period following the period covered by the report.
Laura Anthony, Esq.
Anthony L.G., PLLC
A Corporate Law Firm
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including siting on the board of directors of the American Red Cross for Palm Beach and Martin Counties, and providing financial support to the Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others.
Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.
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