On December 22, 2015, the Securities and Exchange Commission took the first step in overhauling SEC regulation of transfer agents, the little-discussed but critical intermediaries involved in the prompt clearance and settlement of almost all U.S. securities. After many years in which other types of financial market intermediaries took center stage on the SEC’s rulemaking agenda, the Commission issued an advance notice of proposed rulemaking (ANPR) for new requirements for transfer agents, together with a concept release requesting public comment on the SEC’s broader review of transfer agent regulation. The ANPR and the concept release make clear that the SEC intends to modernize the rules applicable to transfer agents, with the SEC acknowledging that its transfer agent rules, first adopted in 1977, are now out of step with the actual practices of transfer agents and the structure of today’s securities markets. Among the areas the SEC identifies as ripe for rulemaking are a transfer agent’s role with respect to unclaimed property, and transfer agent standards for protecting data from cyber attacks.
The issuance of the ANPR and the concept release follows sustained advocacy by SEC commissioners to improve and modernize the transfer agent regulatory regime. In a public statement regarding the issuance of the ANPR and the concept release, Commissioner Luis A. Aguilar noted the actions he and fellow commissioners have taken over the years to advance this effort, and also noted the unanimous support among SEC commissioners to tackle transfer agent regulation. In his statement, Commissioner Aguilar urges the SEC to move as quickly as possible toward proposing a set of carefully considered transfer agent rules and amendments.
Advance Notice of Proposed Rulemaking
The SEC release begins with a hundred-page history of transfer agent regulation in the United States, and then moves quickly to identify specific areas in which the SEC intends to propose new or amended rules. In this regard, the ANPR discusses eight new or amended rules the SEC intends to propose. The new or amended rules would:
- Expand the scope of information collected by the SEC transfer agent forms (Forms TA-1 and TA-2) and capture all such information in a structured, electronic format to enhance aggregation, comparison, and analysis of data;
- Require that any arrangement for transfer agent services between a registered transfer agent and an issuer be set forth in a written agreement that addresses topics such as the transfer agent services to be provided, the fee schedule, and requirements for the handing over of transfer agent records to a successor transfer agent;
- Enhance transfer agents’ requirements for the safeguarding of issuer and securityholder funds and securities;
- Apply an anti-fraud provision to specific activities of transfer agents;
- Require transfer agents to establish business continuity and disaster recovery plans;
- Require transfer agents to establish basic procedures regarding the use of information technology, including methods of safeguarding personally identifiable information;
- Revise the recordkeeping requirements to more fully capture the scope of a transfer agent’s business activities; and
- Conform and update various terms and definitions to reflect modern systems and usage, as well as eliminating obsolete rules, such as those addressing Y2K issues.
Rulemaking - Areas to Watch
- Unclaimed Property and Safeguarding Funds and Securities. New or amended rules are likely to address a transfer agent’s responsibility to safeguard securities and funds, including mutual fund redemption payments and other moneys owed to beneficial owners of securities, including property that ultimately may be escheated to a state. The SEC estimates (based on March 31, 2015, data) that approximately one-third of all transfer agents have possession of funds or securities for some period of time, ranging from a few days to several years. The SEC states that it intends to propose new rules or rule amendments that will, among other things, require transfer agents to comply with “specific minimum best practice requirements,” such as: (1) maintaining secure vaults; (2) installing theft and fire alarms; (3) developing specific written procedures for access and control over securityholder accounts and information; (4) enhanced recordkeeping requirements; and (5) specific unclaimed property procedures (the release states that the SEC intends to propose amendments to Form TA-2 requiring transfer agents to disclose the number and/or dollar value of residual and unclaimed funds but does not otherwise discuss what those procedures might entail or their relationship to state law in the area). The release, however, does request comment on industry best practices for safeguarding residual or unclaimed funds and securities remaining in the transfer agent’s possession or control post-payment but prior to the successful distribution to securityholders or escheatment to a state or territory.
- Conflicts of Interest. Importantly, the ANPR signals that the SEC intends to require transfer agents for the first time to publicly disclose (in Form TA-1 and possibly TA-2) all direct and indirect conflicts of interest, such as may result through common ownership of a transfer agent and an issuer, or a transfer agent and a broker-dealer, as well as disclose the specific services the transfer agent would be providing to the issuer, regardless of the nature of those services. The release seems to assume that disclosure rules of this type would bring greater transparency to the many activities performed by transfer agents.
- Annual Financial Reports. The SEC also intends to propose new rules that would subject transfer agents to financial reporting requirements that currently apply to broker-dealers, e.g., reporting annually to the SEC on a transfer agent’s financial performance, including a statement of financial condition, audited by an independent public accountant, and maintaining issuer and securityholder funds in special segregated bank accounts – a concept designed to focus on the risk profile of individual transfer agents and bring greater scrutiny to their financial position.
- Chief Compliance Officers, Policies and Procedures. The SEC states that it intends to adopt a requirement for transfer agents to appoint a chief compliance officer (CCO), and identify that person in public filings submitted to the SEC. The release specifically asks for comment on whether the CCO should be required to file an annual compliance report with the SEC, and whether the SEC should require certain employees of registered transfer agents to register with the SEC. The release also states that the SEC intends to propose a new rule requiring each registered transfer agent to adopt policies and procedures reasonably designed to achieve compliance with applicable securities laws and the rules and regulations thereunder, and requests comment on whether the SEC should adopt an email retention rule for transfer agents similar to the rule for broker-dealers.
- Cybersecurity. Citing what it believes is a threat to the ownership interests of securityholders and the possibility that trading in the United States could be impaired, the SEC states in the release that it intends to propose new or amended rules requiring transfer agents: to maintain business continuity plans; and to adopt procedures governing the use of information technology, including safeguards to protect the release of personally identifiable information and procedures that cover a transfer agent’s electronic operations. Among other questions, the SEC asks for comment on whether it should impose specific safeguarding, recordkeeping, or other requirements on registered transfer agents and other entities registered or required to be registered with the SEC that “possess or control securityholder and account information (electronic or otherwise).” The SEC also asks for comment on how often transfer agents review operations and compliance policies and procedures related to cybersecurity and in this context, whether transfer agents are utilizing third-party vendors and if so, how transfer agents conduct oversight of such vendors.
- Restricted Securities. The SEC also indicates in the ANPR that it is paying close attention to the role transfer agents play in connection with the resale of restricted securities (i.e., removing restrictive legends/notations from/with respect to such securities) which permits them to trade in a wider market and, owing to its concerns with fraud in that market, intends to propose new rules designed to make illegal distributions of those securities more difficult.
In addition to identifying the specific rulemaking objectives noted above, the SEC release discusses and requests comment on a number of additional transfer agent issues that primarily arise from the diverse array of transfer agent functions and services that have developed over time. Transfer agent issues covered in the Concept Release include:
- Differences between transfer agent recordkeeping for registered securityholders and bank and broker-dealer recordkeeping for beneficial owners, and specifically whether banks and broker-dealers engaging in such recordkeeping should be required to comply with certain transfer agent rules; in this regard, the Concept Release points out that broker-dealers, banks and other intermediaries may actually provide a greater level of recordkeeping and transfer services to beneficial owners than transfer agents do, and queries whether such entities should be subject to the SEC’s transfer agent rules;
- The processing of book-entry securities by transfer agents, and specifically possible amendments to the transfer agent rules to address the applicability of such rules to uncertificated or book-entry securities such as mutual funds;
- Characteristics of and issues associated with transfer agents to mutual funds and other registered investment companies, and whether new or amended rules governing transfer agents’ services and activities with respect to such instruments could be appropriate;
- Possible new or amended rules to address transfer agents’ likely involvement in certain crowdfunding offerings;
- Services provided by transfer agents and other entities that act as “third party administrators” for issuer-sponsored investment plans, and specifically whether new rules may be appropriate to bring greater clarity, consistency, and regulatory certainty to entities that act in such a capacity; and
- Issues associated with outside entities engaged by transfer agents to perform certain services, and transfer agents that do business or are located outside of the United States.
Concept Release - Areas to Watch
- Regulation of Third Party Administrators and Other Intermediaries. As noted above, the release notes that in addition to transfer agents, banks and broker-dealers may provide what are essentially transfer agent services to the beneficial owners of securities, and that, in addition, “some third party administrators and other intermediaries who provide recordkeeping, administrative, and other services for retirement and issuer plans may not be regulated directly at all by any federal financial regulator.” Although the release does not outline what type of rulemaking the SEC may be considering in response to its observations in this regard, commenters are asked to opine on whether there are competitive or other differences among these various types of service providers that warrant different types of regulation. The release also notes that some of the entities operating in this space may have broker-dealer registration issues because they perform functions, such as netting buy and sell orders, which require broker-dealer registration.
- Mutual Fund Transfer Agents. Unlike transfer agents for operating company issuers, mutual fund transfer agents are currently exempt from certain of the SEC transfer agent rules, including certain recordkeeping rules, and in the SEC’s view, may perform functions that are intrinsically more complex than those performed by operating company transfer agents. In view of these and other factors, the SEC believes it is now appropriate to examine the regulation of transfer agents that provide services to investment companies, including open-end funds, closed-end funds, UITs, and ETFs. As part of this examination, the SEC: (1) requests comment on whether it should address specific issues related to mutual fund transfer agents and transfer agents that service other registered investment companies; (2) requests information regarding how mutual fund transfer agents are compensated; and (3) asks for comment on whether the SEC should propose rules specific to “as of” pricing and the use of sub-transfer agents.
There is a 60-day public comment period for both the ANPR and the Concept Release. Comments must be received by the SEC by February 29, 2016. We expect significant interest in the release, in part because it solicits comment on such a broad range of topics, many of which impact the daily operations of issuers, broker-dealers, banks, mutual funds, and retirement plan platform providers, in addition to transfer agents. In all, the release poses 170 questions on which the SEC solicits feedback.