SEC Requires DTC Fairness Procedures

Securities Lawyer 101 Blog

On September 24, 2009, the Securities and Exchange Commission (“SEC”) filed a complaint in the United States District Court for the Middle District of Florida alleging that International Power Group (“IPWG”) had issued shares of common stock in violation of the registration requirements of Section 5 of the Securities Act of 1933.  In the Matter of IPWG,  the Securities and Exchange Commission (“SEC”) reviewed actions taken by Depository Trust Company (“DTC”), and determined that DTC Fairness Procedures were not provided to IPWG and its actions were subject to SEC review.

The SEC alleged that the recipients of the illegally issued shares sold them publicly when no exemption from registration was available.  On September 30, 2009,  DTC issued a notice to its participants notifying them that DTC suspended IPWG’s common stock as an “Eligible Security” and as such, IPWG’s stock could no longer be traded electronically.  According to the SEC no DTC Fairness Procedures were provided.

Upon learning of DTC’s notice, IPWG requested DTC provide a hearing on its decision based upon DTC Rule 22(f)  which provides an opportunity for “Interested Persons” to be heard on any determination by DTC that any security shall cease to be an Eligible Security.

DTC denied IPWG’s request based upon its determination that IPWG was not an Interested Person. Based on DTC’s determination that IPWG was not an interested person, DTC denied IPWG’s request.  The SEC disagreed and determined that because IPWG securities traded using DTC’s services, it is thus, an “Interested Person” under DTC Rule 22.

The SEC stated, “Any suspension by DTC of clearance and settlement services with respect to an issuer’s securities means that all trades in that issuer’s stock would require the physical transfer of stock certificates, which affects the issuer of the suspended securities directly, because of the potential impact on liquidity and price for the issuer’s stock due to the difficulties and uncertainties inherent in physical transfer of stock certificates.”

The SEC found that IPWG is a “person” and therefore is entitled to “fair procedures” under the Securities Exchange Act Section 17A(b)(3)(H) in connection with DTC’s suspension of clearance and settlement services.  The SEC also determined DTC’s suspension determination is subject to SEC review under Exchange Act Section 19(f).

The SEC concluded that DTC’s notice to its participants that suspended services of IPWG’s common stock failed to meet the statutory requirements because: (1) the notice was not sent to IPWG itself, but rather to DTC’s participants; and (2) merely points to the existence of the SEC’s complaint without any explanation of why the existence of the complaint warrants the suspension of clearance and settlement services with respect to IPWG’s securities.

The SEC determined that IPWG is entitled to SEC review of DTC’s suspension of clearance and settlement services with respect to its common shares, and that DTC did not provide IPWG with adequate fair procedure in connection with the suspension of services. In accordance with these determinations, the SEC remanded the matter to DTC for development of the record and for further consideration, pursuant to procedures that accord with the fairness requirements of the Securities Exchange Act.

With respect to DTC’s suspension of services to IPWG, it should be noted that the SEC did not make a determination that DTC’s suspension of services to IPWG was not warranted.  The SEC merely determined that DTC did not follow required fairness procedures.  While DTC must follow adequate fairness procedures, there is no assurance that it will impact DTC’s criteria with respect to suspending its services. Additionally, even with a fairness hearing there is no assurance that DTC will resume its services with respect to  IPWG’s securities.  DTC continues to have considerable discretion in deciding whether or not to provide its services to issuers.  A current list of DTC Participants can be found on the DTC website.

Please visit our blog post below for more information about DTC: