Why The Rules That Apply To Transfer Agents Are Passé

Transfer Agents Attorney
On December 17, 2014, Luis A. Aguilar released a public statement about why the rules surrounding transfer agents should be updated and modernized. [1]  Unfortunately, the rules governing transfer agents were adopted in the 70’s and 80’s and have not kept up with technological advances in the industry.  In the informative release, Commissioner Aguilar explains the important role that transfer agents play in the public markets including as a gatekeeper to securities violations.  

The statement touched on  the important topic of cyber security and corporate hijackings by fraudsters including corporate hijackings which have had a devastating effect on shareholders and investors.  The reports states, “Cyber-threats facing transfer agents include the possible misuse of confidential shareholder information, “hijacking” of public company shells and microcaps, or outright theft of dividend payments, among other things. As a result, it is critical that addressing cybersecurity issues be a part of any review of the transfer agent rules.”

New rules will assist transfer agents in identifying red flags and understanding the compliance measures they should adopt. Transfer agents should expect to see more regulation in the future and should adopt compliance programs that address Commissioner Aguillar’s statements.

Commissioner Aguilar’s Statement is posted below:

1) Why should the public care about the regulation of transfer agents? Why are they important to the financial system?

Transfer agents play an important role in our capital markets. They act as registrars and keep track of changes in the record ownership of a company’s securities.[2] They ensure that companies’ interest, dividends, and other distributions get paid to the right holders of stocks and bonds.[3] Transfer agents also monitor the restrictive legends and “stop transfer” orders that distinguish restricted securities from freely-tradable securities.[4] This responsibility puts transfer agents in a unique position to identify and potentially prevent unregistered securities from being unlawfully distributed. Indeed, the distribution of unregistered securities is often associated with microcap pump-and-dump schemes and other penny stock fraud.[5] The investing public needs capable, honest, and reliable transfer agents to help the capital markets function properly and effectively.

2)The transfer agent rules on the books today mostly date back to the 1970s and 1980s. Are you concerned that the SEC should update these rules?

The transfer agent rules were originally adopted in 1977, with additional rules in the early 1980s, and have been amended rarely since.[6] Technological advances and changes to business practices and market structure have created a significant gap between the transfer agent rules and the actual activities that transfer agents undertake in the current business environment. It is past time that the Commission takes a close look at this gap and modernizes the rules regulating transfer agents.[7]

3)The SEC has increasingly focused on the role that transfer agents could play, intentionally or not, in aiding and abetting microcap fraud by removing restrictive legends on stocks. What kinds of reforms do you think are warranted in this area?

Fraud in the microcap market often involves unregistered offerings, pump-and-dump schemes, and other forms of stock manipulation.[8] Because securities distributed as part of a fraud involving unregistered offerings often pass through transfer agents to remove certain restrictions (or legends) on the stock certificates that otherwise would restrict their transfer, transfer agents could facilitate such fraud.[9] Transfer agents are, thus, well-positioned to prevent violations of the federal securities laws by identifying and preventing the possible distribution of unregistered securities.

We’ve known for a while that more has been needed to be done. In fact, in October 2011, the Commission hosted a public Roundtable on the Execution, Clearance, and Settlement of Microcap Securities, which identified a number of issues related to the transfer agents’ roles in the issuance and transfer of these microcap securities.[10] Among other issues, the Roundtable highlighted the lack of Commission rules addressing appropriate levels of due diligence by transfer agents, the lack of guidance for removing restrictions from securities, and the need for more disclosure to the market of certain information that would inform investors about the appropriateness of transacting in microcap securities.[11]

4) Are transfer agents considered gatekeepers?

There can be no doubt that transfer agents are gatekeepers. After all, they keep track of the ownership of corporate securities.[12] As I mentioned earlier, transfer agents have a key role in removing restrictions (or legends) that would otherwise restrict the transfer or sale of securities. In fact, various JOBS Act provisions may result in an exponential increase in the number of companies whose shares are traded in the secondary market without the benefits of registration, making the transfer agents’ “gatekeeper” function even more critical.[13]

5) There appears to be momentum toward early-stage rulemaking for transfer agents as the Commission staff is considering recommending that the Commission propose a concept release.[14] But concept releases often take years to develop into rules. What would you like to see happen in the way of rulemaking?

The Commission issues concept releases to identify and prioritize those areas where the Commission should proceed to take action.[15] However, unlike a specific proposal, concept releases, by definition, do not usually recommend any specific action. Concept releases may be appropriate in situations where the Commission has a lack of information and is unsure how best to proceed, or whether to proceed at all. However, in circumstances where the Commission has developed experience and information as to known problems, the Commission should be willing to move forward to address those issues through the normal rule making process. The Commission has been studying the transfer agent issues for some time. For example, the 2011 Roundtable and the SEC’s examination and enforcement activities provide significant information to allow the Commission to begin to act.[16]

As one example of action that should be taken, the Commission should adopt rules providing additional safeguards to protect against the unlawful distribution of unregistered securities. These safeguards could include transfer agent due diligence obligations prior to the removal of restrictions (or legends) on stock certificates that otherwise would restrict their transfer.[17] As noted, transfer agents function as gatekeepers, and persuading them to remove the restrictions on unregistered stock certificates is an essential step in perpetrating a fraudulent offering of unregistered securities. Providing transfer agents with guidance to help them identify fraudulent distributions of unregistered securities will greatly advance the Commission’s goal of protecting investors. In addition, transfer agents’ role as gatekeepers in our capital markets provides them with an early opportunity to identify and report possible fraudulent offerings.[18]

6)Transfer agents, at times, arguably could have major conflicts of interests. For example, it would seem to be a conflict where the same persons own and control a transfer agent and a brokerage firm in the same office, and are also officers and directors in a public microcap company that is loaned money by the transfer agent in exchange for common stock. Yet there are no conflict of interest prohibitions for transfer agents. Should there be? If so, what kinds of conflicts raise concerns?

Generally speaking, conflicts of interest are inherently problematic because, left unchecked, they can unduly affect people’s good judgment and lead them to place their personal interests ahead of their clients’ and customers’ interests.[19] The Commission should work to ensure that appropriate rules are in place to eliminate or mitigate potential conflicts of interest in the transfer agent area, wherever, and however, they may arise. Ultimately, any conflict of interest rules should ensure that transfer agents perform their services impartially and objectively, without any improper motivation that could corrupt their ability to exercise unbiased professional judgment.

7)There are no net capital standards, no insurance requirements, or other capital requirements for transfer agents. Should there be? Why is this important? Should the requirements be higher for custody-carrying paying agents?

Clearly, the changes over the years that I’ve mentioned suggest that the Commission should take a renewed look at transfer agents and their operations. When the transfer agent rules were adopted, fewer people owned stock,[20] and those who did typically held their physical stock certificates themselves.[21] Clearly, more American families today are invested in the capital markets and, thus, more people than ever depend on transfer agents to discharge their responsibilities promptly, accurately, and efficiently. In determining what steps may be necessary, we should be guided by the need for investor protection and market efficiency.

8)Transfer agents have no cybersecurity rules, and no disaster and business continuity requirements. Yet the Commission is about to adopt similar such rules for exchanges and some ATS platforms. Why, perhaps, should transfer agents be included? Why should they have these rules? What would happen if a hacking or natural disaster struck these firms?

The increased use of technology in the capital markets and by transfer agents has been transformative. Unfortunately, like other members of the industry, transfer agents are not immune from the omnipresent threat of a cyber-attack. A single technological failure by a transfer agent could have serious consequences, including the loss of shareholder information, erroneous transfers of securities, or misdirected dividend payments.[22] Cyber-threats facing transfer agents include the possible misuse of confidential shareholder information, “hijacking” of public company shells and microcaps, or outright theft of dividend payments, among other things.[23] As a result, it is critical that addressing cybersecurity issues be a part of any review of the transfer agent rules.

Update as of December 17, 2014: At a meeting on November 19, 2014, the Commission adopted Regulation Systems Compliance and Integrity, or “Regulation SCI.”[24] Regulation SCI strengthens the technological infrastructure of the U.S. securities markets by requiring all exchanges and clearing agencies—as well as certain other market participants—to meet certain minimum requirements designated by the Commission. Regulation SCI will ensure that our securities markets are more reliable and resilient, and less vulnerable to natural disasters and cyber-attacks. When Regulation SCI was adopted, Chair White stated that she had “directed the staff to prepare recommendations for the Commission’s consideration as to whether an SCI-like framework should be developed for other key market participants, such as broker-dealers and transfer agents.”[25]

9)It is easier to become a transfer agent than to become a lawyer, a broker, or an accountant. There are no licensing rules or even background checks. What kinds of rules, if any, should the SEC adopt to raise the bar for entry into this space?

As my prior answers make clear, transfer agents play a critical role in the proper functioning of the securities markets. It is, therefore, critical that the persons who assume the role of transfer agents have the integrity and competency to fulfill these responsibilities to the highest capability. The SEC, along with those banking agencies who share responsibility for regulating transfer agents,[26] need to revisit the transfer agent registration requirements to assess whether these requirements are rigorous enough to properly identify and weed out those persons who may not be fit to serve as transfer agents in our capital markets.

10)I have found countless examples of problems with the Forms TA-1 filed by transfer agents. Some omit what seems to be crucial information about prior regulatory violations or other office locations. Some do not update them when control people pass away. Some of them have clear errors, such as problems with the phone number being entered correctly. Should more be done by the SEC to detect these errors?

The transfer agent registration rules require that persons filling out such forms do so truthfully, accurately, and completely.[27] These rules also require persons to correct information that has become inaccurate, misleading, or incomplete.[28] Any viable registration program also requires a consistent and effective review mechanism to catch any inaccuracies that may occur. When the SEC staff becomes aware of such inaccuracies, either in reviewing the registration forms or when examining a transfer agent, I expect the staff to take appropriate action.

11) What steps can the SEC take if transfer agent firms submit false registration applications?

If the Commission staff becomes aware that a transfer agent’s registration was false, misleading, or omitted material facts, the Commission, after notice and opportunity for hearing, can suspend or revoke the registration of that transfer agent.[29] The Commission can become aware of transfer agent issues in a variety of ways, such as through the exam staff’s periodic or unannounced “for cause” exams,[30] or through other tips or information provided to Commission staff.[31] At present, however, if prospective transfer agents fill out the proper registration form, and it appears complete on its face, then the registration automatically becomes effective within roughly one month.[32] As the Commission moves forward on considering transfer agent issues, I expect that the staff would make recommendations to improve the transfer agent registration process.

12)What can you tell me, if anything, about the training program for SEC examiners? Should it be beefed up? Since there are so many shops run out of transfer agents’ own homes, do you think the risk-based approach OCIE is using is helping to make sure resources are being appropriately spent?

The SEC has been working toward improving and expanding its exam program in a broad array of areas, including its oversight over transfer agents. Nonetheless, the agency is not self-funded and has finite resources. Given the size and breadth of the markets that the SEC oversees, these financial constraints put a strain on the examination staff. Accordingly, the exam staff, at times, employs its qualitative and quantitative tools in a risk-based approach to determine where to focus attention to ferret out potentially fraudulent or other misconduct.[33]

13)Finally, transfer agents are not required to have contracts in place when doing business with an issuer. As a result, many complain about high and undisclosed termination fees which, presumably, can be passed onto shareholders. How might the SEC address this?

Transfer agents’ business relationships with their issuer customers are generally governed by state, rather than federal, laws. State laws encourage private parties to enter into written contracts that set the parameters of their agreements, but do not require them to do so. Accordingly, while the Commission does not currently regulate the content of transfer agents’ contracts with their clients, it is always good business practice for customers to have written agreements with their transfer agents, so there will be no surprises or misunderstandings. For their part, customers should always question prospective transfer agents and review documents describing their prospective business relationship prior to entering into a contract.[34] As the Commission looks at updating the transfer agent rules, it should consider what minimum information should be required to be provided to clients, including, for example, the services to be rendered and the fees to be paid.

[*] The views I express are my own, and do not necessarily reflect the views of the U.S. Securities and Exchange Commission (the “SEC” or “Commission”), my fellow Commissioners, or members of the staff.

[1] The following reflects excerpts from an interview that Commissioner Luis A. Aguilar of the U.S. Securities and Exchange Commission gave to Sarah Lynch, financial regulatory reporter at Thomson Reuters, in September 2014. The questions and answers described above are not a verbatim recitation of that interview, but have been edited and also been revised to permit appropriate attribution.

[2] See SEC Website, Transfer Agents, available at http://www.sec.gov/divisions/marketreg/mrtransfer.shtml.

[3] See id.

[4] See id.

[5] See SEC Website, Microcap Stock: A Guide for Investors, available at https://www.sec.gov/investor/pubs/microcapstock.htm (“accurate information about ‘microcap stocks’ – low-priced stocks issued by the smallest of companies – may be difficult to find . . . When publicly-available information is scarce, fraudsters can easily spread false information about microcap companies, making profits while creating losses for unsuspecting investors.”)

[6] See transfer agent rules adopted under the Securities and Exchange Act of 1934 (“Exchange Act”), including Exchange Act Rules 17Ac2-1 (application for registration), 17Ac2-2 (annual reporting), and 17Ac3-1 (withdrawal from registration), and Rules 17Ad-1 through 7 (processing, recordkeeping, and record retention obligations), and Rule 17f-1 (reporting missing, lost, counterfeit or stolen securities), which were originally adopted in 1977. Exchange Act Rule 17Ad-8 (requirement for DTC to provide issuers with a list of participant ownership positions) was adopted in 1980, followed by Exchange Act Rule 17f-2 (fingerprinting of securities industry personnel), which was adopted in 1982. Rules 17Ad-9 through 13 (master securityholder file, safeguarding of funds, and securities and internal control obligations) were adopted in 1983. Rule 17Ad-14 was adopted in 1984. Rule 17Ad-15 (signature guarantee obligations) and Rule 17Ad-16 (notice of assumption or termination of transfer agent activities) were adopted in 1992. Rule 17Ad-17 (lost securityholder obligations) was adopted in 1997. Rule 17Ad-19 (disposition of securities certificates) was adopted in 2003. See also SEC Website, Transfer Agents, available at http://www.sec.gov/divisions/marketreg/mrtransfer.shtml.

[7] For example, in addition to the traditional transfer and recordkeeping activities, many large transfer agents now offer a variety of other services, such as annual meeting services (i.e., electronic proxy delivery, notice and access consulting, internet and phone voting, and proxy tabulation), strategic shareholder consulting services to corporations and shareholder groups working to influence corporate strategy, corporate trust services, and class action administration services, among other services. Additional services provided by large transfer agents often also include investment plan services, communication services (promotion campaigns, loyalty programs, and communication services with brokers and fund managers), global capital markets services (access to international markets and cross border transactions), corporate restructuring, and corporate action consulting. See, for example, the description of transfer agent Computershare’s business at .

[8] See generally SEC Website, Microcap Stock: A Guide for Investors, available at https://www.sec.gov/investor/pubs/microcapstock.htm.

[9] See generally SEC Website, Transfer Agents, available at http://www.sec.gov/divisions/marketreg/mrtransfer.shtml.

[10] See SEC Roundtable on the Execution, Clearance and Settlement of Microcap Securities

Monday (Oct. 17, 2011), available at .

[11] See id. and Transcript of the SEC Roundtable on the Execution, Clearance and Settlement of Microcap Securities (Oct. 17, 2011), available at http://www.sec.gov/spotlight/microcap/microcaproundtable101711-transcript.txt.

[12] See SEC Website, Transfer Agents, available at http://www.sec.gov/divisions/marketreg/mrtransfer.shtml.

[13] For example, the Commission recently proposed rules that would increase the maximum offering amount under Regulation A from $5 million to $50 million in any 12-month period. Securities issued pursuant to the Regulation A exemption are not restricted, which means that purchasers may resell their shares without registration or a holding period. Proposed Rule Amendments for Small and Additional Issues Exemptions Under Section 3(b) of the Securities Act, SEC Release No. 33-9497 (Dec. 18, 2013), available at http://www.sec.gov/rules/proposed/2013/33-9497.pdf. In addition, now that general solicitation and advertising are permitted under Regulation D, shares can be sold to an unlimited number of accredited investors, who can then resell them after a one-year holding period under Rule 144. Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, SEC Release No. 33-9415 (July 10, 2013). Furthermore, under the Commission’s proposed crowdfunding rules, shares issued in crowdfunding transactions, while initially restricted, will be freely tradable after a one-year holding period. Crowdfunding, SEC Release No. 33-9470 (Oct. 23, 2013), available at http://www.sec.gov/rules/proposed/2013/33-9470.pdf.

[14] See Transfer Agent Concept Release, Securities and Exchange Commission Regulatory Flexibility Agenda (Fall 2014), available at http://www.reginfo.gov/public/do/eAgendaViewRule?pubId=201410&RIN=3235-AL55.

[15] See SEC Website, The Investor’s Advocate: How the SEC Protects Investors, Maintains Market Integrity, and Facilitates Capital Formation, available at http://www.sec.gov/about/whatwedo.shtml.

[16] See SEC Roundtable on the Execution, Clearance and Settlement of Microcap Securities

Monday (Oct. 17, 2011), available at . In addition, for a list of recent enforcement cases brought by the Commission involving microcap fraud, see SEC Website, Microcap Fraud, available at http://www.sec.gov/spotlight/microcap-fraud.shtml.

[17] For example, a due diligence rule could require transfer agents to maintain information concerning their clients and securities transactions, similar to FINRA’s “know your customer” rules. See FINRA Regulatory Notice 11-02 (Jan. 2011), available at http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p122778.pdf. A possible due diligence obligation on transfer agents could feasibly also include the obligation to collect and maintain penny-stock and shell company transfer information.

[18] As a comparison, the Treasury Department issued rules under the USA Patriot Act to require broker-dealers to file suspicious activity reports (“SARs”) if customer activity suggests a possible violation of U.S. laws or regulations. Under Treasury’s SAR rule, a broker-dealer is required to file a suspicious activity report if: (i) a transaction is conducted or attempted to be conducted by, at, or through a broker-dealer; (ii) the transaction involves or aggregates funds or other assets of at least $5,000; and (iii) the broker-dealer knows, suspects, or has reason to suspect that the transaction: (a) involves funds or is intended to disguise funds derived from illegal activity, (b) is designed to evade requirements of the BSA, (c) has no business or apparent lawful purpose, and the broker-dealer knows of no reasonable explanation for the transaction after examining the available facts, or (d) involves the use of the broker-dealer to facilitate criminal activity. See SEC Website, Anti-Money Laundering (AML) Source Tool for Broker-Dealers (June 20, 2012), available at http://www.sec.gov/about/offices/ocie/amlsourcetool.htm.

[19] Former Director of the Commission’s Office of Compliance, Inspections and Examinations, Carlo V. di Florio, described it this way: “‘What is a “conflict of interest’? It is hardly a term of art. A simple Google search shows that it is used in varying ways in different contexts. I prefer to think of a conflict of interest as a scenario where a person or firm has an incentive to serve one interest at the expense of another interest or obligation. This might mean serving the interest of the firm over that of a client, or serving the interest of one client over other clients, or an employee or group of employees serving their own interests over those of the firm or its clients. This way of thinking about conflicts takes the discussion to a broad consideration of what is the right thing to do as a matter of law and ethical decision-making. It also recognizes that there are reputational risks that can be damaging or even fatal to a business organization when people or firms make decisions that may be technically within the letter of the law, but are not in keeping with the spirit of the law and hard to explain to the constituencies with which they must keep faith, such as customers, creditors, investors, or employees.” See Carlo V. di Florio, Conflicts of Interest and Risk Governance (Oct. 22, 2012), available at http://www.sec.gov/News/Speech/Detail/Speech/1365171491600.

[20] For example, while 42.4 million individuals owned equities in 1983, a total of 78.7 million, up 85.6%, owned equities in early 1999. In addition, in 1983, approximately 19.0% of all U.S. households owned equities. An estimated 49.2 million, or 48.2%, of all U.S. households owned equities directly or indirectly through stock mutual funds in early 1999. See Equity Ownership in America, Investment Company Institute and the Securities Industry Association (Fall 1999), available at . By 2007, roughly 51% of U.S. households owned stocks. See United States Census Bureau, Table 1209. Transaction Activity in Equities, Options and Security Futures, 1990 to 2010, and by Exchange, 2010, available at .

[21] See Christina Parajon Skinner, Cybercrime in the Securities Market: Is U.C.C. Article 8 Prepared? North Carolina Law Review (2012) (noting that “[f]or the hundred years prior to the 1970s, owners held securities ‘directly’ and in paper form.”), available at .

[22] See, e.g., FDIC, Trust Examination Manual, Section 11 –Role of Transfer Agent (noting that “the failure by a registered transfer agent to promptly and accurately transfer and record ownership of securities can result in securityholders suffering monetary damages by hampering their ability to buy and sell shares, or otherwise prevent shareholders from exercising the rights associated with stock ownership, such as the right to receive dividends and vote proxies.”), available here; see also SEC Website, Transfer Agents, available at http://www.sec.gov/divisions/marketreg/mrtransfer.shtml.

[23] Fraudsters may attempt to steal the identity of a dormant or thinly-traded public company, by falsely presenting themselves as duly authorized officers, directors, or agents (known as “corporate hijacking”). The hijacked entity may then be used to facilitate a pump-and-dump or other fraudulent scheme.

[24] Regulation Systems Compliance and Integrity, SEC Release No. 34-73639 (Nov. 19, 2014), available at http://www.sec.gov/rules/final/2014/34-73639.pdf.

[25] Chair Mary Jo White, Statement at Open Meeting on Regulation SCI (Nov. 19, 2014), available at http://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1370543489640.

[26] Along with the SEC, regulation over transfer agents is the responsibility of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation.

[27] See Exchange Act Section 17A(c) (registration of transfer agents) and Exchange Act Rule 240.17Ac2-1 thereunder.

[28] See Exchange Act Rule 240.17Ac2-1(c) (noting that if any information reported on Form TA-1 becomes inaccurate, misleading or incomplete, the registrant shall correct the information by filing an amendment within 60 days following the date on which the information becomes inaccurate, misleading or incomplete.)

[29] See Exchange Act Section 17A(c)(3).

[30] See Examinations by the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (Feb. 2012), available at https://www.sec.gov/about/offices/ocie/ocieoverview.pdf.

[31] See SEC Website, Enforcement Tips and Complaints, available at http://www.sec.gov/complaint/tipscomplaint.shtml.

[32] See Exchange Act Rule 240.17Ac2-1 (registration of transfer agents).

[33] The Commission’s National Exam Program uses quantitative and qualitative analyses to determine areas of focus that are perceived to have heightened risk. See Examination Priorities for 2014 (Jan. 9, 2014), available at http://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2014.pdf.

[34] See, for example, the transfer agent standard agreement of Interwest Transfer Co., Inc., available at . See also Broadridge’s description of its transfer agent services, available at http://www.broadridge.com/corporate-issuer-solutions/transfer-agent/transfer-agent.

For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, or by email at [email protected].  This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship.  Please note that the prior results discussed herein do not guarantee similar outcomes.

Hamilton & Associates | Securities Attorneys
Brenda Hamilton, Securities Attorney
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