учебный год 2023 / Haentjens, Harmonisation Of Securities Law. Custody and Transfer of Securities in European Private Law

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transfers outside the statutory system of the Wge has been fiercely debated, notably in the instance of globals, but concerning the transfer of Wge securities even more so.

It has been argued that the causal transfer regime of general private law accords badly with securities transfers by credit and debit entries in securities accounts, because these accounts relate more to the accountholder

– intermediary, than to the transferor – transferee relationship, especially when a securities transfer has to be effectuated via the CSD. But also on a more practical level, general rules of transfer law are clearly inconsistent with the Wge. Under the rules of general private law, for instance, the fulfilment of a resolutive condition immediately reverses provisional transfers and gives them proprietary effect, whereas under the Wge, property rights are only obtained upon a credit entry in an accountholder’s securities account. In addition, under general private law, a transferor remains the owner until the delivery has been completed, whereas under securities transfer law, a transferor cannot assert any rights concerning his securities when these securities have been debited from his account, although the transferee’s securities account has not yet been credited.

Fourth, the co-ownership construct that forms the basis of the proprietary protection which the Wge intended to provide for investors, is not only inconsistent with its general private law counterpart, but also fails to fully achieve accountholder protection. General private law contains a codified regime for co-owners that share in a gemeenschap (community of property), but it has been shown that many aspects of the rights that accountholders can assert regarding Wge pools explicitly derogate from that general private law regime. For instance, Wge accountholders cannot request the liquidation of Wge pools, and all administrative powers are exclusively performed by the intermediary that manages the Wge pool, whereas under the general private law regime, all co-owners may request the liquidation of the gemeenschap, and all acts of administration must be performed by the co-owners themselves.

However, while those explicit derogations indicate weak coherence, incoherence is also found. All lower than third-tier accountholders and accountholders that are not entitled to Wge admitted securities lack Wge protection. Thus, contradictory values are applied to situations that do not materially differ, as accountholders usually cannot assess whether an intermediary is a direct CSD participant or whether their securities have been admitted to the Wge system. Their securities accounts do not express such a difference, yet they are treated fundamentally differently when asserting their interests in the account provider’s insolvency, for non-Wge accountholders have a mere contractual claim against the insolvent account provider. It is submitted, therefore, that this distinction presents an example of Wertungswiderspruch.

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Finally, PRIMA as been adopted as the appropriate conflict of laws rule for international private law issues that concern book-entry securities, but it has been shown that traditional conflict of laws rules are still predominant. The precise application of PRIMA has therefore become unclear, which thus presents another instance of the inconsistent relationship between general law and securities law.

In sum, virtually all cornerstones of Dutch securities custody and transfer law, especially those of the Wge system, appear not to fit into general private law. Precisely because of the strict dogmatic structure of Dutch private law, and the application of general private law principles to specific and functional areas of law, the inconsistencies and derogations are clearly apparent, perhaps more so than in less dogmatic systems.210 But where these inconsistencies result in unwarranted consequences, they must be resolved, notably in the instances that accountholder protection suffers.

210 Cf. LOOS (2006), 8.

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8.1 INTRODUCTION

8.1.1 Trading, clearing and settlement

In the USA, the securities market takes place at several stock exchanges. Of the stock exchanges, the New York Stock Exchange (‘NYSE’) and the American Stock Exchange (‘Amex’) are the largest.1 The NYSE was founded in 1817, and was then called the New York Stock and Exchange Board.2 Amex was founded in 1921. In addition, the National Association of Securities Dealers Automatic Quotation (‘NASDAQ’), created in 1971, functions as an electronic marketplace where an impressive number of shares is traded per day.3 The rest of securities trading occurs at five regional stock exchanges and several specialised markets for commodities and financial products.4

It was not until after the ‘paperwork crisis’5 of 1968 that the NYSE established the Depository Trust Company (‘DTC’) in 1973, a limited purpose trust company organised under New York law, in which physical certificates could be immobilised. Thus, a system for the book-entry settlement of transactions was created. In 1976, the National Securities Clearing Corporation (‘NSCC’) was founded as a result of a merger between the clearing corporations of the NYSE, Amex and the National Association of Securities Dealers.6 The NSCC gradually merged with the clearing corporations of the regional exchanges and now performs the multilateral netting of transactions concluded on all US stock exchanges.

1At the end of 2004, the NYSE had an astounding market capitalisation of $12.7 trillion, while the Nasdaq had a market capitalisation of $3.5 trillion; SCOTT (2006), Ch. 13, 4.

2As a recent development, NYSE and Euronext announced on June 2, 2006 a merger of the two companies, thus forming the world’s largest and first transatlantic exchange. At the time of writing however, the merger had not yet taken full effect; see www.euronext.com and infra, Ch. 9.3.2.

3On June 30, 2006, for instance, over 690 million shares were executed trough NASDAQ; www.nasdaq.com.

4The other stock exchanges are: the Boston Stock Exchange, the Philadelphia Stock Exchange, the Cincinatti Stock Exchange, the Chicago Stock Exchange and the Pacific Stock Exchange. For full listing of all markets, as well as for listing/quotation requirements, see BARTOS (2002), 205.

5See infra, s. 8.1.3.

6See www.dtcc.com.

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The NSCC also acts as the central counterparty (‘CCP’) for most stockmarket transactions. After the NSCC has assumed all debit and credit positions of its participants, it nets these positions. Subsequently, NSCC instructs DTC to credit or debit the accounts that participants maintain with the NSCC. In 1999, the Depository Trust and Clearing Corporation (‘DTCC’) became the holding company of both agencies.7 Since 2003, Fixed Income Clearing Corporation (‘FICC’), a new subsidiary of DTCC,8 clears and settles most government-issued securities. DTC has direct links with the CSDs of Canada, Japan, Singapore, Germany, Argentina and Peru. DTC is now the world’s largest CSD and NSCC the largest CCP.9

8.1.2 Sedes materiae

The United States’ system of government is federal, and regulatory authority is conferred to the federal government only in a limited number of matters. General commercial law, contract and property law, and more specific rules that govern the custody and settlement of securities transactions do not fall into that category.10 These areas of law are left to the discretion of the different states. Both federal statutory and case law, however, may pre-empt state law.

Regulation of the securities markets, on the other hand, is a matter of federal law, and the Securities Act of 1933 and the Securities Exchange Act of 1934 are the most important federal statutes in this field.11 Federal securities law is principally enforced by the US Securities and Exchange Commission (‘SEC’), which has a broad range of powers for that purpose.12 The accountholder – financial intermediary relationship is in many respects a matter of federal (regulatory) law, since most securities firms that maintain

7In the US, both CSDs and clearing houses are called ‘clearing corporations’ and both have to be registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934 § 17A(b).

8FICC was formed by the merger of Government Securities Clearing Corporation (‘GSCC’) and Mortgage-Backed Securities Clearing Corporation (‘MBSCC’); see www.dtcc.com.

9In 2004, the value of securities settled by DTCC subsidiaries exceeded the almost incomprehensible figure of $ 1.1 quadrillion; www.dtcc.com.

10See Erie Railroad Co. v. Tomkins, 304 U.S. 46 (1938), where the notion of a federal common law for commercial transactions that Justice Story had formulated in Swift v. Tyson,

41U.S. (16 Pet.) 1 (1824), was rejected. See, e.g., BANE (1983), 9.

11Other important statutes that concern the distribution of securities are the Public Utility Holding Company Act of 1935, the Trust Indenture Act of 1939, the Investment Company Act of 1940, the Investment Advisers Act of 1940 and the Sarbanes-Oxley Act of 2002.

12On the tension between the enforcement of regulation on the federal and on the state level, see SCOTT (2006), Ch. 2, 53.

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accounts for their clients are subject to SEC regulation. Banks in all their activities are mainly regulated by the Federal Reserve.13

Insolvency law is also a federal matter. The Bankruptcy Act and the Securities Investor Protection Act of 1970 represent the most important legislative federal instruments that concern financial intermediary insolvencies. It must be noted however, that federal common law probably does not pre-empt state law in insolvency matters if no significant federal policy is implicated, although different courts have taken different views on this matter.14

Finally, all matters that concern securities issued by the US government and its agencies are governed by federal law. More specifically, the SEC Rules on the Treasury/Reserve Automated Debt Entry System (‘TRADES’) play an important role with regard to the custody and transfer of these securities.

8.1.3 Harmonisation of state law

Since Erie Railroad Co. v. Tomkins, 304 U.S. 46 (1938), both general private and commercial law lie within the realm of state law, and therefore differ from state to state. But several initiatives have been undertaken to harmonise certain aspects of state laws through uniform statutes, not all of which have been entirely successful. The enactment in all states of the Uniform Stock Transfer Act (1909), the first uniform statute that concerned property rights in stocks, for instance, took forty-seven years.15 The failure of some model laws to achieve effective uniformity has been attributed to either the resistance of state legislatures, to the fact that states implemented them differently, or to the federalization of the matters which these models laws addressed.16

The most successful and comprehensive harmonisation of private law has been brought about by the Uniform Commercial Code (‘UCC’), which is directed at the harmonisation of the law that concerns payments and commercial transactions in general. It is therefore not confined to, e.g. relationships between or with merchants. UCC Article 8 deals with the

13 Specifically, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation are federal agencies that regulate financial institutions.

14Accord In re Gaston & Snow, 243 F 3d 599 (2d Cir., 2001), In re Merritt Dredging, 839 F 2d 203 (4th Cir, 1988). Contra In re Lindsay, 59 F 3d 942 (9th Cir, 1995). See GUYNN & ROGERS (2002), 605.

15One of the most important features of this act was the protection of bona fide transferees against competing claims by veri domini, which is called ‘negotiability’ and continues to play an important role in current law. Cf. ROCKS & BJERRE (2004), 1-2 and see infra, s. 8.4.2.

16LITOWITZ (2001), xvi.

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custody and transfer of, and interests in, securities, while Article 9 deals with security interests in property generally. Both Article 8 and Article 9 provide for the harmonisation of both substantive and private international securities custody and transfer law.

The UCC is a model law that has no statutory power in itself, but must be implemented in state law to take effect. It addresses the legal uncertainty that existed because of the complex mixture of state case law, statutory law, the non-uniformity of the laws of the different US states and the out-of-date English law concepts still predominant in common private law.17 Since its first operation in 1945, the UCC has been sponsored by the National Conference of Commissioners on Uniform State Laws (‘NCCUSL’) and the American Law Institute (‘ALI’), with the close cooperation of the American Bar Association. It is kept up to date by a Permanent Editorial Board.18

In 1994 and 1999, UCC Articles 8 and 9, respectively, were revised, and James ROGERS served as the Reporter to the Article 8 revision.19 That revision was an indirect result of the so-called paperwork crunch of 1967, when, because of a dramatic increase in the volume of trade, securities transactions could no longer be settled. At that time, settlement occurred through physical delivery and registration, which proved to be an obstacle for the market to function properly, as the back offices of New York securities firms and financial institutions became unable to effectuate the physical settlement of securities transactions. In order to alleviate the processing of securities trades and to restore market confidence, the US Treasury’s Bureau of the Public Debt immediately issued regulations that provided for the dematerialisation of Treasury bills, notes and bonds, which from that moment onwards could therefore only be registered and transferred by book-entry.20

In response to those regulations, the NCCUSL and ALI agreed to modify UCC Article 8 in 1978, so as to modernise the legal infrastructure for the settlement of all categories of securities. But the modification did not represent an effective acknowledgment of the fundamental changes in market practices that resulted from the immobilisation of securities certificates.21 The 1978 modification of UCC Article 8 catered for the

17LITOWITZ (2001), xv.

18The Permanent Editorial Board also gives opinions on conflicts and inconsistencies within the UCC.

19Unless otherwise indicated, all future references to UCC Articles 8 and 9 concern the current, revised versions. References to UCC Article 1 concern the version as revised in 2001.

20Another direct result of the paperwork crunch and an effort to restore market confidence is the Securities Investor Protection Act (‘SIPA’); GUTTMAN (1990), 438. On SIPA, see infra, s.

21Cf. MOONEY (1990), n.9, GUTTMAN (2005), 1-23 and ROGERS (1996), 1447. On the other hand, the 1978 version did recognise the possibility of a chain of multiple intermediaries; ROCKS & BJERRE (2004), 2.

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custody of completely dematerialised issues, yet was still framed on a system of direct holding and the traditional property law concepts that applied to physical chattels.22 In addition, the market break of the 1980s and the subsequent insolvencies of several financial institutions not covered by regulatory supervision, proved the inadequacy of the 1978 revision, and a new modification of UCC Article 8 was evidently required.23

Thus, it had become clear that a fundamental revision was needed to recognise the change that the modern practice of indirect holding had brought, as outmoded rules apparently had the potential to destabilise financial markets in times of stress.24 Moreover, US Congress concluded that ‘the lack of harmony amongst various state laws detracts from the liquidity of the clearance and settlement system by making it burdensome (an in some cases, impracticable) for investors to finance their payment obligations (…)’.25 The revision process was further stimulated by pressure from the SEC, which was instructed by Congress to promulgate federal regulations, should it find that the absence of such regulations impeded the operation of the clearing and settlement system.26

Only a few years after the NCCUSL and ALI had begun the revision project, a new UCC Article 8 was adopted in 1994 and subsequently implemented in all states of the US. UCC Article 8 now accommodates the direct holding of both certificated and uncertificated securities, but also the indirect holding of immobilised securities, and is generally regarded as providing a highly effective legal infrastructure for the custody and transfer of securities by book-entry.27 Together with federal regulations and state laws, the UCC has thus resulted in a modernisation and unification of US securities law and should therefore be studied as an example for possible future European legislation.28

22See ROGERS (1996), 1456.

23Most notable among them was the collapse of the Drexel Burnham Lambert Group in February 1990; see ROGERS (1996), 1446 and GAO (1997), 60 et seq.

24ROGERS (1996), 1436-1438.

25Cf. Legislative Intent at UCC § 8-101, by the New York legislature; Laws 1997, Ch. 566, §

5.Cf. also ROGERS (1996), 1543: ‘To provide an adequate commercial law foundation for modern securities transactions, it is essential that uniform law be adopted at the state level.

(…) Similarly, the legislative history of the Market Reform Act of 1990 identifies the problem of potential and actual nonuniformity among the states as the major problem with the commercial law foundation of the securities clearance and settlement system.’

26Pursuant to the Market Reform Act of 1990; MOONEY (1990), n.11. In the end it was concluded however, that modernisation on the state level was preferable because of complexities as to federal authority; ROGERS (1996), 1446 and n.26. Cf. 31 CFR § 357, Appendix B.

27SPINK & PARÉ (2004), 345-346.

28The securities custody and transfer law provisions of the UCC have been implemented in all US states with no major differences in implementation; see LAWRENCE (2005), at UCC § 8-113.

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Mainly for that reason, the following sections will analyse in greater detail current US law regarding the custody and transfer of securities, as well as its relationship with more general areas of law. First, the main distinctions with regard to financial instruments will be discussed. In the section that follows, legal aspects of securities custody will be analysed, with particular emphasis on securities accounts, the accountholder – intermediary relationship and the consequences of intermediary insolvencies. In Sections 4 and 5 of this chapter, the transfer of securities by book-entry, and the creation and enforcement of security interests in securities will subsequently be discussed. Section 6 will deal with US private international law concerning securities custody and transfer. The chapter will conclude with answers to the questions posed in Chapter 1.2.2 and a coherence analysis.

8.2 CATEGORIES OF SECURITIES

The characteristics of equity securities and debt instruments are generally determined by state law, with an exception of debt instruments issued by the US government and its agencies. Throughout the US, both equity, i.e. stock and shares, and debt instruments appear in certificated and uncertificated form. But most stock is issued in certificated form, while government bonds and shares in mutual funds are usually uncertificated, so that immobilisation of physical certificates at the CSD level is the most common type of securities custody in the US. Yet the process of dematerialisation is ongoing, and DTCC is actively engaged in that process.29

Uncertificated securities can only appear in registered form,30 while certificated securities appear in either registered or bearer form. The owner of registered securities is registered on the issuer’s register, which is usually maintained by a so-called registrar. An issue of bearer securities typically takes place in the form of a single certificate that is deposited with a CSD, and such a certificate may either contain a varying number of securities, or the entire issue. In the former instance, the certificate is called a balance certificate or jumbo certificate, and the securities not comprised in the jumbo certificate are distributed as individual certificates. When the certificate represents the entire issue, it is called a global, and the securities comprised therein cannot be split up nor distributed individually.31

As foreign issuers cannot distribute their securities directly in the American markets, they must issue so-called American Depository Receipts (‘ADRs’) through a US commercial bank (depository).32 Against the depository, the

29See www.dtcc.com and WHITE & SUMMERS (2000), 100.

30Cf. UCC §§ 8-106 (2001) and 8-102 (2001).

31See, e.g. GUTTMAN (2005), 1-25 et seq. and GUTTMAN (1990), 447-449.

32BARTOS (2002), 241. See also SCOTT (2006), Ch. 2, 84-88.

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ADR holder has certain rights under the depository agreement, such as the right to receive dividends, to vote and the right to exchange the ADR for the foreign, underlying shares. Where the foreign counterparts are denominated in foreign currencies, ADRs are dollar-denominated.33 Issues of foreign debt instruments denominated in US dollars are called Yankee Bonds. Transactions in these instruments may be settled through either DTC or a foreign (I)CSD, whereas non-US dollar denominated notes are usually settled through a foreign (I)CSD.34

8.3 CUSTODY OF BOOK-ENTRY SECURITIES

8.3.1 Introduction

An important distinction to be made when describing the legal aspects of securities custody in the US is between securities that are directly and indirectly held. A direct holding system traditionally concerns the situation that investors themselves hold their securities in a physical form, and in such a custody system issuers thus maintain a direct link with the ultimate investors.35 Currently, however, certificated securities are only occasionally directly held, while uncertificated securities, i.e. dematerialised securities, may also be held directly under US law.36 Uncertificated securities that are directly held are evidenced by book-entry only, but their registration on the issuer’s books does not classify as a securities account.37 Especially US government securities and securities issued by mutual funds are so held.38

The great majority of securities are thus indirectly held. Certificated private company securities issued in registered form are typically registered in the name of Cede & Co., the nominee used by the Depository Trust Company (‘DTC’), which effectively administers the securities holding. Usually, the certificates of both registered and bearer securities are held in a global form with DTC. Banks and securities firms (generally referred to as broker/dealers) can be admitted to DTC’s custody system as participants, and thus maintain omnibus accounts with DTC that express their entitlements to the global.39 These participants, in their turn, administer the

33SCOTT (2006), Ch. 2, 84.

34See BARTOS (2002), 212-213.

35Supra, Ch. 3.2.2.

36Cf. the French practice of custody of titres nominatifs; Ch. 6.3.3.

37Cf. UCC § 8-501(a).

38A mutual fund is an investment vehicle that allows ‘investors to purchase interests representing pro rata shares of the net assets of a pool of securities and other assets’; SCOTT (2006), Ch. 16, 1.

39From a regulatory point of view, however, the distinction between banks and broker/dealers is essential, as banks are regulated by a number of Federal agencies including the Federal Reserve Board, whereas broker/dealers are regulated by the SEC. The regulation of banks

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securities accounts of their customers, who may be either the ultimate investors or still other intermediaries.

Another important distinction must be made between the custody of securities that are issued by the US government, i.e. the Treasury, or US government agencies on the one hand, and the custody of securities that are issued by private companies on the other.40 US Treasury and government agency-issued securities are fully dematerialised by law, and are usually held in the Treasury/Reserve Automated Debt Entry System (‘TRADES’).41 In this system, the Federal Reserve Banks act as the Treasury’s fiscal agents. Only admitted entities may act as participants to the Federal Reserve Banks, which recognise only these entities as accountholders. The participants, in their turn, may act as intermediaries for ultimate investors or other intermediaries. But investors may also hold US Government securities directly with the Federal Reserve Banks or the Bureau of Public Debt, a system which is called ‘Treasury Direct’.

The rules that apply to the government systems of book-entry custody (including conflict of laws rules) are federal rules that are either similar to UCC Article 8 or refer to state law and thus to the implemented versions of UCC Article 8.42 Federal rules apply exclusively to the obligations of the issuer (the Treasury) and the Federal Reserve Banks against their clients/accountholders, and, vice versa, to the claims of the accountholders against these entities. The relationship between the Federal Reserve Banks and their clients is therefore regulated by federal law, but it is reiterated that these rules correspond with those of UCC Article 8. Yet admitted participants have a direct claim against the US, although the Treasury and the Federal Reserve Banks act as account providers.43 As another difference from UCC Article 8, a security interest in US government-issued securities can only be created and perfected by the marking of these securities as pledged on the books of a Federal Reserve Bank. In addition, a security

principally aims at reducing the systemic risk, while the regulation of securities firms is generally aimed at investor protection; SCOTT (2006), Ch. 3, 1. For the purpose of this book, the distinction is less important, and banks and securities firms will therefore be jointly referred to as ‘intermediaries’, ‘custodians’ or ‘account providers’, when acting in that capacity.

40Such as the Government National Mortgage Association (known as Ginnie Mae), the Federal National Mortgage Association (known as Fannie Mae) and the Federal Home Loan Mortgage Corporation (known as Freddie Mac).

4131 CFR § 306.116(a) refers to 31 CFR § 357 for the rules on book-entry US securities. These rules became effective on January 1, 1997; 31 CFR § 357.1.

42Incorporation by reference approved by the Director of the Federal Register; 31 CFR §

357.2.See also 31 CFR § 357.10 and cf. GUTTMAN (2005), 1-25. Cf. 31 CFR § 357, Appendix B: ‘The questions inherent in a tiered system of ownership have been analyzed, and in Treasury’s view, satisfactorily addressed by Revised Article 8.’ The Treasury therefore concluded that the uniformity required for an efficient market for government securities could be attained without an independent system of Federal commercial law.

43See 31 CFR § 357, Appendix B.

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