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

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broader. As a consequence of the definition of ‘financial asset’ in UCC § 8- 102(a)(9), virtually all assets that are held in an indirect holding system by means of a securities account are eligible for application of UCC Article 8 Part 5, either ipso facto or because application has been opted for by the account provider and its client.

2. What is the nature of investors’ interests in securities?

In 1994, some important modifications to UCC Article 8 were made, most notably the introduction of a Part 5 that is solely directed at the custody and transfer of securities by book-entry. Under the provisions of that Part, an accountholder does not enjoy an interest in his securities that can be classified as a traditional common law concept. Instead, an accountholder enjoys a sui generis ‘security entitlement’, which must be understood as a package of rights that an accountholder can assert against his immediate intermediary/account provider. Thus, the security itself and the rights an accountholder enjoys as to this security via an intermediary are sharply distinguished.

Generally, investors can assert direct rights to their securities only in a situation of direct holding, and when securities are indirectly held, the rights of beneficial owners relate to their intermediary’s obligation to pass on the issuer’s primary obligations. Thus, a security entitlement does not establish a direct legal relationship between an accountholder and the securities themselves to which he is entitled, and the concept therefore excludes tracing. Consequently, the number of intermediaries that are interposed between the issuer and ultimate investor does not influence the substance of the latter’s rights.

A security entitlement consists both of rights in rem as well as in personam. The contractual rights of an accountholder against his account provider mainly concern the account provider’s obligation to hold the accountholder’s financial assets in good faith. That rather general obligation is substantiated by more specific duties explicitly codified in UCC Article 8, viz. the duty to obtain, and thereafter maintain the amount of financial assets that corresponds to the aggregate amount of assets to which the intermediary’s clients are entitled, the duty to obtain and pass on the proceeds of the underlying securities, the duty to comply with the accountholder’s directions regarding corporate actions and other rights connected to the accountholder’s assets, the duty to comply with accountholder’s entitlement orders, and the duty to comply with the accountholder’s orders to change the form of holding. But these duties can be contractually avoided, provided the intermediary remains within the limits set by the standard of good faith.

Although an accountholder’s security entitlement does not form part of his account provider’s estate, his rights in rem are enforceable against third

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parties, i.e. against persons other than his account provider, but only in very specific situations. First, it is only in insolvency situations, that an accountholder can assert his rights against the intermediary‘s trustee in bankruptcy, the intermediary’s creditors and other third parties. But an accountholder can only successfully assert his interests against third parties in extraordinary circumstances, viz. if the insolvent intermediary’s estate appears to show a deficit because the intermediary had violated its obligation to obtain sufficient assets, if the trustee in bankruptcy does not enforce the accountholder’s claim, and if the third party concerned is not protected under the rule that protects bona fide transferees against competing claims. Outside of an account provider’s bankruptcy, a dispossessed accountholder can only rarely assert a right of revendication against third parties, as all transferees (including security takers) who had no notice of the dispossessed accountholder’s adverse claim, have control over the assets transferred, and have given value for the transfer, cannot be successfully challenged by a dispossessed accountholder.

2.1 Is a credit entry in a securities account merely a proof of ownership or is it a constitutive element of ownership of the securities concerned?

A security entitlement is the constitutive element of an accountholder’s ownership rights, and his rights cannot be proven in another way. Such entitlement is created by a credit-entry in a securities account, and extinguished by a debit-entry. Thus, a securities accountholder can assert his ownership rights to the securities which his account refers to, even if his account provider does not hold the corresponding assets with a higher tier. But while a security entitlement is the constitutive element of ownership in indirectly held securities, an investor can also have ownership rights in securities that are held in other ways, viz. directly.

2.2 Are informal (i.e. not registered by book-entry) dispositions over securities possible?

In principle, a security entitlement is the constitutive element of an accountholder’s ownership rights, and a security entitlement can only be created and extinguished by creditand debit-entries in a securities account. Yet an entitlement may be created without a corresponding credit entry in a securities account when an intermediary has accepted a financial asset for credit in a securities account but has not already done so, or when an intermediary has not complied with any obligation under non-UCC law to credit a securities account; UCC § 8-501(b)(2) and (3). It is only in these particular instances, that a security entitlement is created without a credit entry, and only then, ‘informal dispositions’ over indirectly held securities are possible.

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2.3 Is provisional credit in book-entry securities possible?

Against his account provider, a securities accountholder can always assert the rights that follow from his security entitlement. Thus, when an account provider has credited its clients’ securities accounts, those clients can assert their security entitlements, even when the account provider does not hold the corresponding assets with a higher tier. Consequently, provisional credits in book-entry securities are possible and have proprietary effect, i.e. can be enforced as if they were final.

Accountholders therefore do not suffer from any illegal activities of their account provider with client assets, or from the unwanted consequences of operational gaps between the moment that a credit-entry is made in their securities account, and the moment their account provider has received the corresponding assets. In addition, the possibility of provisional credit-entries greatly facilitates the extension of securities on margin, i.e. securities that have not (yet) been fully paid for by the accountholder.

3. How are investors’ rights in respect of securities protected against the account provider and third parties?

Under UCC Article 8, accountholder interests in securities held through an intermediary do not form part of that intermediary’s estate. In addition, both the UCC and federal regulations forbid an account provider from disposing of its clients’ securities, either by transfer of title or by granting a security interest, while under federal law, a violation of this prohibition constitutes a criminal offence. An accountholder’s rights in respect of the securities he holds through an intermediary are thus protected against that intermediary. But when an account provider violates the prohibition and transfers or vests security rights in assets that belong to its clients, those clients can only very rarely successfully reclaim their assets under the transferees, as these transferees are generally protected under the negotiability principle.

3.1 Should shortfalls occur in accounts, how are they availed?

Under federal law, the Securities Investor Protection Corporation (‘SIPC’) initiates liquidation proceedings in the case of a securities firm’s insolvency. When a securities firm acts as account provider and its insolvent estate appears to be insufficient to satisfy all its customers’ claims, SIPC makes contributions to an amount of $500,000 per customer to satisfy the deficit. Securities firms bankruptcies that are not covered by SIPA, are governed by Subchapter III of chapter 7 of the Bankruptcy Code. Under the provisions of that code, a similar procedure is applied as just described, but, as a difference, distributions are made by the trustee in bankruptcy, rather than the SIPC.

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3.2 How are an investor’s interests in securities separated from the account provider’s property or how can investors’ interests avail the claims of the provider’s general creditors?

Article 8 does not impose an express obligation on account providers to separate their own assets from their customers’ assets. But although an account provider registers all credit balances in an omnibus account in its own name with a higher-tier intermediary, client assets do not form part of the intermediary’s property, and customers’ claims have priority over their account provider’s claims in the case of the latter’s insolvency.

Accordingly, accountholders take free of the claims of their account provider’s general creditors. If, however, an account provider’s creditors have secured their claims with a security interest in the assets held by that account provider, and that security interest is perfected by control over the secured assets, the secured creditors’ claims trump the accountholders’ claims. In addition, all secured creditors of clearing corporations take free of the claims of the clearing corporation’s clients, regardless of whether these creditors have obtained control of the secured assets.

4. What are the formal requirements for the transfer of ownership of securities?

For the ‘transfer’ of securities by book-entry, a debit-entry in the transferor’s securities account and an identical credit-entry in the transferee’s securities account is the only formal requirement to be fulfilled.

4.1 Can a bona fide acquirer rely on the crediting of his account (especially when acquiring a non domino)?

It is only in extremely rare circumstances, that the UCC allows a third party to successfully challenge an accountholder’s interests, and its version of the negotiability principle expressly protects bona fide acquirers against claims by a verus dominus. Thus, both other accountholders and financial intermediaries are almost always protected against competing claims, and the UCC regime provides accountholders with concrete legal certainty as to their security entitlement.

4.2 Is it possible for a credit in a securities account to be reversed and may transfer orders (or other instructions) be revoked?

Other than for operational reasons, credit entries are seldom reversed, while the UCC does not provide for specific rules on the revocation of a transfer order or other instructions.

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5. What are the formal requirements for the creation and enforcement of collateral?

Theoretically, security rights in (indirectly held) securities can be created and enforced without the fulfilment of any formal requirement. Yet a security interest can only be asserted against third parties when it is perfected. Perfection is effected through ‘control’, by filing the security interest in the UCC register, or automatically, i.e. de iure, when the creditor is the debtor’s account provider. The UCC specifically prescribes the ways in which control over book-entry securities can be obtained. A creditor obtains control when the collateralised securities have been credited to an account in his name, or through a control agreement.

A creditor with a security interest can enforce this interest either by suing for the debt, by enforcing the interest through judicial process, or by executing certain so-called self-help measures. These self-help measures, which are the most important methods of enforcement in practice, are the following: collecting proceeds of the secured assets, taking possession of the secured assets, disposing of the secured assets by sale or otherwise, and appropriating the secured assets (strict foreclosure). Execution of the selfhelp measures is, however, restricted by the standard of commercial reasonableness.

5.1 Is upper-tier attachment possible, i.e. is it possible for an account holder’s claimant to exercise his rights against higher-tier accounts?

Under the UCC indirect holding system, no upper-tier attachment is possible, as creditors cannot trace their debtor’s assets to securities pools held by higher-tier intermediaries.

8.7.2 Coherence

Any coherence account of US securities custody and transfer law is complicated by the fact that it is, in principle, a state law matter. A comprehensive research would therefore have to investigate the relation between, notably, the implemented version of UCC Articles 8 and 9, and the more general areas of law in each US state. In addition, securities custody and transfer law is also governed by rules of federal law, and a specific state- by-state investigation of the said relation and its interplay with US federal regulations would obviously not fit within the set-up of the present study. Moreover, it has been argued that ‘US law is so thoroughly lacking in coherence that no one would think it useful either to criticize it or to reform it with coherence in mind’.241

241 KENNEDY (2006), 10.

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A coherence analysis of the relation between securities law and the more general areas of law in which it is embedded can therefore not be made for US law in the same way as it has been made for Belgian, French and Dutch law. However, the fact that some provisions of UCC Article 8 explicitly refer to ‘other law’ prove that its drafters were conscious of the coherence implications.242 Moreover, several publications by scholars who have been closely involved with the drafting of the 1994 revision of UCC Article 8 expressly address those implications.243 These coherence considerations typically concern the relation of specific UCC provisions on securities custody and transfer law on the one hand, and common private and commercial law on the other. A coherent, comprehensive civil code may be absent in US law, but from the Restatements, the UCC and case law, some general principles can be construed, and a comparison with the relevant provisions of the UCC might indeed be valuable.244

From that comparison, however, it is apparent that the present rules of securities custody and transfer law differ to a large extent from those general rules. First, and most obviously, the 1994 revision of UCC Article 8 introduced the ‘security entitlement’ concept to classify the package of rights an accountholder enjoys against his account provider, which represented a sharp departure from the common law approach of the pre-1994 UCC Article 8. Under the latter approach, accountholder interests were classified as traditional, common law concepts, viz. co-ownership and trust. Yet that approach proved to be ill-suited to the modern practice of indirect securities holding, and thus, the 1994 revision eliminated a discrepancy that formerly existed when common law concepts of contract and property law were thought to be applicable to the sui generis accountholder – intermediary relationship and accountholder interests.

Second, as an acknowledgement of the fungible and intangible nature of book-entry securities, the application of the general property law principle prior tempore potior iure was consciously abandoned when the new UCC Article 8 was adopted. Prior to the revision of that article in 1994, a property law construct was applied that attempted to (fictionally) link accountholder rights to specific, identifiable assets, so that these rights could be distributed under the prior tempore principle. But as it was recognised that such an approach led to fortuitous results when applied to fungible and intangible

242See, e.g., UCC § 8-102, official cmt. 13 and § 8-107(b)(2).

243See, e.g., ROGERS (1996). Cf. also MOONEY (1990), 413: ‘A new model, divorced from common law and U.C.C. property law constructs, also could form a more plausible base for unification of law on the international level. An approach not rooted in longstanding domestic doctrine might provide a more likely basis for harmonizing widely varying doctrine in other nations.’

244On the other hand, the UCC has been referred to as a ‘unified and coherent statute’ that covers an entire field of law; LITOWITZ (2001), xiv.

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assets that are typically commingled, the new version of UCC Article 8 correctly ranks accountholders’ claims pro rata, i.e. in the order of their value, rather than in the order of their seniority.

Third, UCC Article 8 explicitly excludes the application of general doctrines to securities custody and transfer law in some instances. For example, the application of the so-called statute of frauds, which requires a contract to be in writing in order to be enforceable, is explicitly excluded for securities transfers, which are thus enforceable without the fulfilment of any formal requirement, other than a credit-entry in the transferee’s securities account.245

In other words, US securities custody and transfer law currently shares few common principles with more general areas of law, which indicates a weakly coherent system of law.246 But it is submitted that, also from a coherence perspective, the new version of UCC Article 8 is preferable to its former version, because it replaced the incoherence that previously existed with weak coherence, and expressly applies different concepts to distinctly different legal phenomena.247 In the same vein, the revised UCC Article 9 treats investment property differently from other categories of property in the context of the creation and enforcement of security interests, and it is interesting to note that new rules for security interests in deposit accounts have been modelled on UCC Article 8.248

On the other hand, strong coherence has been maintained or restored in those instances where ‘other law’ is explicitly made applicable to certain issues of securities custody and transfer law. In its provisions on securities transfers, for instance, UCC Article 8 explicitly refers to general agency law to determine the effectiveness of an entitlement order. In addition, the way in which an intermediary must perform its duties as an account provider is determined by explicit reference to the general doctrine of ‘good faith’ and ‘fraud’. Furthermore, the general negotiability principle has been given a specific application in the context of securities transfers, although no reference is made to the concepts of ‘good faith’ and ‘bona fide purchaser’ that are generally used in the context of transfers of assets. More specifically, all transferees of book-entry securities are protected against competing third party claims, provided they had no notice of the third party’s adverse claim, obtained control over the assets transferred, and had given value for the transfer.

As has been shown in the previous sections, this rule and its elements derive from general principles of private/commercial law that similarly protect

245Cf. QUINN (2005), 570-571.

246See Ch. 2.3.1.

247Cf. also ROGERS (1996), 1450-1451 and 1456.

248ROCKS & BJERRE (2004), 76.

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purchasers for value, and the current version of UCC Article 8 thus maintains a strongly coherent, albeit functional, relation with those general principles of commercial law. A similar approach has been taken with regard to the UCC rules on the creation and enforcement of security interests in investment property. The 1994 revision of UCC Article 8 introduced the concept of ‘control’ as a central element in the legal framework for security interests in investment property, but in effect, that approach restored coherence with the general principles of creation and enforcement of security interests, as they are also applied to negotiable instruments and documents of title.

In sum, by introducing new concepts for sui generis phenomena, and (functionally) maintaining coherence with other parts of the law, the 1994 revision of UCC Article 8 has turned incoherence into weak coherence, and also retained its strong coherence with general principles of US private and commercial law. Whereas a later chapter must examine whether all normative choices made by the drafters of the UCC should be implemented in a European harmonisation instrument, it is concluded here that the UCC should be regarded as an example from a coherence point of view.

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PART III

HARMONISATION AND MODERNISATION

nec erit alia lex Romae, alia Athenis, alia nunc alia posthac, sed et omnes gentes et omni tempore una lex et sempiterna et inmutabilis continebit

nor will there be one law in Rome, another in Athens, one now and another one later, but one eternal and never-changing law will rule all peoples at all time

CICERO1

1 M. TULLIUS CICERO, DE RE PUBLICA, 3.22.

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