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Going Paperless: Depository Drives Down Certificate Inventory

By Edward C. Kelleher
Going Paperless Article Artwork

The Depository Trust Company’s (DTC) ongoing dematerialization efforts hit a new low – or new high, depending on how you look at it – when the number of certificates held in its vaults dipped below the 3 million mark in September.As of September 30, 2006, the number of certificates held by the depository fell to 2,997,483, according to Joseph Clemente, DTCC product manager, Asset Services.

The ongoing reduction in certificates is part of DTC’s overall dematerialization plan aimed at eliminating all paper certificates in the securities industry. The number of certificates held by the depository has gone from a high of more than 30 million in 1990 to approximately 8 million in 2000, with steady reductions in the past few years, to 3.9 million in 2004 and now fewer than than 3 million.
The DRS factor

Several factors have contributed to the decline in the number of vault certificates. Use of DTC’s Direct Registration System (DRS) – which enables investors to register ownership of their shares electronically with either the issuing company or its transfer agents – has increased dramatically in the last year and a half. "In January 2005, approximately 5% of all eligible issues were opting to use DRS. That number has jumped to 26% in the last 19 months," said Clemente. To date, there are 1,234 issues that are DRS-eligible.

With DRS, investors can choose certificates or DRS statements. "Many of the large broker/dealers are looking to default to DRS statements unless a customer specifically asks for a certificate," said Salvatore DiPaola, DTC transfer agent liaison. Use of certificates should further decline next year when all new issues listing on the New York Stock Exchange, NYSE Arca, Nasdaq and the American Stock Exchange on or after January 1, 2007, will be required to be DRS-eligible. Existing issues will have to become DRS-eligible by January 1, 2008. The Securities and Exchange Commission (SEC) approved the rule changes requested by the exchanges earlier this year.

Also, an increasing number of companies, including industry leaders such as Intel and Nuveen, have gone completely "certificateless" and only register shareholders via paperless electronic ownership records.
Non-transferable certificates

The major contributor to the dwindling vault population, however, is DTC’s ongoing shredding of non-transferable certificates. With the approval of the SEC, DTC began the destruction of thousands of non-transferable certificates in 2004 and continues to shred about 30,000 non-transferable certificates each month.

Over the years, the number of certificates in the depository’s vaults for which no transfer agent service was available grew considerably. In 2004, the number amounted to 1.2 million certificates. Today, that number of non-transferable certificates has been reduced to 959,028. The issues of non-transferable certificates are often equities of companies that have become inactive or insolvent.
PREM paper

Clemente said that brokers also have helped reduce the number of vault certificates by using the depository’s "Position Removal" or PREM function. PREM enables brokers to relinquish their positions in issues of non-transferable certificates, eventually allowing DTC to shred them. It is necessary for a participant to PREM before DTC can shred the certificates.

More than 343,600 certificates have been eliminated by the PREM function in 2006. PREM also lowers expenses for the brokers and their customers, since there is a monthly surcharge fee of $5 per issue for keeping position records open on certificates that have been non-transferable for more than six years. Customers can also deposit their non-transferable securities and immediately place them in PREM. DTC will destroy the certificates for them.

"It’s important that the industry continue to push for the elimination of physical certificates," said Lawrence Morillo, managing director of Pershing LLC and chairman of the Securities Industry and Financial Markets Association’s (SIFMA) Operations, Legal and Regulatory Committee. "Physical certificates are inefficient and expensive. Electronic registration of securities is safer, cheaper and more convenient for investors." SIFMA estimates that the cost of issuing paper certificates each year is $250 million, and that approximately 2 million certificates are lost each year with a replacement cost of $50 million.

DTC follows a four-step program when it destroys any non-transferable securities. First, three months prior to destruction, it publishes a list of CUSIPs and security descriptions for the certificates slated for destruction. Next, it allows customers to withdraw certificates from the list if they wish, and it then images each certificate before moving to the final step when the paper certificates are shredded by giant industrial shredders, supervised by DTC staff.


http://www.dtcc.com/news/newsletters/dtcc/2006/nov/certificate_inventory_down.php