On December 22, 2015, the Securities and Exchange Commission (the “SEC”) issued Exchange Act Release No. 34-76743 (the “Release”), which contains an Advance Notice of Proposed Rulemaking providing public notice that the SEC is considering new and amended rules governing transfer agents. The Release also contains a Concept Release addressing other aspects of transfer agent regulation.

The SEC first adopted transfer agent rules in 1977. These rules remain virtually unchanged, despite significant changes in the structure and operation of the securities markets. The Release covers the following matters:

• Sections II, III and IV of the Release contain a detailed and comprehensive description of the current clearing and settlement system, its history and the role of transfer agents in clearing and settlement.
• Section V provides a detailed account of the development of current transfer agent activities.
• Section VI, the Advance Notice of Proposed Rulemaking, contains a description of the transfer agent rules and rule amendments that the SEC intends to propose and lists some hundreds of questions, divided into 82 categories, that the SEC is seeking responses to in connection with the proposed rules and rule amendments.
• Section VII, the Concept Release, discusses additional regulatory policy and related issues beyond those raised in Section VI and lists some additional hundreds of questions, divided into 88 categories, that the SEC is seeking responses to in connection with the issues identified in Section VII.

The SEC has requested public comment on the Release. Transfer agents, and in particular transfer agents that provide services to mutual funds, may wish to submit comments in order to help shape any rules that the SEC may propose. Comments are due by February 29, 2016. We understand from the SEC staff, however, that the comment period may be extended.

It has been the SEC staff’s long-held position that all the activities of registered transfer agents are subject to SEC oversight, even an activity that in and of itself would not require the person performing the activity to register as a transfer agent. As a result, and in light of the increasing array of services provided by registered transfer agents, users of those services – including private funds, pension plans, employee and shareholder investment plans and issuers of various debt and asset-backed securities not registered under Section 12 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) – may have an interest in both the rule amendments and proposals that the SEC is considering and the additional issues on which the SEC is requesting comment.

ADVANCE NOTICE OF PROPOSED RULEMAKING (SECTION VI)

A. Registration and Annual Reporting Requirements

The SEC intends to propose amendments to Forms TA-1 and TA-2¹ to include additional disclosure requirements regarding certain financial information, such as:

1. annual financial statements;
2. direct or indirect conflicts of interest;
3. the issuers and securities for which a transfer agent is providing transfer agent and other services; and
4. the specific services being provided or expected to be provided for each issuer or security, regardless of the nature of those services.

The information on Forms TA-1 and TA-2 would be captured in a structured, electronic format intended to enhance aggregation, comparison and analysis.

B. Written Agreements between Transfer Agents and Issuers

The SEC intends to propose amendments to require that any arrangement for transfer agent services between a registered transfer agent and an issuer be set forth in a written agreement covering certain topics, including:

1. the transfer agent services to be provided;
2. the terms of payment and fees to be imposed, particularly termination fees; and
3. requirements for the migration of records to a successor transfer agent.

C. Safeguarding Funds and Securities

In light of the provision of “paying agent” services² by many transfer agents, the SEC intends to propose amendments to Rule 17Ad-12³ to require transfer agents to comply with specific minimum best practices requirements related to safeguarding funds and securities, such as:

1. maintaining secure vaults;
2. installing theft and fire alarms;
3. adopting written procedures for access and control over securityholder accounts and information;
4. enhanced recordkeeping requirements; and
5. adopting unclaimed property procedures.

Segregation of Client Funds. The SEC intends to propose a rule requiring transfer agents to segregate client funds so that bank accounts holding the funds are identified in a manner that is designed to protect them from being treated as funds of the transfer agent in the event of its insolvency, and to obtain written notification from banks holding the funds that the funds are for the exclusive benefit of the clients.

Annual Financial Reports. The SEC intends to propose new rules requiring transfer agents to prepare and file annual financial reports (including a statement of financial condition, a statement of income, a statement of cash flows, and other financial statements).

Policies and Procedures. The SEC intends to propose new rules requiring transfer agents acting as paying agents or custodians to prepare and maintain current and detailed policies and procedures reasonably designed to comply with any new or amended possession and control requirements for the safeguarding of client funds and securities that the SEC may adopt.

Controls on Electronic Records. The SEC intends to propose amendments to Rule 17Ad-12 to provide specific requirements for the safeguarding of uncertificated securities, including controls and limitations on access to a transfer agent’s electronic records.

D. Restricted Securities and Compliance with Federal Securities Laws

Restricted Securities. In light of transfer agents’ role with respect to the issuance and transfer of restricted securities, the SEC intends to propose a new rule prohibiting any officer, director or employee of a registered transfer agent from directly or indirectly taking any action to facilitate a transfer of securities if that person knows or has reason to know that an illegal distribution of securities would occur in connection with the transfer.

Anti-Fraud Provision. The SEC intends to propose a new rule prohibiting any registered transfer agent (or any of its officers, directors, or employees) from making any materially false statements or omissions or engaging in any other fraudulent activity in connection with the transfer agent’s performance of its duties and obligations under the Exchange Act and the rules promulgated thereunder.

Policies and Procedures; Designation of CCO. The SEC intends to propose a new rule requiring each registered transfer agent to adopt policies and procedures reasonably designed to achieve compliance with applicable securities laws and rules and regulations thereunder, and to designate and identify to the SEC on Form TA-1 one or more individuals to serve as chief compliance officer.

E. Cybersecurity, Information Technology and Related Issues

The SEC intends to propose new or amended rules requiring registered transfer agents to, among other things, create and maintain:

1. written business continuity and disaster recovery plans, tailored to the size and activities of the transfer agent, identifying procedures relating to an emergency or significant business disruption, including provisions such as data back-up and recovery protocols;
2. basic procedures and guidelines governing the transfer agent’s use of information technology, including methods of safeguarding securityholders’ data and personally identifiable information; and
3. appropriate procedures and guidelines related to a transfer agent’s operational capacity, such as IT governance and management, capacity planning, computer operations, development and acquisition of software and hardware, and information security.

CONCEPT RELEASE (SECTION VII)

Section VII of the Release addresses issues that the SEC believes may be relevant to the regulation of transfer agents but as to which the SEC is not currently planning to propose rules or rule amendments. These issues relate to (A) the processing of book-entry securities, (B) bank and broker-dealer recordkeeping for beneficial owners of securities, (C) transfer agents for mutual funds, (D) crowdfunding, (E) administration of issuer plans, (F) outsourcing activities and Non-Qualifying Securities⁴ serviced by a registered transfer agent, and (G) the appropriate subjects and scope of transfer agent regulation in the current environment and the foreseeable future.

A. Processing of Book-Entry Securities

Noting that virtually all publicly traded debt securities and an increasing number of equity securities are issued in uncertificated (or “book-entry”) form, the SEC is seeking comment on whether – and, if so, how – to amend transfer agent rules to address uncertificated securities specifically.

B. Bank and Broker Recordkeeping for Beneficial Owners

The SEC notes in the Concept Release that although banks, brokers and other intermediaries (collectively, “intermediaries”) provide recordkeeping and transfer services to beneficial owners who hold securities in street name, they are typically not required to register as transfer agents under the Exchange Act as a result of providing these services. Although the SEC states that the transfer agent registration provisions do not apply because these intermediaries provide services with respect to “securities entitlements”,⁵ rather than “Qualifying Securities”, registration as a transfer agent was not required by the SEC before the concept of a securities entitlement was introduced into the Uniform Commercial Code (“UCC”) in 1999. At that time, the SEC staff believed that the highly regulated nature of bank and broker-dealer custody functions would have made the application of transfer agent regulation to those activities duplicative and therefore unnecessary.

Accordingly, the SEC is raising the question of whether intermediaries that provide transfer, processing and recordkeeping services to beneficial owners, including both regulated entities such as banks and broker-dealers and unregulated entities such as third-party administrators (“TPAs”), should be subject to regulation as transfer agents as a result of providing those services.

C. Transfer Agents to Mutual Funds

The SEC notes in the Concept Release that it is examining the regulation of transfer agents to mutual funds (“Mutual Fund Transfer Agents”) and of intermediaries, such as broker-dealers and banks, that provide sub-transfer agent services⁶ to beneficial owners of mutual fund shares similar to those provided to direct holders of shares by transfer agents.

The SEC is conducting this examination due to a number of issues, including the growth of the mutual fund industry since 1977, the growth of the segment of the transfer agent community specifically focused on servicing the mutual fund industry, the proliferation of fund share classes, the growth in intermediary omnibus account arrangements and of the Mutual Fund Transfer Agent community, the complexity of fund processing and the involvement of the National Securities Clearing Corporation’s (NSCC) systems in mutual fund share issuance and redemption.

Mutual Fund Transfer Agents are exempt from certain turnaround, processing and recordkeeping requirements,⁷ described below, that apply to transfer agents to operating company issuers (“Operating Company Transfer Agents”). However, the SEC notes that Mutual Fund Transfer Agents provide many of the same services as Operating Company Transfer Agents and that transaction processing for Mutual Fund Transfer Agents “may be more complex or involve additional responsibilities” due to the following factors:

1. Mutual Fund Transfer Agents receive cash and perform calculations as a part of regular processing of transactions in shares of mutual funds to a greater extent than is involved in the day-to-day work of Operating Company Transfer Agents;
2. Mutual Fund Transfer Agents play a role that assists in the determination of the appropriate price for an investor’s purchase or redemption order (i.e., by coordinating with fund administrators, who calculate the net asset value per share);
3. some mutual funds provide investors with options (e.g., exchanges of funds in the same complex and systematic account withdrawal plans) that may add additional complexity to the Mutual Fund Transfer Agent’s processing tasks;
4. mutual funds’ use of different sales load structures and distribution methods; and
5. Mutual Fund Transfer Agents traditionally have functioned in a more central role in connection with clearing and settlement of securities transactions than have Operating Company Transfer Agents.

Therefore, the SEC is examining – and requesting comment on – whether it should consider amending or eliminating the Rule 17Ad-4 exemption and thereby subject Mutual Fund Transfer Agents to the requirements that apply to other transfer agents, including:

• Rule 17Ad-2, which sets basic standards for transfer agents in turning around and processing transfer requests and performing other functions.
• Rule 17Ad-3, which provides limitations on the expansion of transfer agent activities if a transfer agent is unable to meet the minimum performance standards established by Rule 17Ad-2.
• Rules 17Ad-6(a)(1)-(7), which address the records that transfer agents must maintain with respect to Rules 17Ad-3 and for how long.

The SEC notes that the increasing prominence of omnibus account⁸ and sub-accounting arrangements for mutual fund shareholders has decreased Mutual Fund Transfer Agents’ ability to look-through to beneficial owners. The SEC is examining the issues that may arise in connection with the lack of visibility that mutual funds and Mutual Fund Transfer Agents may have regarding the records maintained by intermediaries that are registered owners of mutual fund shares maintained for the intermediary’s customers that are the beneficial owners of the shares.

D. Crowdfunding

In the Concept Release portion of the Release, the SEC notes several references to transfer agents in rules (“Regulation Crowdfunding”) adopted by the SEC pursuant to the Jumpstart Our Business Startups (“JOBS”) Act. These references generally provide benefits to issuers relying on Regulation Crowdfunding that use a registered transfer agent for the securities being issued.

The SEC is seeking views on the services the transfer agents may be expected to provide to crowdfunding issuers, the risks those activities may pose and the appropriate level of fees to charge for those services.

E. Administration of Issuer Plans

The SEC is seeking guidance on the roles played by transfer agents and by non-regulated entities such as TPAs in providing services to issuer plans, such as employee stock purchase plans, equity-based incentive compensation, odd lot programs and subscription programs in employer-sponsored retirement plans.

Third Party Administrators. While noting that TPAs do not generally perform transfer agent functions, the SEC identifies circumstances in which TPAs process and aggregate orders to purchase and redeem mutual fund shares and otherwise perform intermediary and sub-accounting roles. The SEC questions whether these activities should be included in the activities for which transfer agent regulation is required and subject to regulation under various rules applicable to transfer agents.

Issuer Plans. The SEC notes that, in connection with certain issuer plans, TPAs or, in some cases, the issuer’s transfer agent perform a variety of services that involve purchases of the issuer’s shares either in the secondary market or from the issuer as well as maintaining custody of the shares for plan participants. The SEC questions whether and how those activities should be regulated under the existing transfer agent regulations and under the new regulations and amendments that the SEC is considering.

Potential Broker-Dealer Registration Issues. The SEC notes that in connection with issuer plans transfer agents and TPAs provide transaction execution and order routing services. In some instances these activities are accompanied by handling cash, custodying securities, netting orders and payments and providing settlement services. The SEC questions whether, among other matters, the activities may require broker-dealer or clearing agency registration or regulation or, if carried out by registered transfer agents, new transfer agent regulations.

F. Outsourcing Activities and Non-Qualifying Securities Serviced by a Registered Transfer Agent

The SEC notes that registered transfer agents may outsource functions or services to a variety of regulated and non-regulated and possibly foreign entities, and that registered transfer agents perform services for both Qualifying and Non-Qualifying Securities (such as, for example, shares of non-publicly traded entities and certain foreign issues). In light of those circumstances, the SEC is seeking guidance on, among other things, what activities are outsourced domestically and outside the United States, what standards should apply to outsourcing, whether the SEC’s transfer agent regulations should apply to foreign transfer agents and what control a transfer agent typically has over records that have been outsourced. The SEC is also inquiring whether its current policy of applying the full suite of transfer agency regulations to all activities of a registered transfer agent, including those involving Non-Qualifying Securities, is appropriate.

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If you have any questions regarding the Release, please contact any of the attorneys listed below.

Greg B. Cioffi

Paul T. Clark

Kalyan (“Kal”) Das

Paul M. Miller

Anthony C.J. Nuland

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¹ Transfer agents use TA-1 to register or amend their transfer agent registration with the appropriate regulatory agency (e.g., SEC, Comptroller of the Currency, Federal Reserve Board or FDIC). All registered transfer agents use Form TA-2 to file an annual report with the SEC.

² “Paying agent” services include administrative, recordkeeping and processing services related to the distribution of cash and stock dividends, bond principal and interest, mutual fund redemptions and other payments to securityholders.

³ Rule 17Ad-12 and the other 17Ad rules referred to in this Client Alert were adopted by the SEC pursuant to Section 17A(d)(1) of the Exchange Act.

⁴ Section 17A(c)(1) of the Exchange Act requires any person performing any of the functions enumerated in Section 3(a)(25) of the Exchange Act with respect to any security registered pursuant to Section 12 of the Exchange Act or with respect to any security which would be required to be registered except for the exemption contained in subsection (g)(2)(B) or (g)(2)(G) of Section 12 (“Qualifying Security”) to register with the SEC or other appropriate regulatory agency.

⁵ An “entitlement holder” is a person identified on the records of a securities intermediary (e.g., a clearing corporation, bank or broker-dealer) as the person having a security entitlement against the securities intermediary. Under the UCC, an entitlement holder’s property interest with respect to a particular security is a pro rata property interest in all securities of the issue held by the securities intermediary.

⁶ Services provided by intermediaries such as banks and broker-dealers (sometimes called “sub-accounting” services) include recordkeeping, processing and transfer services.

⁷ Rule 17Ad-4 exempts Mutual Fund Transfer Agents from (i) Rule 17Ad-2, which regulates the time for turning around and processing of transfer requests; (ii) Rule 17Ad-3, which places limitations on the ability of a transfer agent that is not promptly turning around transfer requests to take on new issues or provide new services for existing issues; and (iii) Rules 17Ad-6(a)(1)-(7) and (11), which set recordkeeping requirements for transfer agents.

⁸ Omnibus accounts are held by and registered in the name of a single intermediary, such as a broker-dealer, and the holdings in the account represent the aggregated positions of multiple beneficial owner customers of the intermediary.