SEC proposal would modernize the regulation of the transfer agency industry, particularly with respect to mutual funds.

Last month, the US Securities and Exchange Commission (SEC) issued an Advance Notice of Proposed Rulemaking and Concept Release (together, the Release) requesting public comment on its review of transfer agent regulations.^[1] The Release comes after indications from the SEC that it has been considering revisions to the regulations governing transfer agents for months.^[2] In addition, on January 11, the SEC’s Office of Compliance Inspections and Examinations (OCIE) released its 2016 examination priorities list that included, among other things, transfer agency services, transfer agents’ recordkeeping and record retention practices, safeguarding of funds and securities, and provision of paying agent services.^[3]

The Release includes a discussion of various areas where the SEC plans to adopt new or amended transfer agent rules, and notes that the current regulations governing transfer agents have remained virtually unchanged since they were first adopted in 1977. In a statement accompanying the Release, SEC Chair Mary Jo White emphasized the increasingly important role that transfer agents play in the securities industry.^[4] Transfer agents, which act as agents for securities issuers, play an important role in the settlement of securities transactions. As noted in the Release, transfer agents

(i) track, record and maintain records of ownership of securities,

(ii) cancel and issues securities certificates and perform related recordkeeping services,

(iii) facilitate communications between issuers and shareholders, and

(iv) distribute dividends, principal and interest payments to shareholders.

Advance Notice of Proposed Rulemaking

The Advance Notice of Proposed Rulemaking includes a discussion of various areas where the SEC plans to adopt new (or amend existing) transfer agent rules.

Registration and Annual Reporting Requirements

Currently, before a transfer agent is permitted to perform the statutory functions of a transfer agent as set forth in Section 3(a)(25) of the Securities Exchange Act of 1934, as amended (the 1934 Act), the transfer agent must apply for registration on Form TA-1. In addition, after registering, transfer agents must annually file a report with the SEC on Form TA-2. In the Release, the SEC proposes amending Forms TA-1 and TA-2 to require disclosure covering inherent risks in current transfer agent activities. The added disclosures would require statements of financial condition, income statements, statements of cash flow, a list of all direct and indirect conflicts of interests (including broker-dealers affiliated with a transfer agent, and any affiliation of a transfer agent’s officers and directors with issuers serviced by the transfer agent) and a list of the issuers and securities for which a transfer agent provides transfer agency and other services (including a description of the other services provided).

Written Agreements between Transfer Agents and Issuers

The Release also proposes to adopt a new rule that would require transfer agents and issuers to formalize the provision of transfer agency services in a written agreement. The written agreement would be required to cover the fundamental aspects of the relationship in order to avoid future disputes that could cause disruption in the market or harm shareholders. Such agreements would contain a description of the services provided, terms of payment and fees (specifically termination fees), and a requirement that the outgoing transfer agent turn over an issuer’s records to the new transfer agent.

Apart from the written contract requirement, the SEC stated that it plans to adopt a rule that would require the outgoing transfer agent to provide uniform records to an issuer’s new transfer agent in a timely and efficient manner.

Safeguarding Funds and Securities

A large number of transfer agents have been engaged by issuers to provide certain services that supplement the transfer agency services that they typically provide. These ancillary services are called “paying agent” services, and 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. Currently, only one transfer agent rule addresses paying agent issues, and other SEC rules only indirectly address paying agents.

In the Release, the SEC states its belief that various rules need to be adopted to protect investors, promote operational efficiency, and to address the role of transfer agents as paying agents. Accordingly, the SEC proposes adopting rules that would require transfer agents to comply with certain best practices to safeguard funds and securities, including maintaining secure vaults, installing theft and fire alarms, developing specific written procedures for access to (and control over) accounts and information, and enhanced recordkeeping requirements and unclaimed property procedures. The SEC also proposes adopting a rule that would require transfer agents to segregate client funds to protect against insolvency, and to obtain a confirmation letter from the bank holding client funds that states that the funds belong to the client, not the transfer agent.

In addition, the SEC intends to propose implementing rules similar to those recently adopted for broker-dealers that amend annual reporting, independent auditing, and notification requirements.^[5] Such rules would be designed to increase focus on compliance and internal controls. The SEC also plans to propose rules requiring transfer agents acting in the capacity of a paying agent or custodian to create and maintain policies and procedures that address compliance with possession and control requirements for the safeguarding of customer funds and securities. Additionally, the SEC proposes to make amendments to Form TA-2 that would require the disclosure of residual or unclaimed funds. Lastly, the SEC proposes to amend current Rule 17Ad-12 under the 1934 Act to safeguard uncertificated securities.

Restricted Securities/Compliance with Federal Securities Laws

The Release includes a proposal to adopt new rules that would prohibit a transfer agent from directly or indirectly facilitating a transfer of securities that the transfer agent knows (or should have known) would result in an illegal distribution. Such rules would prohibit the transfer agent from making any materially false statements, omissions, or committing fraud in violation of the transfer agent’s duties under the 1934 Act. Finally, such rules would require transfer agents to adopt policies and procedures that would ensure compliance with applicable securities laws and the rules and regulations thereunder, including a requirement to appoint a chief compliance officer and identify such person on an amendment to Form TA-1.

Cybersecurity, Information Technology, and Related Issues

The SEC proposes adopting new rules that would require transfer agents to create a business continuity plan, and have (and maintain) basic procedures relating to transfer agents’ use of information technology, including methods of safeguarding securityholders’ data and personally identifiable information, as well as appropriate procedures relating to the 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.

Definition, Applications, and Scope of Current Roles

The SEC proposes to revise existing transfer agent recordkeeping requirements so that they align more closely with the many roles that transfer agents now play. This would include, among other things, rescinding obsolete rules, consolidating and updating definitions, updating references throughout the existing rules to correspond more accurately to prevailing industry practice and standards, and amending recordkeeping and retention requirements.

Concept Release

The Concept Release addresses transfer agent regulatory issues and requests comment to determine if additional regulations are needed. The SEC notes that because banks and broker-dealers often hold securities in “street name” and provide recordkeeping and transfer agency services to the beneficial owners of such securities, such banks and broker-dealers often provide services that are identical to those provided by transfer agents, without being subject to the transfer agent rules. Through the Concept Release, the SEC requests information about any regulatory discrepancies resulting from this structure and whether such regulatory gaps should be closed by requiring such banks and broker-dealers to also register as transfer agents.

The Concept Release also addresses the evolution of the mutual fund industry, with the SEC noting that its growth and complexity has resulted in specialization among transfer agents that provide services to mutual funds. The SEC notes that, unlike transfer agents for operating companies that issue securities, mutual fund transfer agents currently are exempt from key turnaround, processing, performance, and recordkeeping requirements under Rule 17Ad-4 because mutual funds issue redeemable securities. The SEC notes that one of the main justifications for historically exempting mutual fund transfer agents was that, unlike operating companies at the time, mutual funds issued uncertificated shares. However, the current process of issuing mutual fund shares is similar to the process for issuing securities of operating companies. Accordingly, the SEC is evaluating whether rules and exemptions need to be created or modified for transfer agents of all types of registered investment companies.

The Concept Release observes that the “collective effect” of the following five factors has led to increased complexity and additional responsibilities in regards to transaction processing for specialized mutual fund transfer agents compared to operating company transfer agents:

1. Mutual fund transfer agents receive cash and perform calculations as part of the 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 assist in determining the appropriate price for an investor’s purchase or redemption by providing fund administrators (who calculate the funds’ net asset values) with the current number of shares.

3. Some mutual funds provide their investors with the ability to exchange fund shares or systematically withdraw their investments.

4. The use of different sales load structures and distribution methods can create additional complexity for mutual fund transfer agents because mutual fund transfer agents are often distributing commissions.

5. Mutual fund transfer agents tend to act in a more central role when clearing and settling transactions and work with sub-transfer agents because mutual funds are not exchange-traded and do not use a clearing corporation.

In addition to these five factors, mutual fund transfer agents also add to their complexity by aiding mutual funds with their anti-money laundering programs, customer identification programs, Suspicious Activity Report (SAR) compliance, and transaction processing.

The SEC also addresses in the Release the added complexity of sub-transfer agents in the mutual fund industry.^[6] Mutual fund transfer agents deal with sub-transfer agents differently than operating company transfer agents, most notably in the context of compensating financial intermediaries. Unlike operating companies, mutual funds frequently compensate intermediaries for shareholder services that would typically be provided by the fund transfer agents. Historically, transfer agents would interface with fund shareholders more directly and provide certain services, such as communicating with shareholders, maintaining records, and providing reports and tax documents. In recent years, however, the use of omnibus accounts by broker-dealers and other financial intermediaries that invest customer assets in mutual fund shares has grown significantly. In an omnibus account structure, a fund’s transfer agent does not interface with each underlying fund shareholder, but rather interfaces with financial intermediaries, each of which may be acting on behalf of many underlying shareholders. These financial intermediaries, in turn, provide many of the services to shareholders that transfer agents have historically provided, and mutual funds or their service providers often compensate these financial intermediaries accordingly. These sub-transfer agency services are commonly referred to as “sub-TA services” and may be paid out of fund assets. In the Release, the SEC notes that the increased presence of financial intermediaries and omnibus accounts has diminished a mutual fund transfer agent’s ability to “look through” to the fund’s beneficial owners. The SEC also found that the increased use of sub-TA services provided by intermediaries and omnibus accounts adds another layer of complexity to mutual fund transfer agents when applying sales charge breakpoints. In addition, the SEC found that the increased use of omnibus sub-accounting arrangements has shifted the traditional shareholder servicing roles and responsibility and has caused a lack of transparency for transfer agents and issuers as to records for those shareholders being serviced by this method.^[7]

Public Comments

The Release sets forth significant proposed changes to the regulation of transfer agents and requests comment on a number of issues, including the changed role that transfer agents play in the modern mutual fund industry. If adopted—and when coupled with the other significant proposed rule changes that the SEC has recently put forth—the Release could result in a substantial increase in fund compliance requirements in the coming months.

Comments on the Release are due February 29, sixty days after being published in the Federal Register.

_{[1] See Transfer Agent Regulations, Exchange Act Rel. No. 76.743 (Dec. 22, 2015).}

_{[2] See Public Statement, SEC Commissioner Luis A. Aguilar, The Importance to the Capital Markets of Updating the Rules Regarding Transfer Agents (Dec. 17, 2014); see also Sarah N. Lynch, “SEC eyes transfer agents in new front against US stock fraudsters,” Reuters (Jan. 12, 2015) (noting SEC in early stages of drafting new rules for transfer agents).}

_{[3] See Press Release, Securities and Exchange Commission, SEC Announces 2016 Examination Priorities (Jan. 11, 2016).}

_{[4] See Press Release, Securities and Exchange Commission, SEC Seeks Public Comment on Transfer Agent Rules (Dec. 22, 2015).} 

_{[5] For a discussion of the recent amendments to the requirements for broker-dealers, see Broker-Dealer Reports, Exchange Act Rel. No. 70073 (July 30, 2013).}

_{[6] The SEC’s Division of Investment Management also recently released guidance on mutual fund distribution and sub-accounting fees. See IM Guidance Update No. 2016-01, Mutual Fund Distribution and Sub-Accounting Fees (Jan. 2016).}

_{[7] The SEC, through its recent distribution-in-guise sweep examination, also has sought to determine whether some mutual fund advisers are unlawfully using fund assets to pay for distribution-related services by masking the payments as sub-TA payments. See also In re First Eagle Inv. Mgmt., LLC & FEF Distribs., LLC, Investment Advisers Act Release No. 4199, Investment Company Act Release No. 31832 (Sept. 21, 2015).}