As tech continues to evolve and faster settlement dates are possible, there are things every issuer should know about how this new timeline will impact equity activity. In the wake of the SEC’s announcement to move from a T+2 to a T+1 settlement date, Amy clarifies what this means for stock plan administration.
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CC8013578 (1023-3JB8) (10/23)
00:00:03:04–00:00:26:10
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Amy Reback:
Well, hello, listeners, and welcome back to Equity Unpacked®. I'm your host, Amy Reback, from the Workplace Financial Services Team at Charles Schwab.
Today's journey is similar to that plane ride where the captain comes on after you take off and says, "Hey, we're expecting a smooth ride to your destination, and it's 54 degrees in St Louis. And the seatbelt sign is going off. Feel free to move about the cabin."
00:00:26:10–00:00:54:10
But then you get about halfway through the flight, and suddenly the seatbelt light goes on, and everything is bumping around. And your drink lands in your lap, and you're thinking, "Smooth ride. What a pack of lies!"
And that, my friends, accurately describes my experience in researching today's topic, which is the move to a T+1 settlement date, officially known as SEC Rule 15c6.
00:00:54:17–00:02:13:08
Super exciting language there.
However, the reason that it's like that bumpy ride is I expected this to be sort of straightforward. But it's really, really complicated, and there are some pretty far-reaching implications. So let's talk about what that means. Now, stay with me. There could be some turbulence, but we're going to get through it together.
So SEC Rule 15c6, which I'll simply refer to as T+1 from here on out, formally changes the settlement date from trade date plus two trade days, or T+2, to trade date plus one trade day, or T+1, for transactions in U.S. equities, corporate debt, and unit investment trusts. And clearly an accelerated settlement date for equities will be particularly relevant for equity compensation events. So here are the facts.
The final requirement for this change were adopted and announced by the SEC just this year on February 15, 2023. And the implementation deadline to be compliant is May 28 of 2024 for all market participants. So why the change? Well, the SEC and several market advocacy groups made reference to the 2017 settlement move from T+3 to T+2 and the positive outcomes that were achieved.
00:02:13:18–00:02:57:27
You know, by the way, when I started in this industry, the settlement cycle was T+5. So I'm now thinking that maybe my kids are right when they accuse me of having a pet stegosaurus. But I digress.
So needless to say, as technology continues to evolve, making even faster settlement dates possible, the SEC agreed that moving to a T+1 settlement cycle would do lots of great things for the market, including overall efficiency of the securities markets, mitigating risk, create better use of capital, promote financial stability, drive infrastructure modernization and standardization of industry processes, and reduction in liquidity requirements and costs. All good things.
00:02:58:14–00:03:21:20
So there's a number of ways that equity compensation practices might be involved here. And I'm not going to cover all of them, but some of them really stood out. So first and foremost, I want to emphasize that the accelerated regulatory requirement of a T+1 settlement specifically relates to activity that involves a trade, meaning a security has been bought or sold in the market.
00:03:22:09–00:03:57:05
And when a grant is issued or a vesting event of RSUs or RSA occurs without a sell-to-cover transaction, there's no actual market activity. No trade? Technically, there's no T+1 requirement. Technically. However, once participants know and understand that regular way stocks, or equities to this audience, are required to settle one day after the trade, they will expect the same for their vested shares, and demand is going to be created to have them appear or delivered in their account on that T+1 schedule as well, even if the regulatory rule doesn't apply.
00:03:57:13–00:04:18:00
Now, the T+1 rule does directly apply to things like option exercises and ESPP purchases and any sell-to-cover, as they both, or all, involve at least one trade in the market. So for our SPAs: What does that mean for you and your teams, and what should you be looking out for?
00:04:19:05–00:04:40:12
Well, probably a lot more than you originally expected. So the good news is your broker-dealer is going to bear all of the work to meet the requirements of T+1 settlement rule. But some of those changes required include accelerated timelines related to trade reporting—meaning, when your broker-dealer has to tell all of the national systems that these trades have occurred.
00:04:41:00–00:05:09:08
And if that has to be accelerated, it could impact your procedures or timelines for things like deadlines to review and approve data for your lapse process [inaudible], especially if you offer a sell-to-cover option for restricted stock or ESPP. Your daily submission deadlines for your payroll files or data updates of any kind might have to be earlier after T+1 is live. Your timeline for sending tax payments to the IRS as a result of sell-to-cover transactions will be moved up by a day.
00:05:09:25–00:05:37:28
And as you start thinking through the details, you'll likely find others that are unique to your firm and your plan. As for timing on your data exchange activities, if your provider does absolutely everything with zero involvement of your teams, you're home free. You'll be fine. If you and your teams prefer to do, let's say, a last quality control check before moving your lapse job into production, you might have to consider some changes to meet those required deadlines, especially when a market transaction is required.
00:05:38:23–00:06:00:06
So just stop for a minute and ask yourself what processes or procedures your team may have to change if your broker-dealer needs your data files two or three hours earlier than they do today. A lot of that depends on the details of your plan, but it could require some pretty serious revisions, such as the date and time you price your shares.
00:06:00:16–00:06:28:04
Will you need to move that pricing to the day before the lapse occurs to meet the deadline? Okay, breathe, because this is the part where the drink lands right in your lap and you're completely surprised. Regardless of the type of grants or securities you offer, every issuer needs to know that this T+1 timeline will absolutely impact equity comp activity because of what we broker-dealers call "asset servicing functions."
00:06:29:00–00:06:56:27
First, let's define. So "asset servicing" refers to activities required by things like reinvesting dividends; dividend reinvestment plans and DERs; any kind of special dividend activity [inaudible] declared by the issuer; dividend ex dates, which is going to drive or set the timelines for income payments—you know, whether you receive an income payment or whether a due bill is attached to that security; the cover or protect date determination for any corporate actions.
00:06:56:27–00:07:18:11
And, of course, the timing and settlement of corporate actions such as tender offers, M&A, and stock splits. These reach pretty far and wide. And it may sound like it's strictly recordkeeping or broker-dealer system recordkeeping. But if those systems are not compliant by that May 28, 2024, deadline, it's going to negatively impact some pretty big functions, and you're going to hear about it.
00:07:18:23–00:07:52:17
That could be things like data accuracy, which . . . those are those big systems that push and pull data from the exchanges and inform balance and trade activity, which also would eventually impact accuracy of trade confirms, statements, and tax documents. We know how complicated it is when tax documents are rewritten or revised. A late notification announcement for corporate actions, which would run afoul of required timelines for voluntary and mandatory reorgs, which could prevent your share owners or participants from voting or participating in those voluntary actions, which could likely cause financial loss.
00:07:52:17–00:08:18:03
Due bill processing. And I want to dig into this one a little thoroughly because I honestly, in all transparency, I had to look this up. Here goes. In a T+1 environment, the ex-date and a record date would be the same. So that was a regular way ex-date. With regular way, due bills are not required because any trade entitled to the dividend would also be settled on the record date.
00:08:18:28–00:08:40:23
But if that doesn't happen, then a due bill is going to be required. So the exchanges will set an ex-date, and typically set a later ex-date—like maybe the day after the payment date—for stock or large cash dividends that are more than 25% of the value of the stock. They do that because it helps to maintain market values.
00:08:40:23–00:09:06:20
And in a regular way ex-date, the price would typically drop by the value of the dividend on that ex-date, but the proceeds would not be paid until later. That could undervalue the stock and impact purchasing power. And any irregular ex-date would still require a due bill. So broker-dealers have to be very careful about adjusting that ex-date period for regular way ex-dates and then modify the due bill calculation for all ex-dates, both regular and irregular.
00:09:07:28–00:09:32:26
Okay, everybody, let's breathe. That was a lot of Xs people. And these Xs do not live in Texas. They live right here in your equity plan. All right. They're shaking their heads at me. I'll stop.
It also affects things like interim accounting process, the silent juggernaut. Now I consider anything involved with payments or due bill collections part of the Pentaverate and is officially above my pay grade.
00:09:32:26–00:09:51:15
However, I will clarify, the interim accounting period is the time period in which a trade that is settling either has income or a due bill attached to it. And that's literally all I can say about that because the definition came from Investopedia late last night, and it's now the full extent of my knowledge on that subject. But it's big stuff, and it's important.
00:09:52:08–00:10:08:29
With that in mind, do you really want to take calls from confused participants on stuff like this? Because you know they're going to call you first, right? I've been in the broker-dealer business for 25 years, and I had to look most of this up. So if that does happen and they're calling you on it, you should immediately take the Fifth and direct them to your provider.
00:10:09:19–00: 10:55:07
But still, if you interact with your participants a lot, they're going to call you first. You know this.
Last but not least, noncompliance with T+1 creates avoidable liabilities related to any reorg events and stock record balances and so on. Keep breathing. Stay with me here. Here's some questions you should ask your broker-dealer. And there's no need to write them down. We will include them in the show notes at the end.
Question 1: How are you preparing to meet the requirements for the T+1 settlement related to recordkeeping and processing of our equity plan? When will system testing begin in advance of the May 28, 2024, deadline? Where will the testing results be documented? When will those results be provided to us for our governance process?
00:10:55:14–00:11:19:00
Even better, maybe rather than ask, state when your governance deadlines or audit deadlines between now and May 28, 2024, are, and ask them if they'll be able to meet them.
Now, there's a caveat here because let's . . . at least understanding that this is a huge undertaking for broker-dealers, and they're going to need some time to adjust. This rule was just adopted and announced in late February of this year.
00:11:19:00–00: 12:17:16
And as of right now, that was just about six weeks ago. Now, I can guarantee that every broker-dealer is aiming to meet that SEC deadline—which may not satisfy your deadlines. And that gap may need to be addressed. You should also be prepared to just understand and accept that your broker-dealer's plan to meet the SEC implementation deadline probably won't be adjusted to meet your audit, technology, governance, or due diligence timelines. And that may require some socialization with your decision makers and possibly your auditors that are responsible for those activities.
What recordkeeping or lapse processes need to change on your side as the broker-dealer? Meaning, how will the recordkeeping and/or processes that lead up to a lapse or a vest change by your provider? Will the participant experience be impacted? What processes need to be changed on the issuer side?
00:12:17:28–00: 13:13:05
So advocate for support here. You're going to need regular communications and results of those final testings to keep you informed. And also understand that your day-to-day contact at your provider team is probably not in the weeds, since the majority or in a remediation, activities are going to be outside of the equity team realm. But they should know enough to connect you with someone on their digital team that is involved in the changes on their recordkeeping platform or anything that's required of their equity platforms, and someone that can also discuss the firm-level initiatives at your provider underway to meet the deadline. Either way, no one can afford to be placated on this subject, and it is okay to press for answers.
Ask your provider if they intend to change their delivery or available date for vesting securities to be in line with T+1, even if the rule doesn't technically apply because there's no market activity.
00:13:13:19–00:13:38:04
Now remember, your participants will begin to expect a T+1 delivery on vested shares, and your team will be inundated with questions about why shares haven't been deposited yet if your provider's not doing that.
Now will a remediation team be created by your provider and easily accessed if postimplementation issues arrive? And if accounting errors do occur and it results in financial loss for your participants, how does your provider plan to compensate them? Does it fall under their regular procedures? And when will those timelines be established?
Whoo! Okay, we have landed the plane. You got splashed with a drink in your lap. It wasn’t a smooth ride. But you're now at least armed with some particulars and have some questions to ask your provider. And starting that conversation will ensure a smooth transition for you, your teams, and your participants.
00:14:03:08–00:14:32:16
So it should be all downhill from here, folks. So let's do a quick review. T+1 is happening. Your broker-dealers are required to comply, which means earlier trade reporting deadlines for them and shorter processing timelines for you and your provider. That means you may need to change your own processes or even features of your plan, which also requires communication and awareness for your C-suite, legal, and finance partners, and your participants.
00:14:32:16–00:14:59:10
Ask questions today, and be in sync with your provider so you have fewer surprises, like a data mismatch on your exes. Talk about unnecessary liabilities, right? Know where to find help and support. Which brings us to the final stretch as we approach the gate. You can easily access details on the T+1 transition requirement—and I highly recommend reviewing the T+1 Playbook, which is literally the master class in project planning and execution; the T+1 Test Approach; and the T+1 workbook or documentation, which was all created by the Depository Trust and Clearing Corporation, also fondly known as DTCC. There's also additional references that identify potential impacts, affected securities, implementation activities, timelines, dependencies, and risk impacts that all market participants or broker-dealers need to consider to successfully prepare for the transition to a T+1 settlement cycle on May 28, 2024.
00:15:26:19–00: 16:08:08
We have included those links, plus additional references, in the show notes and the questions to get you started on that conversation with your provider. And you can find them at schwab.com/equityunpacked. Thanks for joining us on our slightly bumpy ride today. Be sure to check out those excellent resources. And while you're at it, subscribe to our podcast so we can meet again. As always, safe travels, everyone.
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For important disclosures, see the show notes, or visit schwab.com/equity unpacked.