DTC Eligibility and Issues
The Depository Trust Company (“DTC”) is a central securities depository in the U.S. which was originally created as a central holding and clearing system to handle the flow of trading securities and the problems with moving physical certificates among trading parties. The DTC is regulated by the SEC, the Federal Reserve System and the New York State Department of Financial Services. Today, and as noted by the SEC, the “… DTC provides clearance, settlement, custodial, underwriting, registration, dividend, and proxy services for a substantial portion of all equities, corporate and municipal debt, exchange traded funds, and money market instruments available for trading in the United States.”
DTC eligibility is an important aspect of being a public company for all OTC Issuers. Obtaining and maintaining eligibility is of utmost importance for the smooth trading of an Issuer’s float in the secondary market. Moreover, DTC eligibility is a prerequisite for OTC Issuers’ shareholders to deposit securities with their brokers and have such securities be placed in street name. Legal & Compliance keeps abreast of DTC requirements to assist clients in avoiding disruptions to their stock trading activity.
Like a Form 15c2-11 submittal to FINRA, an Issuer cannot make direct application to the DTC for eligibility. An application must be submitted and sponsored by a DTC Participant. A current list of DTC Participants can be found on the DTC website. Many market makers and transfer agents maintain a relationship with DTC participants and can arrange the application process on an Issuer’s behalf.
A Participant can submit an application for a new offering or for a security that has already been issued and is already trading on the OTC market. Note that already-traded securities will be reviewed for eligibility following a reorganization, such as a reverse merger.
Prior to submittal of the application, the Issuer must have a transfer agent and that transfer agent must have a completed DTC Operational Arrangements Agent Letter on file with the DTC and must be participating in the DTC’s Fast Automated Securities Transfer (“FAST”) program. Accordingly, and obviously, this is one of the first questions an Issuer should ask when choosing a transfer agent.
Where the Issuer’s securities are already issued and outstanding (not a new offering), the Participant will need to submit a copy of the physical certificate and a transfer Agent Attestation Form. Most of the forms are PDF fill-in forms and can be uploaded or printed directly from the website. An eligibility application will be reviewed for completeness and will be subject to comments. It is the responsibility of the Participant sponsoring the application to address the comments and provide all information requested. An Issuer should work closely with the Participant to make sure all information is accurate, complete and up to date.
The DTC will also require a legal opinion. Legal opinion letters must be provided by an experienced securities practitioner, properly licensed and in good standing with their bar association. Letters will not be accepted from in-house counsel and the opining attorney may not have a beneficial ownership interest in the security covered by the letter and may not be an officer, director or employee of the Issuer.
The DTC Operational Arrangements criteria (available on the DTC website) sets forth in-depth requirements for eligibility. In addition to the Operational Arrangements, in order to be DTC eligible, an Issuer’s securities must:
(i) be issued in a transaction registered with the SEC under the Securities Act of 1933, as amended (“Securities Act”);
(ii) be issued in a transaction exempt from registration under the Securities Act and that, at the time of seeking DTC eligibility, are no longer restricted; or
(iii) be eligible for resale pursuant to Rule 144A or Regulation S under the Securities Act.
A DTC chill is the suspension of certain DTC services with respect to an Issuer’s securities. Those services can be book entry clearing and settlement services, deposit services (“Deposit Chill”) or withdrawal services. A chill can pertain to one or all of these services.
For a chill on all services, including book entry transfers, deposits, and withdrawals, the term of art is a “Global Lock.”
On March 15, 2012, the Securities and Exchange Commission (SEC) issued an administrative opinion stating that an Issuer is entitled to due process proceedings by the DTC as a result of a DTC chill placed on an Issuer’s securities (In the Matter of the Application of International Power Group, Ltd. Admin. Proc. File No. 3-13687). Following International Power, the DTC immediately began changing its procedures in dealing with Issuers, although it was a slow and evolving process. In September 2013, the DTC published a white paper explaining the circumstances under which a Deposit Chill or Global Lock may be imposed, and procedures that the DTC has developed for Issuers, including notice and opportunities to object. Although the DTC also proposed new procedures by filing a rule change with the SEC, they subsequently withdrew the proposed rules.
The attorneys of Legal & Compliance, LLC are experienced in addressing and removing DTC chills and global locks on behalf of OTC issuers. Contact us if you are currently experiencing any of the aforementioned DTC issues.