SB308: Bill Text

LRB-0622/1

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1997 - 1998 LEGISLATURE

1997 Senate BILL 308

September 30, 1997 - Introduced by Senators Huelsman and George, cosponsored by Representatives Green and Cullen. Referred to Committee on Labor, Transportation and Financial Institutions.

SB308,2,2 An Act to repeal 112.06; to renumber 409.105 (3) (a); to amend 71.02 (2) (e), 112.07 (1), 199.12 (4) (d), 401.105 (2) (d), 401.206 (2), 405.114 (2) (intro.), 409.105 (1) (h), 409.105 (1) (i), 409.106, 409.203 (1) (intro.), 409.203 (1) (a), 409.301 (1) (d), 409.302 (1) (b), 409.302 (1) (f), 409.302 (1) (g), 409.303 (1), 409.304 (1), 409.304 (4), 409.304 (5) (intro.), 409.304 (5) (b), 409.305, 409.306 (1), 409.309, 409.312 (1), 409.312 (7), 551.33 (6) and 766.01 (9) (c); to repeal and recreate chapter 408, 409.103 (6), 409.302 (1) (h) and 409.306 (3); and to create 409.105 (2) (an), 409.105 (2) (ap), 409.105 (2) (aq), 409.105 (2) (cb), 409.105 (2) (gm), 409.105 (3) (ac), 409.105 (3) (ag), 409.105 (3) (as), 409.105 (3) (bh), 409.105 (3) (bp), 409.105 (3) (bt), 409.105 (3) (f), 409.105 (3) (g), 409.105 (3) (h), 409.105 (3) (i), 409.105 (3) (j), 409.115, 409.116 and 409.302 (1) (i) of the statutes; relating to: revising the investment securities chapter of the uniform commercial code.

Analysis by the Legislative Reference Bureau

This bill repeals and recreates the chapter in Wisconsin's uniform commercial code (UCC) that governs investment securities, often referred to as "Article 8". The bill repeals and recreates Wisconsin's Article 8 in order to conform it to the revised Article 8 of the UCC, which was prepared under the joint sponsorship of the National Conference of Commissioners on Uniform State Laws (NCCUSL) and the American Law Institute (ALI). This revised Article 8 was approved and promulgated by those organizations in 1994. In addition, the bill makes certain conforming and miscellaneous changes to other parts of the UCC, which were promulgated by NCCUSL and ALI along with the revised Article 8.

Background

Article 8 governs how changes in ownership of securities are effected. The original version of Article 8, drafted in the 1940s and 1950s, was based on the assumption that possession and delivery of physical certificates are the key elements in a securities holding system. Ownership of securities was traditionally evidenced by possession of the certificates, and changes were accomplished by delivery of the certificates. Article 8 refers to this type of security as a "certificated security". In 1978, NCCUSL and ALI amended Article 8 of the UCC to reflect calls for the elimination of physical certificates and development of a modern electronic system for recording ownership of securities and transfers of ownership. These amendments contained rules governing the transfer of "uncertificated securities" or securities which are not represented by an physical instrument. Instead, the transfers of uncertificated securities are registered upon books maintained for that purpose by or on behalf of the issuer. Both the transfer of certificated securities and the registration of transfers of uncertificated securities on the books of the issuers have been described as "direct securities holding systems", because the owner of a security has a direct relationship with the issuer of the security.

Currently, the vast majority of securities transactions that take place in the U.S. securities markets are effected through what has been described as an "indirect securities holding system", in which both the securities issuer and the beneficial owner have relationships with securities intermediaries, but do not have a direct relationship with each other. Currently, a majority of securities issued by U.S. publicly traded corporations are held by a single securities intermediary, the Depository Trust Corporation (DTC), at which broker-dealers and banks have accounts. Rather than transferring physical securities, transfers are effected by adjusting the participants' accounts with DTC, which acts as a clearing corporation. Because any 2 major broker-dealers may have executed, with each other, numerous trades in a given security for different clients over the course of a trading day, these trades are netted and only the net changes in the positions of each depository participant are made each day.

Under current law, almost all of the provisions in Article 8 are based on a direct securities holding system and are keyed to the concepts of the transfer of physical certificates or registration of transfers of uncertificated securities on the books of the issuer. As a result of the way in which securities are held in an indirect securities holding system, these provisions currently govern only the relationship between the issuer and the direct holder of the securities, typically a clearing corporation. It does not govern the majority of securities trades, which are not effected by delivery of physical certificates or registration of entries on the books of the issuer, but rather by the registration of entries on the books of a securities intermediary. The revised Article 8 in this bill largely retains the existing provisions of Article 8 that govern persons who hold securities directly (typically, a clearing corporation) and adds new provisions which govern the rights of persons who hold securities indirectly through an intermediary.

Scope of revised Article 8

Under current law, Article 8 governs the transfer of "securities", which is defined to include both certificated and uncertificated securities. Under the bill, while the direct-holding-system rules of Article 8 continue to apply only to securities, the new indirect-holding-system rules of the bill's revised Article 8 apply to the broader category of "financial assets". Under the bill, the term "financial asset" includes not only "securities", but also obligations, shares or other interests in a person or in property or an enterprise of a person, which are, or are of a type, which is dealt in or traded on financial markets, or which are recognized as media for investment. "Financial assets" also include property that is held by a securities intermediary for another person in a securities account, if there is an express agreement between the parties that the property is to be treated as a financial asset under Article 8.

Securities entitlements

Under the bill, persons who hold financial assets indirectly through a securities account with a securities intermediary hold a "security entitlement" to the financial asset. The rules regarding securities entitlements created by the bill apply not only to a broker-dealer who maintains a securities account for an investor, but also to a clearing corporation that maintains accounts for broker-dealers or other participants and to a bank who maintains custodial securities accounts for its customers.

Under the revised Article 8, a security entitlement is, itself, a form of property interest, not merely a claim against the securities intermediary. With certain exceptions, a person acquires a security entitlement if a securities intermediary does any of the following: 1) indicates by book entry that a financial asset has been credited to the person's securities account; 2) receives a financial asset from the person, or acquires a financial asset for a person, and accepts it for credit to the person's securities account; or 3) becomes obligated under other law, rule or regulation to credit a financial asset to a person's account. Current Article 8 provides some protections for "protected purchases" to take a security free from adverse claims, if the person purchases and holds a security directly for value and without notice of any adverse claims against the security. The revised Article 8 adds similar protections for persons who do not hold securities directly. Under the bill, an adverse claim may not be asserted against a person who acquires a securities entitlement for value and without notice of the adverse claim.

Securities intermediaries

The bill imposes a number of duties on persons who act as securities intermediaries. Many of these duties, such as the duty to obtain payments or distributions, the duty to exercise rights or the duty to comply with entitlement orders, are satisfied if the securities intermediary acts with respect to the duty in the manner required by an agreement with the entitlement holder, or, in the absence of an agreement, if the securities intermediary exercises due care in accordance with reasonable commercial standards. Many of these duties are also subject to the rights of the securities intermediary arising out of a security interest in the financial assets and to the rights of the securities intermediary granted under law, regulation, rule or agreement due to the failure of the account holder to fulfill obligations to the securities intermediary.

The duties of securities intermediaries created under the bill include the following:

1. The securities intermediary must maintain a sufficient quantity of financial assets to satisfy the claims of all of its entitlement holders. These financial assets may be maintained directly or through one or more other securities intermediaries.

2. The securities intermediary may not grant a security interest in a financial asset that it is required to maintain in order to satisfy the claims of an entitlement holder, unless the entitlement holder has agreed otherwise. The bill also provides that, to the extent necessary for a securities intermediary to satisfy all security entitlements with respect to a particular financial asset, all interests in that financial asset held by the securities intermediary are held for the entitlement holders. These interests are not property of the securities intermediary and are not subject to the claims of the creditors of the securities intermediary.

3. In the absence of a agreement to act otherwise, the securities intermediary must exercise due care in accordance with reasonable commercial standards to maintain financial assets held for entitlement holders.

4. The securities intermediary is required to take action to obtain a payment of distribution made by the issuer of a financial asset. The securities intermediary is obligated to its entitlement holder for a payment or distribution made by the issuer of the financial asset, if the payment or distribution is received by the securities intermediary.

5. The securities intermediary is also required to exercise rights with respect to a financial asset if directed to do so by an entitlement holder.

6. The securities intermediary is required to comply with entitlement orders, if the entitlement order is originated by the appropriate person, if the securities intermediary has reasonable opportunity to assure itself that the entitlement order is genuine and authorized and if the intermediary has had reasonable opportunity to comply with the entitlement order. An "entitlement order" is a notification communicated to a securities intermediary directing transfer or redemption of a financial asset to which the entitlement holder has a security entitlement. If the securities intermediary transfers a financial asset pursuant to an ineffective entitlement order, the securities intermediary is required to reestablish a security entitlement in favor of the person entitled to it and pay or credit, to the entitlement holder's account, any payments or distributions that the person did not receive as a result of the wrongful transfer. If this is not done, the securities intermediary is liable to the entitlement holder for damages.

Security interests in securities

The bill also amends Article 9 of Wisconsin's UCC, which governs secured transactions. In addition to making conforming changes to adapt the existing rules to the new concept of a security entitlement, the bill makes some substantive changes to the way in which security interests in financial assets are created and perfected. The bill continues the long-established principle that a security interest in a certificated security can be perfected by a possessory pledge; however, revised Article 9 does not require that all security interests in investment securities be implemented by procedures based on the concept of the common law pledge. Under the revised Article 9 rules, a security interest in securities can be created in the same fashion as a security interest in any other form of property, that is, by agreement between the debtor and secured party. There is no requirement of a "transfer", "delivery", or any similar action for the creation of an effective security interest.

Under revised Article 9, a security interest may be perfected by "control". In general, obtaining control means taking the steps necessary to place the secured party in a position where the secured party can have the collateral sold off without the further cooperation of the debtor. Thus, for certificated securities, a lender obtains control by taking possession of the certificate with any necessary endorsement. For securities held through a securities intermediary, a lender can obtain control in 2 ways. First, the lender obtains control if it becomes the entitlement holder; that is, has the securities positions transferred to an account in its own name. Second, the lender obtains control if the securities intermediary agrees to act on instructions from the secured party to dispose of the positions, even though the debtor remains the entitlement holder. Such an arrangement suffices to give the lender control even though the debtor retains the right to trade and exercise other ordinary rights of an entitlement holder. Except where the debtor is itself a securities firm, filing of an ordinary Article 9 financing statement is also a permissible alternative method of perfection. However, this filing does not assure the lender the same protections as for other forms of collateral, since the priority rules under revised Article 9 provide that a secured party who obtains control has priority over a secured party who does not obtain control.

The bill also provides for certain security interests in financial assets to be created as a result of the purchase or delivery of a financial asset. If a person buys a financial asset through a securities intermediary in a transaction in which the buyer is obligated to pay the purchase price to the securities intermediary at the time of the purchase and if the securities intermediary credits the financial asset to the buyer's securities account before the buyer pays for the financial asset, then the securities intermediary has a security interest in the buyer's securities entitlement to secure the buyer's obligation to pay. The perfected security interest arises by operation of law; no security agreement is necessary and no steps need be taken in order to perfect the security interest. A similar provision creates a security interest in a certificated financial asset to secure the buyer's obligation to pay for the certificated financial asset. This provision covers situations where the certificated financial asset is delivered pursuant to an agreement between persons in the business of dealing with such financial assets and the agreement class for "delivery versus payment".

Other changes

The bill significantly changes the few provisions in current Article 8 that deal with clearing corporations. The bill repeals provisions of current Article 8 that address the issue of who may act as a clearing corporation or as a custodian bank, as well as the provisions which deal with how a clearing corporation should conduct its operations. These issues are largely addressed under federal securities laws.

The bill simplifies the provisions in current Article 8 governing uncertificated securities. For example, under current Article 8, an issuer who issues uncertificated securities is required to send paper transaction statements when the issuer registers a transfer of the uncertificated securities on its books. These requirements exist under current Article 8 even though no such requirements apply to transfers made by securities intermediaries. This bill repeals the transaction statement requirements for issuers of uncertificated securities.

The bill repeals Wisconsin's uniform act for the simplification of fiduciary securities transfers. In general terms, this act assumed that an issuer would be liable to an adverse claimant if the issuer had notice of an adverse claim. Under the act, a corporation or transfer agent registering a security in the name of a person who is a fiduciary or who is described as a fiduciary is not bound to inquire into the existence, extent or correct description of the fiduciary relationship, and thereafter the corporation and its transfer agent may assume without inquiry that the newly registered owner continues to be the fiduciary until the corporation or transfer agent receives written notice that the fiduciary is no longer acting as such with respect to the particular security. Since, under revised Article 8, notice of an adverse claim does not impose duties on an issuer of securities, the bill repeals the simplification of fiduciary security transfers act.

The people of the state of Wisconsin, represented in senate and assembly, do enact as follows:

SB308, s. 1 Section 1. 71.02 (2) (e) of the statutes is amended to read:

SB308,6,3 71.02 (2) (e) Retention of professional services of brokers, as defined in s. 408.303 408.102 (1) (c), and of attorneys and accountants located in this state.

SB308, s. 2 Section 2. 112.06 of the statutes is repealed.

SB308, s. 3 Section 3. 112.07 (1) of the statutes is amended to read:

SB308,8,2 112.07 (1) Notwithstanding any other provision of the statutes, any fiduciary, as defined in s. 112.01 (1) (b), who is holding securities in a fiduciary capacity, any bank or trust company holding securities as a custodian or managing agent, and any bank or trust company holding securities as custodian for a fiduciary may deposit or arrange for the deposit of such securities in a clearing corporation as defined in s. 408.102 (1) (c) (e). When the securities are so deposited, certificates representing securities of the same class of the same issuer may be merged and held in bulk in the name of the nominee of the clearing corporation with any other such securities deposited in that clearing corporation by any person regardless of the ownership of the securities, and certificates of small denomination may be merged into one or more certificates of larger denomination. The records of the fiduciary and the records of the bank or trust company acting as custodian, as managing agent or as custodian for a fiduciary shall at all times show the name of the party for whose account the securities are so deposited. Ownership of, and other interests in, the securities may be transferred by bookkeeping entry on the books of the clearing corporation without physical delivery of certificates representing the securities. A bank or trust company which deposits securities pursuant to this section shall be subject to such rules and regulations as, in the case of state chartered institutions, the division of banking and, in the case of national banking associations, the comptroller of the currency may from time to time issue. A bank or trust company acting as custodian for a fiduciary shall, on demand by the fiduciary, certify in writing to the fiduciary the securities deposited by the bank or trust company in a clearing corporation pursuant to this section for the account of the fiduciary. A fiduciary shall, on demand by any party to a judicial proceeding for the settlement of the fiduciary's account or on demand by the attorney for such a party, certify in writing to the party the securities deposited by the fiduciary in the clearing corporation for its account as such fiduciary.

SB308, s. 4 Section 4. 199.12 (4) (d) of the statutes is amended to read:

SB308,8,8 199.12 (4) (d) The name of any corporation in which the candidate holds a security, as defined under s. 112.06 (1) (f), the current market value of which is $3,000 or more and the dollar value of such security. In this paragraph, "security" includes any share of stock, bond, debenture, note or other security issued by a corporation which is registered as to ownership on the books of the corporation.

SB308, s. 5 Section 5. 401.105 (2) (d) of the statutes is amended to read:

SB308,8,10 401.105 (2) (d) Section 408.106 408.110 on applicability of ch. 408.

SB308, s. 6 Section 6. 401.206 (2) of the statutes is amended to read:

SB308,8,14 401.206 (2) Subsection (1) does not apply to contracts for the sale of goods (s. 402.201) nor of securities (s. 408.319 408.113) nor to security agreements (s. 409.203).

SB308, s. 7 Section 7. 405.114 (2) (intro.) of the statutes is amended to read:

SB308,8,20 405.114 (2) (intro.) Unless otherwise agreed when documents appear on their face to comply with the terms of a credit but a required document does not in fact conform to the warranties made on negotiation or transfer of a document of title (s. 407.507) or of a certificated security (s. 408.306 408.108) or is forged or fraudulent or there is fraud in the transaction: