The Rise and Effects of the Indirect Holding System - How Corporate America Ceded its Shareholders to Intermediaries

Abstract:     
This paper explains how the choice of the indirect holding system for securities settlement forced U.S. issuers to cede their shareholder data to intermediaries. Part I describes the law applicable to the transfer of certificated securities. Part II describes how the paper-intensive process of transferring certificated securities led to a market failure in the 1960's. It further shows how the indirect holding system was seen as a temporary, second-best solution pending the dematerialization of shares and improvements in communications technology. In the mean time, the effects of separating beneficial and record ownership led to an expensive and inefficient process of shareholder communication and voting. Part III examines this process, whose inefficiency offered service providers the profitable niche industry of assisting issuers to distribute proxy materials through and around extensive chains of intermediaries. Part IV explains how, when law and technology had developed sufficiently to allow a return to a system of direct issuer-shareholder relationships via a direct registration system, intermediaries acted rationally to absorb DRS into the DTTC system, and continue to enjoy their central role between issuers and shareholders. This Part also demonstrates how a truly effective direct registration system could provide the transparency necessary to address problems such as empty voting and could arguably spread the costs of securities settlement more equitably through broader-based netting, rather than pushing them downstream. Part V argues that although the indirect holding system and its negative effects are no longer necessary, a combination of unawareness and interest serves to perpetuate a perceived need for issuers and shareholders to cede their ownership/governance relationship to a custodian utility, which then offers to put them back into contact, for a fee. By explaining the interests behind choices made and the possibility of alternative structures, this paper hopes to assist regulators to serve the entire market, not just its central hub.

Number of Pages in PDF File: 66

Keywords: share transfers, market microstructure, securities settlement, clearing and settlement, UCC, shareholder communications

JEL Classification: K22, K23, N20

working papers series