On February 15, 2023, the Securities and Exchange Commission (SEC) adopted final rule changes to shorten the standard settlement cycle for most broker-dealer transactions in securities from two business days after the trade date (T+2) to one business day after the trade date (T+1). The SEC also adopted new rules related to institutional trades by broker-dealers and certain clearing agencies to facilitate efficient processing and amending certain recordkeeping requirements applicable to registered investment advisers.
Background of the T+1 Security Settlement Cycle Rule Proposal
The settlement cycle rule was changed, in part, to address potential vulnerabilities in the U.S. securities market that arose from increased market volatility following the outbreak of the COVID-19 pandemic in March 2020 and the “meme stock frenzy” of 2021. The SEC believes that a shortened settlement cycle can help mitigate credit, market and liquidity risks from unsettled securities transactions.
The SEC explained in its adopting release that the rule changes are to “reduce latency, lower risk, and promote efficiency as well as greater liquidity in the markets” and that the rule adoption “addresses one of the four areas the staff recommended the Commission address in response to the meme stock events of 2021. Taken together, these amendments will make our market plumbing more resilient, timely, orderly, and efficient.”
Shortened Settlement Cycle
1. Default settlement cycle. Under amended Rule 15c6-1(a), most broker-dealer transactions are now required to settle by T+1, subject to certain exceptions provided under Rule 15c6-1(b).
2. Firm commitment offerings priced after 4:30 p.m. ET are required to settle by T+2. The amendment to Rule 15c6-1(c) shortens the standard settlement cycle for firm commitment offerings priced after 4:30 p.m. Eastern Time (ET) from T+4 to T+2. For example, in a registered underwritten offering that priced after 4:30 p.m. ET, the offering must settle on the second business day after the date of the underwriting agreement, whereas before, it is allowed to settle up to four business days after the date of the underwriting agreement. Offerings that priced before 4:30 p.m. ET will likely be required to settle under the T+1 cycle.
3. Override provisions provide flexibility under the new standard settlement requirement. The so-called override provisions under Rule 15c6-1(a) and (d) are retained. These provisions allow parties to settle later than the standard T+1 timeline if a different settlement date is expressly agreed to by the parties at the time of the transaction.
Same-Day Allocations and Affirmations
To facilitate T+1 settlement and promote the completion of allocations, confirmations and affirmations by the end of trade date for transactions between broker-dealers and their institutional customers, the SEC adopted Rule 15c6-2. This rule prohibits a broker-dealer from effecting or entering into a contract for the purchase or sale of a security1 on behalf of a customer unless such broker or dealer has either (1) entered into written agreements with customers that ensure prompt completion of applicable allocation, confirmation or affirmation processes as soon as technologically practicable and no later than the end of trade date, or (2) established, maintained and enforced written policies and procedures reasonably designed to address certain objectives related to completing allocations, confirmations and affirmations as soon as technologically practicable and no later than the end of trade date.
Reasonably designed policies and procedures shall include elements that do the following:
(i) Identify and describe any technology systems, operations and processes that the broker-dealer uses to coordinate with other relevant parties, including investment advisers and custodians, to ensure completion of the allocation, confirmation or affirmation process for the transaction;
(ii) Set target time frames on trade date for completing the allocation, confirmation and affirmation for the transaction;
(iii) Include procedures that the broker-dealer will follow to ensure the prompt communication of trade information, investigate any discrepancies in trade information, and adjust trade information to help ensure that the allocation, confirmation and affirmation can be completed by the target time frames on trade date;
(iv) Describe how the broker-dealer plans to identify and address delays if another party, including an investment adviser or a custodian, is not promptly completing the allocation or affirmation for the transaction, or if the broker-dealer experiences delays in promptly completing the confirmation; and
(v) Measure, monitor and document the rates of allocations, confirmations and affirmations completed within the target time frames established under the rule, as well as the rates of allocations, confirmations and affirmations completed as soon as technologically practicable and no later than the end of trade date.
Furthermore, Rule 204-2 under the Investment Advisers Act of 1940 was amended to require investment advisers to make and keep true, accurate and current records for transactions subject to Rule 15c6-2. The required records include each confirmation received, and any allocation and affirmation sent or received with a time/date stamp.
Timing and Takeaways
The adopting release is published on SEC.gov via https://www.sec.gov/rules/final/2023/34-96930.pdf and will be published in the Federal Register. The final rules will become effective 60 days after publication in the Federal Register. The compliance date for the final rules is May 28, 2024.
The shorter settlement cycle will enable investors and companies to get proceeds from offerings faster than they could before. On the other hand, with the T+1 settlement and same-day allocations and affirmations requirements as well as other rules in relation to the shortened settlement cycle such as Regulation SHO and Rule 15c3-3(m), and Rule 10b-10 confirmations, the expense and cost for underwriters and broker-dealers to comply with the new rules will likely rise. Moreover, since broker-dealers are required to have either agreements with customers or pre-established written policies before entering into contracts to buy or sell securities for their customers, there will be less flexibility for broker-dealers to buy securities from an offering for their customers, making it more challenging for underwriters to resell these securities to the public.
We recommend that underwriters and broker-dealers work with counsel to review their current practices regarding entering into contracts to buy or sell securities for their customers and make appropriate changes to existing practices or adopt new policies in compliance with Rule 15c6-2 and other SEC rules.
1 Other than an exempted security, a government security, a municipal security, commercial paper, bankers’ acceptances or commercial bills.