Peirce, Uyeda dissent says undertakings imposed on transfer agent equal new disclosure requirement

By Rodney F. Tonkovic, J.D.

The SEC sanctioned a transfer agent for failing to make a reasonable effort to locate lost securityholders. According to the Commission, the transfer agent did not, as required, conduct a simple database search to find a better address for these securityholders but instead added further filtering steps that reduced the universe of lost securityholders that could be contacted. In addition to a civil penalty, the transfer agent agreed to undertakings including asking mutual fund clients to send periodic notifications to shareholders informing them of the risk of escheatment. This enforcement action elicited a dissent from Commissioners Peirce and Uyeda, who said that the undertakings effectively impose a new disclosure requirement on mutual funds (In the Matter of DST Asset Manager Solutions, Inc., Release No. 34-98153, August 17, 2023).

Lost securityholders. Exchange Act Rule 17Ad-17 sets out the process that transfer agents must follow when trying to find "lost securityholders." A securityholder is lost when a transfer agent has possession of an investor's securities but has sent correspondence to the investor that has been returned as undeliverable; in this situation, the assets may be subject to escheatment under state property laws. The rule requires transfer agents to then exercise "reasonable care" to ascertain the securityholder's address, meaning conducting two database searches by taxpayer identification number (used interchangeably with social security number in that order) or by name if the ID number is not reasonably likely to work. Transfer agents are further required to establish written procedures to ensure compliance.

DST's failures. DST is a registered transfer agent based in Massachusetts. At the end of 2022, DST maintained master securityholder files for 6,020,045 individual securityholder accounts as a transfer agent for over 100 mutual fund clients in the U.S. According to the Commission, DST failed to take reasonable steps to find lost securityholders as prescribed by the rule, and around 78 lost securityholders whom DST did not contact had assets totaling approximately $651,000 escheated to the states for the period January 1, 2017 to July 31, 2022.

Between 1997 (when the rule became effective) and late 2021, DST's policies and procedures required a database search by social security number. If that search returned a potentially better address, DST's procedures added an extra filtering step calling for contact to be reestablished only if a further search based on the better address matched the SSN and first name of the lost securityholder in DST's files.

This filtering process, however, violated Rule 17Ad-17, which requires that a name should only be used when an SSN search is not reasonably likely to locate the securityholder. Plus, DST had a longstanding unwritten practice of using additional filtering steps (such as matching the first and last name) that further reduced the lost securityholders that could be contacted.

After filtering, DST sent letters to the better addresses asking the lost security holders to verify their current address and warning that their assets would be escheated if they did not respond. As the order put it, DST's filtering process unreasonably reduced the universe of lost securityholders to be contacted, and those who were unreasonably filtered out by DST's written procedures and actual practices did not receive warning that their assets were in danger of being escheated. DST's data, the Commission noted, showed a 44 percent higher rate of escheatment when DST contacted lost securityholders after its additional filtering versus when using SSNs alone.

Undertakings. The Commission found that DST willfully violated Rule 17Ad-17. In addition to a cease-and-desist order and censure, the agent will pay a $500,000 civil penalty. In addition to these sanctions, DST agreed to:

• Take reasonable steps to locate lost securityholders whose assets were escheated between January 1, 2017 and July 31, 2022. This includes new SSN-only database searches and providing contacted securityholders with information on the process to apply to recover escheated funds.
• Request that mutual fund clients send periodic notifications informing and educating shareholders about the risk of escheatment (including the need to keep addresses updated).
• Provide annual written certification for five years that its written policies and procedures are in compliance and are being followed.

Dissent. Commissioners Peirce and Uyeda dissented, stating that the Commission "once again uses an enforcement action as a substitute for notice and comment rulemaking." The Commissioners' statement says that requiring DST to request that its mutual fund clients send periodic notifications amounts to a substantive new disclosure requirement. While termed a "request," this is effectively a requirement imposed by the Commission, the statement argues, and will be viewed as such by the mutual fund's counsel.

While the order addresses only DST, the Commissioners continue, its reach is broader because the undertaking implies that all mutual funds should be sending the periodic notices if their transfer agents request it. While many mutual funds already include voluntary registration statement disclosure regarding escheatment, the order implies that these existing disclosures regarding escheatment are inadequate, but offers no guidance about what would be adequate, the Commissioners say. If the Commission wants to amend the existing requirements, Peirce and Uyeda say, it can engage in rulemaking, but in this case, it has instead chosen to "send enforcement to do the rulemaking."

The Release is No. 34-98153.