T+3 Rule: Living with Tighter Deadline on Trades

Securities firms are in a dither over what’s believed to be one of the industry’s most important technical shifts in decades: a new rule going into effect next month that’s dubbed T+3.

In a nutshell, T+3 means that trades in corporate stocks and bonds must be completed--securities returned, new purchases paid for--within three business days. That shortens today’s fairly leisurely five-business-day cycle and will have a substantial impact on investors who register securities in their own names and pay for their trades with a check.

It’s worth noting that these people are a minority today. They account for less than 20% of the nation’s estimated 51 million investors.

Industry experts estimate that the great majority of investors set up accounts that allow them to keep their securities at the brokerage in “street name.” When street-name customers sell stocks or bonds, the proceeds are credited to money market accounts in their names. These accounts earn interest and can be tapped the next time the investor wishes to buy stocks or bonds. It’s fast, easy and convenient.

The 5 million to 10 million holdouts who like to personally hang on to their securities and cash are now being urged to switch and keep their assets in street name at brokerage firms. That would eliminate any trouble over the new, faster-paced clearing, industry spokespersons say.

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Is that necessary? Will you be left out in the cold if you continue to hold your own securities?

No. When T+3 goes into effect June 7, the biggest shift most customers not using the street-name process will notice is that they won’t be able to wait for a confirmation statement before they send checks (or securities), says Dick Stream, director of operations and information services at Piper Jaffray in Minneapolis.

In the past, many customers considered their confirmation statements as invoices. And since they had five full business days--seven days total--to complete the trade, trading by mail rarely caused major problems.

However, under the shorter cycle, investors who send checks in the mail will probably have to send them on the day the trade was ordered, Stream says. Or, if they insist on seeing a confirmation first, they may have to physically drive the check down to the broker’s office--or have their bank send a wire or electronic fund transfer. (Wire and electronic transfers are fast, but banks usually charge a fee for them.)

There’s no reason to panic if the money or securities don’t get to the brokerage on time--at least at first, brokers say. That’s because most brokerage houses have the ability to “extend” the clearing process for a few days when the customer requests it and there’s good reason to say yes.

“We often grant extensions to longtime customers who have sent checks and they simply haven’t been received,” says Leslie C. Zuke, spokesman for Quick & Reilly Inc. in New York. “That’s not going to change.”

Extensions are by no means automatic, however. Brokers must get regulatory approval to hold the transactions open, Stream says. Customers who are consistently tardy are likely to be penalized.

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Although most brokers say it is too early to say exactly what those penalties might be, some firms say they’re considering late fees. But more drastic action is possible.

The worst that can happen: If your money or securities do not arrive on or before the deadline, the brokerage is legally able to reverse the trade and hold you liable if there’s a loss on the deal, Stream says.

Another option: The broker may sell other securities or property you have in your brokerage account to pay for the trade, says Hugo Quackenbush, a spokesman for Charles Schwab Co.

It’s unlikely that either of these moves would be undertaken without the customer being contacted, experts say. However, since they are possible, it’s wise to ask when delivery is due; your broker can tell you at the time of trade. Then check with the broker on the given date to make sure your check or securities have been received.

This is particularly important in times of great market volatility. Brokers get nervous when the market is going against them and they have a lot of open trades. (Exchanges can force them to pony up cash on behalf of their customers.) As a result, the system may be less forgiving if stock prices fall significantly.

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Given the risks and inconvenience of sending checks and stock certificates in the mail, why wouldn’t you set up a street-name account?

Some investors collect certificates and simply like to have them. However, experts believe the biggest reason that some investors shun street-name accounts is that they are worried about the safety of their securities and cash.

It’s worth noting, however, that cash and securities in brokerage accounts are generally insured by the Securities Industry Protection Corp. for up to $500,000 (only $100,000 of it in cash). Brokers also commonly buy additional private insurance, which can provide protection for millions of dollars more in individual investments.

This insurance does not protect you from trading losses. It promises to return or replace your cash and stock in the event of brokerage bankruptcy, embezzlement or theft.

Brokers that offer SIPC protection usually say so on customer statements. If you want to know about additional insurance coverage, ask.