I remember receiving a gift of a few shares of stock in some large company or other when I was a kid. I received an engraved certificate with the company’s logo, my name, and a lot of legalese that at the time I couldn’t decipher. The naive thought, of course, is that the piece of paper is the share of stock. But of course, the certificate is not the thing itself—it is just evidence of the holder’s rights. And even at the time of the gift (in the late ’70s, I imagine, or the early ’80s) most shares weren’t held or traded using such certificates. Instead, they were held in the name of securities intermediaries, whose books and records reflected the underlying beneficial interests in the shares that were represented by certificates issued in the intermediaries’ names. Or else, more usually, the beneficial owners’ interests were reflected on the books and records of a broker, whose interest was reflected on a single master certificate held by the Depository Trust Co., a sort of master clearinghouse for US securities transactions.
Several years ago, I had a case where Article 8 of the Uniform Commercial Code, the article governing securities, and I came to learn a bit about the system we have. The UCC was revised at some point to allow for “uncertificated” securities: securities for which no certificates were ever issued but whose ownership was evidenced by book entries only. But our system didn’t develop into a purely uncertificated system. Instead, we have a system of certificated securities held mostly by DTC or someone similar; DTC’s books show the entries of the various brokers and other intermediaries, whose books in turn show the interests of their retail customers. This is not unfamiliar to any bank depositor who treats his account statement as the evidence of his entitlement to money a bank holds on deposit, and in recent times other kinds of interests, such as legal title to mortgaged property (as we would say in Massachusetts, or mortgage liens, as they would say elsewhere) have been similarly “dematerialized” and are now traded electronically, even though a physical piece of paper—the mortgage deed—still gives legal title to the property to the clearinghouse. But it raised all kinds of interesting problems, mostly relating to the beneficial owner’s security. What happens if my securities intermediary can’t make good when I want my securities to be sold to a third party, or registered in my own name? What happens if some third party claims that the securities intermediary has given it a security interest in my securities as collateral for a loan that the intermediary can’t repay? This is the reason why we have the SIPC, which serves a similar insurance function to the FDIC. But having lived through 2008, this limited insurance seems to me imperfect at best. And no doubt the meltdown in 2008 caused investors all over the world, not just in the US, to work to understand exactly what their rights are in the event a securities intermediary fails.
All of this is by way of introduction to the Hague Securities Convention (more formally, the Convention of 5 July 2006 on the Law Applicable to Certain Rights in Respect of Securities held with an Intermediary). In late September, the Senate gave its advice and consent to ratification, the President ratified the treaty, and the United States has now deposited the instrument of ratification. Mauritius and Switzerland ratified the Convention in 2009. So the Convention, which requires three ratifications, will come into force on April 1, 2017.
The goal of the Convention is to provide a conflict-of-laws rule that accounts for the possibility that a national of state A has a beneficial interest in securities issued by an issuer incorporated in state B, but the securities are registered in the name of an intermediary incorporated in state C but with offices in states E, F, and G (and of course there are innumerable variations).
For relevant background about the state of the law in the Anglo-American world (prior to the Convention), you should take a look at UCC § 8-110 and, in general, Article 9, and Article 9(2) of Directive 98/26/EC. I won’t review the status quo here or catalogue the way that the Convention departs from the existing law either in the United States or in Europe.
The Convention applies “in all cases involving a choice between the laws of different States” (Convention art. 3). Thus it should have no application in cases where there is a conflict of laws problem involving the law of more than one U.S. state but not involving any foreign law. In those cases, the UCC will continue to govern.
As to the cases where it does apply, the Convention governs the choice of law on the following issues (art. 2(1)):
- the legal nature and effects against the intermediary and third parties of the rights resulting from a credit of securities to a securities account;
- the legal nature and effects against the intermediary and third parties of a disposition of securities held with an intermediary
- the requirements, if any, for perfection of a disposition of securities held with an intermediary;
- whether a person’s interest in securities held with an intermediary extinguishes or has priority over another person’s interest;
- the duties, if any, of an intermediary to a person other than the account holder who asserts in competition with the account holder or another person an interest in securities held with that intermediary;
- the requirements, if any, for the realisation of an interest in securities held with an intermediary;
- whether a disposition of securities held with an intermediary extends to entitlements to dividends, income, or other distributions, or to redemption, sale or other proceeds.
On the other hand, the Convention does not govern choice of law in the following cases (art. 2(3)):
- the rights and duties arising from the credit of securities to a securities account to the extent that such rights or duties are purely contractual or otherwise purely personal;
- the contractual or other personal rights and duties of parties to a disposition of securities held with an intermediary; or
- the rights and duties of an issuer of securities or of an issuer’s registrar or transfer agent, whether in relation to the holder of the securities or any other person.
Article 2(3)(c) is particularly interesting: the Convention does not displace the UCC or other governing law when there is no securities intermediary involved. So if I hold an old-fashioned stock certificate and I want to exercise my rights, the good old-fashioned UCC continues to govern my relationship with the issuer with respect to my security interest.
In cases where the Convention does apply, the main rule is set out in Article 4. I’m not going to reprint the whole article, which is lengthy. The main gist is that the law chosen by the parties to govern the account agreement (or the law chosen to govern a particular issue) governs, as long as the relevant intermediary has, at the time of the agreement, an office in the chosen state that handles securities accounts and transactions (I am wording all of this very colloquially, of course). Interestingly, the Convention makes it clear that simply having a “back office” function like a call center or a data center is not enough. If these rules don’t result in a choice of law, and the account agreement makes it clear that the beneficial owner did business with the intermediary via a particular office, then the law of the place where that office is located governs. If these rules still do not yield a result, then the Convention calls for application of the law of the place where the intermediary is incorporated, or failing that, the place of the intermediary’s principal place of business. There are some special rules for federal states, too.
The other provision, of particular interest to bankruptcy and insolvency lawyers, is Article 8. On the one hand, it provides: “Notwithstanding the opening of an insolvency proceeding, the law applicable under this Convention governs all the issues specified in Article 2(1) with respect to any event that has occurred before the opening of that insolvency proceeding.” On the other hand, it provides:
Nothing in this Convention affects the application of any substantive or procedural insolvency rules, including any rules relating to—
- the ranking of categories of claim or the avoidance of a disposition as a preference or a transfer in fraud of creditors; or
- the enforcement of rights after the opening of an insolvency proceeding.
The gist here is that a bankruptcy regime cannot have rules to recharacterize things that happened prior to the filing of a bankruptcy petition. For example, whether a security interest was perfected prior to bankruptcy will have to be determined by the law applicable under the Convention, come what may. On the other hand, what happens to the rights as they existed at the time of the bankruptcy remains a matter of the law that the bankruptcy court would otherwise apply.