An Unsettling Deadline For Settling Trades

Charlie Pack is not looking forward to June 7. That's when a new federal regulation will require investors to fork over the cash to pay for securities in three days after a trade instead of five. The rule applies to all stocks, corporate and municipal bonds, and mutual funds. Pack is steamed because he'll lose flexibility over where he parks his cash. "It forces me to keep my money with the broker," says the 56-year-old software engineer from Los Altos Hills, Calif., who trades about twice a month.

Trade-plus-three, or T+3 as it's known, will undoubtedly make more money captive to brokerage money-market funds and asset-management accounts, where it's easily accessible to cover trades. But the Securities & Exchange Commission's stated reason for the shortened pay-up period is to make the markets more efficient and less volatile. The idea is to reduce the number of open transactions at any one time, hence increasing the liquidity of the markets. T+3 also means investors will receive sale proceeds two days sooner.

LATE FEES. For decades, investors who didn't already have spare cash with their brokers to pay for a purchase of stock, bonds, or mutual-fund shares have usually been able to wait to receive a confirmation notice before mailing in a check for the stated amount. Five business days for settlement was plenty, even for the U.S. Postal Service. But under T+3, that won't be the case. Instead, investors will have to deliver the checks in person, send them via overnight delivery service, pay by electronic transfer from your bank, or keep more cash on hand with your broker.

T+3 is already raising hackles with people used to buying securities under the old system. For one thing, they can no longer use their confirmation slips as payment notices. "They have to understand that by the time they get their confirmation, they should have already paid for the trade," says Allan Johnston, regional manager at Wedbush Morgan Securities in Anchorage, Alaska.

Indeed, this change could make mailing checks to your broker obsolete. "You have to send the payment on the day the trade is executed," says Fidelity Investments Senior Vice-President Donna Morris. "With the mail, there's no guarantee the check will arrive by the settlement day." If it doesn't, you can face fees for late payment or risk losing the trade and being held liable for any losses in the security or fund when the broker liquidates your position.

The shorter settlement deadline is especially problematic for investors who hold a stock or bond certificate in their safe-deposit boxes. Getting the paper security out of the bank and to the broker to complete a sale could cost extra days. Many people avoid this problem by having the broker hold the securities in what's known as street name--basically, book-entry purchases in the broker's name.

DRIP DISCOUNTS. But one reason some investors hold certificates in their name is to participate at no cost in dividend reinvestment plans (DRIPs). The DRIP company does the bookkeeping and automatically buys the shareholder new lots of stock, often at a discount with no commission. If certificate holders move their securities to a broker, however, they are likely to be charged fees to take part in DRIPs. Now some brokers are trying to accommodate such customers. Discount broker Charles Schwab offers free DRIP services through its Schwab One account. In October, Fidelity Investments plans to offer a similar service called Equity Dividend Reinvestment Program.

Keeping cash in a brokerage money-market fund or asset-management account may well be the easiest and most efficient way to meet the shorter settlement deadline. Asset-management accounts, sometimes called core accounts, typically offer a choice of competitive money-market funds to capture stock dividends and sales proceeds and to hold cash for future purchases. They also provide extra services such as "gold" credit cards, debit cards, check-writing privileges, consolidated statements, and tax information. Some enable you to transfer money electronically to and from your bank. Most asset-management accounts also carry additional insurance against broker failure. The Securities Investor Protection Corp. insures regular brokerage accounts for up to $500,000, but it protects many asset-management accounts for $50 million or more.

At full-service brokerages, asset-management accounts generally require a $10,000 to $20,000 minimum and cost $75 to $100 a year, but most brokers offer a more basic version for $50 a year that may not have such extras as the enhanced insurance or credit card. And some discount brokers don't charge any fee for centralized cash accounts such as the Schwab One and Fidelity Ultra Service Account, which is free with at least one trade a year or a $50,000 minimum.

MOVING MONEY. Another way to go is to keep your money in a separate money-market account at the same brokerage firm as your securities or mutual funds. The difference is that you have to instruct your broker to move the funds to or from that account when you make a trade. With a cash-management account, the transfer is made automatically. But money-market funds carry small minimums and no extra service fees beyond the management expenses. "It makes sense to have a money-market fund with your broker," says John Markese, president of the American Association of Individual Investors. "There's no true loss because you're just moving money from one cash-equivalent account to another." Returns for most money-market funds don't vary much from one broker or fund company to the next.

If you have upwards of $250,000, you can use a bank trust department as the nexus of your brokerage activities. This enables you to "do all your transactions in one place while keeping the flexibility to deal with different brokers, which is good for frequent traders looking for the best price," says William Newell, managing director of private banking at Chemical Bank. But such freedom comes at a steep price. The fee for Chemical's private banking account is $800 a year.

Mutual-fund holders will have an easier time adapting to T+3 since their securities are already in street name. But they still must have fund payments in by the third day after the trade to ensure buying shares at a specific price. Most people making long-term investments in mutual funds don't care about the exact purchase price. And in such cases, fund companies such as T. Rowe Price Associates will avoid confusion by waiting until they receive the funds before placing the trade, says Debbie Seidel, a T. Rowe Price vice-president.

Investors who chafe at the new T+3 rules may be distressed to learn that there are rumblings in the industry of eventually moving to one-day or even same-day trade settlements. But by the time that happens, advances in electronic banking should have pushed us to a true cashless society. And that's still T+many years away.

Speedier Securities Trades

-- If you have a sizable brokerage account, usually cash and securities totaling $10,000 or more, open an asset-management account. Stock dividends and sale proceeds will automatically be swept into your choice of competitive money-market funds, giving the broker ready cash for future trades.

-- Keep a separate money-market fund at your broker for quick cash transfers. You avoid the fees of an asset-management account. But you won't get extras such as check-writing privileges and you must instruct the broker to liquidate fund shares when money is needed.

-- To avoid delaying the completion of a trade while you send in paper stock and bond certificates, have your broker hold your securities in "street name."


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