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Transfer Agent Liabilities: Under-Estimate Them At Your Peril

Our Top Tips On Protecting Your Company From T-A-Related Liabilities: Doing It Yourself? Bad Advice!

One of the things on the transfer agency scene that has been surprising us of late is the number of companies that still act as their own transfer agent – and how little they seem to care – or know – about the very significant liabilities that come with this set of tasks.

Almost all of the biggest companies – and the vast majority of gas, electric and water utilities that used to serve as their own transfer agents - have outsourced all - or all of the most risky tasks, like making transfers – to full-time professionals over the past 10-15 years. But many smaller companies, and many mid-sized financial institutions too – who really ought to know better – still use the ‘do it all yourself method’ – some in the belief it will produce better service to investors, which often it does – and some who think it will be “cheaper” to do so, using easy to purchase off-the-shelf systems. We estimate that there are probably 750 - 1,000 companies that still do all their T-A work in-house. And none of them, in our first-hand experience, seem to have a clue about the monster-sized potential liabilities that come with the territory.

And guess what? Many of the signed transfer agency agreements we review in the course of an average year for large-cap companies contain provisions in the small type that severely limit or even cap the TA’s liabilities – for the very things you hire them to do as the “expert professionals.”

So we thought we should share a few horror stories about T-A liability – most from one of our side-careers as an expert witness in such matters…and then share our top tips on what to do to minimize YOUR liabilities...

One of the first expert witness engagements we had after departing the T-A biz involved a company that had served as its own transfer agent since its inception – then hired a professional T-A (in this case a pretty large bank back then) when their internal auditors raised a series of questions about their internal control environment …But without telling the TA, of course.

All went smoothly until the day the company merged with a larger one, and DTC came up “short” on the new shares that were delivered to it - to the tune of about $80 million-worth. The new company immediately filed suit against the T-A alleging negligence and demanding either a quick and plausible “fix” or the immediate buy-in of the missing shares.

Soon, it was discovered that an employee of the old company – who was serving as the company’s official T-A until they outsourced – had pulled off an unbelievably clever scam: First, he manufactured a fake claim from DTC that a large number of shares had gone missing. Then he used his position to waive an indemnity bond, and to replace the supposedly “missing shares” in the name of a nominee that he himself formed and controlled. Then, he systematically sold-off all the shares in the nominee name – and reserved some of the proceeds to issue a check to DTC each quarter to cover the stolen shares - that were, of course, in DTC’s vault all along. What started off as a $28 million theft soared to an $80 million one, when the new stock soared following the merger.

Nonetheless, the new company still tried to assert that the bank T-A was negligent – for not discovering and resolving the difference – and should be making the company whole.

Fortunately for the T-A – and unfortunately for the new company - that line of reasoning did not fly very far…So the company was out the entire $80 million. We never understood why they did not pursue the estate of the perpetrator – who shot himself to death once the jig was up: “No one can go through $28 million in three years… on boyfriends” we opined…But he’d given a lot of money to his church too…so we figured it was either worth $80-million to the company to keep the scandal under wraps…OR that they were getting very BAD ADVICE.

Another big source of T-A liability – where your editor has served as expert in over a dozen cases – revolves around the failure to promptly make a transfer of restricted stock because of some real or imagined deficiency in the paperwork – and where the value of the stock on question dropped precipitously while the owner, or his attorney, or his custodian – or sometimes the T-A – diddled and dawdled, and failed to return the stock promptly, along with a clear and accurate description of what needed to be done to MAKE the stock transferable. Two cases where we testified involved losses of $50-80 million.

Among the biggest and most common losses to T-As – or to their issuer customers if the Transfer Agent ends up broke – involve exchange and tender offers. Here too, the most common cases involve a failure to make the exchange in a correct or timely fashion while the stock is dropping…

The biggest case we were involved in however, in terms of dollars in dispute, was a roughly $80 million “difference” in the amount of cash the original T-A said needed to be set aside to satisfy an all- cash merger and the amount of “unexchanged stock” that still stood “on the books and records” some 10 years later. And OUCH! The original T-A had sold its business to another T-A – that foolishly agreed to assume all future liabilities as part of the deal. And ouch again….many of the key records were missing (like big sections of the daily transfer journals) …And ouch again…many of the records that were on the record indicated that some shares had apparently been “exchanged” - and paid for – TWICE. And, oh woe for them… the successor Transfer Agent/Exchange Agent could not produce the SEC required “Control Book” that is supposed to record the number of shares exchanged and retired from the records on a daily basis. (We don’t want to brag - or to reveal the secret either – but the lawyers wanted this case to go on forever (BAD ADVICE). We suggested a way to resolve this issue that cut the T-A’s liability - and the company’s – to less than ten cents on the dollar...But it was peculiar to the particular circumstances here, so don’t bank on pulling rabbits like this one out of a hat.)

Interestingly, relatively little money is lost by issuers or their transfer agents due to fraudulent conveyances: Most of such cases involve relatives or close friends or caregivers of shareholders who are able to obtain enough information to successfully masquerade as the legal owner(s)…And that becomes a matter for the defrauded party to pursue – as long as the T-A has followed proper procedures, that is, as most do. But issuer-agents – and some smaller transfer agents – do not always know enough to tell a valid signature guarantee or an indemnity bond - backed by adequate insurance - from a fake or defective one. And if the value of an improperly transferred or replaced item is large, and the insurance in effect is small or zero, the issuer will be holding the bag here.

One of the biggest losses we’ve seen a transfer agent have to absorb in our long career involved the theft of transfer agency and exchange agency records – when Bank of New York-Mellon had a dozen computer tapes, with 12.5 million shareholder records stolen from the truck that was transporting them to long-term storage. BNY-Mellon had to take a $22 million charge in the 2nd quarter of 2008 – and had to spend well over $10 million more, we estimated, to contact affected shareholders and to purchase 36 months of credit protection insurance for them – not to mention the loss of business and the loss of credibility and goodwill they suffered…which completely spoiled their taste for being in what they had formerly presumed to be a ‘low risk business.’ Please note that this was well before the folks looking to steal this valuable information became able to do it so much easier… in cyberspace…The risks of cybercrime are far, far greater today…so please read our tips, below...


  • If your company serves as its own transfer agent and record-keeper, be 100% sure that you - and all of your employees who are involved in the day-to-day activities - understand the nature and the sources and the potential dollar amounts of the potential liabilities that are involved in such duties: Ask yourselves, “What are the largest amounts that could conceivably be lost on a given transaction, or in a given “event” where, let’s say, the entire system goes awry?”… using the horror stories above as sample scenarios.
  • Next, be sure to at least double or triple that amount, to allow for stock price appreciation, going forward. And please, we urge you, recognize that some stocks - like Berkshire Hathaway or Apple (which is up about 7,000% over the past ten years or so) can go much higher than a mere triple.
  • Meet with your risk-management and internal insurance experts to be sure you have adequate insurance coverage – including resources from ‘self- insurance’ – to adequately cover the worst-case scenarios.
  • Consider outsourcing the securities transfer, securities replacement and ALL exchange and tender processing functions to a professional transfer agent as a way to offload the biggest risks.
  • It may sound silly to say this, but if you decide to explore the idea of outsourcing some or all transfer agency and related functions, make 100% sure that the transfer agents you look at fully understand the risks and the financial liabilities of being IN the business.
    (In one case we were involved in, the owner lost his entire T-A business by filing an “interpleader” instead of merely rejecting a disputed transfer, because (a) he did not fully understand the risks involved and (b) he relied on BAD ADVICE.
  • Make sure that YOU understand (1) all of the insurance coverage the prospective agents have in effect – including all limitations, exclusions and “caps” on losses per item and/or per-event that are imposed by their insurance policies – or by the agent itself, and (2) the overall financial ability of the agents under study to absorb any and all losses that are not covered by insurance.
  • Make sure that you – and they - understand the full potential for cybercrime, including (1) the defenses each prospective agent has in place, (2) the extent and frequency of their testing and systems-challenging procedures.

Make sure that the agents have the ability to absorb the THREE kinds of liabilities that can arise here: (1) The costs of notifying shareholders and buying insurance to protect them if key data is stolen; (2) The ability to make-good on fraudulent conveyances arising from the theft of data, and (3), as in our Exchange-Agency horror story, the potential to absorb any and all losses that may arise because the records to disprove the validity of shareholder claims for funds or stock can not be found, because they have been lost, stolen, erased or destroyed on the TA’s watch.