Direct holding system
The direct holding system is a traditional system of securities clearance, settlement and ownership in which owners of securities had a direct relationship with the issuer. Investors would either be recorded on the issuer's register or be in physical possession of bearer securities certificates.
Within this system, transfers of securities had to be settled through the physical delivery of paper certificates and instruments of transfer. As a result, transactions were expensive in terms of labour and time. They were also risky, especially when transferred over long distances, since paper documents could be lost, stolen or counterfeited. Furthermore, while in transit, securities were not available for use or investment, causing what has been called "pipeline liquidity risk".
Indirect holding system
Because of these disadvantages, the "direct holding system" has been replaced by the indirect holding system. Settlement by physical delivery of certificates worked adequately until the 1960s, when a sharp increase in trading volumes overwhelmed the system. The amount of paper that physically had to be moved around led to the famous "paperwork crisis" on Wall Street in the late 1960s. This provided the impetus for the introduction of the indirect or multi-tiered holding system.
Although the indirect or multi-tiered holding system has increased settlement speed, thus reducing the risk that the counter-party in the relevant transaction will fail before the transaction is settled, it effectively cuts off the issuer of shares from the shareholders. This is because either a central securities depository or a financial institution becomes the recorded shareholder on the books of the company and the real, or beneficial shareholder is known only to the financial institution with which he or she has an account. The result has been to drastically complicate communication between shareholders and their companies, and increase the cost of such communication.
New Direct Holding System
In the 1990s, the U.S. Securities and Exchange Commission (SEC) working with the securities industry, developed a new form of modern, "direct holding system" that would allow both the speedy settlement of securities transactions and communication between shareholders and their companies. This new system was a type of book-entry direct registration system (DRS) operated by transfer agents. This concept would allow any retail investor who wants his or her securities to be registered directly on the books of the issuer, but does not necessarily want to receive a certificate, to register those securities in book-entry form directly on the books of the issuer. The DRS concept has been slow to develop for two reasons. First, many investors do not understand that if they give up paper certificates while joining a DRS, this will return them to the status of direct shareholders of the issuer rather than just customers of a broker (who is the registered shareholder in the eyes of the issuer), and second, once brokers and banks had been inserted as the "indispensable" middlemen between shareholders and issuers, they were not eager to surrender this privileged position of control. As a result, one version of the "direct holding system" is an inefficient relic of the past and a modern DRS form of direct holding remains for most shareholders an unrealized thing of the future.
In a system that used paper certificates for securities, the doctrine of lex loci rei sitae (the law of the place of location of the securities) was applied to determine the validity of certain rights in or transfers of securities. In the case of bearer securities, this is taken to be the law of the jurisdiction where the certificates actually are (e.g., in a pledge, where the recipient of the collateral takes possession of the securities certificate at the time of transfer). In the case of registered securities, the lex loci rei sitae is either the law of the issuer's jurisdiction or the law of the jurisdiction where the securities records of the issuer or its official recordholder are located at the time of transfer. In a system in which securities are mostly held indirectly through brokers and banks (as discussed above) or in which securities are evidenced mainly on accounts (referred to as "dematerialization") rather than by certificates, an alternative rule of "the law of the relevant intermediary" has come to be used. According to this rule, the law chosen in the account agreement with the financial institution that holds the account in which the securities are evidenced or the place where the office of the intermediary with which the account holder normally deals is the law used. This is the technique used in the Hague Convention on The Law Applicable to Certain Rights in Respect of Securities Held with an Intermediary, and also used in the Article 8, "Investment Securities" of the United States Uniform Commercial Code. The advantages of this rule for international financial transactions is that wherever securities are located or regardless of how many offices and branches a financial institution has, persons dealing in the securities can know the law that will govern a transaction such as a sale, a pledge or a loan of securities.
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