Image Credit: Christophe Vorlet
By Jason Zweig | Apr. 15, 2016 11:16 am ET
By the time you finish reading this sentence, an electronic high-frequency trader can send out thousands of buy or sell orders. Why, then, does it take up to three days — and occasionally far longer — for investors to receive cash when they sell and securities when they buy?
Consider the saga of Michael Hartner, a retired public-school superintendent who lives near Poughkeepsie, N.Y. Last Dec. 18, he called three firms where he had retirement accounts to begin transferring the balances into an Individual Retirement Account rollover at his discount broker. Not until Feb. 16 did Mr. Hartner receive the last of the proceeds — although it was $8,000 less than he had been told to expect.
Under Securities and Exchange Commission rules, stock trades must “settle” — with the buyer delivering cash and the seller handing over the securities — no later than three business days afterward. By September 2017, they should settle within two days after the trade. Fortunately, in the meantime, you don’t have to settle for snail-like delivery.
Nor was it always this way.
Until 1892, messenger boys used to scramble through the streets of lower Manhattan lugging sacks of gold, bank checks and stock and bond certificates. When the settlement time of 2:15 p.m. approached, pedestrians risked life and limb as swarms of delivery boys plowed their way toward the cashier windows at the biggest banks. Without a single computer or cellphone, thousands of stock and bond trades regularly settled one day after they were made.
Overnight settlement was standard practice until the 1930s, says Bernard McSherry, interim dean of the NJCU School of Business in Jersey City, N.J., who worked as a broker on the floor of the New York Stock Exchange for four decades through 2005. The settlement period lengthened to two days in 1938 and three in 1946. Then, in 1968, with average daily volume swelling above 10 million shares and Wall Street drowning in paperwork, trades began settling on a five-day lag — where the limit stayed until the SEC lowered it to three days in 1995.
Almost no one holds paper certificates anymore, with nearly every investment in electronic form, so the risk of another 1968-scale back-office crisis has waned.
Still, the U.S. stock market trades fast, but settles slowly. Many European stock markets have already moved to two-day settlement. Stock options have long settled one day after the trade, and China’s stock markets require same-day settlement.
Progress has been slow primarily because of inertia and the intrinsic complexity of a system that handles billions of trades and trillions of dollars a day.
What’s more, brokerage firms long made buckets of money “playing the float,” or holding onto customers’ cash during the settlement period, and by collecting fees on securities they loaned out for a couple days before having to deliver them. Today, with interest rates near zero, an extra day’s income on billions of dollars in unsettled assets isn’t the bonanza it once was.
A large group of financial firms and other market participants is inching the industry toward Sept. 5, 2017. That’s the target date on which U.S. stock trades should finally have to settle within two days — the same standard they had to meet in 1938.
“The benefits to the system far outweigh” any revenue that firms might get by hanging onto securities longer, says Thomas Price, a managing director at the Securities Industry and Financial Markets Association, a Wall Street group. He doesn’t think playing the float has been a factor.
Risk is lessened for brokers and investors alike when money remains in limbo for less time, says John Abel, an executive director at Depository Trust & Clearing Corp., the industry-owned organization that handled more than 345 million trade settlements last year.
Although mutual-fund companies have up to seven days to release your cash, about 80% of fund sales settle the day after the transaction, says Marty Burns, chief industry operations officer at the Investment Company Institute, a trade group for fund managers.
If you do need your money sooner, it pays to ask. Brokerage firms say customers almost never request settlement sooner than three days after a trade. However, firms will honor those requests. Fidelity Investments, for example, permits its discount-brokerage customers to ask for next-day settlement — meaning that if you sell a stock before 4 p.m. on Monday, you will get the cash proceeds in your account on Tuesday. Such a trade carries the same commission, $32.95, as any other broker-assisted stock transaction at the firm.
As for Mr. Hartner, clerical error seems to have accounted for much of the delay. Spokespeople at the firms that formerly held his retirement accounts — American Funds, Nationwide Mutual Insurance Co. and Northwestern Mutual Life Insurance Co. — say they always strive to release the proceeds of sales as soon as possible. Spokesman Ryan Ankrom says Nationwide will make up the $8,000 that Mr. Hartner lost when the stock market crashed in January before the firm could finish processing his sale request. All’s well that ends well, even if it ends later than it should have.
Source: The Wall Street Journal