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By Moshe Silver

The SEC’s Investor Education office tweets an Investor Bulletin explaining DTC chills and freezes (see full text here).  Earlier we reported on a tweet regarding Trading Suspensions.  The SEC's latest message is a bit more arcane, covering an organization that you may not even have known existed, and that exercises broad control over the investment markets, and over the stocks you own, and whose inner workings are often cloaked in secrecy (Edward Snowden, are you listening?)

SEC on “DTC Chills & Freezes” - twi88

Depository Trust Corporation – DTC

The DTC is the largest securities depository in the world, holding some 3.6 million different securities issues, worth around $35 trillion.  Says the Bulletin, the DTC’s brief is “to improve efficiencies and reduce risk in the settlement and clearance of securities transactions.”  DTC accepts deposits of securities from its participating member banks and brokerage firms, and manages the holdings through book-entry recording.  When customers buy and sell stocks, DTC makes the corresponding entries, moving securities from the firm that sold them, to the firm that bought them, both for the benefit of their corresponding customers.

DTC also has frequent interaction with issuers and their transfer agents for ensuring proper crediting of dividend payments, for distributing proxy statements, for corporate actions, and for maintaining accurate share counts.

The Big Chill

Even though it sounds like something you’d enjoy in the midst of this heat wave, a “DTC chill” is definitely not something you want, and a “Freeze” is something you really don’t want.

DTC “chills” a security by restricting one or more services, often while waiting for a problem to be resolved.  As you might have guessed, a “Freeze” is when DTC suspends all services relative to a security.  If DTC believes a transfer agent is not complying properly with DTC requirements around transfer of an issuer’s securities, DTC may chill the security by halting transfers until it resolves the matter with the transfer agent.  Such chills are often resolved in a reasonable time frame, allowing shareholders to resume trading their securities.  Also, DTC chills book-entry transfers during a corporate re-organization, then un-chills once the re-org is complete.

The chills and freezes you need to worry about are those where DTC has been informed there may be a legal problem surrounding an issuer or a particular security.  For example, on July 3rd the SEC announced a “freeze on proceeds from unlawful distribution” of shares of a company called Biozoom

The SEC had already suspended trading in the shares at the end of June, citing a “lack of current and accurate information.”  DTC filed a freeze on Biozoom shares (“suspension of DTC services notice 1177-13) on July 19th.  The SEC has charged eight Argentine nationals with the illegal sale of millions of shares of Biozoom, netting about $34 million.  Assets in US-based accounts of those charged were frozen, but not before $17 million was wired overseas.

What Should You Do?

The SEC recommends that, before buying a security you have never heard of, investors should ask their broker whether there have ever been any DTC restrictions placed on any securities of the issuer.  Unless the security is currently frozen by DTC – in which case it may be illegal to solicit trades in the security at all – your broker will probably not know the answer.  The SEC suggests you ask them to have their Compliance Department check.  The information is easy enough to obtain.  And, for the investor, worth the wait.

Better yet, we recommend you exercise reasonable caution in your investing.  It may be appropriate for you to have a High Risk component to your portfolio.  That doesn’t mean you should abandon common sense.  The SEC release says Biozoom, formerly known as Entertainment Art, Inc, “announced in April that it was changing its name and moving from producing leather bags to developing biomedical technology.” 

Call us unimaginative, but that doesn’t sound like a transferrable skill set.

Moshe Silver is a Managing Director at Hedgeye Risk Management and author of Fixing a Broken Wall Street.