When you purchase shares in a broker, your name is recorded by your broker as a beneficial owner of those shares. The next question would be, then – who is the actual owner of securities held with a broker?
Almost all publicly traded stock is owned by one private company: Cede & Co.
To understand how and why this came to pass, let’s look back to how the stock market has operated through the centuries and how it has changed in the last several decades.
The NYSE is the largest trade exchange in the world, and has been for many decades. From its creation, for hundreds of years the trading techniques stayed the same – paper certificates ran across the trading floor to broker dealers on an individual basis person to person.
This process was complicated and messy, but it worked - the trading day is only part of the day, and only for part of the week. At this earlier market stage, settlement times were T+5 days. Settlement time is the amount of time the seller has to deliver a share to the buyer after purchase. T+5 is the Trade Date, and 5 days refers to the amount of time before delivery is expected.
There was a major need to maintain time at the beginning and end of each day for bookkeeping and auditing – but as trading volume continued to increase every year, this was not enough.
In 1968 there was such a backlog, that it required the exchange to close every Wednesday through the second half of the year. It was clear that some major adjustments needed to be made to the current market system in order to operate at scale. (edited)
The DTC (Depository Trust Company) was founded in 1973 with the main goal of facilitating the electronic purchase and settlement of securities. On paper, this is a fantastic idea – it can help clear the crowded backlog of documents circulating on the trade floor and eliminate paperwork through digitization at the same time. Looking through this lens of minimalization, there has been success. Today, the markets operate more efficiently using a T+2 standard for settlement.
How does that work?
In 1973, legally transferring ownership of stock required exchanging paper certificates and recording the new owner directly on them. In order to get around this legal requirement, the DTC now operates as a communicator and intermediary to handle electronic settlement. It maintains an electronic ledger to reflect who is the beneficial owner (street name) of each share. In 1996, the DTC founded Cede & Co., a separate legal entity from DTC, and formed a partnership with Cede and Co. as a "nominee". The nominee is the named legal owner, and shares are kept in their vault. Through this invention of centralized accounting, efficient settlement was realized.
When a trade is submitted electronically to a broker today, the buyer’s broker and the seller’s broker both submit their trade information to the settlement services provided by DTC. If both submissions match, DTC updates their internal ledger of beneficial owners while their nominee Cede & Co.’s ownership never changes. The beneficial owners on the DTCs ledger are approved by the Central Security Depositories, or CSDs, which include the brokers used by most retail investors. (edited)
The name Cede & Co. comes from "CEntral DEpository".
With the transition to the DTC/Cede & Co. maintaining internal ledgers for all public companies, and holding ownership of all stock for these companies respectively, trade clearing and settlement as a whole became much easier. The DTC simply electronically updates shareholder rights in their central system. No stock certificates need to be physically exchanged, and none of the legacy paperwork needs to be completed, because technically the owner of securities does not change. Settlement times have been decreased to T+2, thanks to these optimizations.
So – when you buy a stock, this system operates not through the legal sale of ownership of the stock, but through the sale of contract rights for the profit and loss of the security (along with any votes, dividends, or other benefits which are associated with the security).
In the next section, another service offered by the DTC will be discussed; the Direct Registration System. Using the Direct Registration System, investors can choose to electronically transfer securities out of Cede & Co.’s vault and into their own name.
Citations:
1. NYSE: The History of NYSE
2. The Great Paperwork Crisis of 1968
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