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The Dividend Department
The Dividend Department is primarily responsible for the proper posting of corporate income distributions to the brokerage accounts of clients who are eligible to receive the distributions. The most common distributions monitored by the Dividends Department are:
A Cash Dividend is a distribution of corporate earnings paid by the corporation to its shareholders – in cash – as of a specified date. Cash Dividends are generally expressed as a rate per share – for example a dividend rate of 16 cents per share means that the shareholder will receive $.16 for each share owned.
Because Cash Dividends are paid from earnings the distributions are taxable as ordinary income in the year received by the investor.
Upon receipt of a Cash Dividend the value of the client’s investment is reduced by the value of the dividend received. The reduction in value results from the disbursement of corporate assets (cash) from the company’s income accounts. After the payment, the company has less assets and, as such, is worth less than it was prior to the payment.
The reduction of investment value is facilitated with a downward adjustment of the company’s share price prior to the open of the next market session.
A Stock Dividend is a distribution of corporate earnings paid by the company to its shareholders, as of a specified date, paid via a distribution of the corporation’s stock. Stock Dividends are generally expressed as a percentage of the shareholder’s investment.
For example, a 50% Stock Dividend means that for each share held the investor receives a 50% dividend or ½ share. A 100% Stock Dividend would pay the investor one full share for each share owned. However, typical Stock Dividends on US equity shares do not generally exceed 10%.
A Stock Dividend can be either taxable or non-taxable to the investor. The tax status of a particular stock dividend is dependent on the specific terms of the distribution. The tax on shares received through a taxable Stock Dividend is paid at the time the investor sells the additional shares. This differs from dividends paid in cash which are reportable in the year in which paid.
Similar to cash dividends, upon receipt of the Stock Dividend, the value of the client’s investment is reduced by the market value of the dividend received. The reduction in value results from the disbursement of corporate assets (shares) from the company’s income accounts. After the distribution the company has less assets and, as such, the company is worth less than it was prior to the dividend.
As with cash distributions, the reduction of investment value is also facilitated with a downward adjustment of the company’s share price prior to the open of the next market session.
A Stock Split is a corporate action through which the corporation increases the number of shares outstanding by dividing the number of shares outstanding into smaller units of ownership. Each share outstanding is ‘split’ into two or more shares.
The general purpose of a Stock Split is to make a stock more attractive to potential investors by lowering the stocks price per share. This is accomplished by increasing the number of shares outstanding while the market value of those shares remains constant.
Similar to the Stock Dividend, the stock price is adjusted on the split date to account for the increased number of shares. Therefore, a client who owned 100 shares valued at $100 each would own 200 shares at $50 each after the split. The market value of the client’s investment both before and after the split is $10,000.
Market Value Before Split:
Market Value After Split:
For the investor, the major difference between Stock Splits and Stock Dividends is that Stock Splits are never distributions of corporate earnings and therefore are never taxable to the investor.
Stock Splits are generally expressed in a ratio – such as 2:1 or 3:1 or 3:2. The second number in the ratio signifies the number of shares the client owns before the split. The first number in the ratio identifies the number of shares the client will own after the split. For example, a 2:1 or 2-to-1 Stock Split means that each share outstanding is ‘split’ into two shares. A client who owned one share before the split will own two shares after the split. A 3:1 or 3-to-1 Stock Split means that each share outstanding is split into three shares. A 3:2 or 3-to-2 split means that a client who owns two shares before the split will own three shares after the split.
A Reverse Stock Split is the exact opposite of a Stock Split. In the Reverse Split, the corporation reduces the number of shares outstanding by combining multiple shares of stock into 1 share – thereby increasing the ownership value of each share by increasing the market price of the security.
As with a regular split, a Reverse Stock Split is also expressed as a ratio – 1:5 or 2:3 - the second number representing the number of shares owned before the Reverse Split and the first number representing the number of shares that will be owned after the split.
For example, a client owning 5 shares of XYZ Co. stock will own 1 share after a 1:5 or 1-to-5 Reverse Stock Split. Similarly, a client owning 6 shares of stock prior to a 2:3 or 2-to-3 will own only 4 shares after the Reverse Split.
The total investment value remains unchanged after a Reverse Split because the share price is adjusted by the same ratio as the stock. Therefore, in the 1-to-5 Reverse Split, 5 shares worth $3 per share before the split are worth the same amount - $15 – as the 1 share owned after the split. The Reverse Split does not generate investment income for the investor and is therefore a non-taxable event.
Return of Principal
In a Return of Principal a corporation returns to its shareholders a portion of the cash that the shareholder invested in the company. Similar to Cash Dividends, a Return of Principal is expressed as a rate per share. Additionally, upon payment, the value of the client’s investment is reduced by the amount of capital returned to the investor. This is accomplished by an adjustment to the company’s share price prior to the start of the next trading session.
A Return of Principal differs from a Cash Dividend in that the Return of Principal is paid from the company’s Capital – not from earnings. Therefore, unlike Cash Dividends, the Return of Principal is never taxable to the investor.
A Spin-Off is a corporate action through which the corporation divests an asset or assets – typically equity ownership in another entity – by distributing part or all of the asset(s) to its shareholders. As with other forms of corporate distributions, the value of the shareholder’s original shares is reduced by the value of the asset received. The market value of the shareholder’s total investment, however, remains unchanged.
For example, assume that there are 100,000 shares of XYZ Co. common stock outstanding and that each share has a market value of $100 per share. The total market value of XYZ Co. is $10,000,000 – or:
Additionally, assume that XYZ Co. owns 100,000 shares of Gamma Ray Gun, Inc., valued at $30 each. XYZ Co.’s equity investment in Gamma Ray Gun, Inc. is worth $3,000,000 – or:
XYZ Co. divests its ownership of Gamma to its common stock shareholders through a Spin-Off. Each XYZ shareholder will receive 1 share of Gamma Ray Gun for each share of XYZ Co. owned. After the distribution of assets, XYZ Co. has a new market value of $7,000,000 – or:
Accordingly, XYZ Co.’s stock price is reduced from $100 per share to $70 per share to reflect the transfer of assets to the shareholders.
The market value of the investors holdings remains unchanged after the Spin-Off. For example, assume our investor, Slick Sam, owns 100 shares of XYZ Co. stock prior to the Spin-Off. The market value of Slicks’s investment in XYZ Co. is $10,000 – or:
After the distribution, Sam owns 100 shares of XYZ Co. valued at $70 each and 100 shares of Gamma Ray Gun, Inc. valued at $30 each. The market value of Slick’s total investment is still $10,000:
A Spin-Off might be taxable if it is intended as a distribution of corporate earnings. If this is the case, the Spin-Off is treated as a Stock Dividend by both the investor and the corporation and is taxed accordingly.
An Optional Dividend is payable at the discretion of the shareholder - that is, the shareholder has an option as to whether or not he/she receives the distribution. Optional Dividends are very similar to Voluntary Reorganizations in that shareholder participation in not mandatory.
For Optional Dividends the Dividend Department must solicit from the firm's eligible investors whether or not each wishes to participate in the distribution. Once collected, this information on the firm's clients that elect to receive the distribution is forwarded to the issuers paying agent so that the distribution is received on the proper number of securities.
The Dividend Department is generally responsible for crediting the firm’s investors with the periodic interest payments received on its client’s fixed income investment. The periodic payment of interest by the debt issuer represents payment to the debt investors for the use of the investor’s funds by the issuer. The coupon rate and frequency, and the payment date are typically stated in the bond description.
Coupon Interest payments are classified by the type of debt instrument held. The most common are:
Corporate Bond Interest is the interest paid by a corporation on its corporate debt issues. Municipal Bond Interest is the bond interest paid by municipalities on municipal debt issues. US Government Bond interest is the bond interest paid by the US Government on its debt issues.
Principal and Interest – P&I Payments
Principal and Interest payments – or P&I – are distributions to investors in Mortgage Back Securities. The most common securities that pay periodic P&I distributions are GNMA, FNMA and CMO’s.
The P&I payment is part principal and part interest. The principal portion represents a return of part of the debt holder’s initial investment. The return of principal is not investment income and is therefore never taxable. The value of the investment is reduced by the amount of principal returned to the invesstor. The reduction is facilitated through the use of a bond factor.
The interest portion of the P&I payment is taxable investment income. The interest payment represents the interest paid by the mortgage holder’s that is passed to the Mortgage Back Security investor.
Dividend Reinvestment Programs
Many brokerage firms offer clients the ability to participate in Dividend Reinvestment Programs. A Dividend Reinvestment Program automatically reinvests cash distributions into additional shares of the paying entity.
The cash distribution is a fully taxable Cash Dividend that is fully taxable in the year received. The proceeds of the distribution are used to purchase the additional shares which are booked into the client’s account by the Dividend Department.
As the custodian of its client’s securities investments, the brokerage firm must take the necessary steps to ensure that all investment distributions paid by the entities in which the firm’s clients are invested, are both received by the brokerage firm and properly credited to its clients.
For every investment distribution the firm's Dividend Department must perform the following tasks:
Fortunately, although the number and type of investment distributions are varied, the process employed by the firm’s Dividend Department to ensure that each payment is properly credited to the appropriate client account is typically very similar for each distribution type.
To better understand the processing of investment distributions by the Dividend Department, the following concepts should be understood:
The Distribution process is typically initiated by the Announcement that a distribution will be made. For equity securities a formal Announcement or Declaration is made by the Company’s Board of Directors that specifies the type of distribution, the rate per share and the Record Date and Payable Date of the payment.
Unlike equities, fixed income securities do not generally require a formal announcement or declaration because the payment rates and dates are generally stated in the security description. For the purposes of understanding the payment flow for fixed income security distributions we will consider this to be the bond interest announcement.
Investment distributions are typically paid to all the investors who were the registered owners - holders - of that investment security at the close of trading on a specified date. The specified date - the Record Date - is set forth by the announcement. Specifically, Record Date means that all holders of record - the 'record' being the company's shareholder registration listing - at the close of business on Record Date will receive the distribution. This applies even if the investor sells the security before the distribution is received.
The Payable Date of the distribution is the date on which the paying entity makes the actual distribution to the eligible shareholders. On Payable Date the dividends department credits the distribution to the client's account.
Holders of record on Record Date are entitled to the distribution regardless of whether or not they are still the registered owner of the security on Payable Date.
The brokerage trade-cycle general gives the investor three business days to pay for securities purchased in a typical securities purchase. The investor is not considered to own the purchased securities for the purposes of receiving investment distributions until the trade Settlement Date. Similarly, the seller of securities remains entitled to all investment distributions until Settlement Date, at which time that right is transferred to the buyer.
If the Settlement Date of the trade is on or before the distribution Record Date the purchaser is entitled to the distribution. If the Settlement Date occurs after Record Date the seller - not the purchaser - is entitled to the distribution.
The Ex-Dividend Date - or the Ex-Date - is the first business or trading day for which the Settlement Date for all Regular Way Trades - three day settlement - will fall after Record Date. The Ex-Dividend Date is therefore the proverbial line in the sand. Investors buying securities on or after the Ex-Dividend Date are said to be purchasing the security 'Ex' - or without - the dividend, and are not entitled to the distribution because they will no be the owners of record on Record Date. Similarly, investors selling securities on or after the Ex-Dividend Date remain entitled to the distribution because the will be the owner of record on Record Date.
The Ex-Dividend Date is also the date on which the share price is reduced by the amount of the distribution. Investors buying securities 'Ex' the distribution pay the adjusted share price on and after Ex-Date.
Record Date Position
Investment distributions are paid - on Payable Date - to all holders of record at the close of business on Record Date. All legal owners on Record Date are eligible to receive the distribution regardless of whether or not they continue to own the security on Payable Date. Accordingly, the Dividends Department must identify all the firm's clients that are the Record Date holders for each distribution announcement, and track these investors until Payable Date.
The complete listing of all the firm's clients who are eligible to receive a specific investment distribution is called the firm's Record Date Position. The Record Date Position is a snap-shot or list of client accounts eligible for a particular distribution taken at a specific moment in time - that moment in time being the close of business on the distribution Record Date.
A firm's DTC Position is the number of shares or bonds held in custody at the Depository Trust Company - DTC - for the benefit of the brokerage firm and its clients at the close of business on Record Date. It is the responsibility of the Dividend Department to reconcile its Record Date Position to its DTC Position to ensure that sufficient cash - or shares - is received so that each eligible client is properly credited for the distribution.
The vast majority of US Domestic Securities are held on deposit at the Depository Trust Company - DTC. All securities held in custody by DTC are registered in 'Nominee Name'. Registration in Nominee Name means that the securities held are registered in the name of the custodian - DTC - for the benefit of the actual owner of the securities - the brokerage client. The nominee registration name for securities held at DTC is "Cede and Co."
Because all securities held by DTC are registered in DTC's Nominee Name - Cede and Co. - the distribution paying agent recognizes the Depository Trust Company - the custodian - as the holder of record at the close of business on Record Date. Accordingly, on Payable Date, the issuer or the issuer's paying agent makes the distribution payment to DTC. DTC in turn distributes the money or shares received to its members - the brokerage firm's on whose behalf the securities are held. Each individual brokerage firm then allocates the payment to its eligible clients.
Dividend Short Charges
An investor can have either a 'long' position or a 'short' position in a marketable security. Investors with a long position in a security at the close of business on Record Date are owners of that security and are eligible to receive an investment distribution.
An investor with a short position in a security ultimately owes that security to another investor or investors. There are several reasons why an investor might have a short position in a security. Most commonly, a short position is created by either:
Although the origins of a short position might differ, short positions are generally treated in the same manner for processing investment distributions.
Because and investor with a short position ultimately owes the short securities to another investor(s), the short investor also owes any dividends - or other corporate distribution - paid while the investor was short to that investor(s) as well.
Short investors are said to be "liable" for any investment distributions announced if the investor continues to maintain that short position at the close of business on Record Date. The entry process to collect a distribution from a short client's account is commonly referred to as a Dividend Short Charge - or Short Charge. The Short Charge can be for either money, shares or money and shares depending on the nature and terms of the particular distribution.
To collect a cash dividend - or other cash distribution - from a short investor the Dividends Department processes a Short Charge to the client's account for a cash amount equal to the distribution rate multiplied by the number of shares of the short position.
For example, assume that XYZ Co. announces a cash dividend for $.20 per share and that one of the firm's clients is short 1000 shares of XYZ Co. stock on the dividend Record Date. The Dividend Department will process a Short Charge - or debit - for $20 to the short client's account to collect the dividend payment from that short client.
To collect a Stock Dividend or other share distribution from a short client the Dividend Department increases the client's short position by the number of shares owed for that distribution.
For example, assume that XYZ Co. announces a 10% Stock Dividend and that one of the firm's clients is short 1000 shares on the Dividend Record Date. The Dividend Department will process a Short Charge for 100 shares of XYZ Co. stock to the short client's account to collect the Stock Dividend from the short client.
The client's short position is increased from 1000 shares of XYZ Co. stock to 1100 shares. The short client now owes 1100 shares to the other investor(s).
The Dividend Department generally processes Short Charges on Record Date to protect both the firm and its long clients from the risk that a short client might leave the firm prior to the distribution Payable Date and fail to meet his or her obligation - liability - to the long investors.
Treatment of Fractional Shares - Cash in Lieu
Due to varying distribution rates, share distributions - Stock Dividends, Splits, Spin-Offs etc. - do not always result in the client receiving a nice and even, well-rounded number of shares form the distribution. Sometimes, fractional share units result. For example, assume a company distributes an asset to its shareholders through a Spin-Off at a rate of .762 shares for each share of the parent company held by the investor.
An investor who owns 200 shares of the parent company's stock would theoretically receive 152.4 shares of stock as a result of the distribution.
The .4 share that the client would receive as part of the distribution is referred to as a fractional share, because it is less that a full share - that is, it is a fraction of a share.
Because for many investment securities, such as exchange traded equities, fractional shares are not readily liquid investment units they are generally not distributed to clients by the Dividend Department. Instead, the client receives an amount of cash equal to the market value of the fractional share. The cash payment is referred to as a "Cash in Lieu" payment - or CIL - because the client receives cash in lieu of receiving the fractional share unit.
To generate cash for the CIL payment, the Dividend Department accumulates all the fractional share units due to its clients and liquidates (sells) them on an appropriate exchange or market. The proceeds from the liquidation are then distributed to the firm's eligible clients.
Dividend Settlement Service - DSS
When two firms enter into a brokerage transaction for the sale of marketable securities the selling firm is obligated to deliver the sold securities to the buying firm on the trade Settlement Date. Frequently, the selling firm is unable to satisfy its obligation to deliver the securities on Settlement Date.
When a firm is unable to deliver securities in on Settlement Date that firm has an open obligation or deliverable record on its general ledger. This open deliverable is known as a Fail-to-Deliver. If the security in question 'Goes Record' - that is, the Record Date for a declared distribution passes - prior to the settlement delivery, the firm failing to deliver the securities becomes obligated to the buying firm for that distribution.
For example, suppose Firm B buys 1000 shares of XYZ Co. from Firm A for its client - Slick Sam. The trade Settlement Date is September 2nd. On Settlement Date, legal ownership of the shares transfers from Firm A to Slick Sam. However, due to circumstances beyond its control, Firm A is unable to deliver - Fails-to-Deliver - the XYZ Co. shares to Firm B on Settlement Date.
Also assume, that the Board of Directors for XYZ Co. announced a $.25 per share cash dividend payable on September 10th to all holders of record at the close of business on September 4th. Because Sam is the legal owner of the securities as of September 2nd - Settlement Date - he is legally entitled to the cash distribution.
Unfortunately for Sam, Firm A did not deliver the sold securities to Firm B until September 5th - one day after Record Date. On September 5th - the day of the delivery - the registration of the securities changes from Firm A to Firm B - Firm B as the custodian for Slick Sam. That is, on September 5th Firm B becomes the registered holder or the holder of record.
Although Sam is the legal owner of the shares at the close of business on September 4th, the securities were still registered in the name of Firm A because of the failed delivery. Because Firm A (not Sam) was the registered holder - a.k.a. the holder of record - on Record Date, Firm A will receive the cash dividend from the issuer on Payable Date - not Sam.
Firm A is not entitled to the Dividend because legal ownership of the shares was transferred on Settlement Date - even though the actual delivery - and corresponding change of registration - did not take place for several days after Settlement Date. As such, Firm A is obligated to transfer the distribution - when received - to Firm B - and ultimately to Slick.
Firms can utilize the NSCC Dividend Settlement Service - DSS - to facilitate the transfer of distribution between firms in settlement of obligations that result from failed transactions or securities lending arrangements.
The firm seeking payment on a distribution initiates the DSS process, which is a two step process. The first step is the completion of the 'Intent to Charge' - or simply the 'Intent' - which alerts the contra firm to the pending distribution charge. The DSS Intent Notice includes the following information:
The intent is submitted to the NSCC - the NSCC in turn delivers the intent notification to the opposing brokerage firm. This is generally done on the day after Record Date to allow the receiving firm sufficient time to review and verify the notice.
The second step of the DSS process occurs on the distribution Payable Date. On Payable Date a 'DSS Charge' is submitted to the NSCC. The NSCC collects cash from the paying firm by debiting its NSCC settlement account. In turn, the NSCC transfers the payment to the receiving firm by crediting its settlement account.
Continuing the previous example - on the morning following Record Date the Dividend employee at Firm B receives a Record Date Position report. The Record Date Position report shows the open Fail with Firm A.
The Dividend Department employee completes the DSS Intent and sends it to the NSCC. The NSCC, in turn, delivers the Intent to the Dividend Department at Firm A. Upon receiving the Intent Notice, the Dividend Employee at Firm A verifies the validity of the charge. If Firm A does not agree with the Intent to Charge it is returned to Firm B. Otherwise, on Payable Date the Dividend Department at Firm A will accept the distribution charge from Firm B.
On Payable Date the Dividend Department at Firm B initiates the NSCC DSS Charge to Firm A. Both firms process bookkeeping entries to account for the transfer of funds.
As you will learn in the next two sections - Fail Tracking and DTC Code 78 - the Dividend Settlement Service is typically utilized for non-DTC eligible securities only.
DTC Fail Tracking
Fail Tracking is a service provided by the Depository Trust Company that assists the Dividend Department with the proper collection and allocation of corporate distributions to the firm's clients. As mentioned in the previous Dividend Settlement Service discussion, brokerage firms are not always able to make securities settlement deliveries on Settlement Date - resulting in a 'failed' delivery.
Often, a distribution Record Date is passed before the failed securities are delivered to the purchasing firm. As a result of the delayed settlement, the delivering firm will receive the distribution from the paying agent on payable date because it was in possession of the securities at the close of business on Record Date. The delivering firm, however, is no longer the legal owner of the securities and not entitled to the distribution.
If the ultimate delivery of securities is made utilizing DTC's book entry delivery system, the delivering firm is required to enter the original trade Settlement Date of the transaction. The DTC Fail Tracking System then compares the original Settlement Date to the actual delivery date to determine whether or not a distribution Record Date was passed during the period of the fail.
For example, Firm A sells 1,000 shares of XYZ Co. stock to Firm B for Settlement on the 1st of September. For reasons beyond its control, Firm A is unable to deliver the sold securities to Firm B on Settlement Date - Firm A has a Fail-to-Deliver and Firm B has a Fail-to-Receive. The Board of Directors of XYZ Co. announces a $.15 per share cash dividend with the following terms:
Firm A does not deliver the 1,000 shares of XYZ CO. to Firm B until the 4th of September - one day after record date. The delivery is made via the DTC book entry delivery system. Firm A enters the correct trade Settlement Date - September 1st - on the DTC delivery.
Because Firm A was the holder of record at the close of business on September 3rd - Record Date - it will receive the cash distribution from XYZ Co. on September 7th. Firm A is not entitled to that distribution because legal ownership of the securities was transferred to Firm B on Settlement Date - September 1st. Firm B is the legal owner of the securities on September 3rd and is entitled to the Dividend payment.
The DTC Fail Tracking System compares the actual delivery date - September 4th to the original Settlement Date - September 1st and determines that a Record Date - September 3rd - was missed as a result of the failed delivery. On Payable Date - September 7th - the Fail Tracking System automatically deducts the dividend amount from Firm A and credits it to Firm B. The system alerts the respective Dividend Departments about the cash adjustment.
The Fail Tracking System eliminates the need for the Dividend Department to complete a DSS - Dividend Settlement Service - claim form for securities delivered through DTC if the correct Settlement Date is entered in the DTC book entry delivery system. For non-DTC deliveries - or if an incorrect Settlement Date is entered - a DSS form may still be necessary.
DTC Code 78
Under certain circumstances the Fail Tracking System limits the need for the Dividend Department to complete a DSS. This need is further reduced for DTC eligible securities due to the availability of the Service Payment Order or SPO Charge. An SPO Charge is a money only charge submitted through the Depository Trust Company. The firm requesting payment - the 'Payee' - initiates the SPO Charge on its DTC terminal. The firm to be charged - the 'Payor' Firm - is notified by DTC of the money only charge. DTC debits the Payor's account and credits the Payee's account for the amount of the SPO Charge.
The SPO charge can be used by the Dividend Department to collect dividend payments from other brokerage firms on failed trades or other special handling circumstances - so long as the security in question is eligible for deposit at DTC. The Payee - the firm initiating the charge - must indicate on the SPO Charge that it is a dividend related charge. This is done at the time the charge is initiated, so the charge can be appropriately routed to the Dividend Department at the Payor firm.
The charge is designated as a dividend related payment through the utilization of a special payment code. The Payee firm enters a special payment code for each SPO Charge submitted to DTC. The special payment code for Dividend Payments is Code 78. Therefore, to collect a dividend payment for a DTC eligible security from another firm the Dividend Department can submit a Code 78 SPO Charge to that other broker through DTC.
Due Bill Tracking Period
The Due Bill Tracking Period is the period of time between the Record Date and the Ex-Date for both non-cash distributions and fixed income payments of coupon interest. The Due Bill Tracking Period is required because the payment cycle for non-cash distributions and coupon interest payments differs from that of typical cash distributions in that the accounting for cash distributions is tracked for settled trades whereas share distributions and interest payments are tracked on a trade date basis.
What does this mean? The procedures for processing stock distributions and coupon interest payments and start out very similarly to those for cash distributions. A company announces a distribution (or it is announced in the bond indenture) to all holders of record as of the close of business on a specified date - Record Date - to be paid on Payable Date. Ex-Date marks the first trading date on which new investors are not eligible for the pending distribution and is also the date on which the market price of the underlying security is adjusted to reflect the distribution.
The major difference between the a cash distribution and a non-cash distribution or interest payment is that not all holders of record at the close of business on Record Date will remain eligible for that distribution on Payable Date. For the remainder of this discussion the term 'non-cash distribution' will be used to signify both non-cash share distributions and coupon interest payments. Investors who sell securities on or before Payable Date are no longer entitled to the pending non-cash distribution - even if they were the holder of record at the close of business on Record Date. For the purposes of non-cash distributions, the securities are considered sold on Trade Date - not on Settlement Date as with cash distributions.
The reason for the difference is tied to the timing of the related adjustment to the market price of the security. Those investors who pay the full - unadjusted - pre-distribution market price for their securities are entitled to any distribution received as a result of the investment. Conversely, those investors who pay the adjusted post-distribution market price for the securities have - by virtue of the reduces price - already received the benefit of the distribution and are not entitled to any additional securities or income.
This is best explained with an example. XYZ Co. announced a 2:1 Stock Split on the first of the month with the following details:
Our investor, Slick Sam, purchases 100 shares of XYZ Co. on the 1st of the month and is the holder of record at the close of business on the 15th - Record Date. (For the purposes of this illustration assume that the market value of XYZ Co. stock remains constant - $100 per share - for the entire month).
If Slick chooses to hold this investment for the entire month, at the close of business on Payable Date - the last day of the month - Slick will receive an additional 100 shares of XYZ Co. stock as a result of the 2:1 split.
On the first business day following Payable Date - the 1st of the next month - the market price of XYZ Co. is reduced from $100 per share to $50 per share - prior to the start of trading - to adjust for the split. The first of the month - the next business day after Payable Date - is the distribution Ex-Date for two reasons. First, it is the day on which the market price is adjusted for the distribution. Second, it is the first day on which new investors are not entitled to the distribution.
If Slick decides to sell his investment on or after the Ex-Date, he will receive the same $50 per share that a new investor in XYZ Co. would pay. Because he would receive the adjusted share price he is not eligible for the distribution.
Had Slick decided instead to sell his shares on or before payable date (prior to receiving the distribution) he would have received the full $100 for each share of XYZ Co. sold. Because he received the full unadjusted share price Slick is no longer entitled to the pending distribution.
From a processing viewpoint, Record Date becomes the starting point for all non-cash distributions. At the close of business on Record Date - just as with cash distributions - the Dividend Department must identify its Record Date Position. The Record Date Position details all the accounts that are eligible for the pending distribution at that specific point in time.
Different from cash distributions, for all non-cash or bond interest distributions, the Dividend Department must monitor all purchases and sales of that security transacted between the distribution Record Date and the distribution Ex-Date and adjust the firm's distribution payable records - the Record Date Position -accordingly. The period of time between Record Date and Ex-Date is called the Due Bill Tracking Period. The Ex-Date is called the Due Bill Off Date and signifies the end of the Due-Bill Tracking Period.
Accounts that sell securities after the distribution Record Date but prior to Ex-Date - and receive the full unadjusted share price - are no longer entitled to the pending distribution. Therefore, the Dividend Department must remove all accounts that sell the security during the Due Bill Tracking Period from the firm's distribution payment records by the Dividend Department.
Conversely, accounts that purchased the securities during the Due Bill Tracking Period paid the full unadjusted market price for the purchased securities and are therefore entitled to the pending distribution when paid. The Dividend Department must add these accounts to the distribution payment records.