Corporate-Actions Conundrum

Corporate-actions reconciliation represents a formidable stumbling block in the race to achieve STP.

They come by the thousands every day, bombarding custodians with news of reorganizations, stock splits, name changes and bankruptcies. They come from multiple venues, including vendors, the Depository Trust Company and the companies themselves. The problem with these tidbits of information, called corporate actions, is that their verification and reconciliation is often manual.

As anyone listening to the straight-through-processing dialogue in the securities industry knows, anything manual is bad. That's because manual means human intervention and humans, occasionally, make mistakes.

But corporate-actions processing, except for a few exceptions, continues to be a labor-intensive effort, occasionally resulting in mistakes that cost custodians or investment managers huge sums of money when they have to make good on opportunities their clients missed.

"The risk is because we are the conduit of information and the buck stops here," says Amy Harkins, first vice president and director of global asset servicing with Mellon Financial, a top-tier global custodian.

Corporate-actions processing is all about reconciling disparate feeds of data in an attempt to figure out the facts. In general, public companies, whose securities are DTC eligible, report any corporate actions to the DTC. Additionally, there are more than a few corporate-actions data vendors that collect information from multiple sources, including the DTC, and funnel it to custodians and investment managers. The vendors then feed that information to their customers.

As the information moves from one party to the next, institutions attempt to verify specific pieces of data by comparing them against corresponding information from another source. If two independent sources report the same information, then it is judged to be accurate.

Many corporate-actions events, such as stock splits, only require that the shareholder be notified. Some events, however, demand a decision from the investment manager who must, for example, inform the custodian whether to take cash or stock, or whether a shareholder wants dividends reinvested.

While working for the Society for Worldwide Inter-Bank Financial Telecommunication, Tim Lind, now a senior analyst with Mass.-based TowerGroup, developed a list of 60 corporate-actions events. Lind agrees with Harkins' notion that coping with corporate actions is mostly a headache for custodians. "It is up to the custodian to advise the shareholder of their rights pursuant to an event, whether or not a decision needs to be made," he says.

"The problem with corporate actions in the U.S. is the different ways that issuers communicate events. They have different ideas about the data and the fields," says Lind.

Therein lies the main problem with corporate-actions processing in the United States. Companies report events in different ways, using different technologies, to different venues -some vendors scour the newspapers as a potential source of information. From that point on down the line, organizations impacted by those corporate actions are joined in a constant struggle to figure out what really happened so they can adjust their holdings accordingly.

While custodians have to deal with feeds from multiple vendors and the DTC, their investment manager clients have an even more complex situation in their shops. Investment managers not only have to deal with all the feeds that custodians grapple with but usually have dozens of custodians holding the same security for them. That means a huge number of corporate-actions feeds coming into a buy-side organization.

Information from just one of those custodians doesn't spur an investment manager to immediate action. "If I get notification from a custodian, I don't necessarily act on it. I wait for a corroborating event from a vendor or another source," says Lind.

Most large custodians have some automated method of sending and receiving corporate-actions information with their buy-side clients, but that doesn't mean investment managers are availing themselves of these offerings because the buy side still seems to have a love of faxes.

Frustrated by the buy side's unwillingness to adopt any electronic corporate-actions solution, Northern Trust, one of the largest custodians in the world, says that at some point in 2003, it will no longer accept corporate-actions faxes.

Northern, like all custodians, wants out of the fax business because faxing screams operational risk. First off, Jeffrey White, senior vice president in charge of the investment-managers' liaison group and trade processing at Northern Trust, says that faxing is especially susceptible to fraud because it is difficult to ensure that it is coming from the purported source. Secondly, Northern Trust personnel have to enter the fax's information into an application and that is an opportunity for errors.

When errors do occur in this scenario, they are the fault of the custodian which then may have to cut a large check to its client. Moving clients off the fax and onto the Web means the information is entered by the investment manager so it becomes the culpable party, taking the custodian out of harm's way.

White says Northern is working to move its clients to some form of automation, whether it be Northern's proprietary CRD (Corporate Actions Delivery and Response) system, Swift's network or a yet-to-be-released DTC data hub.

"We don't care what they choose, we want it automated," says White. "There are a lot of liability issues around these things and we want to make sure we are on the same page with our customers."

Northern's CRD system provides a Web-based way for a custodian to make its clients aware of corporate-actions events, receive instructions on how the client would like the event to be handled, and communicate verification back to the investment manager after action has been taken.

Mellon Financial's Harkins says that her firm is debating whether to take the Northern approach. She says that Mellon also offers a Web-based workbench product for corporate actions but it is only being embraced by about 28 percent of the custodian's clients. The rest still send faxes.

"Northern has gone out and said we're going to force all our clients to use our product," says Harkins. "We're debating that at Mellon. We think that's great to say and we would love to do that but we don't know if they will bite on it."

Harkins is skeptical that corporate-actions processing will ever be fax-free. "I don't think I will ever get away from sending faxes in corporate actions because firms still want them from me."

One firm that has moved away from faxes, Fidelity, developed a highly automated corporate-actions solution which it now markets to outside firms.

Linda Stewart, president of Fidelity Enterprise Data Systems, the entity set up by Fidelity to administer the solution, says that the system automatically matches and verifies about 85 percent of the corporate actions that come into the firm.

For the 15 percent that do not match, Fidelity Enterprise employs between 25 and 30 research analysts who manually investigate the discrepancy, sometimes calling the company directly.

Currently, Fidelity Enterprise has about 15 clients that purchase the scrubbed and cleansed data, such as Lehman Brothers, Merrill Lynch and ABN Amro.

Lind says that firms need to find a way to automate the handling of corporate actions as quickly and extensively as possible. Whether that means investing in Swift's 15022 solution or embracing a custodian's, the faxes have got to go.

"I think 15022 represents the standard that will make a lot of automation happen. I think custodians will use the Swift network in 2003 as their primary means to communicate with sophisticated buy-side firms."

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Corporate-Actions Processed By Fidelity Enterprise Data Systems September 2002

-Total: 7200 Corporate Actions per day (826 manually processed)

-5000 Fixed Income (659 manually processed)

-2200 Equity (165 manually processed)