3.2 Trade Settlement

Settlement is the process of transferring securities from seller to buyer and payment from buyer to seller. Understanding settlement cycles is critical for the SIE exam.

What is Settlement?

Settlement is the final step in a securities transaction where:

The buyer receives the securities

The seller receives payment

Ownership officially transfers

Key Distinction: Trade date (T) is when the transaction is agreed upon. Settlement date is when the exchange of securities and money is completed.

Regular Way Settlement: T+1

As of May 28, 2024, the standard settlement cycle for most securities is T+1 (one business day after trade date).

Securities That Settle T+1

Corporate stocks: T+1

Corporate bonds: T+1

Municipal bonds: T+1

ETFs: T+1

Mutual funds (most): T+1

Exchange-traded options: T+1

Limited partnerships (exchange-traded): T+1

Historical Context

Before 1993: T+5

1993-2017: T+3

2017-2024: T+2

May 2024+: T+1

Why T+1? The SEC shortened settlement to reduce credit and market risk, lower costs, and provide quicker access to funds.

Other Settlement Cycles

Not all securities settle T+1:

U.S. Treasury securities: T+1

Government agency securities: T+1

Options: T+1

Cash trades: Same day (T+0)

When-issued securities: As specified

Ex-Dividend Date Changes

With T+1 settlement, the ex-dividend date is now usually the same as the record date (the business day before it if the record date is not a business day).

Key Dates for Dividends

Declaration Date: Company announces dividend

Record Date: Must be shareholder of record to receive dividend

Ex-Dividend Date: First day stock trades without dividend (usually equals record date under T+1)

Payment Date: Dividend is paid

Ex-Dividend Example (T+1)

Record date: Wednesday

Ex-dividend date: Wednesday (same day)

To receive dividend: Must buy by Tuesday (day before)

Exam Alert: Under T+1, the ex-dividend date usually equals the record date; if the record date is not a business day, the ex-date is the business day before it. Buy BEFORE the ex-date to receive the dividend.

Regulation T: Customer Payment

Regulation T governs extensions of credit by broker-dealers for securities purchases.

Payment Requirements

Cash Account: Customer must pay 100% of purchase price

Margin Account: Customer must pay 50% of purchase price (can borrow the rest)

Payment Deadline

Under Reg T, customers must pay within 2 business days after settlement (S+2).

Timeline

T: Trade date

T+1: Settlement date

T+3: Payment due (S+2)

Note: Payment is due by T+3 (settlement + 2 days), not T+1.

The Settlement Process

Step-by-Step

1. Trade Execution (T) - Buyer and seller agree to terms

2. Trade Comparison - Details confirmed between parties

3. Clearing - DTCC/NSCC nets and clears trades

4. Settlement (T+1) - Securities and funds exchanged

Key Players

DTCC: Depository Trust & Clearing Corporation - parent organization

NSCC: National Securities Clearing Corporation - clears and guarantees trades

DTC: Depository Trust Company - holds securities in book-entry form

Good Delivery

For settlement to occur, the selling broker must make good delivery of securities:

Requirements for Good Delivery

Correct security

Proper form (registered or street name)

Correct quantity (round lots or specific certificates)

All necessary endorsements

Legal transfer documents (if required)

Round Lot vs. Odd Lot

Round lot: Standard trading unit (typically 100 shares)

Odd lot: Less than a round lot (1-99 shares)

Settlement Failures

If settlement doesn't occur on time:

Buyer doesn't pay: Buy-in: Broker purchases securities and charges customer

Seller doesn't deliver: Sell-out: Broker sells securities and credits/debits difference

Cash Settlement (Same Day)

Some trades settle the same day:

Buyer and seller agree to cash settlement

Securities and funds exchange on trade date

Higher risk due to compressed timeline

Key Takeaways

Regular way settlement is T+1 (one business day)

Ex-dividend date now usually equals record date

Customer payment due by T+3 (S+2)

DTCC subsidiaries handle clearing and settlement

Good delivery requirements must be met for settlement