SEC Settlement Date Change Affects Equity Compensation Plan Administration

The Securities and Exchange Commission (SEC) on February 15, 2023, amended rules under the Securities Exchange Act of 1934 to shorten the securities transaction settlement cycle for most broker-dealer security transactions. See SEC.gov | Shortening the Securities Transaction Settlement Cycle for the final rules.

Settlement dates are referred to as T+1, T+2, T+3, and so forth, and “T” stands for transaction date, the day the transaction takes place. The numbers 1,2, or 3 denote the number of subsequent days on which the transfer of money and security “settlement” takes place. Weekends and public holidays are not included in the day count.

Currently, the standard settlement cycle for all stocks is T+2 but effective May 28, 2024, it will be T+1.

Why is the SEC Rule on Settlement Date Important to Employers?

The T+1 rule accelerates the date on which the participants in equity compensation plans utilizing a same-day sale arrangement becomes the shareholder of record entitled to appreciation, dividends, etc.  Plans such as stock-settled restricted stock units (RSUs), stock options, stock appreciation rights (SARS) and Employee Stock Purchase Plans (ESPPs) will all be impacted.  The accelerated settlement date also marks the beginning of the timeline on which withheld income and employment taxes must be deposited along with the employer’s share of employment taxes.

Coordination between broker, payroll department, tax department and transfer agent is important to ensure that the employer makes timely payroll tax deposits under the accelerated timeline. 

Tax Withholding

With a shortened settlement cycle for broker-assisted equity transactions, employers may need to review how to satisfy the tax withholding requirements when there is not sufficient cash being processed through the payroll system. Historically, options to satisfy the withholding liability were provided to the employee on the transaction date with two business days to deliver the funds to the employer before settlement. Having only one day between transaction and settlement might not provide adequate time to deliver the needed funds unless a standard process is adopted to ensure the employee timely moves the needed funds for tax withholding.

U.S. Tax Remittance

Under the current rules, an employer subject to the U.S. “next day deposit” rule would deposit on T+3, the third day following the transaction date but one day after the current settlement requirement. Because the new rule accelerates the settlement date to T+1, the deposit date under the next day deposit rule will be T+2.

The “next day deposit” is started on a day employer initiates share transfer. So in rare cases the transfer is initiated on the day vest or exercise occurs, the taxes will need to be deposited next day in practice making it T+1.

The application of these shortened settlement dates to companies already struggling to meet the existing tax deposit rules puts even more pressure on companies to implement processes that facilitate efficiency. 

Impact on Share-Based Awards

Automation

Companies may take this time to look at their processes and identify opportunities for automation.

Given the constraint on timing and resources imposed by the new regulations, BDO  Global Equity Mobility Solution (GEMS) tool, an automated solution that utilizes transaction data and cross-border travel information can  help companies avoid risk and consider opportunities when working through their payroll reporting and withholding obligations. To learn more about GEMS, see BDO Global Equity Mobility Solution.

Fair market value (FMV) considerations 

Companies may want to revisit the FMV they use for valuation purposes. If using the closing price on the day of vesting, for example, the companies are shortening the window to execute all the steps to meet T+1 settlement and T+2 tax deposit deadlines.

Awards settlement

Share delivery would need to be initiated on the transaction date for settlement to occur on T+1. Therefore, withholding taxes will need to be finalized on the day of the transaction.

Companies may want to revisit the alternatives  they are providing their employees to fund the taxes, such as net settlement, sell-to-cover, and cash payment, because some of the options may further delay settlement.