Transitioning to T+1 Settlement: The Impact

The SEC’s decision to shift from T+2 to T+1 settlement is set to take effect on May 28, 2024. This decision by the securities and exchange commission is going to significantly alter the cadence of securities transactions, and for equity professionals, this change is one that comes with quite a few challenges but also opportunities to modernize and revisit existing processes.

In this article, we will explore the anticipated impacts of the T+1 settlement cycle on stock plan administration, offer guidance on preparing your processes and systems for the change, and provide insights into how to communicate effectively with the involved parties to navigate this new terrain together.

The Rationale Behind the Move

The change to T+1 is part of a methodical and incremental approach to modernizing market infrastructure, which began with the move from T+3 to T+2 in 2017, but the underlying rationale for this change is multifaceted. 

The Concerns

The transition to T+1 settlement is anticipated to bring several challenges specific to stock plan administrators and one such challenge, is the increased pressure on day-to-day operations. The shift from T+2 to T+1 effectively halves the time available to settle trades, which necessitates quicker and more reliable communication between the various parties involved, including brokers, payroll, tax, and transfer agents. So, with the time frame to settle transactions shortening, so too does the margin for error and the ability to resolve issues post-trade. This means that as stock plan administrators we will need to ensure that all verifications and audits are completed promptly and accurately before settlement because as we all certainly know, unwinding transactions becomes much more difficult after settlement.

Key Considerations and Best Practices

Adjusting Processing Timelines

Consideration: With T+1, equity professionals must adapt to shortened processing times for stock plan transactions, including same-day sales and sell-to-cover transactions. This requires brokers to receive shares and have funds transferred to cover the transaction and tax withholding requirements within a much tighter timeframe. The operational workflows, from transaction initiation to completion, must be revisited to accommodate this expedited timeline, ensuring that all steps can be completed within one business day after the trade date​​.

Best Practice: Equity admins should conduct thorough process mapping exercises to identify time-intensive steps in their current workflows and if possible, invest in automated systems to facilitate the transfer of shares and funds to help mitigate time constraints imposed by T+1. It is also worth it to consider cross-training team members to handle peak times efficiently.

Impact on Various Transactions

Consideration: While cash and net exercises, as well as share withholding transactions, do not directly involve open market sales and are theoretically outside the T+1 mandate, it’s possible that some brokers may apply the T+1 settlement cycle across the board due to system constraints. This standardization could simplify operations but will also require adjustments in how these transactions are processed and communicated​​.

Best Practice: It would be wise to create a clear plan, if you haven’t already, for transactions like cash and net exercises that may not typically involve open market sales. This could involve setting up pre-arranged processing agreements with brokers and creating standard operating procedures that cater to the nuances of these transactions within the T+1 framework.

Handling Complex Transactions

Consideration: For international employees or those involved in more complex tax scenarios, the shortened settlement cycle introduces additional challenges. Equity administrators will need to streamline communications with local payroll services and possibly adjust withholding rates to ensure compliance within the constrained timeframe. This may involve adopting maximum tax rate withholdings initially, with adjustments made subsequently through payroll refunds​​.

Best Practice: It may be beneficial to create a centralized communication hub for international employees to access updated tax information, as well as implementing agile software solutions capable of managing varying withholding rates.

Navigating IRS Deposit Deadlines

Consideration: The T+1 cycle affects the timing of IRS deposits for same-day sales, where the cumulative deposit liability exceeds $100,000. Stock plan admins must ensure that deposits are made within the updated deadlines to avoid penalties, necessitating close attention to settlement dates and corresponding IRS requirements​​.

Best Practice: Consider establishing an internal calendar that aligns with the new IRS deadlines, and integrating alert systems to provide reminders to relevant departments.

Collaborating with Brokers

Consideration: Proactive engagement with brokers is an essential part of understanding their preparations for T+1 and exploring testing opportunities. Equity professionals should be outlining their needs early in the transition process to ensure that their brokers' systems and processes align with their operational requirements under T+1​​.

Best Practice: Schedule regular check-ins with brokers to monitor their preparedness and establish a clear communication channel for testing feedback and updates. Document all process changes and ensure that both internal teams and brokers are fully trained on these updates and that all parties are on the same page.

Educating Employees and Participants

Consideration: Clear communication with employees about the changes in settlement periods is crucial. Stock plan administrators should ensure that educational materials accurately reflect the transition to T+1 and provide guidance on how this will affect participants' transactions.

Best Practice: Design a comprehensive communication strategy that includes updated FAQs, webinars, and one-pagers on T+1 changes. Utilize multiple communication platforms to reach all participants, ensuring they understand the implications of the transition. This will be imperative to maintaining employee trust and limiting confusion.

Conclusion