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We want to understand how a securities firm (OurCo) should manage stock dividends. This includes positions in firm and customer accounts, fails, and stock borrow/loan arrangements. We are interested in the accounting, the receivable/payables (if any), and the actual cash movements. We also use dividends to discuss a common situation in developing IT systems, the differences in the understanding of a topic among different groups, such as the front office, back office, accounting, regulatory, and IT. See A Note on Ex-Date and Ex-Date Definitions.
It is easiest to start by considering the actions of the securities issuers and the custodians who will be making the payments. This provides the underlying context for understanding the issues that an investment firm must address.
Looking ahead, much of this discussion will be applicable to Coupon Interest as well.
Let's look at a simple dividend being paid by XYZ Corp. Our example consists of the following events:
|5/15||Declaration date||On 5/15 the XYZ Board of Directors announces a dividend of $1.80/share. In order for all the parties involved to prepare for the payment of the dividend, XYZ's Board fixes the record date as 5/30 and the payment for 6/30.
This announcement creates a liability for XYZ, which cannot usually be rescinded without approval by the stockholders.
|5/30||Record date||All owners of the stock at end-of-day on 5/30 are entitled to the dividend payment.
The payments are typically made by the custodian. The custodian is responsible for making the receives and delivers associated with settlement (see Transaction Operations), as well as any other transfers, and maintains records of the positions of each firm with an account at the custodian. The custodian for XYZ shares is CTDN.
A custodian maintains books and records just as any other firm in the securities industry. We are particularly interested in the position CTDN will have for OurCo.
In our example CTDN has the following stock record. It shows that the 1,000 shares issued by XYZ and held at CTDN are divided among three firms.
|6/30||Payment date||XYZ Corp transfers the total amount of the dividends ($1,800) to the custodian for the shares held there. The custodian then credits each holder with $1.80/share for the positions identified on the record date. The credit can be to a cash account at the custodian or a wire to the holder's bank.|
Though there is a lot of work to be done to make the dividend payments (and the financial stakes are typically enormous, of course), there is very little complicated about it.
What steps does OurCo have to take in order insure that the dividend is correctly managed, collected, and disbursed?
The situation in OurCo can be viewed as the complement of the custodian's discussed above, with two major differences:
It is also useful to keep the distinction clear between firm inventory, which is shown on the firm's books on a trade date basis (see Inventory and Trading P&l) and ownership, which is based on settlement date.
As ownership is based on positions (rather than trades), we need to consider the stock record (see the Knowledge Base for a discussion of the accounts). For our example we have the following:
|T||9012||700||Firm account: long|
|T||9165||400||Firm account: short|
|T||9375-SLON||100||Securities loaned out to counterparty 7675|
|C||6987||100||Counterparty position in safekeeping|
|C||7334||100||Fail to receive from counterparty|
|L||Box||200||On custodian's books|
In the stock record ownership is reflected in long positions. Trader 9012 will be credited with dividend income of $1,260 (700 shares * $1.80/share). Counterparty 6987 will get a dividend of $180.
As we mentioned, the custodian knows nothing of the ownership positions internal to OurCo. They only know the 200 shares, and thus will supply $360. This is the complete picture of OurCo's dividend responsibilities:
|T||9012||1,260||Trader dividend income|
|T||9165||720||Trader dividend expense|
|T||9375-SLON||180||Receivable from stock loan counterparty (7675)|
|C||6987||180||Payable to counterparty|
|C||7334||180||Receivable from counterparty|
|L||Box||360||Receivable from custodian|
The dividend payment by the custodian is the easiest part of the processing.
In advance of payment date OurCo will be communicating with the counterparties on all receivables and payables. On payment date they are expected to settle, though the payments can also fail (see Transaction Operations).
There are a number of ways the dividend accounting can be set up, based on the dates used and whether they are based on presumed or actual payments.
The approach here will be based on presumed payment.
Though the amounts above net to zero, it is not in general possible to match up the dividend responsibilities given above, e.g., that the $180 to be received from counterparty 7675 should be used to offset part of trader 9012's dividend income.
Instead, a dividend clearing account (DVC; see Money Accounts for all the codes discussed here) will be used to balance the transactions.
We have the following register entries to record the responsibilities listed above:
|2011||1||JNL-DIVI||XYZ||1,260||G||DVC||G||DVI 9012||Self-closing journal entry|
|2012||1||JNL-DIVX||XYZ||720||G||DVX 9165||G||DVC||Self-closing journal entry|
The dividend clearing account, DVC, nets to zero. Note that handling dividends involves a combination of journal entries (for trading account dividend income and expense) and open items (for payables and receivables). The open items for fails are discussed in ¶ 2.134 of [AICPABDSec06].
We have the following trial balance associated with this dividend processing. It is simply a more formal accounting treatment of the earlier "Dividend Responsibilities" table.
Handling the trader income and expense is complete. If all wires are sent and received on payment date, the open items would be closed out as follows (see Data Structures):
All of the receivable and payable items are now closed. See Transaction Operations for further discussion of the processing.
We have this final trial balance:
We have already remarked on the difference between dividend payments by the issuer (through the custodian) and the accounting required within a securities firm. It is quite possible, for instance, to have no position at the custodian, but still be required to make journal entries or payments. Two examples:
Finally, the situation with regards to custodians and fails and borrows/loans is changing. Some custodians for certain security types are now tracking these other payables/receivables. This will not address internal situations such as those in the first bullet point above, of course.
We have made no mention of trades, ex-date, etc. Entitlement is based on positions on the record date, not outstanding trades.
This topic often receives a great deal of attention. If you do a trade whose settlement date is after record date, it won't add to your entitlement position. If you are in a T+3 situation (settlement date is three business days after trade date), and your trade date is less than three days before record date (it could even be after record date), your settlement date will be after the record date. The point is the relationship of settlement date to record date, not trade date.
Because prices are quoted on the basis of customary settlement (e.g., T+3; see Inventory and Trading P&L), the price should drop two days before the record date. In our example, that would be 5/28 (assuming there are no holidays or weekends between 5/28 and the record date, 5/30). A trade done on 5/27 would settle on 5/30, so it would add to the firm's position at the custodian. 5/28 is thus called the ex-dividend date (or ex-date).
In some markets the period between trade date and settlement date is a matter of the trade contract. In our example, if you're able to do a trade on 5/28 with settlement date 5/30, it would affect your entitlement position and the price would thus not have the dividend adjustment.
One of the purposes of the architectural material on this site is to assist IT personnel in gaining the type and degree of understanding necessary to analyze, design, and develop systems to support the business. The understanding needed by IT is not the same as that required by Operations or the front office or other groups. Ex-date provides an excellent illustration of this.
If you understand that there is usually an interval between trade date and settlement date, and that entitlement to dividends is based on settlement date positions, you know all you really need to know about ex-date. You can figure out all the implications without much difficulty.
The definitions available, however, won't generally lead you to that understanding (IT is not usually their first choice for an audience!). Here we review a number of the available definitions for ex-date (and sometimes related terms).
|[AICPABDSec06]||"The date that the market price of the security is reduced to reflect the amount of the dividend (that is, securities traded on that date do not include rights to the upcoming dividend payment)." See ¶ 2.128.
While a true statement, this does not tell you anything about the importance of settlement date or of normal settlement practices for the security. Nor does it mention the importance of positions. For IT purposes, this focuses on something that is really a side effect of those other factors.
|[SecuritiesOps02]||"The date used to determine whether seller or buyer has entitlement to certain types of corporate action on (primarily) equity securities."
Ex-Dividend: "Execution of a trade on an ex-dividend basis entitles the seller to the dividend whilst the buyer does not gain entitlement."
Simmons addresses dividends in detail and considers many aspects which we don't consider. For our purposes, however, the first definition (for ex-date) could lead one to think that entitlement is based on trade date positions; the relation to settlement date basis and record date is not emphasized.
The second definition continues the emphasis on trades and entitlement, rather than positions. While both definitions are true, they don't really suit our needs.
|[AcctLangBus05]||"Said of shares whose market price quoted in the market has been reduced by a dividend already declared but not yet paid. The corporation will send the dividend to the person who owned the share on the record date. One who buys the share ex dividend will not receive the dividend although the corporation has not yet paid it."
By far the best definition we know of. This is a good example of why we consider this one of the truly indispensable resources.
|[AfterTrade86]||"The first day on which the purchaser of the security is not entitled to the dividend. It is also the day that price of the security drops to the next highest fraction of the dividend amount."
We have seen similar definitions earlier, and this is one of the better ones of this type. It is just not very helpful to us.
We will also point out that the second sentence applies only if the stock price would otherwise be constant. In reality, the drop on ex-date can easily get swamped in the normal price volatility.
|[BarronsFin98]||"date on which a stock goes ex-dividend, typically about three weeks before the dividend is paid to shareholders of record. Shares listed on the New York Stock Exchange go ex-dividend four business days before the record date. This NYSE rule is generally followed by other exchanges." (This was written when T+5 was still the convention.)
Ex-dividend: "Interval between the announcement and the payment of the next dividend. An investor who buys shares during the that interval is not entitled to the dividend. Typically, a stock's price moves up by the dollar amount of the dividend as the ex-dividend date approaches, then falls by the amount of the dividend after that date. A stock that has gone ex-dividend is marked with an x in newspaper listings."
Date of Record: "date on which a shareholder must officially own shares in order to be entitled to a dividend. For example, the board of directors of a corporation might declare a dividend on November 1 payable on December 1 to stockholders of record on November 15. After the date of record the stock is said to be ex-dividend."
Another example of what we have seen several times before. The first definition appears to tie ex-date to payment date. The reference to "announcement" (presumably declaration date) in the second definition appears to be wrong, and the definition of ex-date (the first definition) does not rely on it. The last sentence of the third definition is also incorrect (it equates record date with ex-date).
|[NASDAQGlossary]||"The first day of trading when the buyer of a stock is no longer entitled to the most recently announced dividend payment ( i.e. the trade will settle the day after the record date, too late for the buyer to appear on the shareholder record and receive the dividend.)"
Ex-Dividend: "This literally means "without dividend." The buyer of shares when they are quoted ex-dividend is not entitled to receive a declared dividend. It is the interval between the record date and the payment date during which the stock trades without its dividend-the buyer of a stock selling ex-dividend does not receive the recently declared dividend."
A definite improvement over earlier versions on their website. Interestingly, there is also no mention of the change in price.
Our point is not that these definitions are incorrect (with the noted exceptions), it's just that the understanding of a topic is different for IT than for other groups. Further, it is is extremely difficult for someone outside IT to understand what IT needs in terms of information.
Last updated: June 21, 2016. Copyright 2005-2017, Eclipse Software, Inc (ESI). E-mail: WebSite@eclipsesoftware.biz.