ESI: Dividends

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.

At the Custodian

Let's look at a simple dividend being paid by XYZ Corp. Our example consists of the following events:

Date Name Description

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This announcement creates a liability for XYZ, which cannot usually be rescinded without approval by the stockholders.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.

Custodian CTDN Stock Record as of 5/30

Security XYZ
Account Long Short Description

C OurCo 200 OurCo's position
C OtherCo1 500 OtherCo1's position
C OtherCo2 300 OtherCo2's position
C XYZ 1,000 Shares held at the custodian

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.

At the Securities Firm

What steps does OurCo have to take in order insure that the dividend is correctly managed, collected, and disbursed?

Record Date

The situation in OurCo can be viewed as the complement of the custodian's discussed above, with two major differences:

OurCo is concerned with the individual accounts having an ownership position. This includes firm trading accounts, counterparty accounts, and borrow/loans. The custodian sees only OurCo's net position.
At OurCo the Box position in the stock record corresponds to the position the custodian has for OurCo. However, ownership is based on settlement date (see Contractual Terms), not what actually settles.

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:

OurCo Stock Record as of 5/30

Security XYZ
Account Long Short Description

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:

OurCo Dividend Responsibilities as of 5/30

Security XYZ
Account Long Short Description

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.

Payment Date

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).

Accounting

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:

Register Entries

Key Type Stock M Money Distribution Comment

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

2013 1 DIV-REC XYZ 180 C 7675 G DVC Open item

2014 1 DIV-PAY XYZ 180 G DVC C 6987 Open item

2015 1 DIV-REC XYZ 180 C 7334 G DVC Open item

2016 1 DIV-REC XYZ 360 C CTDN G DVC Open item

Register Entries
Key					Comment
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

2013	1	DIV-REC	XYZ	180	C	7675	G	DVC	Open item

2014	1	DIV-PAY	XYZ	180	G	DVC	C	6987	Open item

2015	1	DIV-REC	XYZ	180	C	7334	G	DVC	Open item

2016	1	DIV-REC	XYZ	360	C	CTDN	G	DVC	Open item

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.

Trial Balance — before Payment

Account Debit Credit

G DVI 9012 1,260
G DVX 9165 720
C 7675 180
C 6987 180
C 7334 180
C CTDN 360

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):

Register Entries

Key Type Stock M Money Distribution

2013 1 DIV-REC XYZ 180 C 7675 G DVC

2014 1 DIV-PAY XYZ 180 G DVC C 6987

2015 1 DIV-REC XYZ 180 C 7334 G DVC

2016 1 DIV-REC XYZ 360 C CTDN G DVC

2043 1 WIRE-IN XYZ 180 G CSH C 7675

2044 1 WIRE-OUT XYZ 180 C 6987 G CSH

2045 1 WIRE-IN XYZ 180 G CSH C 7334

2046 1 WIRE-IN XYZ 360 G CSH C CTDN

Associations

Key Type KO M

2072 2013 1 SETL 180
2072 2043 1 SETL -180

2073 2014 1 SETL -180
2073 2044 1 SETL 180

2074 2015 1 SETL 180
2074 2045 1 SETL -180

2075 2016 1 SETL 360
2076 2046 1 SETL -360

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:

Trial Balance — after Payment

Account Debit Credit

G DVI 9012 1,260
G DVX 9165 720
G CSH 540

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:

One trader is long and another is short the same amount, resulting in having nothing in the Box. In this case we would have two journal entries, one each for the dividend income and the expense.
One trader is long and the counterparty is failing to deliver. We have both the journal entry for the income and the receivable for the counterparty (hopefully followed by a cash receipt).

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.

A Note on Ex-Date

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.

Ex-Date Definitions

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).

Source Definition

[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.

Source	Definition
[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.

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