Perfecting Security Interests in Treasury Securities

Alan J. Mogol
410-347-7332
ajmogol@ober.com

You may be in for a rude surprise if you think you have a perfected security interest in Treasury securities taken before January 1, 1997. On that date, the new Treasury/Reserve Automated Debt Entry System (TRADES) regulations, issued by the U.S. Department of Treasury, became effective. The regulations change the requirements for perfecting a security interest in Treasury securities, generally requiring compliance with revised Article 8 of the Uniform Commercial Code.

Under the old law, some security interests in Treasury securities were perfected by relying on the "bailee with notice" approach under the UCC, providing written notice to the debtor’s broker of the security interest. Typically, the notice was not signed by the broker. This is no longer satisfactory since the secured party must now obtain "control" over the Treasury securities, which will require that the broker sign a control agreement with the secured party. Under the control agreement, the broker must agree unconditionally to comply with the instructions it receives from the secured party as to disposition of the collateral, without requiring any acknowledgment or consent by the debtor. If you perfected your security interest in Treasury securities by sending a bailee letter to the broker which did not rise to the level of a control agreement, your security interest is no longer perfected, since the TRADES regulations pertain to all Treasury securities in existence on January 1, 1997.

Under the new regulations, perfection of a security interest in Treasury securities is governed by revised Article 8 of the UCC. If the state in which the debtor is located has adopted revised Article 8, then that state’s version of Article 8 will govern. If the state has not adopted revised Article 8, then the 1994 Official Text of Revised Article 8 will govern. It should be noted that revised Article 8 permits perfection of a security interest in "security entitlements" (which includes Treasury securities) by three means, which give different levels of protection: (1) by filing a financing statement (the weakest level); (2) by use of a control agreement; or (3) by registering the security entitlements in the name of the secured party (the strongest level). The option to perfect by filing a financing statement is only available if the state in which the debtor is located has actually adopted revised Article 8. Perfection by filing is sufficient to defeat the claim of a bankruptcy trustee, but if another creditor has perfected a security interest in the same security entitlements by use of a control agreement, that secured party will have priority over the security interest perfected by filing even if the filing was made before the conflicting security interest was perfected by control.

A control agreement should include the following features:

a. The broker must unconditionally agree to comply with the secured party’s instructions with respect to disposition of the collateral, without requiring any further acknowledgment or consent by the debtor.

b. The debtor and the broker should confirm: that a specific securities account has been established with the broker; that the debtor is the sole owner of that account; and that specific securities are held in that account.

c. The broker should confirm that it has not previously entered into a control agreement with respect to that securities account with any other party.

d. Whether the debtor is to be permitted to withdraw or substitute any of the securities, or proceeds received with respect to the securities, from the securities account; whether the debtor is to have trading rights with respect to the securities contained in the account; and whether the broker may extend credit to the debtor to be secured by a lien on the securities in the account. It should be noted that the broker’s lien would have priority over the secured party’s lien.

The careful lender will review its transactions to confirm that the appropriate steps have been taken to perfect (and maintain perfected) its security interest in Treasury securities.