This year’s Investment Securities portion of the Uniform Commercial Code Survey addresses three themes—certain assets covered by the Article 8 direct and indirect holding systems, Article 8 entities, and the duties of such entities—from two different perspectives. The first perspective is rooted in cases from 2023, examining these themes under the relevant version of Article 8 of the U.C.C. (the “pre-2022 Version”). The second perspective examines the themes considering the 2022 amendments to Article 8 of the U.C.C. (the “2022 Amendments”). The aim of this section is to draw comparisons between recent case law and the 2022 Amendments to demonstrate the flexibility and adaptability of Article 8 and to provide a picture of the evolving U.C.C. landscape and its practical implications.
Unlike many commercial law rules, Article 8 was intentionally designed to provide adaptable definitions of categories of assets. The definitions in U.C.C. section 8-102, according to the official comments, “are worded in general terms, because they must be sufficiently comprehensive and flexible to cover the wide variety of investment products that now exist or may develop.” Assets covered by the Article 8 direct and indirect holding systems are generally understood to encompass “financial assets,” which fit into one of three different categories.
The first category is simply a “security” as defined under U.C.C. section 8-102(a)(15). The second is “an obligation . . . a share, participation, or other interest . . . which is, or is of a type, dealt in or traded on financial markets, or which is recognized in any area in which it is issued or dealt in as a medium for investment.” Under the third category, a “securities intermediary” which holds an asset in a “securities account” for a person, can agree with that person “that the property is to be treated as a financial asset” for the purposes of the indirect holding system. This latter category is often referred to as a “financial asset election.”
Two cases in 2023 examine assets under the Article 8 direct holding system: the unpublished opinion, Albasir v. City of Hoboken, examines whether bearer bonds are “certificated securities,” while In re D’Angelo examines whether certain LLC membership interests constitute “financial assets.” These cases are not particularly illuminating, as they contribute to the well-known contours of case law defining assets covered by the Article 8 direct holding system. However, each of the cases forms a nice backdrop to discuss certain aspects of the 2022 Amendments. These amendments and the official commentary focus on new technology, such as digital assets that can constitute “controllable electronic records” or “CERs” under the new Article 12 of the U.C.C.
The 2023 case, Albasir, is shocking only for the fact that it revolves around an almost-extinct financial product: the bearer bond. The original trial court decision had found the bearer bonds at issue were negotiable instruments under Article 3 of the U.C.C. The appellate court in Albasir, however, corrected this characterization finding that Article 8—not Article 3—governs bearer bonds. While it is true that bearer bonds can look like negotiable instruments, the characterization of bearer bonds as assets covered by the Article 8 direct holding system has been settled since the replacement of the Uniform Negotiable Instruments Law with the U.C.C. in the 1950s. Similarly, the 2022 Amendments introduce text and commentary to clarify known principles, such as (i) the availability of Article 8 “financial asset” status to digital assets held in a securities account under an agreement with the securities intermediary to treat them as such, and (ii) the distinction between “securities” as defined under Article 8 and “securities” as defined under U.S. securities laws.
Albasir contains simple facts: the plaintiff was gifted bearer bonds issued by, and payable by, the City of Hoboken (the “City”). When the plaintiff sought to redeem the bonds, the City claimed the records were destroyed in Superstorm Sandy and the bonds might have escheated to the State. The plaintiff filed a complaint seeking damages for the City’s failure to pay the principal and interest due on the bonds. The trial court granted the City’s motion to dismiss, relying on the Sewerage Authorities Law to find that bonds were negotiable instruments under Article 3 of the U.C.C. Therefore, the statutes of limitation under section 3-118 of the U.C.C. applied to the plaintiff’s claim and those clocks had long ago run.
The appellate court reversed this dismissal, finding that the trial court incorrectly applied the rules of Article 3 of the U.C.C. to an Article 8 instrument. Article 8 defines “securities” as “an obligation of an issuer . . . which is represented by a security certificate in bearer or registered form . . . which is one of a class or series . . . is, or is of a type, dealt in or traded on securities exchanges or securities markets; or . . . is a medium for investment and by its terms expressly provides that it is a security governed by this Article.” Further, sections 8-102(2) and (4) of the U.C.C. defines a bearer bond as “a security that is represented by a certificate” that “is payable to the bearer.” In finding that the bearer bonds were certificated securities, the appellate court pointed to section 3-102 of the U.C.C., which states that the rules governing negotiable instruments do not apply to securities under Article 8. Therefore, the court held that the bearer bonds were governed by U.C.C. Article 8, and not subject to the statute of limitations under Article 3.
The 2022 Amendments primarily clarify the application of Article 8 to new varieties of financial products. However, they also add further precision to well-established Article 8 principles. Pre-Amendments, new financial products, such as digital assets, can fit into several categories under Articles 3, 8, and 9 of the U.C.C. Therefore, like bearer bonds in the 1950s, it became necessary to clarify when digital assets are “financial assets” or “securities” for Article 8 purposes. The 2022 Amendments provide this clarification specifically for CERs, which “are a subset of what often are referred to as digital assets.” First, U.C.C. section 8-103(h) provides that a CER is “not a financial asset unless Section 8-102(a)(9)(iii) [(the Article 8 financial asset election provision)] applies.” This provision was one of the few added to the statutory text of Article 8. It was designed to prevent “the inadvertent application of the Part 5 rules to intermediaries who may hold [CERs].”
Second, the new commentary bolsters the well-known principle that a “security” under section 8-102(15) of the U.C.C. is not synonymous with the U.S. securities law definition of a “security.” The official commentary then states that “a [CER] is not itself a ‘security,’ . . . [i]t also is not ‘a share or similar equity interest,’ an ‘investment company security,’ or ‘an interest in a partnership or limited liability company.’” This is important because whether a digital asset is a “security” within the meaning of U.S. securities law has been a significant ongoing question in the digital asset markets. This new commentary distinguishes the two definitions to ensure that the improvements and certainty in commercial law do not become needlessly entangled in the quagmire of U.S. securities laws.
Another interesting intersection between the 2022 Amendments and the 2023 cases is the discussion of limited liability company (“LLC”) membership interests and when such interests constitute Article 8 “financial assets.”
Unlike Albasir, the facts in In re D’Angelo are convoluted and span multiple entities and bankruptcy and state court actions. For simplicity’s sake, the focus here is on the court’s summary examination of the LLC membership instruments (“TIL Interests”) at issue and of Article 8. In March 2019, Mr. D’Angelo and his non-debtor wife assigned their TIL Interests to an entity known as RPMI as collateral for a debt. RPMI took possession of the certificates evidencing the interests, but did not file a U.C.C. financing statement. In August 2021, Mr. D’Angelo filed for Chapter 11 bankruptcy protection, but did not use his avoidance powers to avoid RPMI’s unperfected lien in the TIL Interests. In December 2022, the D’Angelos assigned the TIL Interests to one of the plaintiffs (a group of Purlin entities) as an incentive for the entities to support Mr. D’Angelo’s reorganization plan and to withdraw from a separate state court action. After the assignment, the Purlin entities had the LLC cancel and reissue the TIL Interests. In 2023, Purlin entity 5 granted a security interest in the TIL Interests to Purlin entity 4 to support a loan made by Purlin entity 4 to the TIL LLC. Purlin entity 4 filed a U.C.C. financing statement to perfect its interest. At the time of the case, both RPMI and the Purlin entities asserted their rights to the TIL Interests and RPMI had purported to sell the canceled TIL Interests in a foreclosure sale.
Given these complicated facts, the court’s first step was to categorize the TIL Interests under the U.C.C., which would then clarify each party’s interest in the assets. RPMI claimed that the TIL Interests were “securities” under Article 8. The court concluded that the TIL Interests were not “securities” under Article 8 because the interests were not “dealt or traded on securities exchanges or in securities markets” as required under section 8-103(c) of the U.C.C. The Purlin entities contended that when they reissued the TIL Interests, they opted into section 8-103(c) of the U.C.C. Therefore, at that later time, the TIL Interests became “securities” within the meaning of Article 8. However, the court found that the agreement did not have any such opt-in language and without such language, the assets were not “financial assets,” but rather “general intangibles” under Article 9. The court further noted that claims related to the TIL Interests were “matters of state law, which weave together claims having their basis under Article 9 of the U.C.C. . . . and state contract law. . . which are in no way limited or tied to the existence of a predicate bankruptcy case.” Therefore, the bankruptcy court did not have subject matter jurisdiction to determine the claims.
The 2022 Amendments now include two specific commentary examples that describe when LLC membership interests are assets covered by the Article 8 direct holding system or general intangibles. In the first LLC membership interest example, the interests are uncertificated and satisfy the requirements of section 8-103(c) of the U.C.C. as they are “dealt in or traded on securities exchanges or in securities markets and . . . by their terms are securities governed by Article 8.” In the second LLC membership example, the LLC membership interests “are not securities governed by U.C.C. Article 8.” Therefore, the interests are “not investment property” and are instead general intangibles.
These examples were provided to show that the law governing rights in LLC membership interests would not change even with the addition of Article 12 of the U.C.C. In particular, the examples examine situations in which the LLC uses digital assets (that are CERs) to facilitate transfers of interests. The commentary provides that Article 12 of the U.C.C. would govern the transfer of control of the CER in both examples. However, where the interest is an Article 8 instrument, Article 8 (and other state law, as provided by 8-110(a)), would govern rights in the membership interests. Likewise, where the interest is a general intangible, Article 9 (or other state law) would still apply. The examples therefore demonstrate that the law governing rights in LLC membership interests would not change even with the additional complications of CERs facilitating transfers of interests.
Article 8 was also designed to provide flexibility in defining categories of entities subject to its provisions. As the official comments note “a particular entity, such as a bank, may act in many different capacities in securities transactions.” Therefore, the flexible categorization of an entity (and, as discussed in Part III, its duties) under Article 8 is often dependent on the capacity in which the entity is acting.
One case in 2023 examines this categorization principle. In Parseghian v. Frequency Therapeutics Inc., the plaintiff trusts (the “Trusts”) claimed that an entity breached its statutory duty of care as a securities intermediary under Article 8 and the court addressed whether the entity was, in fact, acting as a “securities intermediary” within the meaning of section 8-102(a)(14) of the U.C.C. Coincidently, the 2022 Amendments contain further official commentary on when an entity acts as a “securities intermediary.” While the U.C.C. commentary clarifications are not surprising, they do specifically call out crypto entities to describe when such entities may be acting as “securities intermediaries.”
In Parseghian, the Trusts held common stock in Frequency Therapeutics, Inc. (“Frequency”). Frequency designated Computershare Trust Company, N.A. (“Computershare”) as its transfer agent responsible for registering securities transfers and maintaining records of the shares. Due to a surge in Frequency’s stock price, the Trusts decided to sell their shares. The Trusts alleged that Computershare obstructed the transfer as part of a coordinated effort to delay or prevent shareholders from transferring shares, thereby artificially inflating the stock price. The Trusts claimed that this obstruction breached Computershare’s statutory duty of care as a securities intermediary. Computershare and Frequency countered that Computershare was not a securities intermediary for the purposes of the transfer, and therefore, such statutory duties did not apply.
As a quick refresher, the U.C.C. defines a securities intermediary as “a person, including a bank or broker, that in the ordinary course of its business maintains securities accounts for others and is acting in that capacity.” A “securities account” is then defined as an “account to which a financial asset is or may be credited in accordance with an agreement under which the person maintaining the account undertakes to treat the person for whom the account is maintained as entitled to exercise the rights that comprise the financial asset.” The Trusts argued that Computershare had agreed that “transfer agents are recordkeepers who record the shares . . . and maintain the file of registered holders” and that these actions constitute the maintenance of a “securities account” within the meaning of section 8-501(a) of the U.C.C.
The court scrutinized the specific nature of Computershare’s role in the transfer at issue to determine whether it was acting as a “securities intermediary.” The court found that a securities intermediary’s role “cover[s] the relationship between institutional investors and their customers in which the former manages the latter’s holdings.” Therefore, the role did “not cover the relationship between a company’s transfer agent and the company’s investors.” This case clarifies that even though an entity may maintain securities accounts in general, if it acts as a transfer agent in a disputed transaction, it would not be a securities intermediary in that context.
While there are limits to what constitutes a “securities intermediary” (as demonstrated in Parseghian) the term “securities intermediary” under section 8-102(a)(14) of the U.C.C. is quite broad and the 2022 Amendments only reaffirm this breadth. In addition to distinguishing between entity types, the case also gives us a clear look at the definition of “securities intermediary” and the way it is inherently tied to the definition of “securities account.”
First, the pre–2022 Version commentary provides that while “the most common examples of securities intermediaries would be clearing corporations holding securities for their participants, banks acting as securities custodians, and brokers holding securities on behalf of their customers . . . a person need not be such an entity in order to be a securities intermediary.” The reason for this flexibility is tied to the fact that a section 8-501(a) “securities account” can hold more than just securities; it can hold the broad class of “financial assets” under section 8-102(a)(9) of the U.C.C. The 2022 Amendments further affirm this flexibility. New commentary adds that “the securities accounts that a securities intermediary maintains may consist exclusively of financial assets described in Section 8-102(a)(9)(ii) and (iii),” meaning shares, participations, or other interests of a type, dealt in or traded on financial markets and/or assets covered by the Article 8 financial asset election.
The flexibility described above is particularly important for new financial products, such as digital assets. As described above, a crucial step to make a financial asset election is for the parties (the securities intermediary and entitlement holder) to agree that section 8-102(a)(9)(iii) applies to the digital assets that are CERs. However, the entity types that have custody of digital assets in the current market are not typically the clearing corporations, banks, and brokers described in the pre-2022 Version commentary. The 2022 Amendments helpfully clarify that even “a cryptocurrency exchange that holds only cryptocurrencies (and not securities) for customers might be a securities intermediary.” While these clarifications are not ground-breaking, they are helpful nonetheless in reaffirming how flexible and adaptive the Article 8 rules are to new financial products and entities.
The final themes discussed in this survey section are the duties of transfer agents and securities intermediaries in financial market transactions. As described above, an entity may act in different capacities over the course of such a transaction. In line with this principle, the duties that an entity will be subject to under Article 8 vary depending on the capacity in which the entity is acting.
As described in Parseghian above, transfer agents perform tasks as agents of the issuer of a security. Therefore, under Article 8 (and as described below), these agents are subject to the same duties as the issuer. These Article 8 duties are partly derived from common law principles that describe the obligations of entities engaged in certain transaction types. One such common law concept is “bailment,” which is still a relevant part of state common law in the Untied States. The Parseghian case provides an enlightening take on the relationship between the Article 8 duties of a transfer agent and those of a bailee under common law bailment.
The 2022 Amendments also provide new commentary on the duties of Article 8 entities. The official commentary reaffirms the existence of an issuer’s duties (and by extension, those of a transfer agent) under the U.C.C. In addition, the commentary expounds on the duties of securities intermediaries (commonly known as the “Part 5 duties”) operating in the indirect holding system. These Part 5 duties were already flexible under an analysis of the pre–2022 Version official commentary. The 2022 Amendments reaffirm this flexibility and clarify that not all the Part 5 duties need apply for the parties to maintain a relationship governed by the Article 8 indirect holding system.
First, we again turn to Parseghian and the claim that Computershare was negligent in its failure to promptly execute the Trust’s transfer instruction. The Trusts asserted two breach-of-duty theories with respect to the transfer agent: one rooted in common law bailment and the other rooted in Article 8. Under the common law theory, the Trusts asserted that Computershare breached its duty to “exercise reasonable care with respect to the property under the terms of the bailment” when it did not transfer the property promptly. The Trust also asserted that, under Article 8, Computershare, as transfer agent, had “the same obligation to the holder . . . [of the] security with regard to the particular functions performed as the issuer.” Further, under section 8-401(b) of the U.C.C., an issuer with a duty to register a transfer is “liable . . . for loss resulting from unreasonable delay in registration or failure or refusal to register [a] transfer.”
The court in Parseghian found that this latter statutory duty “displaces common law negligence actions for the same conduct.” Other courts have likewise found that rights of actions pursuant to this statutory duty are broader than those of common law bailment, as the latter could be read to limit rights of actions against the transfer agent to those brought by the issuer. However, where common law might be replaced or fill in the gaps of the duties provided under Article 8 (whether those of an issuer, transfer agent, or securities intermediary) is an area of continuous legal development. It is worthwhile to stay apprised of these cases, especially given that both common law bailment and Article 8 are becoming increasingly relevant.
The duties of Article 8 entities are also further clarified by the 2022 Amendments. Our exploration of these duties requires us to circle back to our analysis of LLC membership interests, financial assets, and securities intermediaries in the previous two sections.
The LLC membership interest examples discussed in the first section above did more than specify what law applies in determining rights in such interests; the commentary also clarified that the duties of an issuer to register a transfer (and, by extension, the transfer agent to register a transfer) of an asset held in the Article 8 direct holding system are not changed when an issuer uses digital assets that are CERs to facilitate the transfer. As provided in the example, if an LLC membership interest satisfies the requirements of section 8-103(c), even if digital assets are used to facilitate the transfer instructions, the section 8-401 duties of the issuer (and by extension, the section 8-407 duties of the transfer agent) remain unchanged.
Second, our discussion of what constitutes a “securities intermediary,” “securities account,” and “financial asset” under Article 8 above is tied intrinsically to whether it “makes sense” for the securities intermediary to perform its duties as a securities intermediary with respect to the financial assets in the securities account. As the U.C.C commentary notes, having a financial asset or security held in an arrangement with an intermediary is not enough to constitute a “securities account” within the meaning of U.C.C. section 8-501. Rather, “whether the relationship between an institution and a person on whose behalf the institution holds an asset falls within the scope of the term securities account as defined in Section 8-501 . . . turns in large measure on whether it makes sense to apply the Part 5 [duties] to the relationship.” Therefore, the U.C.C. places a heavy emphasis on the Part 5 duties to determine whether an Article 8 relationship exists between the parties.
Depending on the reading of Article 8, this emphasis had the potential to be problematic for entities engaging in certain activities, including custodial activities, with respect to digital assets, as the duties associated with digital assets may not directly correlate to the duties under Part 5. For instance, U.C.C. section 8-506 provides that “[a] securities intermediary shall exercise rights with respect to a financial asset if directed to do so by an entitlement holder.” While some digital assets may provide voting or other rights to the holder, some may not provide such rights. However, the new official commentary affirms (in true Article 8 flexibility) that Article 8 was written so that “[i]t is not necessary for all of the Part 5 [duties] to be relevant to a particular financial asset for the relevant property to qualify as a ‘financial asset’ credited to a securities account.” In addition, the commentary affirms that the scope of these Part 5 duties is flexible: the securities intermediary and the entitlement holder can contract to specify how such duties are met. Therefore, even when the rights granted to holders of digital assets do not precisely fit within the Article 8 framework, these assets can still be “financial assets” under section 8-102(a)(9)(iii) if it overall “makes sense” to apply the framework.
Through an analysis of recent case law developments and the 2022 Amendments related to Article 8 of the U.C.C., this portion of the survey has attempted to provide insights into the evolving landscape of commercial law and its practical implications. Firstly, the discussion of assets covered by the Article 8 direct holding system included two 2023 cases that supported our current understanding of the “security” and “financial asset” definitions. The 2022 Amendments further emphasized the adaptability of the definitions of these Article 8 asset types to accommodate technological advancements and new products. Second, the examination of securities intermediaries and transfer agents in Parseghian underscored the importance of understanding the diverse roles and responsibilities of entities involved in securities transactions. The 2022 Amendments provided additional clarity to the categorization of entities and to the flexibility of Article 8 to accommodate the evolving market practices of these entities. Lastly, the discussion of the duties of Article 8 entities highlighted an area of interest for further development and the importance and flexibility of a securities intermediary’s duties. The Parseghian case elucidates the interplay between Article 8 duties and common law bailment, emphasizing the comprehensive framework provided by the U.C.C. The 2022 Amendments further clarify the application of the duties of various Article 8 entities to new financial assets, emphasizing contractual flexibility within the Article 8 framework. Article 8 of the U.C.C. is an adaptable framework, and the 2022 Amendments demonstrate its promise in addressing contemporary challenges in commercial transactions. As financial markets continue to evolve, the principles outlined in Article 8 will undoubtedly continue to play a crucial role in shaping regulatory frameworks and facilitating efficient financial market transactions.
Kathryn expresses her gratitude to Carl S. Bjerre and Sandra M. Rocks for their input and review in connection with the preparation of this article. The information contained in this article represents the view and opinions of the author only and does not necessarily represent the views or opinions of Fidelity Investments.
