1. "Adverse claim". The definition of the term "adverse claim" has two
components. First, the term refers only to property interests. Second, the
term means not merely that a person has a property interest in a financial
asset but that it is a violation of the claimant's property interest for the
other person to hold or transfer the security or other financial asset.
The term adverse claim is not, of course, limited to ownership rights,
but extends to other property interests established by other law. A security
interest, for example, would be an adverse claim with respect to a transferee
from the debtor since any effort by the secured party to enforce the security
interest against the property would be an interference with the transferee's
The definition of adverse claim in the prior version of article 8 might
have been read to suggest that any wrongful action concerning a security,
even a simple breach of contract, gave rise to an adverse claim. Insofar as
such cases as Fallon v. Wall Street Clearing Corp., 586 N.Y.S.2d 953, 182
A.D.2d 245, (1992) and Pentech Intl. v. Wall St. Clearing Co., 983 F.2d 441
(2d Cir. 1993), were based on that view, they are rejected by the new definition
which explicitly limits the term adverse claim to property interests. Suppose,
for example, that A contracts to sell or deliver securities to B, but fails
to do so and instead sells or pledges the securities to C. B, the promisee,
has an action against A for breach of contract, but absent unusual circumstances
the action for breach would not give rise to a property interest in the securities.
Accordingly, B does not have an adverse claim. An adverse claim might, however,
be based upon principles of equitable remedies that give rise to property
claims. It would, for example, cover a right established by other law to rescind
a transaction in which securities were transferred. Suppose, for example,
that A holds securities and is induced by B's fraud to transfer them to B.
Under the law of contract or restitution, A may have a right to rescind the
transfer, which gives A a property claim to the securities. If so, A has an
adverse claim to the securities in B's hands. By contrast, if B had committed
no fraud, but had merely committed a breach of contract in connection with
the transfer from A to B, A may have only a right to damages for breach, not
a right to rescind. In that case, A would not have an adverse claim to the
securities in B's hands.
2. "Bearer form". The definition of "bearer form" has remained substantially
unchanged since the early drafts of the original version of article 8. The
requirement that the certificate be payable to bearer by its terms rather
than by an indorsement has the effect of preventing instruments governed by
other law, such as chattel paper or article 3 negotiable instruments, from
being inadvertently swept into the article 8 definition of security merely
by virtue of blank indorsements. Although the other elements of the definition
of security in section 8-102(a)(15) probably suffice for that purpose in any
event, the language used in the prior version of article 8 has been retained.
3. "Broker". Broker is defined by reference to the definitions of broker
and dealer in the federal securities laws. The only difference is that banks,
which are excluded from the federal securities law definition, are included
in the article 8 definition when they perform functions that would bring them
within the federal securities law definition if it did not have the clause
excluding banks. The definition covers both those who act as agents ("brokers"
in securities parlance) and those who act as principals ("dealers" in securities
parlance). Since the definition refers to persons "defined" as brokers or
dealers under the federal securities law, rather than to persons required
to "register" as brokers or dealers under the federal securities law, it covers
not only registered brokers and dealers but also those exempt from the registration
requirement, such as purely intrastate brokers. The only substantive rules
that turn on the defined term broker are one provision of the section on warranties,
section 8-108(i), and the special perfection rule in article 9 for security
interests granted by brokers, section 9-309.
4. "Certificated security". The term "certificated security" means a
security that is represented by a security certificate.
5. "Clearing corporation". The definition of clearing corporation limits
its application to entities that are subject to a rigorous regulatory framework.
Accordingly, the definition includes only federal reserve banks, persons who
are registered as "clearing agencies" under the federal securities laws (which
impose a comprehensive system of regulation of the activities and rules of
clearing agencies), and other entities subject to a comparable system of regulatory
6. "Communicate". The term "communicate" assures that the article 8
rules will be sufficiently flexible to adapt to changes in information technology.
Sending a signed writing always suffices as a communication, but the parties
can agree that a different means of transmitting information is to be used.
Agreement is defined in section 1-201(3) as "the bargain of the parties in
fact as found in their language or by implication from other circumstances
including course of dealing or usage of trade or course of performance". Thus,
use of an information transmission method might be found to be authorized
by agreement, even though the parties have not explicitly so specified in
a formal agreement. The term communicate is used in sections 8-102(a)(8) (definition
of entitlement order), 8-102(a)(12) (definition of instruction), and 8-403
(demand that issuer not register transfer).
7. "Entitlement holder". This term designates those who hold financial
assets through intermediaries in the indirect holding system. Because many
of the rules of part 5 impose duties on securities intermediaries in favor
of entitlement holders, the definition of entitlement holder is, in most cases,
limited to the person specifically designated as such on the records of the
intermediary. The last sentence of the definition covers the relatively unusual
cases where a person may acquire a security entitlement under section 8-501
even though the person may not be specifically designated as an entitlement
holder on the records of the securities intermediary.
A person may have an interest in a security entitlement, and may even
have the right to give entitlement orders to the securities intermediary with
respect to it, even though the person is not the entitlement holder. For example,
a person who holds securities through a securities account in its own name
may have given discretionary trading authority to another person, such as
an investment adviser. Similarly, the control provisions in section 8-106
and the related provisions in article 9 are designed to facilitate transactions
in which a person who holds securities through a securities account uses them
as collateral in an arrangement where the securities intermediary has agreed
that if the secured party so directs the intermediary will dispose of the
positions. In such arrangements, the debtor remains the entitlement holder
but has agreed that the secured party can initiate entitlement orders. Moreover,
an entitlement holder may be acting for another person as a nominee, agent,
trustee, or in another capacity. Unless the entitlement holder is itself acting
as a securities intermediary for the other person, in which case the other
person would be an entitlement holder with respect to the securities entitlement,
the relationship between an entitlement holder and another person for whose
benefit the entitlement holder holds a securities entitlement is governed
by other law.
8. "Entitlement order". This term is defined as a notification communicated
to a securities intermediary directing transfer or redemption of the financial
asset to which an entitlement holder has a security entitlement. The term
is used in the rules for the indirect holding system in a fashion analogous
to the use of the terms "indorsement" and "instruction" in the rules for the
direct holding system. If a person directly holds a certificated security
in registered form and wishes to transfer it, the means of transfer is an
indorsement. If a person directly holds an uncertificated security and wishes
to transfer it, the means of transfer is an instruction. If a person holds
a security entitlement, the means of disposition is an entitlement order.
An entitlement order includes a direction under section 8-508 to the securities
intermediary to transfer a financial asset to the account of the entitlement
holder at another financial intermediary or to cause the financial asset to
be transferred to the entitlement holder in the direct holding system (e.g.,
the delivery of a securities certificate registered in the name of the former
entitlement holder). As noted in comment 7, an entitlement order need not
be initiated by the entitlement holder in order to be effective, so long as
the entitlement holder has authorized the other party to initiate entitlement
orders. See section 8-107(b).
9. "Financial asset". The definition of "financial asset", in conjunction
with the definition of "securities account" in section 8-501, sets the scope
of the indirect holding system rules of part 5 of revised article 8. The part
5 rules apply not only to securities held through intermediaries, but also
to other financial assets held through intermediaries. The term financial
asset is defined to include not only securities but also a broader category
of obligations, shares, participations, and interests.
Having separate definitions of security and financial asset makes it
possible to separate the question of the proper scope of the traditional article
8 rules from the question of the proper scope of the new indirect holding
system rules. Some forms of financial assets should be covered by the indirect
holding system rules of part 5, but not by the rules of parts 2, 3, and 4.
The term financial asset is used to cover such property. Because the term
security entitlement is defined in terms of financial assets rather than securities,
the rules concerning security entitlements set out in part 5 of article 8
and in revised article 9 apply to the broader class of financial assets.
The fact that something does or could fall within the definition of
financial asset does not, without more, trigger article 8 coverage. The indirect
holding system rules of revised article 8 apply only if the financial asset
is in fact held in a securities account, so that the interest of the person
who holds the financial asset through the securities account is a security
entitlement. Thus, questions of the scope of the indirect holding system rules
cannot be framed as "Is such-and-such a 'financial asset' under article 8?".
Rather, one must analyze 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. That question
turns in large measure on whether it makes sense to apply the part 5 rules
to the relationship.
The term financial asset is used to refer both to the underlying asset
and the particular means by which ownership of that asset is evidenced. Thus,
with respect to a certificated security, the term financial asset may, as
context requires, refer either to the interest or obligation of the issuer
or to the security certificate representing that interest or obligation. Similarly,
if a person holds a security or other financial asset through a securities
account, the term financial asset may, as context requires, refer either to
the underlying asset or to the person's security entitlement.
10. "Good faith". Section 1-203 provides that "Every contract or duty
within the code imposes an obligation of good faith in its performance or
enforcement". Section 1-201(b)(20) defines "good faith" as "honesty in fact
and the observance of reasonable commercial standards of fair dealing". The
reference to commercial standards makes clear that assessments of conduct
are to be made in light of the commercial setting. The substantive rules of
article 8 have been drafted to take account of the commercial circumstances
of the securities holding and processing system. For example, section 8-115
provides that a securities intermediary acting on an effective entitlement
order, or a broker or other agent acting as a conduit in a securities transaction,
is not liable to an adverse claimant, unless the claimant obtained legal process
or the intermediary acted in collusion with the wrongdoer. This, and other
similar provisions, see sections 8-404 and 8-503(e), do not depend on notice
of adverse claims, because it would impair rather than advance the interest
of investors in having a sound and efficient securities clearance and settlement
system to require intermediaries to investigate the propriety of the transactions
they are processing. The good faith obligation does not supplant the standards
of conduct established in provisions of this kind.
In revised article 8, the definition of good faith is not germane to
the question whether a purchaser takes free from adverse claims. The rules
on such questions as whether a purchaser who takes in suspicious circumstances
is disqualified from protected purchaser status are treated not as an aspect
of good faith but directly in the rules of section 8-105 on notice of adverse
11. "Indorsement" is defined as a signature made on a security certificate
or separate document for purposes of transferring or redeeming the security.
The definition is adapted from the language of section 8-308(1) of the prior
version and from the definition of indorsement in the Negotiable Instruments
Article, see section 3-204(a). The definition of indorsement does not include
the requirement that the signature be made by an appropriate person or be
authorized. Those questions are treated in the separate substantive provision
on whether the indorsement is effective, rather than in the definition of
indorsement. See section 8-107.
12. "Instruction" is defined as a notification communicated to the issuer
of an uncertificated security directing that transfer be registered or that
the security be redeemed. Instructions are the analog for uncertificated securities
of indorsements of certificated securities.
13. "Registered form". The definition of "registered form" is substantially
the same as in the prior version of article 8. Like the definition of bearer
form, it serves primarily to distinguish article 8 securities from instruments
governed by other law, such as article 3.
14. "Securities intermediary". A "securities intermediary" is a person
that in the ordinary course of its business maintains securities accounts
for others and is acting in that capacity. 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. Clearing corporations are listed separately
as a category of securities intermediary in subparagraph (i) even though in
most circumstances they would fall within the general definition in subparagraph
(ii). The reason is to simplify the analysis of arrangements such as the NSCC-DTC
system in which NSCC performs the comparison, clearance, and netting function,
while DTC acts as the depository. Because NSCC is a registered clearing agency
under the federal securities laws, it is a clearing corporation and hence
a securities intermediary under article 8, regardless of whether it is at
any particular time or in any particular aspect of its operations holding
securities on behalf of its participants.
The terms securities intermediary and broker have different meanings.
Broker means a person engaged in the business of buying and selling securities,
as agent for others or as principal. Securities intermediary means a person
maintaining securities accounts for others. A stockbroker, in the colloquial
sense, may or may not be acting as a securities intermediary.
The definition of securities intermediary includes the requirement that
the person in question is "acting in the capacity" of maintaining securities
accounts for others. This is to take account of the fact that a particular
entity, such as a bank, may act in many different capacities in securities
transactions. A bank may act as a transfer agent for issuers, as a securities
custodian for institutional investors and private investors, as a dealer in
government securities, as a lender taking securities as collateral, and as
a provider of general payment and collection services that might be used in
connection with securities transactions. A bank that maintains securities
accounts for its customers would be a securities intermediary with respect
to those accounts; but if it takes a pledge of securities from a borrower
to secure a loan, it is not thereby acting as a securities intermediary with
respect to the pledged securities, since it holds them for its own account
rather than for a customer. In other circumstances, those two functions might
be combined. For example, if the bank is a government securities dealer it
may maintain securities accounts for customers and also provide the customers
with margin credit to purchase or carry the securities, in much the same way
that brokers provide margin loans to their customers.
15. "Security". The definition of "security" has three components. First,
there is the subparagraph (i) test that the interest or obligation be fully
transferable, in the sense that the issuer either maintains transfer books
or the obligation or interest is represented by a certificate in bearer or
registered form. Second, there is the subparagraph (ii) test that the interest
or obligation be divisible, that is, one of a class or series, as distinguished
from individual obligations of the sort governed by ordinary contract law
or by article 3. Third, there is the subparagraph (iii) functional test, which
generally turns on whether the interest or obligation is, or is of a type,
dealt in or traded on securities markets or securities exchanges. There is,
however, an "opt-in" provision in subparagraph (iii) which permits the issuer
of any interest or obligation that is "a medium of investment" to specify
that it is a security governed by article 8.
The divisibility test of subparagraph (ii) applies to the security — that is, the underlying intangible interest — not the means by which that
interest is evidenced. Thus, securities issued in book-entry only form meet
the divisibility test because the underlying intangible interest is divisible
via the mechanism of the indirect holding system. This is so even though the
clearing corporation is the only eligible direct holder of the security.
The third component, the functional test in subparagraph (iii), provides
flexibility while ensuring that the article 8 rules do not apply to interests
or obligations in circumstances so unconnected with the securities markets
that parties are unlikely to have thought of the possibility that article
8 might apply. Subparagraph (iii)(A) covers interests or obligations that
either are dealt in or traded on securities exchanges or securities markets,
or are of a type dealt in or traded on securities exchanges or securities
markets. The "is dealt in or traded on" phrase eliminates problems in the
characterization of new forms of securities which are to be traded in the
markets, even though no similar type has previously been dealt in or traded
in the markets. Subparagraph (iii)(B) covers the broader category of media
for investment, but it applies only if the terms of the interest or obligation
specify that it is an article 8 security. This opt-in provision allows for
deliberate expansion of the scope of article 8.
Section 8-103 contains additional rules on the treatment of particular
interests as securities or financial assets.
16. "Security certificate". The term "security" refers to the underlying
asset, e.g., 1000 shares of common stock of Acme, Inc. The term "security
certificate" refers to the paper certificates that have traditionally been
used to embody the underlying intangible interest.
17. "Security entitlement" means the rights and property interest of
a person who holds securities or other financial assets through a securities
intermediary. A security entitlement is both a package of personal rights
against the securities intermediary and an interest in the property held by
the securities intermediary. A security entitlement is not, however, a specific
property interest in any financial asset held by the securities intermediary
or by the clearing corporation through which the securities intermediary holds
the financial asset. See sections 8-104(c) and 8-503. The formal definition
of security entitlement set out in subsection (a)(17) of this section is a
cross-reference to the rules of part 5. In a sense, then, the entirety of
part 5 is the definition of security entitlement. The part 5 rules specify
the rights and property interest that comprise a security entitlement.
18. "Uncertificated security". The term "uncertificated security" means
a security that is not represented by a security certificate. For uncertificated
securities, there is no need to draw any distinction between the underlying
asset and the means by which a direct holder's interest in that asset is evidenced.
Compare "certificated security" and "security certificate".
Definitional Cross References:
"Agreement". Section 1-201(b)(3).
"Bank". Section 1-201(b)(4).
"Person". Section 1-201(b)(27).
"Send". Section 1-201(b)(36).
"Signed". Section 1-201(b)(37).
"Writing". Section 1-201(b)(43).