Shorter SEC Settlement Cycle: Time Is Now for Tech Upgrades
Uncover the role of tech adoption; automated solutions protect against tax violations and ensure compliance resilience.
Tara Hagen and Mandy Zeman of Global Tax Network explore the impact of the SEC’s shortened settlement cycle on equity compensation compliance and discover how technology can streamline processes and mitigate risks.
Starting in May 2024, the U.S. Securities and Exchange Commission’s new, shorter settlement cycle kicks in—and it could leave businesses scrambling. HR, payroll, tax, and equity teams will have one fewer day to deliver shares and manage the related equity compensation tax implications. Plus, when the settlement window is shortened, it will focus more on the complexity of managing a mobile workforce.
However, these new settlement cycles could serve as the wake-up call businesses need to jump-start much-needed technology upgrades. Why is the SEC’s rule so important for companies that offer equity compensation, and how can technology protect against tax violations, lost compensation, and burnout in this new environment?
What Do the SEC’s New Settlement Cycle Rules Mean for Businesses?
In 2022, the SEC announced it would require a shorter settlement time for broker-dealer transactions, reducing settlements from two days after the transaction (T+2) to one day after the transaction (T+1). Shortening the settlement cycle creates new challenges for public U.S. businesses that dole out global equity compensation.
Managing reporting and withholdings for equity compensation has always been difficult. It generally requires input from many departments, from HR and equity teams to payroll, tax, and more. That means teams may already be cutting it close—even with multiple days after a transaction to coordinate.
Starting in May 2024, the settlement time these teams have to work within will be cut in half. Here are a few reasons this could cause significant headaches for businesses:
1. Setting up withholding is a cross-departmental job
Shortening the settlement cycle is alarming for many businesses, given that setting up reporting and withholding for global equity relies on input from multiple departments and alignment with third-party brokers’ systems.
Company HR, tax, and payroll teams need to figure out an employee’s location, their jurisdiction’s reporting and withholding requirements, and any special rules, and they need to attempt to predict the amount of cash needed for tax withholding before execution of the equity transaction in the broker system.
This is so important because the broker needs to sell enough of an employee’s shares to cover taxes for withholdings. From there, the resulting transaction details and funds netted for withholding are relayed back to payroll and tax teams. On top of this, tax withholding deposits for some countries are due to be paid to taxing authorities within 24 hours of the delivery of the shares.
2. Teams have less time to determine correct reporting and withholding
Noting all the parties involved—and now the updated time restrictions—there is even less time to get the reporting and withholding right. Moving to a T+1 settlement reduces the time your teams have to determine the rules of each jurisdiction where employees work, decide tax obligations, and set aside the correct amount of money.
Many of today’s businesses manage reporting and withholdings for their mobile employee populations by sorting through spreadsheets and manually plugging in figures. As the time frame to report shrinks, these manual methods could become too slow and tedious for teams to keep up.
Determining a precise figure requires calculations after the fair market value is finalized at market close. Otherwise, an estimated amount could be too high. Then you are selling more shares than necessary—not a great result for the employer looking to provide a valuable benefit or for the employee looking for an appreciable asset.
Alternatively, if the estimate is too low, more funds must be collected separately for employee tax withholdings, adding administrative burden to the company and a bad taste in the mouth of the employee.
3. Rules can differ between regions
As mentioned, the new settlement cycle is even more challenging if businesses employ mobile workers. Different regions, states, and countries could have different reporting obligations. Especially if employees move or travel often, they may be on the hook for global equity tax in multiple regions. For instance, if an employee first receives equity in one country and works in another country when their equity awards vest or are exercised, they may be subject to taxation, reporting, and withholding obligations in both countries.
Ultimately, businesses must pinpoint each region’s rules, calculate how much benefit is reported in each jurisdiction, and determine how much tax withholding is due. Additional tax expertise is frequently necessary to correctly interpret the interaction of multijurisdiction tax laws and reliefs for a single transaction.
Separate computations are generally needed for income reporting and tax withholding for each country, state/local, and social tax type required. One fewer day makes it harder—if not impossible—to achieve. If teams make calculations by hand or do any of the work manually, they may not have the time or resources to hit the new T+1 timeline.
How to Use Technology to Avoid Tax and Compliance Violations
To keep up with the new T+1 settlement rules, businesses must rely on technological upgrades. Here are some things businesses should consider as they adopt technology to hit that shrinking reporting and withholding target.
1. Automation is a must
The easiest way for businesses to meet the new T+1 settlement deadlines is to adopt an automated system. It’s becoming less and less realistic for teams to handle spreadsheets, manually type data, and calculate withholding figures by hand.
When guided by knowledgeable professionals, technology can identify regional tax rules and calculate withholdings in a fraction of the time. Automated solutions will also reduce the potential for human data entry errors, which could rise as teams rush to hit the shortened deadline.
When selecting an automated solution, choosing one that can be bridged to your payroll, broker, and human resources information systems is important. It complements your team’s technical knowledge and your company’s size.
For example, some brokers offer modules marketed as mobility tax solutions; however, brokers are barred from providing tax advice. Therefore, if your team doesn’t have technical worldwide tax knowledge, these modules may be frustrating to use—or worse, could put your company at risk if set up incorrectly.
A better solution for companies with limited internal resources may be to select an automated solution supported by mobility tax professionals who will guide your team in determining the correct tax logic to apply to any situation and who can spot problems and solve them before they occur.
The window for settlements is also likely to keep narrowing. In 2017, the SEC reduced settlements from T+3 to T+2 and is expected to move to T+0—or instantaneous settlement—sometime in the future. In all cases, automation looks more and more like an essential function.
2. Beware of security breaches
Businesses and teams must share data to meet reporting and withholding requirements for equity compensation. For instance, an equity team must sell shares in their broker system.
Then, they’ll pass that data on to payroll to report and deliver taxes to the relevant authorities. There’s a danger of security breaches at every stage of this process. Therefore, ensuring their systems are secure when working with third parties is important.
See More: Breach and Tell: The Current State of Breach Disclosures
Set up Technology Soon to Avoid Havoc in the Future
When the new settlement cycle starts, your business will have less time to accomplish this complex task. However, teams can use technology to stay ahead of this spring’s new rules.
By adopting automated tax and HR management systems, businesses can avoid tax violations when the May changes set in—and prepare for an even shorter settlement cycle.
How is your business navigating SEC’s move to make tech upgrades essential? Let us know on Facebook, X, and LinkedIn. We’d love to hear from you!
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