A settlement date is attached to each of the millions of trades made daily in the stock market. This date is three days after the date of the trade for stocks and the next business day for government securities and bonds.
It represents the day that the buyer must pay for the securities delivered by the seller. It also affects shareholder voting rights, payouts of dividends and margin calls. It is the date that the transaction associated with a trade can be considered final.
Origins of Settlement Date
The origins of settlement dates are rooted in trading practices which predate the modern electronic stock market. In the early days, a stock trade was executed by a buyer and a seller who had three days to deliver the securities and the money required to settle the transaction. Previously, this transaction was done by mail and was much slower than today.
Today, this rule is still in practice because a person can buy stock from a party who for various reasons may not actually own the stock. If those shares are then sold to a third party, the whole transaction can be made null and void by the fact that the second party never really owned the stock.
Definition of Settlement
The settlement date for stocks and bonds is three business days after the trade was executed. For government securities, options and mutual funds the settlement date is the next business day. These settlement times apply to trades made in the United States markets and may be different in markets in other parts of the world.
The settlement date is the date by which an executed security trade must be settled. That is, the date by which a buyer must pay for the securities delivered by the seller.
Misconceptions on Settlement
There is a misconception that the proceeds from the sale of stock can't be used in the purchase of other securities until the settlement date. Experienced traders will bypass the restrictions of settlement dates by signing up with their brokers to trade stocks on margin.
Margin is essentially buying stock with money borrowed from the trader's broker. Usually, there is interest charged on these borrowed funds, however, the interest does not begin until the settlement date of the stock bought with the borrowed funds. Since the settlement date of the sold stock being borrowed against will come before that of the bought stock, normally there is no interest charged.
Implications of Settlement
There are two main implications attached to the settlement date of a stock trade. The settlement date affects whether or not a dividend gets paid on stocks that pay dividends.
A dividend is a percentage of the share price paid out quarterly to the shareholders. If the dividend is paid before the settlement date the buyer will not receive the dividend. Inversely, if the dividend is paid after the settlement date the buyer of those shares will receive the dividend.
The other implication of the settlement date affects the voting rights of shareholders. If there is a shareholder vote held before the settlement date, the new buyer will have no vote. If a vote is held after the settlement date, then all voting rights apply to the buyer.
Read More: Ex-Dividend Rules
Considerations on Settlement
Much thought and consideration must be given before a margin account is set up with a broker. Many inexperienced traders have caused themselves financial hardship when they are unable to meet their margin calls, the date that borrowed funds must be repaid to the broker. Many online brokers will allow stocks to be bought with unsettled funds with the stipulation that those shares cannot be sold until the funds used to buy them have been settled.
Damon Koch has years of writing experience ranging from software manuals to song lyrics. His writing has appeared in software manuals for Human Arc and on the CDs "Small Craft Advisory" and "Impersonating Jesus." He also has worked in building maintenance since 2004. He has attended Lorain County Community College as well as Cleveland State University.