What is a Dirty Stock

A dirty stock is an equity security that fails to settle properly, disrupting transactions.

BREAKING DOWN Dirty Stock

A dirty stock does not achieve good delivery for one reason or another. When stock gets transferred from one owner to another, transfer agents create a legal record of the change. For example, when a company issues stock to shareholders, a transfer agent deals with the paperwork required to issue those certificates and file all associated records necessary with the Securities and Exchange Commission (SEC) or a bank regulatory agency, depending upon the agent’s registration.

Good delivery of a stock occurs when the transfer of its title meets all legal and regulatory requirements. For delivery of stocks from broker-dealers or investors, this generally means a transfer agent ensures the validity of all signatures transferring the title of a stock certificate, confirms that the certificates cover the appropriate number of shares, ensures the presence of attachments where necessary and notes the presence of a uniform delivery ticket. When delivery lacks one or more of these elements, the transfer agent will not allow the transfer, and the stock gets labeled as dirty.

Dirty Stocks and Failure to Deliver

Dirty stocks interrupt the transaction process until any paperwork issues get resolved, but they do not necessarily indicate bad faith on the part of any party to the transaction. The reasons for failure generally arise from missing attachments or invalid endorsements, such as the inclusion of deceased signatories, minors or a single signature on a jointly owned account. Forgeries can also disrupt the process. Any interruption of good delivery that delays the process beyond the settlement date causes a situation known as failure to deliver.

Avoiding Dirty Stocks with Book-Entry Securities

Since dirty stock issues typically arise out of misfiled paperwork, investors can usually avoid the issue entirely by relying upon paperless or book-entry securities. Transfer of these securities takes place electronically, rather than through the issuance of engraved certificates. Certificates for these securities never reach stockholders, instead residing with transfer agents or in a central clearinghouse. Stockholders receive statements to prove their ownership, and the clearinghouse or transfer agent processes payments made in association with the stock, such as dividends and interest. Since the certificates do not actually change hands, transfer of securities becomes a simpler matter of changing ownership on the electronic system.

Although book-entry stocks can help avoid the pitfalls associated with dirty stock transactions, the clearinghouse may temporarily restrict certain transactions, including deposits and withdrawals of certificates. This process, called a chill, typically occurs during a restructuring that affects existing positions, such as a merger or acquisition involving the purchase or sale of existing stock.