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    Going Straight to the Source: AAII's 2007 Guide to Direct Purchase Plans

    by Maria Crawford Scott

    Want a simple, low-cost way to invest a small amount of money in an individual company?

    One approach is to go straight to the source. Currently, over 430 companies in the U.S. offer direct purchase plans, allowing you to buy shares directly from the company without a broker.

    Direct purchase plans are a form of dividend reinvestment plan, but in a traditional dividend reinvestment plan you must first enroll in the plan in order to participate, which means buying your initial shares through a broker. Direct purchase plans allow you to completely bypass brokers.

    The Dividend Advantage

    The attraction of dividend-paying stocks has increased since dividends started to receive preferential tax treatment in 2003, and it should continue now that that treatment will be extended through 2010. Reinvesting dividends allows you to build up your position in a company and keeps your money working for you over time. But keeping costs low is important, which is one of the attractions of a direct purchase plan.

    Of course, a number of major discount brokerage firms offer their own dividend reinvestment plans, which allow you to reinvest the dividends of the stocks you own through the brokerage firm with no fees attached. This is an advantage because the amount of many dividend payments would otherwise typically entail the purchase of odd-lot sizes, which often have higher transaction charges.

    However, many corporate direct purchase plans allow participants to make additional cash purchases of shares at little or no cost—a feature no brokerage firm can match.

    And, direct purchase plans typically have lower minimum investments than most brokers.

    Direct purchase plans are custom-made for long-term, buy-and-hold investors. While they are not on their own a reason to buy a stock, they serve as a shareholder bonus on a company with promising long-term growth prospects.

    How Do You Join?

    Currently, around 430 companies offer direct purchase plans, with minimums ranging from $25 to $2,500, with $250 a typical minimum. In a few cases, direct purchase plans are offered even though no cash dividend is paid.

    Table 1 lists the companies that offer direct purchase plans, along with a contact phone number and initial investment minimum. They include major corporations, as well as REITs (real estate investment trusts).

    Direct purchase plans are described in a plan prospectus, which you can receive by contacting either the company’s shareholder relations department or the plan administrator. You should read the plan prospectus or description carefully. While the overall structure of most direct purchaseplans is similar, they vary in the details. The prospectus or plan description will provide information on such items as: eligibility requirements, plan options, costs, how and when purchases are made, how and when certificates will be issued, and how participants withdraw from the plan.

       How Direct Purchase and Dividend Reinvestment Plans Work

    A company's direct purchase or dividend reinvestment plan will be described in the plan's prospectus, which you should read carefully. While the overall structure of most dividend reinvestment plans is similar, they vary in the details.

    Administration

    Most companies appoint an outside agent to serve as the administrator for their dividend reinvestment plan. The administrator maintains records, sends account statements to participants, furnishes certificates for shares upon request and liquidates participants' shares when they leave the plan. The agent also is responsible for the purchase of company shares for the plan. When you join a plan, you will sign a card that authorizes the agent to make purchases on your behalf.

    Joining the Plan

    Direct purchase plans allow you to buy the shares directly from the plan administrator. Dividend reinvestment plans without the direct purchase feature require that you own at least one share (and sometimes more) registered in your name—you are a shareholder "of record." That means your name appears on the corporate records as the owner of the shares rather than the nominee name ("street name") of the broker or bank that may have purchased the shares for you (and who may be safekeeping them for you). If your shares are held in street name, you should ask your broker to transfer the shares to your own name.

    Shares purchased under a direct purchase or dividend reinvestment plan are held by the plan and registered in the nominee name of the agent or plan trustee on behalf of the participants, each of whom has an account under the plan. For participants in dividend reinvestment plans, that means you may hold the company's shares in two places—your original registered shares, with the certificates either held by you or in custody at a bank or brokerage firm, and the shares purchased through the dividend reinvestment plan, held by the plan.

    Many dividend reinvestment plans will allow participants to deposit certificates of shares registered in their own name into their dividend reinvestment plan account for safekeeping at no charge or for a modest fee; these shares are then treated in the same way as the other shares in the participant's account.

    Certificates for shares purchased under the plan are usually issued only upon written request, although often at no charge. Certificates are also issued when a participant no longer wants to participate in the plan.

    Plan Options

    Aside from the initial purchase, direct investment plan and dividend reinvestment plan mechanics are the same. The basic plan offers reinvestment of dividends on all shares of stock registered in the participant's name. This is often referred to as "full reinvestment."

    Under most plans, it isn't necessary to reinvest all dividends. Instead, participants are allowed to reinvest dividends on a portion of their registered shares while receiving cash dividends on the remaining shares. This is usually referred to as a "partial reinvestment option." Most plans also allow participants to purchase additional shares by making cash payments directly to the plan. This option is often referred to as "optional cash payment," and since the allowable amounts can be large, it offers participants a low-cost way to build a sizeable holding in a company. The payments are optional—participants are not committed to making periodic cash investments.

    However, usually there are minimums for each payment made, and often there is a maximum.

    It is also important to note the frequency with which the plan invests cash payments, since interest is not paid on payments received in advance of actual investment.

    A twist on the cash payment option is that some companies will allow registered shareholders to make cash investments without requiring them to reinvest dividends on the shares they are holding, although they may do so if they want. This is frequently referred to as the "cash payment only option."

    An added convenience for participants who wish to make systematic cash investments is an automatic investment feature that is offered by most of the companies. The company or the plan agent automatically debits the investor's checking or savings account at regular intervals to purchase additional shares.

    The Costs

    Participant costs usually come in two forms: service charges and prorated brokerage commissions. Service charges cover administrative costs and are generally levied on each transaction; participants can hold costs down by combining a cash payment with a dividend reinvestment transaction, since usually the charges are capped (a $5.00 per transaction maximum is typical). Brokerage commissions levied on open market shares are at institutional rates (since the number of shares purchased is large), and are therefore considerably lower than the rate an investor would pay on his own.

    Many companies cover all of the costs for share purchases from both reinvested dividends and optional cash payments. Some companies levy service charges, others prorate brokerage costs, and still others charge participants for both-there are many variations, so check the prospectus or plan description carefully.

    When participation is terminated, some dividend reinvestment plans will sell plan shares for you, if you prefer, instead of sending you certificates. The cost to the participant is usually any prorated brokerage commissions, a lower-cost alternative than selling through a broker. Some plans will sell plan shares for you even if you are not terminating. Check the prospectus or plan description.

    Share Purchases

    The source of share purchases under a dividend reinvestment plan is spelled out in the plan description and prospectus.

    The most common source is the secondary market-through an exchange where the shares are traded, in the over-the-counter market, or through negotiated transactions. Another source for some purchases is the company itself, using authorized but unissued shares of common stock or shares held in the company's treasury.

    In plans that prorate brokerage commissions among participants, the source of share purchases is a concern. When shares are purchased directly from the company, there are no brokerage expenses to prorate.

    When shares are purchased directly from the company, the prospectus will describe how the share price is determined. Usually, it is based on an average of the high and low or the closing price for the stock as reported by a specified source.

    Some companies offer participants discounts on the share price, but there is wide variation in how this is offered. Most often, the discounts are available only on shares purchased with reinvested dividends, but sometimes discounts apply to shares purchased both with reinvested dividends and with cash payments. Discounts are described in detail in plan prospectuses.

    A Note About Taxes

    Direct purchase and dividend reinvestment plans have many advantages, but their tax status is not one of them—unless you are investing through an IRA (offered by a few companies).

    Whether you receive your dividends in cash or have them reinvested, a taxable event has occurred, although the tax treatment now is lower than it was previously.

    In addition, if you reinvest dividends, the IRS considers the “dividend” to be equal to the fair market value of shares acquired with reinvested dividends. The fair market price is the price on the exchange or market where shares are traded, not any discounted price. Furthermore, any brokerage commissions paid by the company in open market purchases to acquire the shares are considered additional dividend income to the participant.

    When shares are sold, the tax basis is the fair market value as of the date the shares were acquired, plus any brokerage commissions paid by the company, and it is treated as income to the participant. Participants receive 1099-DIV forms each year from the company detailing dividends to be treated as income as reported to the IRS.

    Where to Get Information on Direct Purchase Plans

    Companies with direct purchase plans appoint an outside agent to serve as the administrator for their plan. These administrators maintain plan records, send account statements to participants, furnish certificates for shares upon request—and handle the purchases and sales of the shares.

    Five major firms serve as administrators for U.S.-based direct purchase plans and dividend reinvestment plans:

    • American Stock Transfer & Trusts,
    • Computershare,
    • Bank of New York,
    • Mellon Investor Services, and
    • Well Fargo.

    All five have extensive Web sites (see accompanying box) with information on the direct purchase and dividend reinvestment plans that they administer, as well as educational articles on direct purchase and dividend reinvestment plans in general.

    All five Web sites also allow you to buy direct purchase plan shares on-line at their sites. Other plan administrators serving only a handful of plans include LaSalle Bank, National City Bank, Registrar and Transfer Company, and UMB Bank. In a few of these cases, you can find the most information by contacting the company directly. Also, several companies act as administrators for their own plans. To find plan information from a company directly, go to the company Web site and look in the Investor Relations area or call the phone numbers provided here.

       Direct Stock Purchase and Dividend Reinvestment Plan Administrators

    The Major Firms

    American Stock Transfer & Trust Co.
    www.amstock.com [go to Shareholder Services]
    www.investpower.com

    Provides a list of all direct purchase plans and dividend reinvestment plans administered by the firm. By clicking on the name of each company you can get a brief description of either kind of plan. For a direct purchase plan prospectus, click “buy,” and then click on “plan materials.” For a dividend reinvestment plan prospectus, contact the shareholder relations department of the company you are interested in.

    The Bank of New York
    www.stockbny.com

    Go to Company Facts & Forms, then Company List and select “United States” under search by country for a list of both direct purchase and dividend reinvestment plans. For a direct purchase plan prospectus, click on “yes” in the Company Specific Forms column and then click on “Brochure/Prospectus.” To bring up the list of direct purchase plans with a link to buying on-line, go to Initial Purchase and select “United States” under search by country. For a dividend reinvestment plan prospectus, call the toll-free number listed and request a prospectus. Clicking on the company name itself will link you to the company Web site.

    Computershare
    www.computershare.com

    Click on Investor Centre under Shareholder Services. Then click on Investment Plans under Transact. You can get a complete list of all dividend reinvestment plans and direct purchase plans, or search for each separately. For a direct purchase or dividend reinvestment plan prospectus, click on “View” under “Plan Summary” and then select the PDF link for “Plan Brochure.”

    Mellon Investor Services
    www.melloninvestor.com

    Go to Investors and then Investment Plans for a listing of direct purchase and dividend reinvestment plans. For a direct purchase plan prospectus, click on “Invest Now” and then click on “View Plan Material.” For a dividend reinvestment plan prospectus, contact the shareholder relations department of the company you are interested in.

    Wells Fargo
    www.wellsfargo.com/com/shareowner_services

    Click on “Investment Plans” for a list of direct purchase and dividend reinvestment plan companies. Click on a company name to access a prospectus link, to buy on-line or to print out an application form to mail.

    Other Administrators

    LaSalle Bank
    www.lasalleshareholderservices.com

    Choose Investment Plan Enrollment for a list of direct purchase and dividend reinvestment plans. Choose “Invest Now” then “View Plan Material” for a plan prospectus. Choose “Invest Now” to buy on-line.

    Registrar and Transfer Company
    www.rtco.com

    Choose “Dividend Reinvestment” under Investor Services.

    UMB Bank
    www.umb.com/Commercial/ShareholderServices/TransferAgent/index.html

    A general page of information is provided, but no lists of plans. Call or E-mail for more information.


    Maria Crawford Scott is editor of the AAII Journal; Cara Scatizzi is associate financial analyst at AAII.


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