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87-19 Federal Regulation of Government Securities Brokers and Dealers Under the Government Securities Act of 1986
TO: All NASD Members and Other Interested Persons
On October 28, 1986, President Reagan signed the Government Securities Act of 1986 (Act) which provides for the federal regulation of government securities brokers and dealers. The new legislation, which becomes effective on July 25, 1987, creates new Section 15C under the Securities Exchange Act of 1934 (Exchange Act) entitled "Government Securities Brokers and Dealers." The new section provides for various conforming amendments to the Exchange Act, the Investment Company Act of 1940 and the Investment Advisers Act of 1940.
When implemented, the regulations under the Act will assure that all brokers and dealers in government securities are subject to a system of regulation and enforcement.
While the Act's provisions apply to brokers, dealers and financial institutions, 1/ this notice only addresses the applicability of the Act to brokers and dealers.
Section 15C(a)(l)(A) under the new legislation requires a government securities broker or dealer (GSBD), other than a currently registered broker or dealer, to register with the Securities and Exchange Commission (SEC). In addition to SEC registration, a GSBD must become a member of a national securities exchange or the NASD by July 25, 1987.
Under Section 15C(a)(l)(B), a GSBD that is currently registered as a broker or dealer is required to file written notice of its status with the SEC by July 25, 1987. Form BD is being revised to incorporate a GSBD status category and is expected to be available by the end of April 1987. Therefore, affected NASD members will have sufficient time to meet the notification deadline.
A GSBD that is not currently regulated and is required under the new legislation to register with the SEC is not precluded from registering as a broker or dealer under Section 15(b) of the Exchange Act, which relates to general securities brokers and dealers. A GSBD that registers under new Section 15C(a)(l)(A) will be limited to conducting a government securities business only.
The NASD will guarantee completion of membership processing before July 25, 1987, to GSBDs submitting complete applications prior to April 15, 1987. If the NASD receives applications after April 15, it will make every effort to complete processing prior to July 25, but cannot guarantee it. After July 25, 1987, only registered GSBDs will be permitted to conduct a government securities business.
Rules Applicable to Transactions in Government Securities
Section 15C(b)(l) under the new legislation authorizes the Secretary of the Treasury (Secretary or Treasury) to propose and adopt rules governing transactions in government securities. 2/ These rules will address financial responsibility matters, including, but not limited to, capital adequacy standards, acceptance of custody and use of customers' securities, carrying and use of customers' deposits or credit balances, and transfer and control of government securities subject to repurchase agreements and similar transactions. Government securities brokers and dealers will also be required to file periodic financial reports as well as audited annual financial statements certified by an independent public accountant.
Section 15C(d)(l) authorizes the SEC to inspect the books and records of GSBDs registered with the SEC and to enforce the rules adopted under Section 15C. For GSBDs that are also NASD members, the NASD will have responsibility for enforcing compliance with the applicable provisions of Section 15C and the rules and regulations promulgated thereunder. The NASD's authority in this area is provided through an amendment to Section 15A of the Exchange Act, which governs registered securities associations. The amendment to Section 15A provides that a registered securities association may adopt and implement rules to: (l) enforce compliance by its members with the provisions of Section 15C; (2) provide that its members will be appropriately disciplined for violations of Section 15C; (3) provide for reasonable examination of the books and records of registered brokers and dealers; and (4) prohibit fraudulent, misleading, deceptive and false advertising.
In promulgating these rules, the Secretary is also authorized under the legislation to consider the adequacy of rules already applicable to GSBDs. In this connection, Sections 15C(a)(4) and (b)(3) permit the Secretary to exempt GSBDs from the provisions of Section 15C in areas in which such brokers and dealers are already adequately regulated.
Treasury Department's Proposed Regulations
On February 25, 1987, the Treasury published proposed regulations for GSBDs. Under the Government Securities Act, temporary regulations must take effect by May 26, 1987, and final regulations by July 25, 1987. As proposed, the regulations would apply to Section 15C registrants but would exempt GSBDs registered under Section 15 or 15B that remain subject to the SEC's financial responsibility rules; e.g., Rule 15c3-l, capital requirement; Rule 15c3-3, protection of customers' securities and balances; Rule 17a-3, recordkeeping requirements; and Rule 17a-5, financial reportings.
The Treasury's proposal relating to capital, customer protection, recordkeeping and reporting requirements adopts and incorporates much, and in some categories all, of the relevant existing SEC rules by cross references to SEC regulations. However, one area of significant difference relates to the capital requirement. Treasury does not use the SEC net capital and haircut provisions of Rule 15c3-l for GSBDs. Instead, it has incorporated into its proposal the capital adequacy guideline recommended by the Federal Reserve Bank of New York, 3/ with some modifications.
Members who have unregistered GSBD affiliates are urged to study the proposal carefully to determine the actions necessary to comply with the regulations within the time frames specified.
Persons Subject to Statutory Disqualifications
Section 15C(c)(l) under the new legislation charges the SEC to censure, place limitations on the activities of, suspend for a period not to exceed 12 months, or revoke the registration of a GSBD if it determines, on the record and after notice and opportunity for hearing, that such broker or dealer is or has associated with it any person who is subject to a statutory disqualification, as defined under Section 15(b)(4) of the Exchange Act. The SEC may also impose similar sanctions on any person subject to a statutory disqualification who is associated or seeking association with a GSBD. The Act also gives the NASD the authority to deny or condition membership or association with a member based upon the existence of a statutory disqualification. A GSBD applicant seeking broker-dealer registration and NASD membership that employs an individual subject to a statutory disqualification may be required to undergo a proceeding before the SEC or an appropriate NASD committee before registration or membership becomes effective.
Important: Potential GSBDs that employ statutorily disqualified individuals should begin membership! and registration application processing as soon as possible since delays may occur.4/
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Attached is a copy of the Treasury Department's summary that accompanied its February 25, 1987, proposal. A copy of the full text of the proposal can be obtained from the Government Securities Regulation Project, Room 4417, Main Treasury Building, Washington, D. C. 20220, or by calling (202) 566-2278.
Questions concerning this notice may be addressed to either your local NASD District Office, or to Walter J. Robertson, Associate Director, NASD Surveillance, (202) 728-8236 or to Thomas R. Cassella, Vice President, NASD Financial Responsibility, (202) 728-8237.
John E. Pinto
Senior Vice President Compliance
Department of the Treasury • Washington, D.C. • Telephone 566-2041
FOR IMMEDIATE RELEASE
February 23, 1987
CONTACT: Arthur Siddon
Treasury Issues Proposed Regulations Under the Government Securities Act
The Treasury Department today released proposed regulations under the Government Securities Act of 1986. The regulations, which for the first time would establish a system of identification and regulation of entities that deal solely in government securities and other exempted securities, will be published in the Federal Register on February 25 for 30 days of public comment. Under the Government Securities Act, temporary regulations must take effect on May 26, 1987 and final regulations on July 25, 1987. The proposed regulations affect all brokers and dealers in government securities, including those newly required to register under the Government Securities Act, registered broker-dealers, and some financial institutions.
The proposed regulations' include a financial responsibility requirement for currently unregulated government securities brokers and dealers that is based on the capital adequacy guidelines published in May, 1985 by the Federal Reserve Bank of New York. SEC-registered broker-dealers and financial institutions would not be subject to any additional capital requirement. The proposal also would require newly registered government securities brokers and dealers to follow SEC rules concerning possession or control of customer securities, recordkeeping and reporting, with modifications designed to enhance the knowledge and protection of all parties to repurchase transactions. Many of the repurchase agreement modifications would also apply to government securities brokers or dealers that are registered broker-dealers or financial institutions. The proposal also includes regulations concerning the custodial holdings of government securities by banks and other depository institutions.
The Treasury believes that these regulations, when implemented, will fairly and fully meet the mandate of the Government Securities Act, and will assure that all brokers and dealers in government securities are subject to a system of federal regulation and enforcement. While no regulations can guarantee against losses caused by fraud, the protections included in these regulations, combined with their vigorous enforcement by the SEC, federal financial institution regulators and self-regulatory organizations, should minimize such occurrences.
In developing the proposed regulations, the Treasury consulted with a broad range of interested parties. However, since the Government Securities Act provided only four months in which to develop the proposal, it is clear that some affected parties may not have been consulted. The Treasury especially urges smaller government securities brokers and dealers and investors to take this opportunity to provide their comments.
Reprints of the proposal (one set per firm) may be obtained from the Government Securities Regulation Project, Room 4417, Main Treasury Building, Washington, D.C. 20220 or call (202) 566-2278. Written comments should be submitted to the same address.
Summary of Treasury Proposed Regulations Under the Government: Securities Act of 1986
These proposed regulations cover all brokers and dealers in government securities, including SEC-registered broker-dealers and financial institution brokers and dealers. 1/ However, exemptions and special provisions throughout the regulations are designed to lessen the burden on these already regulated entities by avoiding duplicative regulation. The government securities involved extend beyond Treasury securities to, among other things, securities issued or guaranteed by agencies and government sponsored corporations and off-exchange options, puts, calls, etc. on those securities.
The proposed regulations carry a 30-day public comment period. Under the Government Securities Act of 1986 ("GSA"), regulations become effective as temporary regulations on May 26 and as final regulations on July 25, 1987.
Many entities, particularly financial institutions, that do not hold themselves out as government securities brokers or dealers engage in government securities transactions that would make them brokers or dealers under traditional definitions. In recognition of the fact that these institutions are already subject to governmental supervision, the regulations contain exemptions from registration and from the regulatory requirements for financial institutions whose only government securities activities are: (i) issuing or redeeming Savings Bonds or forwarding Savings Bond transactions; (ii) submitting tenders for the account of customers at Treasury auctions; (iii) transactions in a fiduciary capacity; (iv) doing repurchase and a limited number of reverse repurchase transactions; and (v) doing a limited number of actively solicited brokerage transactions or doing all such transactions through a broker or dealer on a fully disclosed network basis.
Other Savings Bond issuing and paying agents and forwarders are also exempt if they have no other government securities business. Corporate credit unions doing repurchase transactions with other credit unions are also exempt. Proposed regulations to be published shortly by the SEC are expected to limit the number of entities regulated by the Commodity Futures Trading Commission who will be subject to these regulations.
It is difficult to predict the number of entities that will register as government securities brokers or dealers (in contrast to full-line broker-dealers) and, therefore, be subject to all the requirements in these regulations. Further exemptions, classifications and modifications of rules may be provided to applicants who demonstrate full application of the rules is not necessary in the public interest and for the protection of investors.
Currently unregulated government securities brokers and dealers who register under Section 15C of the Securities Exchange Act would be required to have liquid capital in excess of 120% of measured market risk. The system for measuring market risk involves a series of risk assessment factors (called "haircuts") based on current market conditions that take into account both the risks of fixed-rate financing and risk-reduction available through hedging. This standard is similar to the voluntary capital adequacy guidelines published by the Federal Reserve Bank of New York. It builds upon but is different than the SEC's Rule 15c3-l in both the ratio requirement and the risk assessment factors.
SEC-registered broker-dealers and financial institution government securities brokers and dealers would be required only to follow the capital standards to which they are already subject.
Possession or Control of Customer Securities
Generally, the proposal follows the SEC requirements for custody and safekeeping of customer funds and balances. The proposed regulations also contain rules dealing specifically with securities that are the subject of repurchase transactions.
Under the proposed regulations, all master repurchase agreements with customers will have to be in writing, with specific transactions (including substitutions) confirmed in writing. In addition, a dealer must maintain possession or control of securities subject to hold-in-custody repurchase agreements both over night and during the trading day unless (i) the total amount of outstanding repurchase transactions with a customer is $5,000,000 or more and (ii) the customer has specifically consented to such use. These requirements applicable to securities subject to hold-in-custody repurchase agreements are designed to provide greater assurance for the smaller institutional or fiduciary investors, such as local governments, that their interest in such securities are dealt with appropriately, while maintaining flexibility for the larger investors that are more accustomed to assessing the risks and benefits of such transactions.
Recordkeeping and Reporting
Newly registered government securities brokers and dealers will be required to follow SEC recordkeeping and audit rules, with minor modifications related to repurchase transactions. The reporting forms are the SEC's FOCUS reports modified to reflect the different capital requirements. Only the repurchase transaction modifications, which are identical to those proposed by the SEC in September 1986, would apply to SEC-registered broker-dealers.
For the most part, financial institution brokers and dealers would not be required to keep records other than those now required by the financial institution supervisory agencies. However, position records would be required (as is now the case for bank municipal securities dealers), as would annual counts of securities held for customers within the bank's broker or dealer function.
Custody of Government Securities by Depository Institutions
Subchapter B of the proposed regulations implements Title II of the GSA by proposing regulations to safeguard customer securities held by a depository institution other than in a fiduciary capacity or in a trust department.
The regulations would require that such securities be kept in an account separate from the depository institution's proprietary accounts, free from lien, that records be kept for each customer, and that the securities be periodically counted and the counts reconciled to bank records.
1/ A "financial institution" is defined as a bank, a foreign bank or a federally insured savings and loan association.
2/ The Treasury's rulemaking authority expires on October 1, 1991. In 1990, the Treasury, the SEC and the Federal Reserve Board will report to the Congress on extension of the Treasury's authority.
3/The Federal Reserve Bank of New York, Capital Adequacy Guideline for U. S. Government Securities Dealers (May 20, 1985).
4/The acts and events constituting a statutory disqualification are enumerated in Sections 3(a)(39) and 15(bX4) of the Exchange Act. Included among the class of disqualified persons are individuals subject to SEC and self-regulatory organization bars, persons convicted of certain enumerated crimes and persons subject to securities-related orders of injunction. This listing is not complete and members and their counsel should refer to the cited sections of the Exchange Act for more detail.
1/ The SEC is responsible for interpreting the terms "government securities broker" and "government securities dealer," and for registering currently unregulated government securities brokers or dealers. SEC-registered broker-dealers and financial institution government securities brokers and dealers will be required to notify their regulators of their status as government securities brokers or dealers on or before July 25, 1987. The SEC and Federal Reserve will publish proposals on Wednesday, February 25, concerning registration and notice.