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91-41 Department of Treasury Proposes Significant Amendments to the Regulations Issued on July 24, 1987 Under the Government Securities Act of 1986; Last Date for Comments: June 17, 1991

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EXECUTIVE SUMMARY

On April 17, 1991, the Department of Treasury issued 56 FR 15529-15532 containing proposed amendments to 17 CFR Part 403 ("Protection of Customer Securities and Balances"). The proposal would implement a buy-in requirement for mortgage-backed securities that are in fail status for more than 60 calendar days and all government securities that are needed to complete a sell order of a customer (other than a short sale) if the securities have not been received from the customer within 10 business days after the settlement date. The change would apply to all firms that are required to be registered or provide notice of their status as government securities brokers or dealers pursuant to Section 15C(a)(1) of the Securities Exchange Act of 1934. The Treasury Department's comment period expires June 17, 1991. The text of 56 FR 15529-15532 follows this notice.

SUMMARY OF PROPOSED CHANGES

I. PROTECTION OF CUSTOMER SECURITIES AND BALANCES
A. Buy-ins for Fails to Receive

Presently under 17 CFR 403.4(g), all government securities except for mortgage-backed securities are subject to the buy-in requirements of paragraph (d)(2) of SEC Rule 15c3-3. The Treasury Department proposes to amend the rule by adding a paragraph that requires all registered brokers or dealers to take prompt steps to buy in or otherwise obtain mortgage-backed securities that are in a fail-to-receive status longer than 60 calendar days.
B. Buy-ins for Customer Sell Orders

Presently, paragraph (m) of SEC Rule 15c3-3 does not apply to transactions in government securities. The Treasury Department proposes to add paragraph 403.4(1) that will adopt, with certain modifications, paragraph (m) of SEC Rule 15c3-3 for government securities. This would require any registered broker or dealer that executes a customer sell order (other than a short sale) and that has not obtained the securities from the customer within 10 business days after the settlement date to close out the transaction with the customer by purchasing securities of like kind and quantity.

NASD members that wish to comment on the proposed rule change should do so by June 17, 1991. Comment letters should be sent to:

Government Securities Regulations Staff
Public Debt, Department of the Treasury
999 E Street, NW, Room 209
Washington, DC 20239-0001.

All comment letters received will be made available for public inspection and copying at the Treasury Department Library, Room 5030, Main Treasury Building, 1500 Pennsylvania Avenue, NW, Washington, DC 20220.

Members are requested to send copies of their comment letters to:

Stephen D. Hickman
Corporate Secretary
National Association of
Securities Dealers, Inc.
1735 K Street, NW
Washington, DC 20006-1506.

Questions concerning this notice may be directed to Walter Robertson, NASD Associate Director, Financial Responsibility, at (202) 728-8236 or Samuel Luque, Associate Director, Financial Responsibility at (202) 728-8472.

Federal Register / Vol. 58, No. 74 / Wednesday, April 17, 1991 / Proposed Rules

DEPARTMENT OF THE TREASURY

Office of the Assistant Secretary (Domestic Finance)

17 CFR Part 403

Implementing Regulations for the Government Securities Act of 1338

AGENCY: Office of the Assistant Secretary (Domestic Finance), Treasury.

ACTION: Proposed rule.

SUMMARY: The Department of the Treasury ("Department") is issuing for comment proposed amendments to the regulations issued on July 24, 1987 (52 FR 27910) under the Government Securities Act of 1986 (the "Government Securities Act" or "GSA") (Pub. L 99-571,17 CFR Ch. IV). The proposed amendments would implement a buy-in requirement for (1) Mortgage-backed securities that are in a fail to receive status for more than 60 calendar days, and (2) all government securities that are needed to complete a sell order of a customer (other than a short sale) if the securities have not been received from the customer within ten business days after the settlement date. These proposed requirements would apply to all entities that are required to register or provide notice of their status as government securities brokers or dealers pursuant to section 15C(a)(1) of the Securities Exchange Act of 1934 ("Exchange Act").

DATES: Comments must be submitted on or before June 17, 1991.

ADDRESSES: Comments should be sent to: Government Securities Regulations Staff, Public Debt, Department of the Treasury, Room 209,999 E Street, NW., Washington, DC 20239-0001. Comments received will be available for public inspection and copying at the Treasury Department Library, room 5030, Main Treasury Building, 1500 Pennsylvania Avenue, NW., Washington, DC 20220.

FOR FURTHER INFORMATION CONTACT: Ken Papaj (Director) or Clifford Rones (Attorney-Advisor), Public Debt, room 209,999 E Street NW., Washington, DC 20239-0001, (202) 376-4632.

SUPPLEMENTARY INFORMATION:

I. Background

Sections 403.1 and 403.4 (17 CFR 403.1 end 403.4) of the final GSA regulations incorporate the buy-in provision contained in Securities and Exchange Commission (SEC) Rule 15c3-3(d)(2) (17 CFR 240.15c3-3(d)(2)) for transactions in government securities conducted by registered brokers or dealers and registered government securities brokers or dealers. Financial institutions that filed notice as government securities brokers or dealers are subject to a similar buy-in rule set out at § 403.5(c)(1)(iii) of the GSA regulations. These rules require a government securities broker or dealer to take prompt steps to obtain possession or control of customers' fully paid and excess margin government securities that have been in a fail to receive status for more than 30 calendar days through a buy-in or other procedure. Mortgage-backed securities, however, are not subject to these buy-in requirements.

The buy-in provisions for fails to receive of mortgage-backed securities, which had been included in the temporary GSA regulations (52 FR 19642, 19703-18705), were suspended in the final regulations. This suspension was in response to a number of industry comments which expressed concerns over the difficulties and problems of buying-in mortgage-backed securities, particularly where the customer specified delivery of a particular pool number with unique characteristics. In addition, the SEC had already suspended enforcement of the buy-in requirement as it applied to mortgage-backed securities. For these reasons, the Department suspended the buy-in provision for mortgage-backed securities pending further examination and investigation of this market The Department and staff of the SEC have worked together to gain a better understanding of the complexities and unique features of the mortgage-backed securities market that contribute to the scarcity of securities and to the larger number of deliveries not accomplished en the scheduled settlement date as compared to transactions in other government securities. Treasury and the SEC have been assisted in their efforts to develop e workable buy-in rule for mortgage-backed securities by an industry task force, organized by the Public Securities Association (PSA).1 For the reasons more fully explained below, the Department supports a 60-day buy-in rule for mortgage-backed securities.

In addition, the Department is reproposing that paragraph (m) of SEC Rule 15C3-3 (17 CFR 240.15c3-3(m)), which requires the buying-in of securities that have not been received after tea days and that are needed to complete a customer sell order (other than a short sale), be incorporated by cross reference and be made applicable to government securities transactions conducted by registered brokers and dealers and registered government securities brokers and dealers.2 A similar provision that would apply to financial institutions that have filed notice as government securities brokers or dealers is also being proposed at § 403.5(g).
II. Analysis
A. Buy-ins for Fails to Receive

Currently, 17 CFR 403.4(g), which applies to both registered brokers or dealers end registered government securities brokers or dealers, states that the buy-in requirement of paragraph 240.15c3-3fd)(2) is suspended with respect to mortgage-backed securities. The Department proposes to modify § 4Q3.4(g) such that the requirements of paragraph 240.14c3-3(d)(2) to take prompt steps to obtain possession or control of failed to receive securities through a buy-in procedure or otherwise would apply to mortgage-backed securities in a fail to receive status for more than 60 calendar days. Similarly, paragraph 403.5(c)(1)(iii), which applies to financial institutions that have filed notice as government securities brokers or dealers, would be modified to prescribe a similar buy-in requirement for these entities.

The Department proposes a longer buy-in period of 60 calendar days for fails to receive for mortgage-backed securities (as compared to the 30 calendar day time frame applicable to other government securities that is currently in place). This difference can, for the most part, be attributed to the length of the settlement cycle associated with mortgage-backed securities, which, in many instances, may be as long as 30 days. In addition, as previously stated, the buying-in of mortgage-backed securities can be difficult to the complexities of the instruments, the particularities of the settlement process, and the scarcity in the market of specified pools, especially when a customer requests delivery of a particular pool with unique characteristics. These factors indicate that a time frame greater than 30 days may be required to successfully settle or otherwise acquire a specified mortgage-backed securities trade. Therefore, a time frame of 60 calendar days reasonably addresses the concerns of customer protection while, at the same time, taking into consideration the ability of brokers or dealers to acquire the securities.

Historically, mortgage-backed securities have had a high fail rate because of the reasons cited above, particularly the variances in the settlement time frames. As a result, several years ago, an attempt was made by market participants to standardize the settlement process for mortgage-backed securities. Specific monthly settlement dates were assigned to each particular class or pool of mortgage-backed securities. This settlement date system has proved to be successful in alleviating the workload during the heaviest settlement periods. Although a settlement date other than a scheduled settlement date can be requested, the buyer pays a premium for this exception. Thus, in order to avoid the additional expenses associated with abnormal settlements, any buy-in accomplished pursuant to the proposed rules would be permitted to settle on the next regularly scheduled settlement date for that particular class or pool of mortgage-backed securities.

The Department is also aware that a larger number of fails have been due to the loss of physical securities and problems associated with the clearance and settlement of mortgage-backed securities that have not yet been converted to book-entry form and maintained by the Participant Trust Company (FTC) system, which serves as a book-entry depository for Government National Mortgage Association (GNMA) securities. Although the number of fails of mortgage-backed securities is expected to decrease as more GNMA securities are converted to book-entry form and maintained by FTC, the scarcity of specific pools, together with the complexity of mortgage-backed securities and their extended settlement cycle, will continue to be problematic. Thus, a 60-day buy-in time frame for mortgage-backed securities appears to be reasonable and appropriate as part of an overall framework to ensure that customer security positions are protected. The 60-day time frame will provide adequate time for most fails to receive to be corrected through existing procedures.

It is the Department's understanding that the PSA will develop buy-in procedures for mortgage-backed securities similar to those already in place for other government securities. We also understand that the SEC staff does not object to the 60-day buy-in time frame for mortgage-backed securities and that it intends, at some future time, to recommend to the Commission a proposal to revise Rule 15c3-3(d)(2) in a manner consistent with the Department's proposed change to paragraph 403.4(g).
B. Buy-ins for Customer Sell Orders

The Department is reproposing a buy-in requirement for customer sell orders that was included in the temporary regulations but was suspended in the final regulations. In the temporary regulations (52 FR19642, 19704], the Department adopted, with certain modifications, paragraph (m) of SEC Rule 15c3-3 (17 CFR 24G.15c3-3(m)) for government securities. This rule had been suspended by the SEC in 1973 with respect to exempted securities, including government securities.3 Paragraph (m), which was applicable to registered brokers and dealers and registered government securities brokers and dealers, states that if a broker or dealer executes a customer sell order (other than a short sale) and the broker or dealer has not obtained the securities from the customer within ten business days after the settlement date, then the broker or dealer shall close out the transaction with the customer by purchasing securities of like kind and quantity. The temporary GSA regulations (paragraphs 403.1 and 403.4(i]) modified paragraph (m) of SEC Rule 15c3-3 by defining the term "short sale" and by extending the time frame to 30 calendar days for mortgage-backed securities. However, in response to commenters' objections to the operational burdens of this provision, the incorporation of paragraph (m) was excluded from the final regulations (52 FR 27910, 27921-22), which had the effect of suspending the applicability of this paragraph to transactions in government securities conducted by government securities brokers and dealers. The Department also noted that it would, in consultation with the SEC, continue to study this issue to determine if eventual application of a buy-in rule for customer sell orders in government securities would be desirable.

In light of the resolution of issues in the mortgage-backed securities market that now enables the Department to propose a buy-in rule for fails to receive on mortgage-based securities, and given the fact that a buy-in rule for all other government securities has been in operation for approximately three years without any significant problems, the Department believes that the operational burdens associated with a buy-in rule for customer sell orders have been significantly diminished. Accordingly, the Department proposes to add paragraph 403.4(1) to the GSA regulations, which incorporates by reference, paragraph (m) of SEC Rule 15c3-3, with one modification. The modification defines "short sale" for the purposes of the rule to mean that the customer has informed the broker or dealer that the sale is a short sale.

A companion, buy-in rule for financial institutions that have filed notice as government securities brokers or dealers is also being proposed by adding this provision as new paragraph 403,5(g). Existing paragraph 403.5(g) would be redesignated as paragraph 403.5(h), and it would be revised to give the appropriate regulatory agencies for financial institutions the authority to grant extensions of the 10-day buy-in requirement for customer sell orders. This additional authority is being provided to the bank regulatory agencies because paragraph (n) of SEC Rule 15c3-3 (17 CFR 24G.15c3-3(n)) gives a registered national securities exchange or a registered national securities association the authority to grant extensions of time for the close-out of a customer sell order in exceptional circumstances.

The main purpose of the buy-in requirements for customer sell orders is to encourage brokers and dealers to close-out transactions after a stated period of time. These provisions are also intended to prevent customers from attempting to take advantage of changes in the market value of securities by refusing to deliver a security to a broker or dealer when the price goes up after a sell order has been executed. The buy-in rules for customer sell orders will also enhance customer protection since a customer's failure to deliver a security to the executing broker or dealer could result in that broker's or dealer's failure to deliver to its counterparty.

The Department is proposing a 10-day close-out time frame for all government securities. The roles provide an exemption for short sales, which are the primary cause of non-delivery. Since the government securities market is primarily a dealer market, and one in which short sales are common practice, the exemption of short sales from these requirements should make the rules inapplicable to the majority of sell orders. In addition, if more than ten days are needed, the appropriate regulatory agencies have the authority to extend the buy-in time period, if so requested by the broker or dealer. The Department specifically invites comments regarding the appropriateness of the 10-day time frame.

It is the Department's understanding that the SEC staff intends to recommend to the Commission's a proposal to reinstate paragraph I$c3-3(m) in a manner that conforms with the Department's proposed rule in paragraph 403.4(1).
III. Special Analysis

The proposed rules would require government securities brokers or dealers that registered or filed notice pursuant to section 15C(a)[l) of the Exchange Act to take prompt steps to buy-in or otherwise obtain mortgage-backed securities that are in a fail to receive status longer than 60 calendar days. The proposed rules supplement the 30-day buy-in requirement for other government securities by terminating the suspension of buy-in requirements for mortgage-backed securities. The Department had previously incorporated buy-in requirements for mortgage-backed securities in the proposed and temporary regulations. However, they were suspended in the final regulations in response to commenter concerns, including a suggestion that an industry task force, organized by the PSA. study the issues involved and develop a recommended buy-in rule and related procedures. In was understood, that upon completion of this evaluation, a buy-in rule for mortgage-backed securities would be forthcoming.

These amendments proposing a 60-day buy-in rule for mortgage-backed securities are responsive to the concerns expressed by the industry commenters and reflect the additional complexities of the mortgage-backed securities market. As such, the proposed rules would establish buy-in requirements for mortgage-backed securities. Similar rules are already in place for all other government securities. Regarding the buy-in rule for customer sell orders, the exemption for short sales provided in the rules should exclude most fails from being subject to this provision. Thus, the two proposed buy-in rules do not impose any substantial additional regulatory requirements.

It is the Department's view that the proposed buy-in regulations will not impose any major increase in costs on those affected or significantly affect the economy in general. The buy-in rules are intended to strengthen customer protection and to ensure that transactions which have been contracted to occur, actually do occur. Since the proposed regulations reinstate a suspended buy-in requirements for mortgage-backed securities, and a suspended buy-in rule for customer sell orders, the Department has also concluded that they will not have an unnecessary or inappropriately differential impact on classes of entities affected by .them such as to create a burden on competition. The rules are intended to impact equally upon all participants in the government securities market. Based on the foregoing, the Department has concluded that the proposed regulations do not constitute a major rule for the purposes of Executive Order 12291 and that a regulatory impact analysis is not required.

In addition, pursuant to the Regulatory Flexibility Act (5 U.S.C. 601, et. seq.), it is hereby certified that the proposed regulations, if adopted, will not have a significant economic impact on a substantial number of small entities and, as a result, a regulatory flexibility analysis is not required.

The Paperwork Reduction Act (44 U.S.C. 3504(h)) requires that collections of information prescribed in proposed rules be submitted to the Office of Management and Budget for review and approval. Since these proposed rules contain no new collections of information, the submission described in the Paperwork Reduction Act is inapplicable.

List of Subjects in 17 CFR Part 403

Banks, banking, Brokers, Government securities.

For the reasons set out in the Preamble, it is proposed that 17 CFR part 403 be amended to read as follows:

PART 403—PROTECTION OF CUSTOMER SECURITIES AND BALANCES

1. The authority citation for Part 403 continues to read as follows:

Authority: Sec. 101, Pub. L. 99-571,100 Stat. 3209 (15 U.S.C. 78o-5(b)(1)(A), (b)(2)).
2. Section 403.1 is revised to read as follows:

§ 403.1 Application of part to registered brokers and dealers.

With respect to their activities in government securities, compliance by registered brokers or dealers with § 240.8c-1 of this title (SEC Rule 8c-1), as modified by § 403.2(a), (b) and (c), with § 240.15c2-1 of this title (SEC Rule 15c2-1), with § 240.15C3-2 of this title (SEC Rule 15c3-2), as modified by § 403.3, and with § 240.15c3-3 of this title (SEC Rule 15c3-3], as modified by § 403.4(a)-(d), (e)(2)-(3), (f)-(1), and (1), constitutes compliance with this part.
3. Section 403.4 is amended by revising paragraph (g) and by adding paragraph (1) to read as follows:

§ 403.4 Customer protection—reserves and custody of securities. * * * * *
(g) For the purposes of this section, § 240.15c3(d)(2) of this title is modified to read as follows:
"(2) Securities included on his books or records as failed to receive more than 30 calendar days, or in the case of mortgage-backed securities, more than 60 calendar days, then the broker or dealer shall, not later than the business day following the day on which such determination is made, take prompt steps to obtain possession or control of securities so failed to receive through a buy-in procedure or otherwise; or"

* * * * *
(1) For purposes of this section, § 240.15c3-3(m] of this title shall apply to government securities, notwithstanding the May 9, 1973, order of the Commission (38 FR 12103) suspending such applicability, except that "an order to execute a sale of securities which the seller does not own" shall mean that the customer placing the sell order has identified the sale as a short sale to the broker or dealer.
* * * * *
4. Section 403.5 is amended by revising paragraph (c)(1)(iii); by redesignating paragraph (g) as paragraph (h) and revising newly redesignated paragraph (h); and by adding new paragraph (g) to read as follows:

§ 403.5 Custody of securities held by financial institutions that are government securities brokers or dealers.

* * * * *
(c)(1) * * *
(iii) Take prompt steps to obtain possession or control of securities failed to receive for more than 30 days, or in the case of mortgage-backed securities, for more than 60 days; or
* * * * *
(g) If a financial institution executes a sell order of a customer (other than an order to execute a sale of securities which the seller does not own, which for the purposes of this paragraph shall mean that the customer placing the sell order has identified the sale as a short sale to the financial institution) and if for any reason whatever the financial institution has not obtained possession of the securities from the customer within ten business days after the settlement date, the financial institution shall immediately thereafter close the transaction with the customer by purchasing securities of like kind and quantity.
(h) The appropriate regulatory agency of a financial institution that is a government securities broker or dealer may extend the period specified in paragraphs (c)(1)(iii) and (g) of this section on application of the financial institution for one or more limited periods commensurate with the circumstances, provided the appropriate regulatory agency is satisfied that the financial institution is acting in good faith in making the application and that exceptional circumstances warrant such action. Each appropriate regulatory agency should make and preserve for a period of not less than three years a record of each extension granted pursuant to this paragraph, which contains a summary of the justification for the granting of the extension.

Dated: April 5th, 1991.

Jerome H. Powell,

Assistant Secretary for Domestic Finance.

[FR Doc. 91-8925 Filed 4-16-91; 8:45 am]

BILLING CODE 4813-40-M


1 The task force, having completed its examination of the mortgage-backed securities market, recommends that government securities brokers or dealers initiate buy-in procedures for customers' fully paid or excess margin mortgage-backed securities that are failed to receive for more than 60 calendar days.

2 The temporary regulations incorporated, with some revisions, SEC Rule 15c3-3(m). Sec 52 FR 19642,18704 (temporary § 403.4(i)).

3 38 FR 12103 (May 9, 1873).


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