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89-14 SEC Approves Amendments to Rule 17f-1, Lost and Stolen Securities Program

SUGGESTED ROUTING*

Government Securities
Legal & Compliance
Operations
Registration

*These are suggested departments only. Others may be appropriate for your firm.

EXECUTIVE SUMMARY

The Securities and Exchange Commission (SEC) has adopted amendments to Rule 17M, also known as the Lost and Stolen Securities Program. Among other things, the amendments: 1) expand the definition of reporting institution to include government securities broker-dealers; 2) amend the exemptions from registration to include a reporting institution that limits its activities exclusively to uncertificated securities or whose business activities do not involve the handling of certificates; 3) identify the Federal Bureau of Investigation as the "appropriate law enforcement agency" to receive reports in instances of suspected criminal activity; 4) define the terms "customer" and "securities-related transaction" for purposes of the customer inquiry exemption; and 5) revise the reporting and inquiry provisions to exempt uncertificated securities and to eliminate the exemption for registered-form government and agency securities. The amendments became effective December 27,1988.

BACKGROUND

SEC Rule 17f-l governs the Lost and Stolen Securities Program, which was established in 1977 as a means of tracking and deterring trafficking in missing, lost, stolen, or counterfeit securities. The rule requires certain financial institutions to register as participants in the program. These participants, which are referred to as reporting institutions, are required to file reports and make inquiries about missing, lost, stolen, or counterfeit securities. The SEC's designee to receive all such reports and inquiries is the Securities Information Center (SIC), located in Wellesley Hills, Massachusetts. SIC serves as the central facilities manager responsible for maintaining this data base.

EXPLANATION

The amendments, which originally were published for comment three years ago, are designed to codify long-standing interpretations of the rule, focus the rule on negotiable certificated securities and clarify common questions about the program. The changes that may be applicable to NASD members are discussed below.

Definition of Reporting Institution

The amendments expand the definition of the term "reporting institution" to specifically include government securities broker-dealers. This clarification, which is compatible with the requirements of Section 102 of the Government Securities Act of 1986, should eliminate any confusion about the applicability of Rule 17f-l to these firms, i.e., government securities broker-dealers are required to register with the SIC and must comply with the reporting and inquiry provisions of the rule.

Exemptions from Registration

One revision to the rule's registration exemptions provides for a more functional exemption that takes into account the increasing immobilization of securities. The revision replaces the previous exemption for broker-dealers that engage solely in the sale of variable contracts or limited partnership interests and that do not take or hold securities subject to the reporting or inquiry provisions of the rule.

Specifically, the amendments exempt any reporting institution that limits its securities activities exclusively to uncertificated securities, global securities issues, or any securities issue for which neither record nor beneficial owners can obtain a negotiable securities certificate. These terms are defined later in this Notice. Although the SEC expects that, at present, this exemption will apply infrequently because few institutions deal exclusively in uncertificated issues, the SEC anticipates that, as an increasing number of issues become available in book-entry-only form, a larger number of institutions will be able to take advantage of this exemption.

The amendments also add another exemption from registration. Any reporting institution whose business activities do not involve the handling of securities certificates is not required to register with the SIC. However, the SEC advises that the phrase "the handling of securities certificates" includes, among other things, any involvement in the sale, purchase, pledge, transfer, or safekeeping of securities. This is a rather limited exemption that is available to certain securities firms, such as mergers and acquisitions specialists, that because of the nature of their business would never have occasion to make inquiries or reports to the SIC. The exemption would not be available to firms that introduce business on a fully disclosed basis.

In connection with these amendments, the SEC issued a warning statement to any firm claiming an exemption from registration under these provisions. The SEC has advised that if a member accepts even one securities certificate for processing, even on an accommodation basis, it will be required to register with the SIC and otherwise participate in the program for at least six months.

Reporting Requirements

The amendments make several changes to the rule's reporting requirements. The first change concerns instances involving the discovery of a theft or loss of any securities certificates where there is a substantial basis for believing that criminal activity was involved. Previously, in these cases, reporting institutions were required to file their reports (Form X-17F-1A) with the "appropriate law enforcement agency," as well as with the SIC and the registered transfer agent. The term "appropriate law enforcement agency" has been deleted, and the amended rule now specifically requires that the reports involving suspected criminal activity be filed with the Federal Bureau of Investigation. The SEC cautions, however, that this change does not in any way affect members' obligations under other statutes, rules, or regulations. Furthermore, the SEC advises that, as a matter of good business practice, members should routinely continue to report all losses where potential criminal activity may be indicated to the police and all federal law-enforcement agencies with jurisdiction, as well as to their designated examining authority.

Secondly, the changes to the reporting requirements include a technical conforming amendment that clarifies how reports must be completed when a mail loss has occurred. Members now are specifically required to use the check-off box on Form X-17F-1A to indicate, when appropriate, that certificates were lost in the U.S. mails. This will enable the SIC to promptly notify the Postal Service of losses that are under its investigative jurisdiction.

The amendments also make a clarification concerning recovery reports. The obligation to report recoveries of securities previously reported missing, lost, or stolen is limited to the institution that originally reported the security as missing, lost, or stolen. Since, in the past, some reporting institutions interpreted this obligation differently, the rule has been amended to state this limitation clearly.

Inquiry Requirements

The only amendment to the inquiry requirements pertains to the customer exemption and only to the extent that the rule now includes a definition of "customer." The language of the customer exemption remains unchanged, but the terms "customer" and "securities-related transaction" are defined in the first section of the rule.

The term "customer" means any person with whom the reporting institution has entered into at least one prior securities-related transaction. The term "securities-related transaction" is defined as a purchase, sale, or pledge of investment securities, or a custodial arrangement for investment securities. According to the SEC, requiring some prior securities-related transaction should ensure that members have previously investigated the customer's identity and thus should inhibit instances of stolen or forged securities certificates. Members should be aware, however, that the SEC intends to construe this exemption strictly. For example, if a customer presents securities registered in his or her name, as well as someone else's (e.g., a spouse's), the exemption is available only if both owners are "customers" under the definition.

Securities Subject to Inquiry And Reporting Requirements

The amendments to the inquiry and reporting provisions of the rule eliminate the exemption for registered U.S. government and U.S. government agency securities. Registered-form government securities now are subject to these requirements, as are bearer-form government securities, which have been covered by the program since 1979.

Since the program in its current form has no applicability to functionally uncertificated issues, the amendments add these types of securities to the list of securities that are not subject to inquiry and reporting. Uncertificated securities, global securities issues, and any securities issues for which neither record nor beneficial owners can obtain a negotiable securities certificate, therefore, now are exempt from the reporting and inquiry provisions of the rule.

The amendments also have added to the rule definitions of the terms "uncertificated security" and "global certificate securities issue." The term "uncertificated security" means a security not represented by an instrument and the transfer of which is registered on books maintained for that purpose by or on behalf of the issuer. The term "global certificate securities issue" means a securities issue for which a single master certificate representing the entire issue is registered in the nominee name of a registered clearing agency and for which beneficial owners cannot receive negotiable securities certificates.

The revised text of Rule 17f-l, as well as additional background and commentary, is contained in SEC Release No. 34-26096, which was published in the Federal Register, September 26, 1988. Questions concerning this notice may be directed to Roberta Donohue, Development Specialist, NASD Surveillance Department, at (202) 728-8203.


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