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93-17 SEC Approves Changes To Uniform Practice Code Establishing Close-Out Procedures for Fails

SUGGESTED ROUTING

Senior Management
Operations

Executive Summary

On January 14, 1993, the Securities and Exchange Commission (SEC) approved amendments to Sections 59 and 65 of the NASD's Uniform Practice Code (UPC) establishing close-out procedures for instruments based on the performance of an index, currency, or other measure and establishing close-out and fail procedures to be used in customer account transfers. The text of these amendments, (along with sample forms), which take effect March 1, 1993, follow this Notice.

Background

The amendment to Section 59 of the UPC establishes fail-to-deliver and liability-notice procedures for foreign currency and index warrants and other similar instruments.1 These instruments may be exercised at any time and do not provide for a guaranteed post-expiration period for the buyer to deliver the physical certificates. Moreover, because the decision to exercise these instruments is based on the performance of a currency, index, or other standard, the buyer's exercise instruction to the agent may occur at any time and cannot be delayed. Because the buyer of foreign currency and index warrants has no protection under current UPC liability rules, the NASD has amended Section 59 to initiate a liability-notice procedure for these types of instruments. The amendment permits immediate origination and retransmission of liability notices, requires that the liability notice be written or transmitted through an electronic device having immediate receipt capabilities, requires mutual consent before cancellation of a liability notice, and cautions members to retain documentation relating to exercise requests. Sample forms relating to liability notification will be included in the NASD Manual following Section 59 and are included in this Notice following the new rule language.

Section 65 of the UPC establishes procedures for timely processing of customer account transfers. Section 65(c) currently makes account transfers dependent on the disposition of "non-transferable assets," which are separately defined. The amendment to Subsection 65(c) adds new categories of non-transferrable assets such as foreign securities, baby bonds, and certain limited partnerships. Further, the amendments clarify the members' responsibility to resolve and reverse transfers of improperly identified assets and requires members to update their records and notify customers of such action.

Subsections 65(d) through (f) have also been amended to clarify their application. Subsection 65(d)(1), which requires members to freeze accounts and cancel open orders upon validation of transfer instructions, has been amended to exempt options positions that expire within seven days. Subsection 65(d)(3), which permits a member receiving a transfer instruction to take exception under certain circumstances, has been expanded to include: the lack of transferrable assets in the account; an incorrect account number; and duplicative requests. If the transfer request is rejected because the account reflects no transferrable assets, the requesting or receiving member may not retransmit the request without attaching a copy of the customer's most recent account statement.

Subsection 65(e), which relates to the completion of a transfer, has been amended to delete the reference to options positions. This amendment recognizes that options positions are not deliverable instruments and, therefore, buy-in, closeout, and fail-to-deliver procedures do not apply to such positions. Rather, as a result of the direct interface between the National Securities Clearing Corporation (NSCC) and the Options Clearing Corporation (OCC), open options positions in a customer account subject to a transfer instruction are transmitted through NSCC to OCC for settlement. Thus, the reference in Subsection 65(e) to options is unnecessary.

Subsection 65(f), which relates to the establishment of fails resulting from account transfers, has been amended to require members to promptly resolve such fails in accordance with all applicable close-out and liability procedures. The subsection has also been amended to provide that the requirement to clearly identify such fails does not apply to a fail that is entered into a repricing and reconfirmation service and that emerges from such service without settling. Any fail that emerges from such a service without settling will continue to be a fail subject to all applicable rules.

Subsection 65(g), which relates to the resolution of discrepancies in transferred accounts, has been expanded to require the prompt transfer or distribution of assets that accrue (i.e., dividends, bond interest) to the customer's account after the initial transfer has been completed.

Subsections 65(h) and (i) have been added to establish close-out and sell-out procedures for fails in instruments that do not currently have such procedures (i.e., zero-coupon bonds, mutual funds, limited partnerships). The amendments provide a means of closing-out or selling-out fails in certain instruments that previously had remained outstanding for extended periods of time. Such unresolved fails have, on occasion, prevented accounts from transferring completely.

New Subsection 65(h), which relates to close-out procedures for fails that the carrying member has not settled, adds procedures to permit the receiving member to close the fail not sooner than the third business day following the delivery due date pursuant to required written notification. This new subsection also permits redelivery of a notice, in the form of a retransmission, against any existing fail, regardless of its origin, to facilitate the completion of the transfer and greatly reduce the member's general fail file. These procedures are based on the buy-in rules set forth in Section 59.

New Subsection 65(i), which relates to sell-out procedures for certain fails that result from account transfers, adds notification and sell-out procedures to permit the carrying member to sell any and all securities due or deliverable in the best available market, where the receiving member failed to accept delivery or where a properly executed Uniform Reclamation Form, a depository generated rejection advice, or a valid Reversal Form is lacking.

Sample forms relating to close-outs and account transfers will be included in the NASD Manual following Section 65 and are included in this Notice following the new rule language.

Questions concerning this Notice may be directed to Dottie Kennedy, NASD Operations Department at (212) 858-4340, or to Elliott R. Curzon, Senior Attorney, Office of General Counsel at (202) 728-8451.


1 Such warrants are also known as American style warrants, in contrast to European style warrants that can only be exercised during a specified period before the warrant expires.


Amendments to Sections 59 and 65 of the Uniform Practice Code

(Note: New text is underlined; deleted text is in brackets.)

Close-Out Procedure "Buying-in"

Sec. 59

* * * * *

Failure to Deliver and Liability Notice Procedures

(i)
(1)
(A) Text unchanged.
(B) If the contract is for a deliverable instrument with an exercise provision and the exercise may be accomplished on a daily basis, and the settlement date of the contract to purchase the instrument is on or before the requested exercise date, the receiving member may deliver a Liability Notice to the delivering member no later than 11:00 A.M. on the day the exercise is to be effected. Notice may be redelivered immediately to another member but no later than noon on the same day. Such notice must be issued using written or comparable electronic media having immediate receipt capabilities. If the contract remains undelivered at expiration, and has not been cancelled by mutual consent, the receiving member shall notify the defaulting member of the exact amount of the liability on the next business day.
(C) In all cases, members must be prepared to document requests for which a Liability Notice is initiated.

* * * * *

Customer Account Transfer Contracts

Sec. 65

* * * * *

Transfer instructions

(c)
(1)

* * * * *
(C) With respect to transfers of securities accounts other than retirement plan securities accounts, the customer affirms that he or she has destroyed or returned to the carrying member any credit/debit cards and/or unused checks issued in connection with the account.

For purposes of this rule, a "non-transferrable asset" shall mean an asset that is incapable of being transferred from the carrying member to the receiving member because it is:
(i) - (iv) Text unchanged.
(v) an asset that is an issue for which the proper denominations cannot be obtained pursuant to governmental regulation or the issuance terms of the product (e.g., foreign securities, baby bonds, etc.)
(vi) limited partnership interests in retail accounts.
(D) The carrying member and the receiving member must promptly resolve and reverse any non-transferrable assets which were not properly identified during validation. In all cases, each member shall promptly update their records and bookkeeping systems and notify the customer of the action taken.

* * * * *

Validation of transfer instructions

(d)
(1) Upon [receipt] validation of a transfer instruction, a carrying member must "freeze" the account to be transferred, i.e., all open orders, with the exception of option positions which expire within seven (7) business days, must be cancelled and no new orders may be taken.
(2) A carrying member may not take exception to a transfer instruction, and therefore deny validation of the transfer instruction, because of a dispute over securities positions or the money balance in the account to be transferred. Such alleged discrepancies notwithstanding, the carrying member must transfer the securities positions and/or money balance reflected on its books for the account.
(3) A carrying member may take exception to a transfer instruction only if:
(A) it has no record of the account on its books;
(B) the transfer instruction is incomplete; [or]
(C) the transfer instruction contains an improper signature[.];
(D) the account is "flat" and reflects no transferrable assets;
(E) the account number is incorrect; or
(F) it is a duplicate request.
If a carrying member takes exception to a transfer instruction because the account is "flat," as provided in (D), the receiving member may re-submit the transfer instruction only if the most recent customer statement is attached.

* * * * *

Completion of the transfer

(e) Within five (5) business days following the validation for a transfer instruction, the carrying member must complete the transfer of the account(s) to the receiving member. The receiving member and the carrying member must immediately establish fail-to-receive and fail-to-deliver contracts at then-cur-rent market values upon their respective books of account against the long/short positions [(including options)] in the customer's account(s) that have not been physically delivered/received and the receiving/carrying member must debit/credit the related money amount. The customer's account(s) shall thereupon be deemed transferred.

Fail contracts established

(f)
(1) Any fail contracts resulting from this account transfer procedure [must be closed out promptly.] shall be included in a member's fail file and shall be promptly resolved according to applicable close-out and liability procedures.
(2) A carrying member may not reject ("DK") a fail contract, including a Receive/Deliver Instruction [balance order] generated by an automated customer account transfer system, in connection with assets in an account transferred that have not been delivered to the receiving member.
(3) All fail contracts established pursuant to the requirements of this rule should be clearly marked or captioned as such. This subsection will not apply if a fail contract participates in a repricing and reconfirmation service offered by a registered clearing agency.

* * * * *

Prompt resolution of discrepancies

(g)
(1) Text unchanged.
(2) The carrying member must promptly distribute to the receiving member any transferrable assets which accrue to the account after the transfer of a customer's securities account.

Close-out procedures

(h) A valued fail contract in a security, for which there are no established close-out procedures, and which has not been completed by the carrying member, may be closed by the receiving member no sooner than the third business day following the date delivery was due, in accordance with the following procedure:
(1) Written notice shall be delivered to the carrying member at his office not later than 12 noon, his time, two business days preceding the execution of the proposed "close-out".
(2)
(A) Every notice of "close-out" shall state the settlement date, the quantity and contract price of the securities covered by said contract, and shall state further that unless delivery is effected at or before a certain specified time, which may not be prior to 3:00 P.M. local time in the community where the carrying member maintains his office, the security may be "closed-out" on the date specified for the account of the carrying member.
(B) Original notices may only be issued pursuant to fail contracts marked or captioned as fails established pursuant to subsection (f)(3) of this rule.
(C) Notice may be redelivered immediately to another member from whom the securities involved are due in the form of a re-transmitted notice. A re-transmitted notice must be delivered to subsequent members not later than 12 noon one business day preceding the original date of execution of the proposed close-out.
(D) Re-transmitted notices may be issued against any fail contract regardless of its origin.
(3)
(A) On failure of the carrying member to effect delivery in accordance with the notice, or to obtain a stay as hereinafter provided, the receiving member may close the contract by purchasing the securities necessary to complete the contract. Such execution will also operate to close-out all contracts covered under re-transmitted notices.
(B) The party executing the "close-out" shall immediately upon execution, but no later than the close of business, local time, where the seller maintains his office, notify the member for whose account the securities were bought as to the quantity purchased and the price paid. Such notification should be in written or electronic form having immediate receipt capabilities. If a medium with immediate receipt capabilities is not available, the telephone shall be used for the purpose of same day notification, and written or similar electronic notification having next day receipt capabilities must be sent out simultaneously. In either case formal confirmation of purchase along with a billing or payment (depending upon which is applicable) should be forwarded as promptly as possible after the execution of the "close-out". Notification of the execution of the "close-out" shall be given to succeeding members to whom a re-transmitted notice was issued using the same procedures stated herein.
(C) If prior to the closing of a contract on which a "close-out" notice has been given, the receiving member receives from the carrying member written notice stating that the securities are 1) in transfer; 2) in transit; 3) being shipped that day; or 4) due from a depository and include the certificate numbers, then the receiving member must extend the execution date of the "close-out" for a period of seven (7) calendar days from the date delivery was due under the "closeout", except for those securities due from a depository.
(4) In the event that a "close-out" is not completed on the day specified in the notice, said notice shall expire at the close of business on the day specified in the notice, or if extended, at the close of business on the last day of the extension.

Sell-out procedures

(i)
(1) Upon failure of the receiving member to accept delivery in accordance with the terms of the contract, and lacking a 1) properly executed Uniform Reclamation Form; 2) depository generated rejection advice; or 3) valid Reversal Form, the carrying member may, without notice, "sell-out" in the best available market, for the liability of the party in default, all or any part of the securities due or deliverable under the contact.
(2) The party executing a "sell-out" as prescribed above shall notify, no later than the close of business (local time where the receiving member maintains his office) on the day of execution, the member, for whose account and liability such securities were sold, of the quantity sold and the price received. Such notification should be in written or electronic form having immediate receipt capabilities. A formal confirmation of such sale should be forwarded as promptly as possible after the execution of the "sell-out".
(h) - (l) redesignated as (j) - (n).

SAMPLE FORMS

SAMPLE LIABILITY NOTICE

PDF TO BE INCLUDED

SAMPLE RE-TRANSMITTED LIABILITY NOTICE

PDF TO BE INCLUDED

SAMPLE NOTICE OF CLOSE-OUT

PDF TO BE INCLUDED

SAMPLE NOTICE OF RE-TRANSMITTED CLOSE-OUT

PDF TO BE INCLUDED PDF TO BE INCLUDED

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