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84-3 Temporary Relief from Certain Provisions of Rules 15e3-4 and 15c3-3 Dealing with Registered Municipal Securities is Extended until March 31, 1984, by SEC Staff

TO: All NASD Members and Other Interested Persons

On December 30, 1983, the staff of the SEC's Division of Market Regulation agreed to an extension of the temporary relief it previously granted under Rule 15e3-l (the "net capital" rule) and Rule 15c3-3 (the "customer protection" rule). This temporary relief, which was scheduled to expire on December 31, 1983, provides an extension of certain time periods specified in the rules before which capital deductions and/or other actions are required for transactions involving registered municipal securities. The determination to request an additional extension was based in part on the fact that since the requirement to issue bonds in registered form has only been in effect since July 1983, its full impact has not yet been realized. In requesting the extension, the Association agreed to continue to monitor the use of the temporary extensions and the impact of aged fails in the municipal marketplace. In light of this, the relief provided by the July no-action letter was extended by the Commission staff through March 31, 1984.

A brief discussion of the background concerning the Association's request, and the sections of the rules affected as a result thereof, follows. Also, a copy of the letter issued by the Division of Market Regulation is reprinted as part of this Notice. For additional information, members should refer to Notice to Members 83-41, dated July 25, 1983.

BACKGROUND

In July 1983, the Association's Capital and Margin Committee, and others, expressed concern that the issuance of municipal securities in registered form, as required by the provisions of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), would have a deleterious effect on the clearance and settlement of municipal securities transactions. As a result, the Association sought temporary relief for its members from certain increased capital and reserve requirements which would result from an increase in the number of fails related to registered municipal securities. This temporary interpretative relief was granted by the Commission staff effective through December 31, 1983.

The SEC staff, as a condition for granting relief in this area, required the designated examining authority to secure data from each broker-dealer who took advantage of the temporary extension. In this regard, the Association requested members to submit data with its regular FOCUS Part I Report for each month in which the member relied on any of the extensions provided for in the no-action letter. The data collected thus far indicates that the number of fail items and corresponding contract values have increased significantly since July. This seems to reflect an increase in the amount of fails in the marketplace although no firm conclusions can be drawn due to the limited number of municipal broker-dealers submitting reports.

While these figures do not reflect widespread use of the interpretative relief afforded by the Commission, the general consensus is that the full impact of the requirement to issue municipal bonds in registered form has not been realized and probably will not be realized until there are a significant number of registered bonds trading in the marketplace. Since the requirement for registration has only been in effect since July 1983, the impact of the new rule has been limited. However, as more and more registered issues are brought to the market, more pressure will be exerted on the municipal securities industry back-offices. It is anticipated that this will be even more apparent as the problems associated with record ownership transfer increase and collection of interest through a simple redemption of bearer coupons is replaced by the complexities of crediting interest to a beneficial holder of record.

While the Association recognizes that the Municipal Securities Rulemaking Board (MSRB) has initiated steps to promote the efficient clearance and settlement of municipal securities transactions, it is anticipated that municipal securities broker-dealers, clearing agencies and depositories will need time to respond to these initiatives. In this regard, the MSRB has enacted recent rule changes relating to the comparison of interdealer trades, the acknowledgement and confirmation of customer trades through the facilities of a clearing agency, and mandatory book entry settlement for depository eligible securities. As a result, the number of physical deliveries of municipals and resultant fails will be reduced. However, in order to ease the transition to automated clearance, the MSRB has delayed the effective dates of these rule changes until August 1, 1984 (mandatory use of clearing agencies), and February 1, 1985 (mandatory book entry settlement).

In light of the above findings and discussions, the Association petitioned the Commission to extend the relief applicable to registered municipal securities provided by its no-action letter issued in July.

PERTINENT PROVISIONS OF THE NET CAPITAL AND CUSTOMER PROTECTION RULES

SEC Rule 15c3-l

The relief provided under the net capital rule for transactions in registered municipal securities is as follows:

  • Subparagraph (c)(2)(ix) provides for a deduction from net capital for those municipal fails to deliver which are outstanding for 21 business days or longer. This time period has been extended to 30 business days for transactions involving registered municipal securities.
  • Under subparagraph (c)(2)(iv)(B), an existing interpretation provides that broker-dealers must make appropriate deductions from net worth for deficits in cash accounts for C.O.D. transactions involving municipal securities 42 calendar days after trade date. This time period has been extended to 60 calendar days after trade date for transactions involving registered municipal securities.
  • Subparagraph (a)(8) permits a municipal securities broker's broker to compute its capital requirements in accordance with specified guidelines. In this regard, subparagraph (a)(8)(iv) requires such a broker to make a deduction from net worth equal to 1% of the market value of the underlying security for municipal securities fails to deliver which are outstanding for 21 business days or longer. This time period has been extended to 30 business days for fails to deliver involving registered municipal securities.

SEC Rule 15c3-3

The relief provided under Rule 15c3-3 for registered municipal securities fails to deliver is as follows:

  • In computing its reserve requirement, a broker-dealer is required to exclude from the debit side of the formula fails to deliver which are outstanding more than 30 calendar days. This time period has been extended to 45 calendar days for fails to deliver involving registered municipal securities.

REPORTING REQUIREMENT

During the extended period, the Association will continue to monitor the use of the interpretative relief and the impact of aged fails in the municipal marketplace and to report such findings to the Commission on a periodic basis.

In this regard, an Association member for whom the NASD is the designated examining authority is requested to continue to submit the form, entitled "Supplemental Report - Relief from Operational Deductions for Aged Fails to Deliver in Registered Municipal Securities," to the Association along with its FOCUS Part I Report for each month in which the member relies on any of the extensions for aged fails permitted by the SEC's temporary no-action letter. This form (copy enclosed) must be submitted even if the member uses the interpretation in only one instance.

Members are reminded that the relief provided by the no-action letter is available only for fails involving registered municipal securities and is effective only through March 31, 1984.

Questions concerning this Notice may be directed to James M. Cangiano, Associate Director, Department of Policy Research, at (202) 728-8273. Questions regarding the filing and the completion of the Supplemental Report form should be referred to your local NASD District Office.

Sincerely,

John T. Wall
Vice President
Member and Market Services

Attachments

DIVISION OF MARKET REGULATION

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

December 30, 1983

Mr. John T. Wall
Executive Vice President
Member and Market Services
National Association of Securities Dealers, Inc.
1735 K Street, N.W.
Washington, D.C 20006

Dear Mr. Wall:

Our letter dated July 7, 1983, to Gordon S. Macklin, President of the National Association of Securities Dealers, Inc. ("NASD"), took a no action position with respect to a temporary extension of certain time periods specified in the net capital and customer protection rules before capital deductions and/or other actions were required to be taken for transactions involving registered municipal securities. The temporary relief was scheduled to expire on December 31, 1983.

The Division, as a condition for taking its position in this area, required the appropriate designated examining authority to secure data from each broker-dealer which took advantage of the temporary extension. In this regard, the NASD requested a member to submit data with its regular FOCUS Part I reports for each month in which the member relied on any of the extensions provided.

You claim that while the available figures do not reflect widespread use of the temporary relief the general consensus among industry representatives is that the full impact of municipal bond registration has not been realized and probably will not be realized until there are a significant number of registered bonds trading in the marketplace. However, you believe as more registered issues are brought to the market, the problems associated with record ownership transfer will increase as will the collection of interest.

You state that the NASD believes that the municipal securities industry led by the Municipal Securities Rulemaking Board ("MSRB") has initiated steps toward promoting efficient clearance and settlement of municipal securities transactions. You believe that recent rule changes of the MSRB relating to the comparison of interdealer trades, the acknowledgement and confirmation of customer trades through the facilities of a clearing agency, and mandatory book entry settlement for depository eligible securities will help facilitate the more efficient and timely settlement of municipal securities. As a result, the number of physical deliveries of municipal securities and resultant fails will be reduced.

In order to ease the transition to automated clearance however, the MSRB has delayed the effective dates of these rule changes until August 1, 1984 (mandatory use of clearing agencies), and February 1, 1985 (mandatory book entry settlement). Given these circumstances, the NASD requests that the Commission extend to at least July 1, 1984, the relief provided by the July no-action letter.

Should the Commission act favorably on this request, you state that the NASD will continue, during the extended period, to monitor the use of the temporary extensions and the impact of aged fails in the municipal marketplace and to report such findings to the Commission on a periodic basis.

Finally, you state that the NASD believes that the data already gathered demonstrates that the interpretation has not been abused or used as an excuse in delaying the completion of securities transactions, and that the industry is as desirous as the Commission of eliminating inefficiencies and delays in the clearance and settlement of municipal transactions and is working diligently to achieve that goal.

We agree that an extension of the temporary relief heretofore granted is appropriate because of the continued uncertainties in the registered municipal bond market and to ensure an orderly transition in the broker-dealers1 adapting to registered bonds. However, in view of the small number of fails which have exceeded the aging period, we believe that a 6 month period is not warranted. We believe that the period should be extended only to March 31, 1984, unless more substantial and convincing evidence of its need to the industry is submitted in support of any further request for an additional extension.

We appreciate your efforts in bringing this matter to our attention and your cooperation in our attempts to understand the issue fully.

Sincerely,

Douglas Scarff
Director


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