[Federal Register Volume 64, Number 92 (Thursday, May 13, 1999)]
[Notices]
[Pages 25940-25942]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-12139]
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SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-41378; File Nos. SR-MSRB-98-06, SR-NASD-98-20, SR-NYSE-
98-07]
Self-Regulatory Organizations; Municipal Securities Rulemaking
Board; National Association of Securities Dealers, Inc.; and New York
Stock Exchange, Inc.; Order Approving Proposed Rule Changes Regarding
the Confirmation and Affirmation of Securities Transactions
May 7, 1999.
The Municipal Securities Rulemaking Board (``MSRB''), the National
Association of Securities Dealers, Inc. (``NASD''), and the New York
Stock Exchange, Inc. (``NYSE'') have filed with the Securities and
Exchange Commission (``Commission'') proposed rule changes pursuant to
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\
proposing amendments to their confirmation/affirmation rules.\2\
Notices of the proposals were published in the Federal Register on
April 13, 1998.\3\ The Commission received two comment letters.\4\ For
the reasons discussed below, the Commission is approving the proposed
rule changes.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ On February 18, 1998, the NYSE filed and on March 26, 1999,
amended its proposed rule change (File No. SR-NYSE-98-07). On March
5, 1998, the NASD filed and on December 22, 1998, and February 17,
1999, amended its proposed rule change (File No. SR-NASD-98-20). On
April 3, 1998, the MSRB filed and on April 16, 1999, amended its
proposed rule change (File No. SR-MSRB-98-06). The amendments filed
by the MSRB, NASD, and NYSE represent technical amendments to the
proposed rule changes and as such do not require republication of
notice.
\3\ Securities Exchange Act Release Nos. 39830 (April 6, 1998),
63 FR 18060 (NYSE); 39831 (April 6, 1998), 63 FR 18057 (NASD); 39833
(April 6, 1998), 63 FR 18055 (MSRB). On May 1, 1998, the Commission
extended the comment period for the proposals for thirty days.
Securities Exchange Act Release No. 39944 (May 1, 1998), 63 FR
25531.
\4\ Letters from Mari-Anne Pisarri, Esq., Pickard and Djinis, on
behalf of Thomson Financial Services (``Thomson'') (May 12, 1998)
and Ronald J. Kessler, Chairman, Operations Committee, Securities
Industry Association (``SIA'') (June 1, 1998).
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I. Description
Currently, the confirmation/affirmation rules of the MSRB, NASD,
and NYSE (collectively referred to as self-regulatory organizations or
``SROs'') \5\ require the SROs' broker-dealer members to use the
facilities of a securities depository \6\ for the electronic
confirmation and affirmation of transactions in which the broker-dealer
provides either delivery-versus-payment (``DVP'') or receive-versus-
payment (``RVP'') \7\ privileges to its customer. Broker-dealers
generally extend DVP and RVP privileges only to their institutional
customers.
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\5\ The confirmation/affirmation rules are MSRB Rule G-
15(d)(ii), NASD Rule 11860(a)(5), and NYSE Rule 387(a)(5).
\6\ The term ``securities depository'' is defined in the SROs'
confirmation/affirmation rules as a clearing agency that is
registered under Section 17A of the Act, 15 U.S.C. 78q-1.
\7\ DVP privileges allow an institutional seller to require cash
payment before delivering its securities at settlement. RVP
privileges allow an institutional buyer to pay for its purchased
securities only when the securities are delivered.
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Certain vendors of electronic trade confirmation (``ETC'') services
have requested that they be allowed to provide confirmation/affirmation
services for DVP and RVP trades even though they are not registered
clearing agencies. Under the rule changes, the SROs' broker-dealer
members will be able to comply with the confirmation/affirmation rules
by using the facilities of either a registered clearing agency or a
``qualified vendor'' for the confirmation and affirmation of DVP and
RVP transactions.\8\
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\8\ Just being a qualified vendor will not entitle an ETC vendor
to provide ``matching'' services (in which broker-dealer
confirmations are matched with institutional allocation instructions
to produce affirmed confirmations) as part of its confirmation/
affirmation system. The Commission has concluded that matching
services may be provided only by a registered clearing agency or by
an entity that has received an exemption from clearing agency
registration. Securities Exchange Act Release No. 39829 (April 6,
1998), 63 FR 17943.
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[[Page 25941]]
In order to become a qualified vendor under the rule changes, an
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ETC vendor will be required to certify to its customers that:
(1) With respect to its electronic trade confirmation/
affirmation system, it has a capacity requirements, evaluation, and
monitoring process that allows the vendor to formulate current and
anticipated estimated capacity requirements;
(2) Its electronic trade confirmation/affirmation system has
sufficient capacity to process the specified volume of data that it
reasonably anticipates to be entered into its electronic trade
confirmation/affirmation service during the upcoming year;
(3) Its electronic trade confirmation/affirmation system has
formal contingency procedures, that the entity has followed a formal
process of reviewing the likelihood of contingency occurrences, and
that the contingency protocols are reviewed and updated on a regular
basis;
(4) Its electronic trade confirmation/affirmation system has a
process for preventing, detecting, and controlling any potential or
actual systems integrity failures, and its procedures designed to
protect against security breaches are followed; and
(5) Its current assets exceed its current liabilities by at
least $500,000.
In addition, a qualified vendor will be required initially and
annually to submit to the SROs and to the Commission staff a report
prepared by independent audit personnel (referred to in the rule
changes as ``Auditor's Report''). Each Auditor's Report must: (1)
verify the certifications described above; (2) contain a risk analysis
of all of the entity's information technology systems; and (3) contain
the written response of the entity's management to the Auditor's
Report's verifications and risk analysis. The Auditor's Report must be
deemed not unacceptable by Commission staff.\9\
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\9\ At this time, the Commission staff intends to indicate that
an entity's initial Auditor's Report is not unacceptable by issuing
a letter to the entity stating that it will not recommend
enforcement action against any of the SROs' member organizations
that elect to use the confirmation/affirmation systems of the
entity. Subsequent Auditor's Reports submitted to the Commission
staff by the qualified vendor will be considered acceptable unless
the Commission staff otherwise informs the qualified vendor.
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Qualified vendors will be subject to ongoing requirements under the
rule changes. For each transaction in which it provides confirmation/
affirmation services, a qualified vendor will be required to: (1)
deliver a trade record to a registered clearing agency in the clearing
agency's format; (2) obtain a control number for the trade record from
the clearing agency; (3) cross reference the control number to the
confirmation and subsequent affirmation of the trade; and (4) include
the control number when delivering the affirmation of the trade to the
clearing agency. A qualified vendor will be required to notify the SROs
and the Commission staff in writing of any changes to its systems that
significantly affect or have the potential to significantly affect its
electronic trade confirmation/affirmation system. In addition, a
qualified vendor will be required to supply supplemental information
regarding its confirmation/affirmation system as requested by the SROs
or by the Commission staff. If a qualified vendor intends to cease
providing confirmation/affirmation services, it must notify the SROs
and the Commission staff in writing.
II. Comment Letters
The Commission received two comment letters in response to the
notices of the SROs' proposed rule changes.\10\ The SIA Operations
Committee stated that it supports the proposed rule changes. The
Operations Committee expressed its belief that the proposed criteria
should address the regulatory concerns associated with allowing new
entrants into the clearance and settlement system while providing to
the system the innovations and cost reductions that competition can
produce.
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\10\ Supra note 4.
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Thomson stated that it was delighted that the SROs are amending
their rules to allow commercial vendors to process institutional trade
confirmations and affirmations.\11\ However, as discussed below,
Thomson believes that the SROs' proposals should be changed (1) to make
the initial and ongoing process of designating qualified vendors
objective and self-executing and (2) to limit the audit requirements to
the areas that pose the most risk to post-trade information processing
systems.
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\11\ Thomson's comment letter refers to differences in the
proposed rule changes from a statement of principles agreed to
between the SIA and Thomson. The NASD noted in the first amendment
to its rule filing that it ``does not believe that the statement of
principles is relevant, much less controlling, with respect to
whether there is a statutory basis for the proposed rule change.''
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Thomson stated that it supports the fundamental approach of the
Auditor's Reports. However, Thomson believes that the scope of the
Auditor's Reports is too broad. Thomson particularly objected to the
requirement that the Auditor's Report contain an audit of all of the
entity's information technology systems. Thomson stated that it
believes that auditing the certification that the entity would be
required to provide under the proposed rule changes is sufficient to
address the risk factors related to allowing unregulated entities to
provide confirmation/affirmation services.
The Commission believes that the scope of the Auditor's Reports
under the rule changes is reasonable. In particular, the Commission
believes that the risk analysis component of the Auditor's Report is
necessary to determine whether an entity should be a qualified vendor.
Because electronic confirmation/affirmation services are critical
to the settlement of institutional securities trades, a breakdown in
the confirmation/affirmation system could have a significant negative
impact on the entire clearance and settlement system. Moreover,
problems or insufficiencies in any aspect of a qualified vendor's
information technology system could adversely affect the qualified
vendor's confirmation/affirmation system. As a result, the Commission
believes that it is appropriate for the Auditor's Reports to contain a
risk analysis of the entity's information technology systems.
In addition, registered clearing agencies that provide
confirmation/affirmation systems are already subject to extensive
regulatory requirements. Among other things, registered clearing
agencies must submit rule changes to the Commission for approval and
are subject to inspections, including systems reviews, by the
Commission staff. As a result, the Commission has continuous oversight
and authority over registered clearing agencies' operations, including
any confirmation/affirmation services they provide. Under the SROs'
rule changes, qualified vendors will not be subject to such continuous
oversight and authority. The Commission believes that the requirements
under the rule changes with respect to the Auditor's Reports are
reasonably intended to assure that the Commission and the SROs will be
able to prevent an entity from becoming a qualified vendor if its
confirmation/affirmation system poses a risk of compromising the safety
and soundness of the national clearance and settlement system.
Thomson objected to the idea that the Commission staff would issue
a no-action letter to indicate that an entity's initial Auditor's
Report is not unacceptable. Thomson stated that the process of becoming
a qualified vendor should be largely self-executing in that an entity
should become a qualified vendor automatically as long as its initial
Auditor's Report does not contain any findings by the auditor of
material
[[Page 25942]]
weakness. Thomson stated that under the self-executing process it
supports, the Commission and the SROs ``would function more as report
depositories than traditional application examiners.''
The Commission believes that in order for Commission staff to
adequately review an Auditor's Report to determine whether it is not
unacceptable, the staff must do more than simply read the report to
determine whether it contains a finding of material weakness. Under the
rule changes, the Commission staff may deem an Auditor's Report
unacceptable for any reason if it believes that the report demonstrates
that an entity would not be capable of providing confirmation/
affirmation services in a manner that would not compromise the
integrity of the national clearance and settlement system.
Thomson also contended that there is no legal context in which the
Commission staff may issue no action letters to qualified vendors.
Thomson stated that the only party to which the Commission staff is
authorized to recommend or not recommend enforcement action is the
Commission itself and that any such recommendation or decision to not
make a recommendation must be related to the federal securities laws or
Commission rules promulgated thereunder. Thomson expressed concern that
the proposed rule changes do not provide objective standards that the
Commission staff will use when considering whether to grant the initial
no-action letter.
The Commission believes that the use of a no-action letter to
indicate that an entity's initial Auditor's Report is not unacceptable
is a reasonable method for indicating that an entity is a qualified
vendor under the SROs' rules. Section 21 of the Act, which authorizes
the Commission to investigate and to bring enforcement action with
respect to violations of the rules of a self-regulatory organization by
any person, provides a legal context for the issuance of a no-action
letter to qualified vendors.\12\ The Commission also believes that the
rule changes are reasonably designed to provide objective guidance to
the Commission in its review of the Auditor's Reports and to the SROs
to deny ``qualified'' status to and to terminate the ``qualified''
status of ETC vendors whose confirmation/affirmation services fall
below acceptable standards.
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\12\ 15 U.S.C. 78u.
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Thomson stated that it agrees with the requirement that a qualified
vendor notify the SROs and the Commission staff if it decides to stop
providing confirmation/affirmation services. Thomson objected to a
provision in the NASD's proposed rule change that states a qualified
vendor may cease to be qualified if the Commission staff (1) deems an
Auditor's Report unacceptable either because it contains any finding of
material weakness or for any other identified reasons or (2) notifies
the qualified vendor that it is no longer qualified.
As noted above, the Commission staff may deem an Auditor's Report
unacceptable for any reason if it believes that the report demonstrates
that an entity would not be capable of providing confirmation/
affirmation services in a manner that would not compromise the
integrity of the national clearance and settlement system. In addition,
the Commission staff may revoke a no-action position if it determines
that a revocation is consistent with the public interest or the
protection of investors.
III. Discussion
Under Section 19(b)(2) of the Act, the Commission is directed to
approve the SROs' proposed rule changes if it finds that they are
consistent with the requirements of the Act and the rules and the rules
and regulations thereunder applicable to the SROs.\13\ Sections
6(b)(5), 15A(b)(6), and 15B(b)(2)(C) of the Act \14\ require, among
other things, that the SROs' rules be designed to foster cooperation
and coordination with persons engaged in regulating, clearing,
settling, processing information with respect to, and facilitating
transactions in securities. Sections 6(b)(8), 15A(b)(9), and
15B(b)(2)(C) of the Act \15\ also require that the SROs' rules not
impose any burden on competition not necessary or appropriate in
furtherance of the purposes of the Act. For the reasons discussed
below, the Commission believes that the SROs' proposed rule changes are
consistent with their obligations under the Act.
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\13\ 15 U.S.C. 78s(b)(2).
\14\ 15 U.S.C. 78f(b)(5), 78o-3(b)(6), and 78o-4(b)(2)(C).
\15\ 15 U.S.C. 78f(b)(8), 78o-3(b)(9), and 78o-4(b)(2)(C).
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The Commission believes that the changes to the SROs' confirmation
rules are consistent with the SROs' obligations under the Act because
they will require unregulated entities that wish to provide
confirmation/affirmation services to establish links and interfaces
with a registered clearing agency. This requirement should increase
cooperation and coordination among the SROs' members, registered
clearing agencies, and entities that become qualified vendors under the
rule changes.
In addition, in reviewing the proposed rule changes the Commission
has considered whether the proposed rule changes would impose any
burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act. The Commission believes that
the rule changes have been carefully designed to allow unregistered ETC
vendors to provide confirmation/affirmation services for institutional
trades in a manner which is not unduly burdensome for ETC vendors and
which preserves the safety and soundness of the national system for the
clearance and settlement of securities transactions. Therefore, the
Commission believes that the SROs' proposed rule changes should not
impose any burden on competition that is not necessary or appropriate
in furtherance of the purposes of the Act.
IV. Conclusion
On the basis of the foregoing, the Commission finds that the
proposals are consistent with the requirements of the Act and in
particular with the requirements of Section 17A of the Act and the
rules and regulations thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule changes (File Nos. SR-MSRB-98-06, SR-NASD-98-20,
SR-NYSE-98-07) be and hereby are approved.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\16\
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\16\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-12139 Filed 5-12-99; 8:45 am]
BILLING CODE 8010-01-M
