WAIS Document Retrieval[Federal Register: February 28, 1994]


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DEPARTMENT OF THE TREASURY

Office of the Under Secretary for Domestic Finance

17 CFR Part 403

RIN 1505-AA42

 
Implementing Regulations for the Government Securities Act of 
1986

AGENCY: Office of the Under Secretary for Domestic Finance, Treasury.

ACTION: Final rule.

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SUMMARY: The Department of the Treasury (``Department'') is issuing in 
final form amendments to the regulations issued under the Government 
Securities Act of 1986, as amended (the ``Government Securities Act'' 
or ``GSA''). The amendments implement a buy-in requirement for 
mortgage-backed securities that are in a fail to receive status for 
more than 60 calendar days; and all government securities that are 
needed to complete a customer sell order (other than a short sale) if 
the securities have not been received from the customer within 30 
calendar days after the settlement date for all government securities 
except mortgage-backed securities, or 60 calendar days after the 
settlement date for mortgage-backed securities. The final rule adopts 
without substantive change the buy-in requirements for mortgage-backed 
securities in a fail to receive status that were prescribed in the 
proposed rules published for comment on April 17, 1991. However, the 
time frames for buy-ins of customer sell orders have been revised in 
the final rule in response to comments received on the proposed rules. 
These requirements apply to all entities that are required to register 
or provide notice of their status as government securities brokers and 
dealers.

EFFECTIVE DATE: April 29, 1994.

FOR FURTHER INFORMATION CONTACT: Ken Papaj (Director), or Lee Grandy 
(Government Securities Specialist), Public Debt, Government Securities 
Regulations Staff, 999 E Street, NW., room 515, Washington, DC 20239-
0001, (202) 219-3632. (TDD for hearing impaired: (202) 219-9274.)

SUPPLEMENTARY INFORMATION:

I. Background

    The GSA regulations currently require a government securities 
broker or dealer to take prompt steps to obtain possession or control 
of customers' fully paid or excess margin securities that have been in 
a fail to receive status for more than 30 calendar days through a buy-
in procedure or otherwise. However, mortgage-backed securities are not 
subject to this buy-in requirement since the Department suspended the 
application of this rule to such securities in the GSA regulations that 
were issued in July 1987.<SUP>1 In addition, the current GSA 
regulations do not impose a buy-in requirement for customer sell orders 
where the government securities broker or dealer has not obtained the 
securities from its customer. A temporary rule imposing such a 
requirement on registered government securities brokers and dealers was 
suspended in the July 1987 GSA regulations issued by the 
Department.<SUP>2
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    \1\ 52 FR 27910, 27920-21 and 27948-50 (July 24, 1987).
    \2\ 52 FR 27910, 27921-22 and 27948-50 (July 24, 1987).
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    On April 17, 1991, the Department proposed for comment amendments 
to sections 403.1, 403.4, and 403.5 of the GSA regulations.<SUP>3 The 
proposed amendments prescribed buy-in requirements for: (i) Mortgage-
backed securities in a fail to receive status for more than 60 calendar 
days, and (ii) customer sell orders (other than short sales) in which 
the securities were not received from the customer within ten business 
days after the settlement date.
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    \3\ See 56 FR 15529 (April 17, 1991). The rule changes to these 
three sections of the GSA regulations would make the buy-in 
requirements applicable to all classes of government securities 
brokers and dealers that were required to register or file notice 
pursuant to section 15C(a)(1) of the Securities Exchange Act of 1934 
(15 U.S.C. 78o-5(a)(1)). Section 403.1 would apply to registered 
brokers and dealers that were required to file notice as government 
securities brokers and dealers with the Securities and Exchange 
Commission; section 403.4 would apply to registered government 
securities brokers and dealers (i.e., those entities that were 
required to register with the SEC); and section 403.5 would apply to 
financial institutions that were required to file notice as 
government securities brokers and dealers with their respective 
appropriate regulatory agency.
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    The proposed rule was intended to subject mortgage-backed 
securities to a 60 calendar day buy-in requirement, rather than the 30 
calendar days applicable to other government securities due to the 
unique nature of the mortgage-backed market, particularly the lengthy 
settlement cycle. The reader is referred to the preamble to the 
proposed rule<SUP>4 for a more detailed discussion of the Department's 
reasons for adopting a 60 calendar day time frame for buy-ins of 
mortgage-backed securities. The proposed rulemaking also included buy-
in rules for customer sell orders that would apply to all government 
securities brokers and dealers, including financial institutions. 
Specifically, the provisions proposed that if a government securities 
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 would be required to close out the transaction with 
the customer by purchasing securities of like kind and quantity. The 
Department specifically requested comments concerning the 
appropriateness of the ten-day time frame.
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    \4\ See 56 FR 15529, 15530-31 (April 17, 1991).
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    The comment period for the proposed rules closed on June 17, 1991. 
Only one letter<SUP>5 was received in response to the proposed rule 
changes. The commenter supported the 60-day buy-in time frame for 
mortgage-backed securities in a fail to receive status but opposed the 
proposed rule for customer sell orders. However, the commenter 
suggested modifications to the time frame for buy-ins of customer sell 
orders if Treasury decided to adopt such a rule.
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    \5\Letter from Peter J. Murray, Chairman, Government Securities 
Operations Committee, Public Securities Association (PSA) and Laura 
E. LoCosa, Chairperson, Mortgage-Backed Securities Operations 
Committee, PSA, to Kenneth Papaj, Director, Government Securities 
Regulations Staff, Bureau of the Public Debt, Department of the 
Treasury, dated June 17, 1991 (hereinafter ``June 17, 1991 PSA 
Letter'').
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    Treasury did not issue these rules in final form prior to the 
expiration of its rulemaking authority on October 1, 1991. Treasury's 
authority under the GSA was permanently reauthorized on December 17, 
1993, hence the long delay in finalizing these rules.

II. Section-by-Section Analysis of Proposed Changes

A. Buy-Ins for Fails To Receive

    The Department is now adopting without significant change 
amendments to paragraphs 403.1, 403.4(g) and 403.5(c)(1)(iii) that were 
proposed in April 1991. These provisions would require all government 
securities brokers and dealers that are required to register or file 
notice pursuant to 15C(a)(1) of the Exchange Act to take prompt steps 
to obtain possession or control of mortgage-backed securities that are 
in a fail to receive status for more than 60 calendar days through a 
buy-in procedure or otherwise.<SUP>6 The Public Securities Association 
(PSA), which was the only commenter on the proposed rules, supported 
the 60 calendar day time frame for buy-ins of mortgage-backed 
securities, stating that ``* * * the proposal is a reasonable 
approach.''<SUP>7 This time frame reflects the recommendations made in 
July 1989 by an industry-wide task force established by the PSA.<SUP>8
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    \6\The term mortgage-backed securities includes only those 
mortgage-backed securities that are included in the definition of 
``government securities'' as set out in section 3(a)(42) of the 
Exchange Act (15 U.S.C. 78c(a)(42)).
    \7\June 17, 1991 PSA Letter, supra note 5, at 2.
    \8\Letter from Marianna Maffucci, Vice President and Assistant 
General Counsel, Public Securities Association, to Kenneth Papaj, 
Director, Government Securities Regulations Staff, Bureau of the 
Public Debt, Department of the Treasury, and Michael Macchiaroli, 
Assistant Director, Division of Market Regulation, Securities and 
Exchange Commission, dated July 10, 1989.
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    As discussed in more detail in the preamble to the proposed rules, 
the Department is adopting a longer buy-in time frame for fails to 
receive for mortgage-backed securities than the 30-calendar day time 
frame in place for other government securities. This longer time period 
is appropriate given the normally longer settlement cycle for mortgage-
backed securities (which is often as long as 30 days),<SUP>9 the 
complexities of these instruments and the scarcity in the market of 
specified pools. To avoid abnormal settlements,<SUP>10 the Department 
reiterates that any buy-in accomplished pursuant to these rules would 
be allowed to settle on the next regularly scheduled settlement date 
for that particular class or pool of mortgage-backed securities.
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    \9\The PSA has developed a system to standardize the settlement 
process for mortgage-backed securities. See Public Securities 
Association, ``Uniform Practices for the Clearance and Settlement of 
Mortgage-Backed Securities and Other Related Securities'' at 15-1 
(1988). This system has proven successful in alleviating operational 
workloads during the heaviest settlement periods, which has 
contributed to a reduction in the high fail rates for mortgage-
backed securities.
    \1\0A settlement date other than the regularly scheduled 
settlement date can be requested, however, the buyer pays a premium 
for this abnormal settlement.
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    The Department understands that the PSA will implement buy-in 
procedures for mortgage-backed securities similar to those in place for 
other government securities. We believe that reliance on procedures 
that are already familiar to the broker-dealers should facilitate the 
implementation of this rule and view efforts to standardize the 
operational procedures as a positive step.

B. Buy-Ins for Customer Sell Orders

    The Department's proposed rules included a requirement to buy-in 
customer sell orders (other than a short sale) in cases where the 
government securities broker or dealer had not obtained the securities 
from the customer within ten business days after the settlement date. 
For registered government securities brokers and dealers the Department 
was proposing to add paragraph 403.4(l) which incorporated by reference 
paragraph (m) of SEC Rule 15c3-3 (17 CFR 240.15c3-3(m)), with one 
modification pertaining to the definition of a short sale.<SUP>11 This 
rule has been suspended by the SEC with respect to exempted securities 
since 1973, including government securities.<SUP>12 A companion buy-in 
rule for customer sell orders that would apply to financial 
institutions that are required to file notice as government securities 
brokers and dealers was also proposed in April 1991 by adding new 
paragraph 403.5(g) to the GSA regulations.
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    \1\1 The proposed rule also included an amendment to section 
403.1 which would make paragraph 403.4(l) apply to registered 
brokers and dealers that were required to file notice as government 
securities brokers and dealers with the SEC.
    \1\2 Securities Exchange Act Release No. 10093 (April 10, 1973), 
38 FR 12103 (May 9, 1973).
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    In its comment letter, the PSA stated that the ten-day buy-in rule 
for customer sell orders should not be adopted because it has minimal 
customer protection benefits. The PSA noted that improvements in the 
settlement processes and the fact that most Treasury, agency and 
government mortgage-backed securities are now in book-entry form have 
resulted in increased deliveries and fewer overall fails. For those few 
fails that may still occur, the PSA stated that ``[b]roker-dealers have 
business incentives to clean up fails to limit their market 
exposure.''<SUP>13 For mortgage-backed securities, the ten-day buy-in 
time frame would be problematic since it would require delivery of 
securities outside of the regularly scheduled settlement cycles. The 
PSA suggested that, if Treasury believes a buy-in rule for customer 
sell orders must be adopted, the time frame should be consistent with 
the applicable buy-in time frames for fails to receive.
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    \1\3June 17, 1991 PSA Letter, supra note 5, at 3.
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    The Department continues to believe that buy-in rules for customer 
sell orders are needed to strengthen customer protection because a 
customer's failure to deliver a security to an executing broker or 
dealer could result in that broker's or dealer's failure to deliver to 
another counterparty. Further, these rules will prevent customers from 
taking advantage of market fluctuations by refusing to deliver a 
security to a broker or dealer when the price rises after a sell order 
has been executed.
    In response to the comments made by the PSA, the Department is 
revising the buy-in time frame for customer sell orders in new 
paragraphs 403.4(l) and paragraph 403.5(g), applicable to registered 
government securities brokers-dealers and financial institution 
government securities broker-dealers, respectively, from ten business 
days to 30 calendar days for all government securities, except 
mortgage-backed securities, and to 60 calendar days for all government 
mortgage-backed securities.<SUP>14 These time frames are consistent 
with the buy-in requirements for fails to receive addressed above. The 
Department also modified the customer sell order rules to permit the 
use of alternatives other than purchasing securities (e.g., securities 
may be borrowed, substituted or bought back) in closing out orders. 
Again, this is consistent with the buy-in rules for fails to receive.
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    \1\4The Department is also adopting without change, the 
amendments to section 403.1, which requires registered broker-
dealers to comply with paragraph 403.4(l).
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    The buy-in rules for customer sell orders continue to provide an 
exemption for short sales, which are the primary cause for non-
deliveries. This should significantly reduce the number of fails 
subject to these requirements. Similar to buy-ins of mortgage-backed 
securities that are in a fail to receive status, broker-dealers will be 
allowed to effect buy-ins for customer sell orders of mortgage-backed 
securities at the next regularly scheduled settlement cycle.<SUP>15
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    \1\5The SEC's buy-in requirement for customer sell orders has 
been suspended with respect to exempted securities. See Securities 
Exchange Act Release No. 10093 (April 10, 1973), 38 FR 12103 (May 9, 
1973). It is the Department's understanding that SEC staff intends 
to recommend to the Commission a proposal to lift the suspension of 
paragraph (m) of Rule 15c3-3 with respect to exempted securities and 
amend the provision in a manner that would conform with Treasury's 
final rule in paragraph 403.4(l) as it relates to government and 
mortgage-backed securities.
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    Finally, the Department is also adopting without change 
redesignated paragraph 403.5(h), which will now grant the appropriate 
regulatory agencies for financial institutions the authority to extend 
the 30- and 60-calendar day time frame for buy-ins of customer sell 
orders if a financial institution broker-dealer requests an extension. 
No comments were received on this provision.

C. Effective Dates

    The final rules become effective April 29, 1994. This will provide 
sufficient time for all government securities brokers and dealers to 
become acquainted with the new requirements and to implement operating 
procedures. Additionally, the lead time will enable the PSA to finalize 
and distribute buy-in procedures it is developing for the industry.
    In its comment letter, the PSA requested that the Treasury's buy-in 
rules be enacted contemporaneously with the Commission's amendments to 
Rule 15c3-3(d)(2) and (m). Since Treasury's rules apply to all 
government securities brokers and dealers, and given the Department's 
understanding that the buy-in rules to be proposed by the Commission 
will conform to those adopted herein, the Department believes that 
there is no compelling reason to defer implementation until the 
Commission acts.

III. Special Analysis

    The Department has determined that this action does not constitute 
a ``significant regulatory action'' for the purposes of Executive Order 
12866 (58 FR 51735, October 4, 1993). Accordingly, it was not subject 
to review under the Executive Order by the Office of Information and 
Regulatory Affairs, Office of Management and Budget.
    In the preamble to the proposed rules, the Department certified 
that these amendments would not have a significant economic impact on a 
substantial number of small entities. Accordingly, a regulatory 
flexibility analysis was not prepared. In reviewing the final rules 
being adopted herein and after considering the comments received on the 
proposed rules, the Department has concluded that there is no reason to 
alter the previous certification that these rules will not have a 
significant economic impact on a substantial number of small entities.
    Since these final rules contain no new collections of information, 
the requirements of the Paperwork Reduction Act (44 U.S.C. 3504(h)) are 
inapplicable.

List of Subjects in 17 CFR Part 403

    Banks, Banking, Brokers, Government securities.

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

PART 403--PROTECTION OF CUSTOMER SECURITIES AND BALANCES

    1. The authority citation for part 403 is revised to read as 
follows:

    Authority: Sec. 101, Public Law 99-571, 100 Stat. 3209; sec. 
4(b), Public Law 101-432, 104 Stat. 963; sec. 102, sec. 106, Public 
Law 103-202, 107 Stat. 2344 (15 U.S.C. 78o-5(b)(1)(A), (b)(4)).


    2. Section 403.1 is revised to read as follows:


Sec. 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 Sec. 240.8c-1 of this 
title (SEC Rule 8c-1), as modified by Secs. 403.2 (a), (b) and (c), 
with Sec. 240.15c2-1 of this title (SEC Rule 15c2-1), with 
Sec. 240.15c3-2 of this title (SEC Rule 15c3-2), as modified by 
Sec. 403.3, and with Sec. 240.15c3-3 of this title (SEC Rule 15c3-3), 
as modified by Secs. 403.4 (a)-(d), (e)(2)-(3), (f)-(i), and (l), 
constitutes compliance with this part.
    3. Section 403.4 is amended by revising paragraph (g) and by adding 
new paragraph (l) after paragraph (k) to read as follows:


Sec. 403.4.  Customer protection--reserves and custody of securities.

* * * * *
    (g) For the purposes of this section, Sec. 240.15c3-3(d)(2) of this 
title ismodified to read as follows:
    ``(2) Securities included on its 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 government securities 
broker or government securities 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''
* * * * *
    (l) For purposes of this section, the suspension of Sec. 240.15c3-
3(m) of this title (38 FR 12103, May 9, 1973) is no longer effective 
and the paragraph is modified to read as follows: ``(m) If a government 
securities broker or government securities dealer 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 government securities broker or dealer) and 
if for any reason whatever the government securities broker or 
government securities dealer has not obtained possession of the 
government securities, other than mortgage-backed securities, from the 
customer within 30 calendar days, or in the case of mortgage-backed 
securities within 60 calendar days, after the settlement date, the 
government securities broker or government securities dealer shall 
immediately thereafter close the transaction with the customer by 
purchasing, or otherwise obtaining, securities of like kind and 
quantity. For purposes of this paragraph (m), the term ``customer'' 
shall not include a broker or dealer who maintains a special omnibus 
account with another broker or dealer in compliance with section 4(b) 
of Regulation T (12 CFR 220.4(b)).
* * * * *
    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:


Sec. 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 calendar days, or in the 
case of mortgage-backed securities, for more than 60 calendar 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 government 
securities, except mortgage-backed securities, from the customer within 
30 calendar days, or in the case of mortgage-backed securities within 
60 calendar days, after the settlement date, the financial institution 
shall immediately thereafter close the transaction with the customer by 
purchasing, or otherwise obtaining, 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: February 14, 1994.
Frank N. Newman,
Under Secretary for Domestic Finance.
[FR Doc. 94-4402 Filed 2-25-94; 8:45 am]
BILLING CODE 4810-39-W