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UNITED STATES SECURITIES AND EXCHANGE COMMISSION 

SECURITIES LENDING AND 

SHORT SALE ROUNDTABLE 

PAGES: 1 through 209 

PLACE: U.S. Securities and Exchange Commission 

100 F Street, NE 

Washington, D. C. 20549 

DATE: Tuesday, September 29, 2009 

The above-entitled matter came on for hearing, 

pursuant to notice, at 9:36 a.m. 

Diversified Reporting Services, Inc. 

(202) 467-9200 
 

 

 

 

 

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P R O C E E D I N G S 

CHAIRMAN SCHAPIRO: Good morning. I'm sorry we're 

a few moments late. I want to welcome everyone to day one of 

the Securities and Exchange Commission's Securities Lending 

and Short Sale Roundtable. The Commission is very grateful 

that so many have agreed to participate in today's meeting, 

and I think I can speak for my colleagues on the Commission 

in saying that we look forward to the panelists' comments, 

insights and recommendations on these two very important, 

interconnected areas of the securities industry. 

Today's focus will be on securities lending. 

Securities lending is a practice where an institution with a 

portfolio of investment securities temporarily lends out, on 

a collateralized basis, some of its portfolio securities that 

would otherwise be sitting idle. 

Securities lending has existed in some parts of the 

world since at least the 19th century, if not earlier. In 

the 1970s, securities lending increased in the U.S. as 

custodian banks lent out the portfolio securities of their 

custodial clients, and registered investment companies began 

lending their securities. 

In the 1990s and early 2000s, with the expansion of 

the global securities markets and investing, and the 

exponential increase in short selling and related strategies, 

the demand for securities lending also grew. 
 

 

 

 

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For a long time securities lending was regarded and 

described as a relatively low risk venture, but the recent 

credit crisis revealed that it can be anything but low risk. 

This was particularly the case with cash collateral 

reinvestment programs, which experienced unanticipated 

illiquidity and losses. Some institutions that lent their 

securities and the beneficiaries relying on those 

institutions were significantly harmed. 

As a result, many questions have arisen with 

respect to the securities lending market, and whether it may 

be improved for the benefit of market participants and 

investors. We hope to explore many of these important 

questions in today's roundtable. 

Throughout the day, we will hear from panelists on 

four different panels. Each panelist will take a few moments 

to share his or her thoughts on the issues being discussed, 

and when the opening statements are complete, the floor will 

be open to questions from the moderators and the 

Commissioners. 

The first panel will in part serve to provide an 

overview of securities lending, its participants and 

processes -- a "securities lending 101," if you will -- to 

provide us with context for the ensuing panels. The 

panelists will describe the mechanics of securities lending, 

the major participants, its compensation structure, as well 
 

 

 

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as the motivations for lending and borrowing securities. The 

panelists will also comment on the benefits and pitfalls of 

securities lending given their recent and past experiences in 

this arena. 

The second panel will explore a number of topics 

relating to investor protection concerns, such as cash 

collateral reinvestment and the problems that many lenders 

and lending agents experienced when the credit crisis hit; 

alternatives to cash collateral and lending practices that 

could perhaps have mitigated the recent experience; default 

risk; lending agent compensation and fee splits; and proxy 

voting issues. 

The third panel will discuss the issue of 

transparency: what it is, whether it exists in the current 

securities lending marketplace, and whether steps need to be 

taken to improve it. We're interested in hearing about 

transparency related to the pricing of securities lending 

transactions as well as transparency in any other area of 

securities lending the panelists may wish to discuss. The 

panel will also explore issues related to newly emerging 

electronic lending platforms, central counterparties and 

issues of accountability. 

The fourth and final panel of the day will discuss 

the future of securities lending, what are the factors that 

are likely to drive its future evolution, and the risks going 
 

 

 

 

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forward. In addition, that panel will assess whether there 

are any regulatory gaps in the marketplace, and finally what 

areas, if any, are in need of additional SEC action to 

enhance investor protection. 

The panelists we will hear from today are leaders 

in their respective fields and represent a range of 

constituencies that includes beneficial owner lenders, agent 

lenders, borrowers, regulators, academics, consultants and 

others. We are truly privileged to have them here and to 

have them share their thoughts with us. We look forward to a 

spirited and substantive discussion. 

Let me turn this over now to Jamie Brigagliano, 

co-acting Director of the Division of Trading Markets, who 

will introduce and moderate our first panel. Thank you. 

MR. BRIGAGLIANO: Thank you, Chairman Schapiro. We 

will now begin the day's first panel, titled Overview of 

Securities Lending: Participants; Process; Benefits and 

Pitfalls. Following introductions, the panelists will each 

make a brief opening statement. Because we have a lot of 

information to cover in a relatively short amount of time, we 

ask that the panelists limit their opening statements to no 

more than three minutes. 

During your prepared remarks, we will hold up a 

yellow card indicating that you have one minute remaining. 

Following opening statements, we will engage in discussion 
 

 

 

 

 

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with the Commission. While responding to questions from the 

Chairman and Commissioners, panelists are encouraged to 

engage in dialogue with one another. We welcome discussion 

of other panelists' viewpoints, differing opinions and 

additional thoughts in response to other panelists' remarks. 

Before we begin, I'd like to welcome and introduce 

our distinguished panel. Jerry Davis is the Chairman of the 

Board of Trustees for the New Orleans Employees' Retirement 

System. He's also the Employee Representative on the Board 

of Trustees. 

David Downey is the Chief Executive Officer of 

OneChicago. Irving Klubeck is a Managing Director of 

Pershing LLC, where he is a member of the customer processing 

and services group, and is responsible for securities lending 

operations and global clearance and settlement. 

William Pridmore is an independent consultant. He 

provides advice to large institutional investors on their 

participation in the securities lending and short-term 

investment markets. And Dr. Adam Reed is the Julian Price 

Associate Professor of Finance at the University of North 

Carolina's Kenan-Flagler Business School. 

Jerry, would you like to start us off with your 

opening statement, please? 

MR. DAVIS: Thank you very much, Mr. Brigagliano. 

I represent the City of New Orleans Retirement System. 2008 
 

 

 

 

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was not a good year, to put it kindly. We were a mid-sized 

pension fund, we're now flirting with the problem of being a 

small pension fund, as we struggle to recover from all that. 

The carnage of last year was widespread enough 

among our stock and bond managers. We expect that. We 

expect stocks to fall and rise in accordance with what's 

happening in the overall global markets. What we did not 

expect was the kind of disaster in the securities lending 

program that we experienced. 

This was sold to us as an idea some 20 years ago by 

what was then Chemical Bank. It was going to be free money 

from your idle assets. That was a very seductive concept, 

and it worked for a long time. 

But then Lehman failed, then Sigma failed, and all 

of a sudden, in our securities lending program, we lost six 

years worth of revenues in a matter of weeks. So we're 

sitting here now owing the bank about $400,000 in collateral 

that the bank invested for us. 

This raises some concerns from us about the 

possibility of the same kind of cross-contamination that 

affected the stock and bond markets last year. These huge, 

vertically and horizontally integrated financial institutions 

play in so many areas of the market that it's hard to imagine 

that they're not aware upfront of all the risks that can 

arise in a program like lending. 
 

 

 

 

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The suspicious part of me says maybe they did know 

and could have done something about it and perhaps did do 

something about their own level of risk and that of selected 

clients. This is part of the reason I'm here today, is to 

raise suspicions that I think are probably widespread, given 

the number of securities class actions that are beginning to 

take place on this issue. 

The idea of cross-contamination in the markets is 

very troubling in an issue such as securities lending, where 

the banks typically, at least for smaller investors, have 

full discretion to do whatever they choose in terms of 

lending and borrowing -- their relationships with borrowers, 

their use of the cash collateral. 

We had a very broadly written contract, which I've 

since learned is pretty typical for the industry for small 

investors. All the discretion fell with the bank, and the 

losses fell to us. We discussed with the bank the 

possibility of some kind of modified action or modified 

relationship to help us deal with the losses -- the bank has 

been non-receptive, and I think that's been pretty constant 

with all of my associates that I've talked to. 

The overriding issue that has presented us with is 

that we desperately need to develop new due diligence 

checklists, not only for all of our investment practices, but 

for every relationship we've got, including the custodial 
 

 

 

 

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relationship. We need checklists that will go down the line 

in terms of everything they're doing for us, what can go 

wrong, what can go right, and what are we going to do about 

each one. 

We know that Washington cannot provide all the 

answers to this process, but I certainly am very happy that 

the SEC is bringing people together to discuss this in a very 

intense way so that we can hopefully arrive at some workable 

solutions. Regulations are a scary concept because they can 

have unintended consequences, but I think if we work together 

we can come out with a positive result. 

MR. BRIGAGLIANO: Thank you, Jerry. David Downey. 

MR. DOWNEY: Thank you very much. Many of you 

might wonder what a single stock future exchange would be 

doing here at securities lending, and it's because securities 

lending is an over-the-counter transaction, whereby you're 

not really lending, you're legally selling stock and in 

return you're accepting a forward contract to get that stock 

back at some point in time. 

So you're lending -- you're selling stock and 

you're buying a forward contract. That forward contract is a 

future, a single stock future. It has all of the attributes 

of a single stock future. In fact, at OneChicago, we trade 

EFPs, exchanging that stock for this future everyday. We 

price them -- they look just like the securities lending 
 

 

 

 

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rates. 

What's of interest is, securities lending rates 

have a huge effect on single stock futures. Because it's not 

transparent, this force acts negatively and positively on 

these futures. Customers who come in and trade do not have 

access to this price information, this valuable price 

information. Accordingly, they are at market risk of people 

with more intelligence, like the people who control lending 

rates. So I'm concerned about this because my customers, who 

are using my product, are doing it in a very blind way. 

Secondly, there's a lot of money involved, and I'd 

like to just run through a couple of round numbers, and we'll 

use one stock in particular. We're going to pick Sears 

Holdings, a large organization. As of last night, there was 

15,225,000 shares of Sears sold short. It closed last night 

at $66. That represents $1.480 billion worth of notional 

value. 

In the lending market, 102 percent of that is put 

up as collateral and reinvested. That reinvestment is split 

between the lender, the custodian, the prime broker and the 

hedge fund. They invest in at Fed Funds, which is about 13 

basis points or 13-hundredths of a percent, that only comes 

out to about $1.3 million a year, certainly not impressive, 

not enough to bring all these people together. 

But if we go back to interest rates of 2007 at 5 
 

 

 

 

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percent, that would jump up to $51 million a year. Still not 

bad, but split it between four organizations that size. But 

there's a difference here. This is in hard-to-borrow stock. 

And as it goes hard to borrow, suddenly only three people get 

paid, the custodian, the lender, and the prime broker -- the 

borrower gets cut out, and in fact he pays a Commission. 

As of last night, the Commission on Sears Holding 

was 28 percent, 28-hundred basis points. The return on 

28-hundred basis points on that collateral comes out to about 

$281 million a year. Now that's something that people want. 

The interesting thing is, as we watch these values 

of the futures fluctuate, these things have fluctuated in the 

last 34 days between 13 percent for Sears Holding and 42 

percent. That indicates a level of inefficiency in this 

market because of a lack of transparency and a lack of 

participation. That has to change. This market can be 

accessible, it should be accessible, and there's too much 

money around to leave it up to a small group of people. 

MR. BRIGAGLIANO: Thank you, David. Irv Klubeck. 

MR. KLUBECK: Thank you very much. I'm happy to be 

here. I'd like to thank the Chairman for inviting me and the 

Commissioners, and I hope that over the course of not just 

this hour but the next day-and-a-half that we have an 

opportunity to explain and explore and to shed some light on 

the securities lending process and to make sure that everyone 
 

 

 

 

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involved in the process has a clear understanding of the 

economics and the rules of economics that actually apply to 

the securities lending market. Thank you, I look forward to 

helping. 

MR. BRIGAGLIANO: Bill. 

MR. PRIDMORE: Thank you. I'm pleased also to 

participate in today's panel session. For the last 15 years 

I've worked as an independent financial consultant, and prior 

to that I had some experience in broker dealer finance. So 

pretty much all of my career I've had some touch on the 

securities finance business, including securities lending. 

Today I work only for the beneficial owners of 

securities being lent. I don't receive any compensation from 

the lending service providers such as vendors or broker 

dealer firms. My goal is to provide the beneficial owners 

with an independent assessment of securities lending risks 

and rewards. Chairman Schapiro is right, in that the common 

perception of lending was that there was no or little risk in 

securities lending. Events of the past year have proved 

otherwise. 

In order to fix this problem, first you need to 

understand how the situation arose. Lending was viewed by 

many as a custody service and a securities processing 

service, not an investment service. Most institutional 

investors delegated lending to their custody bank with little 
 

 

 

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thought. That custodian or lending agent charged a fee based 

on the percentage of income earned, so more income to the 

client automatically generated more income to the lending 

agent. 

So there was a natural emphasis on growing lending 

income so that each participant could get a larger share. 

Over the past 10 years, technology allowed the entry of 

third-party lenders that were separate from the beneficial 

owners or the custodian bank. These third-party lenders 

often focused on trying to provide better lending 

performance, which generated more income to the beneficial 

owners. 

With this competition for the very profitable 

lending agent business, custodian lenders also began to focus 

more and more on generating higher lending income. Since 

cash was the predominant form of collateral, how that 

collateral was invested was a prime factor in determining 

lending income. Securities lending agents, both custodian 

and third party, realized they could boost earnings by taking 

more risk in the investment of cash collateral. 

For the most part, it was not done by taking credit 

default risk -- beneficial owners could and did control that. 

But rather, the added risk came from taking on liquidity 

risk. Frequently beneficial owners did not understand the 

true dimension of that liquidity risk. Thanks. 
 

 

 

 

 

 

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MR. BRIGAGLIANO: Dr. Reed. 

MR. REED: I'd like to thank the Commission for 

having this roundtable and inviting me to speak at it. I 

appreciate the opportunity to talk about this. 

So I'm one of a very small set of academics that 

studied this market and study short selling more or less 

exclusively. So what I'll talk about in my opening statement 

is just sort of two categories of results that I've found and 

others have found. 

The first category is on short selling and how 

constraints on short selling affect markets. And the basic 

idea here is that finance academics would be in probably 

nearly 100 percent agreement that short selling improves 

market efficiency. These people are bringing information to 

markets and they're providing liquidity. 

So as a corollary to that, we could think of 

constraints on short selling decreasing market efficiency. 

That's a result that's been found -- it's a result that's 

been found in connection with the securities lending 

industry, too, as some stocks become difficult to borrow or 

they become expensive to borrow, these so-called stock 

specials, market efficiency tends to decrease in those cases. 

And that's how securities lending sort of connects with 

market efficiency. 

Recently, the Commission's rules on banning short 
 

 

 

 

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selling and requiring a pre-borrow had the expected effects. 

They decreased liquidity, and there's a number of papers sort 

of showing that short selling became expensive and liquidity 

fell, also market efficiency fell. 

One result that's a little bit unexpected out of 

the recent rule changes was the fact that some short sales 

actually had more price impact after the rule change than 

before the rule change. And these were the short sales in 

the period of the ban for stocks with options. 

In other words, since short sellers have to pay 

extreme fees and go through extreme measures to conduct a 

short sale through the options market, market participants 

other than the short seller himself saw that as an informed 

trade. 

The second category of research that I'd like to 

mention here is research directly on the securities lending 

market. In the securities lending market there are lots of 

characteristics, but one of the primary characteristics is 

that the majority of stocks are easy to borrow and cheap to 

borrow for short sellers, but everyday there are some stocks 

that are difficult to borrow. And these so-called stock 

specials that are hard to borrow stocks tend to arise out of 

episodic corporate events such as mergers and acquisitions or 

dividends. 

Specialness can decrease market efficiency, and one 
 

 

 

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of the more recent results is the fact that the search costs, 

the fact that securities lenders are fragmented contributes 

to price dispersion -- in other words, different short 

sellers paying different prices to borrow stock -- and also 

the level of prices. In other words, the lack of 

transparency in the market for borrowing stock makes it 

difficult to short sell, which has a direct impact on market 

efficiency. 

MR. BRIGAGLIANO: Thank you, Dr. Reed. And we 

appreciate the range of thoughtful perspectives we've heard 

at the open. And perhaps if the Chairman agrees, we could 

begin with Irv Klubeck providing a brief overview of the 

securities lending process today from the broker dealer 

perspective, and then we'll lead in to questions from the 

Commission. 

MR. KLUBECK: Thank you. The securities lending 

market in the U.S. equities market, specifically, really 

started in the late 1960s, early 1970s. During that time 

there was a paper crunch on Wall Street, and in fact back 

offices of Wall Street brokerage firms needed an extra day 

just to settle the massive amounts of paper that were being 

moved by the trades that were happening on the exchanges. 

One of the problems with settling trades, or not 

settling trades, if you will, is that you have risk to the 

counterparty. Securities lending transaction, in one way, 
 

 

 

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helps mitigate settlement risk. So if a broker, on behalf of 

a customer, were to sell securities to another broker and for 

some reason that stock was not available at the time -- and 

typically this happened especially when the securities 

markets were in a material form, when everyone actually had 

stock certificates and they had to go through a transfer 

process before we could actually make delivery on a security. 

So the broker dealer was -- wanted to make delivery 

of that sale, assuming a customer sold securities, but if 

they couldn't make delivery on the sale because the 

securities were not yet available to them -- my favorite 

example is the Disney stock that had the great pictures of 

all the Disney characters on the back of the stock, and 

everybody would take it and place it on their wall for the 

kids when they would go to college, and hopefully save it 

some day and then sell their stock. 

But if you didn't take the stock off the wall, you 

made the transaction to actually sell the securities but you 

didn't have the stock in hand at the time, the broker who was 

clearing your trade for you couldn't make that delivery on a 

timely basis. 

And so securities lending was really born out of 

the need to make deliveries, and that need to make delivery 

required the broker dealer to then go find securities. They 

had to borrow securities from someone who had them available 
 

 

 

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and willing to lend. 

And so the broker dealer would borrow the 

securities and then use those securities that they had 

borrowed to complete the delivery of the stock transaction 

that their customer had made. The cash collateral was 

received and had to be given to the lender of the 

securities -- Jerry mentioned 102 percent. 

So the broker dealer would borrow the securities 

and give 102 percent as cash collateral to the lender of the 

securities. The broker dealer will complete that delivery, 

and actually reduce their risk. They would reduce the risk 

because the party who was receiving the actual settlement of 

the trade now had their securities and paid for the trade 

that the customer had made, in effect reimbursing the broker. 

The broker would be able to collect the proceeds of the sale 

and use that to help finance for the borrowing of the 

securities. 

And why it reduced the risk to the broker dealer 

was because now the broker dealer had a transaction with a 

lender, as opposed to a settlement party, and that lender and 

the broker dealer would mark to the market every day. We 

would exchange cash to make sure that the lender always had 

102 percent or at least 100 percent of the market value of 

the securities on hand on a nightly basis. And so the 

securities lending market had daily mark to markets and it 
 

 

 

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still does today, and that is a way of mitigating the risk on 

the settlement side. 

Now the -- as the dematerialization of securities 

in the U.S. occurred, with the advent of DTC in the 1970s, 

and most of the securities in the U.S. markets, the equities 

markets started to clear and settle through a automated 

fashion at DTC, the securities lending process moved from a 

physical process also on to DTC and became a dematerialized 

transaction for the most part. 

And to this day, there are a number of automated 

processes that most medium to large -- and even the smallest 

of broker dealers -- will utilize to settle transactions. 

And most of them through the DTC -- Depository Trust 

Company -- electronic platform. In fact, most broker dealers 

today, I would say, borrow the vast majority of the 

securities that they need to make deliveries in an 

electronic, straight-through process with a lending 

counterpart. And for the most part it's done in a 

straight-through way. And in fact, the two parties probably 

don't have to talk to each other on a daily basis to transact 

in most securities lending transactions. 

This is a great panel because I think we've covered 

the wide gamut of who is involved in the lending process. So 

there's a lender of securities, there's a borrower of 

securities in every case. The borrowing of securities in the 
 

 

 

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U.S. markets are only allowed to be done by broker dealers. 

And on the bank side, you have custodial banks or agent 

lenders who are allowed to lend securities but not borrow 

securities. So broker dealers actually can both borrow and 

lend securities. 

And the broker dealers -- and that's where my 

expertise lies -- in the broker side of the equation, broker 

dealers typically use securities lending transactions to 

reduce settlement exposure, as I mentioned before, by 

eliminating fails. We also borrow securities as a 

alternative means of financing, and we borrow securities all 

encompass, though, in the U.S. marketplace, only in 

compliance with Regulation T, which sets out the permitted 

purposes that a broker dealer in the U.S. is allowed to 

borrow securities. 

I'll wrap it up very quickly. So the broker dealer 

side of the equation will borrow securities, will give up 

cash. I mentioned that it is a way of alternative means of 

financing. Many customers, throughout the course of history, 

have borrowed securities -- bought securities, rather, on 

margin. And when they buy securities on margin, what they're 

really doing is they buy securities and then they borrow some 

cash from their broker dealer to help them allow them to buy 

the securities. 

In the U.S., margin regulations allow a customer to 
 

 

 

 

 

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buy securities and they can pay for half of it and borrow the 

other half from their broker dealer. The portion of the 

securities that they don't pay for when they buy the 

securities -- the piece that they've, in effect, bought on 

margin -- the broker dealer is allowed to use those 

securities to help raise cash to replenish its own bank 

account for the money its lent to the customer. That term is 

rehypothecation -- I'm sorry, it's a very long word -- but it 

means basically to borrow securities in this case. 

And the broker dealer can take those rehypothecated 

securities, those securities that were bought on margin, and 

pledge them to a bank to borrow money to replenish its cash 

supply, or it can lend securities to another party, and by 

doing so it replenishes its cash supply. 

Thank you. 

MR. BRIGAGLIANO: Chairman Schapiro. 

CHAIRMAN SCHAPIRO: Thanks, Jamie. Mr. Klubeck, 

would you mind just a couple more minutes to explain to us 

what the components of the compensation structures are in the 

lending and borrowing chain? 

MR. KLUBECK: Thank you, yes. I think I'm in 

almost the right sequence -- not quite, though. So if Jerry 

and the New Orleans fund -- pension fund, and I hope I got 

that right, I'm sorry -- if their firm was to contract with 

an agent to lend securities, and that agent lent the 
 

 

 

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securities to a broker dealer, and the broker dealer was 

using those securities to either cover a fail or let's say 

that a conversation came up around a short seller or a hedge 

fund, so those are the four parties basically in the 

transaction. 

The ultimate beneficial owner, the lending agent, 

the broker dealer who is borrowing the securities, and then 

the need for the securities -- and let's say that there's a 

short seller involved. The vast majority of the profit in 

the transaction and the interest rate profit, as David 

described, can be sometimes very small or it can be very 

large. 

The majority of the profit on both ends of the 

equation would go to the lender of the securities, who would 

be the beneficial owner, and they would typically have an 

arrangement with the lending agent in terms of doing that. 

Current market practices could be anywhere from 70 to 80 

percent of the profit in that transaction would go to the 

lender -- the beneficial owner. 

The bank would share in that -- their component of 

the profit, and that would be the fee, if you will, for them 

to act as agent in the transaction. The broker dealer, in 

effect, becomes the middle man in the transaction, borrowing 

the securities from the agent bank, the custodial lender, and 

then, in effect, lending them to -- or at least providing so 
 

 

 

 

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that the short seller could do the short sale transaction. 

In David's example you had a wide range. You have 

fed funds today at 13 or 14 basis points, and then you have 

the example of Sears -- which I don't have the exact numbers 

in front of me; I'll use David's numbers and assume they're 

perfect -- 28 percent spread. 

The securities lending market is actually a supply 

and demand market -- it follows the basic laws of economics. 

And if Sears, in David's example, if Sears had been in 

plentiful supply and readily available in the lending 

marketplace, and there were plenty of shares able to be 

borrowed, then that security would be easy to borrow and 

there would be no supply-demand effect on that spread, and 

then we'd be talking with the 13 basis points equation. 

In the case where something may not be easy to 

borrow, and a security is -- there's a lot of interest in 

selling a stock short, and there's more shorts, if you will, 

than the supply would allow, then basic laws of supply and 

demand would say then, just like any other goods or services, 

if there's a tremendous demand and not enough supply the 

price would move towards the proper efficient price. 

And in the securities lending market, that price 

movement is actually the rebate rate, or the interest rate 

paid by the ultimate borrower of the securities to the 

ultimate lender of the securities. 
 

 

 

 

 

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So hopefully -- I'll get right to your answer, 

right to the question, is, that most of the profit goes to 

the beneficial owner, and in the case of a hard to borrow, 

most of the payment is made by the actual ultimate short 

seller. 

CHAIRMAN SCHAPIRO: Thank you, that's really 

helpful. And it leads to a question -- and somebody 

mentioned this in their submission, and I read these last 

evening so I can't tell you exactly who mentioned it, but 

also a question maybe for everybody -- to what extent has the 

goal of growing lending income driven investment decisions so 

that more and more investment decisions may be made by funds 

in order -- in hard-to-borrow securities, because the revenue 

from that will be higher, rather than maybe fundamental 

investment strategies? 

MR. PRIDMORE: I think that might have been my 

submission. 

CHAIRMAN SCHAPIRO: I actually think it was your 

submission. 

MR. PRIDMORE: You know, it's interesting, in the 

hard-to-borrow stocks, most of the compensation is coming 

from the intrinsic value of that lending transaction. For 

the more readily available securities, the portion of 

compensation that comes from the intrinsic value is very 

small, and most of the return is generated in that spread 
 

 

 

 

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between where the cash collateral is invested and the rebate 

rate. 

And generally it is a fairly small margin. So if 

you take a little bit of extra risk in investing the cash 

collateral and, say, gain 10 more basis points of return on 

the cash collateral -- which doesn't sound like a lot -- it 

might be -- represent a 40 percent or 50 percent increase in 

lending income for that transaction. 

So the dynamics on the hard-to-borrow stocks, a 10 

basis point change in investment return won't make that much 

difference. On a 2800 basis point return on Sears stock, 10 

basis points doesn't mean a lot. But on a more normal 

transaction which might have a spread of 25 basis points, 10 

basis points can mean a lot. 

So most transactions in securities lending for the 

beneficial owner I think are skewed towards those more normal 

types of returns of 25 basis points. So there is a bigger 

incentive to take more risk with a cash collateral 

investment. That's my perspective. 

MR. DOWNEY: I agree, but in the general 

collateral -- today, the beneficial owners -- correct me if 

I'm wrong -- are basically paying for custody today. 

Effectively they're paying a few basis points. The fact is, 

is that I know very few professional traders who are getting 

any rebate on any name because of the low interest rates. So 
 

 

 

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negative rebates are across the board. 

Accordingly, someone who is long in a stock, who is 

the custody or the prime broker, is lending this out a 

negative rate, and then getting positive rates from the 

lender. So there's still a spread out there. And when you 

talk about 10 basis points or maybe 12 basis points, I think 

that's what CalPERS said that they earned on their lending. 

So they made a ton of money, you know, 12 basis points added 

up to $150 million for them in 2007. 

So in many of the general collateral names today, 

you see negative rebate rates sometimes approaching 50 basis 

points, 32 basis points, 12 basis points, right. And it 

fluctuates daily. So there is profits in this trade. Don't 

be confused that it's just a couple basis points here and 

there. When you talk about doing this stuff in size, it 

really adds up to real money that buys an awful lot of 

pencils. 

COMMISSIONER PAREDES: One of the points that Mr. 

Davis made is the development of checklist on a going-forward 

basis, and using that as something to key off. I'm curious, 

now that there's a greater appreciation for what some of the 

concerns are and what some of the risks are along the whole 

chain of the transaction, in addition to the prospect of 

diligence checklists, what other market-based adjustments, if 

any, have been made or are folks contemplating or do you 
 

 

 

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folks anticipate being made in the future? And I'd be 

curious in terms of what some of the items are in terms of 

the checklist that you all are considering. 

MR. DAVIS: The central problem that we encountered 

was in the mark-to-market area. Historically, of course, the 

bank was always very careful to mark the mark to 

market -- the value of the securities out on loan, but as 

we've seen, there's no requirement at all to mark to market 

the value of the collateral that's sitting there. 

And if you invest collateral in paper of various 

kinds -- and for reasons of market action or that individual 

issuer the paper is becoming less valuable -- there appears 

to be no procedure in place to regularly monitor that. And 

so since that's the only area of loss we've ever experienced, 

I think that's where we're looking for checklists to come 

from the bank -- what are you doing about the type of 

collateral you've accepted or put in place for our securities 

out on loan, and how are you monitoring the changes in that 

value, and what would you do -- what can you do as the 

lending agent to adjust the collateral when in fact the 

security on loan may not have changed in value at all but the 

investment you made in collateral has changed. 

COMMISSIONER WALTER: In that respect, we've heard 

that mutual funds may not have experienced the same levels of 

losses that other lending institutions have. Do you have any 
 

 

 

 

 

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comments on that, or is there anything that other types of 

institutions can learn from how the funds handle this? 

MR. DAVIS: Well, we don't invest in mutual funds 

at all, so hopefully one of the other panelists might have an 

idea of why the difference exists. 

MR. PRIDMORE: I do some work for some mutual fund 

complexes, and I think that you're right, many of them 

approached securities lending with a little bit different 

perspective, and would focus on the reinvestment of cash 

collateral as one of the key principal areas of risk in the 

transaction. 

I worked very closely with a fund complex that was 

very skeptical about lending, and concerned about potential 

about the potential price impact on their portfolio, but also 

was very concerned about the risk of securities lending, not 

only broker dealer defaults, but also the investment risk. 

And they took an approach that studied the market 

and studied these risks and put in place a program with a 

third-party lending agent, and actually entered the lending 

market in September of 2008, which you could argue was 

probably the worst time possible to enter the securities 

lending market. 

And from a risk perspective, they operated their 

program for about a month, and because of the concerns of 

systemic failure of the financial system, they decided to 
 

 

 

 

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shut their lending program down, and they were able to 

withdraw from lending and get all their collateral -- all 

their securities back and liquidate their cash collateral 

investments at par. 

How do they do that? They invested the cash 

collateral in 2a-7 money market funds that -- and further, 

they took an even more conservative approach and invested 

only in Treasury and agency money market funds. They didn't 

even want the investment risk underlying a typical money 

market fund. 

COMMISSIONER WALTER: Do you have any insight into 

why a more conservative approach was taken there? Is it 

because of the nature of the business, is it because of some 

of the aspects of investment company regulation, or is it 

just pure speculation and we can't say? 

MR. PRIDMORE: I think it was because of the active 

management -- active involvement of the investment management 

people, staff, in the process. They took an investment 

management approach to the whole securities lending world and 

decided that the cash collateral investment risk was one of 

the key areas of risk, and designed the whole program to 

contain risk. 

They also took an approach that was not designed to 

maximize the income of their service provider, but was 

designed to maximize the risk-adjusted income that they were 
 

 

 

 

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going to earn from the program. And part of that was not 

ballooning their balance sheet with more loans, but instead 

focus on only the most profitable lending transactions. And 

in doing so, they keep the size of their book smaller than it 

might have been in other situations. 

So smaller size, less risk; more conservative 

investment, less risk -- those are the sorts of things that 

they looked at. I don't know that I could attribute it to 

any regulation, it was more the investment management 

approach that they employed. 

COMMISSIONER WALTER: Thank you. 

MR. DOWNEY: Could I comment on that? There's two 

different types of people in this world, there are front 

office people and there are back office people. And front 

office are traders. They think in a particular way, they 

have a particular language, you talk in BIP rates. 

And back office people, they are very -- they're 

low key, they're conservative, and they're the ones who 

harbor all these stocks, and they're the ones that -- they 

knocked on their door, can I borrow your shares and I'll give 

you some free money. You see, that's where the pension 

funds, they gather all their assets and they put them in our 

back office and it's the back office who are dealing with 

these sharks, these traders who are very good with BIPs and 

know how to trade. 
 

 

 

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And in the mutual fund, mutual funds that I had 

talked to, these guys are traders. They know exactly what's 

going on, and I know several who they don't participate in 

any of that general collateral names, because they only trade 

the intrinsic value, which is the hard-to-borrow names. Not 

all of them, but in general I find that the mutual funds are 

generally more attuned to the fact that securities lending is 

a financing tool, securities lending is an integral part of 

trading, and as I mentioned in my comments, that this is a 

back-office operation. That's what the failure here -- if 

this was in the traders' hands, this would not have occurred 

because they would have covered their risk a lot sooner than 

happened. 

MR. BRIGAGLIANO: I have a question for Jerry 

Davis. You expressed concerns about the master loan 

agreement that you executed when your fund allowed its shares 

to be lent. Do you have any views on whether there should be 

more disclosure in that agreement, specifically of the risks 

and how collateral can be reinvested? 

MR. DAVIS: I absolutely think there should be more 

disclosure and a more precise commitment from the lending 

agent, in terms of what they will do under what 

circumstances. The exhibits to that agreement were marvels 

of simplicity. The exhibit number three, I will never 

forget. It purported to list the allowable investments for 
 

 

 

 

 

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collateral alone. And it said cash, securities and letters 

of credit, period, the full content of that page. 

There was nothing about the rating of these various 

instruments, there was nothing at all about the monitoring of 

the instruments, there was nothing at all that described how 

the bank was going to care for those instruments. So I think 

that even though the document itself, for a small fund like 

ours, was 30 pages, the meat of it was the protection for the 

lending agent, not for the beneficial owner. 

CHAIRMAN SCHAPIRO: If I could just follow up on 

that and on the conversation about how mutual funds might 

have done it a little bit better. Do any of you have a sense 

of, sort of across the industry, when the credit crisis hit 

the number of securities lending, cash reinvestment programs 

that experienced real illiquidity or restrictions on 

reinvestment or the inability for investors to get 

their -- beneficial owners to redeem? 

MR. DAVIS: Wrong panel. You've got to talk to the 

custodians. 

MR. PRIDMORE: I think it was pretty universal. I 

don't think that there's a major securities lending program 

that didn't have some less-than-liquid securities in their 

cash collateral investment portfolios. 

And part of the reason was that many of them were 

purchasing securities that were really designed to fit the 
 

 

 

 

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securities lending buyer, the securities lending cash 

collateral investor. And those instruments were frequently 

designed to appeal to a securities lending investor by having 

a floating -- a short-term floating rate, but a long 

maturity. 

So they might have a daily fed funds float or a 

one-month LIBOR floater rate on the instrument, but it would 

have a three-year maturity. So it could pay a overnight 

market rate, but when there was a liquidity crisis there were 

no buyers, because the natural short-term investor, like 

let's say a 2a-7 money market fund, cold not buy that 

security. 

And other short-term investors were hording their 

cash and putting it into repurchase agreements or overnight 

Treasuries, so that left most institutions who had invested 

in that type of paper with a pretty serious liquidity 

problem. 

MR. DAVIS: You can pretty well identify the banks 

by the securities class actions that have been filed. I know 

of a number of them. We are very active litigators. We were 

not large enough in this particular area to be assigned lead 

plaintiff, but I know there are least three actions out there 

involving the big four in the lending business, and probably 

others I'm not aware of. 

MR. BRIGAGLIANO: Do the Chairman or Commissioners 
 

 

 

 

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have additional questions? Commissioner Casey? 

COMMISSIONER CASEY: I just have a follow-up 

question for Mr. Pridmore with respect to what your view is 

about the state of independent risk assessment. You 

mentioned that there were practical steps that investors 

could take, and do you distinguish those between -- you 

distinguished between those with good independent assessment 

practices and those who didn't, in terms of how they fared 

through the credit crisis. 

Do you have a sense of -- maybe any of you could 

answer this -- a sense of how much improvement you've seen 

over the course of the crisis? 

MR. PRIDMORE: Well, I don't know that the 

improvement has hit home yet. I think there is so much shock 

in the system that most institutional funds really, truly 

were shocked that they had this problem, that they were 

sold -- they believed they had purchased a program that had 

limited risk. And I'm not accusing the third-party lenders 

or the custodian banks of doing anything to hide this risk. 

It was a risk that really hadn't been experienced in a major 

way before, and I think that they hadn't really assessed the 

possibility of it occurring. 

But I think that in my discussion this shock is 

beginning to wear off, and people are saying, let's think 

about lending now in terms of how do we limit those sorts of 
 

 

 

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risks, and going forward, designing risk controls that take 

those risks into consideration. 

MR. DAVIS: The unprecedented situation we were 

placed in -- when a manager gets in trouble with us, we 

always have the discretion to fire them within 30 days. When 

the securities lending program tanked and it was clear that 

our cash collateral situation was going to be a very bad one 

and our revenues were not going to be good for some time, we 

said, well, let's just quit lending for a while. And the 

bank said, well, that's fine, but you'll have to write us a 

check for $500,000 if you want to get out. 

So the idea of having to pay to exit a program that 

we were already losing money on was a pretty instant and 

nasty shock, and it's left a bad taste in everyone's mouth. 

So we're still participants of a sort. We're still receiving 

small monthly checks from the various lending operations the 

bank is doing, but we got that half million dollar bill 

hanging over our head for the lesser value of the collateral 

out on loan for previous lending operations. 

COMMISSIONER WALTER: Professor Reed, you've talked 

a little bit about your research. Can you give us an 

overview of what the other research in the field is -- and I 

gather there aren't that many of you -- and whether there's 

in general a consensus among the folks who have been doing 

academic research? 
 

 

 

 

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MR. REED: Yeah, in some sense there is -- there's 

one area where there is some controversy and one area where 

there is more or less consensus. Most of the academic 

research that's come out, especially recently, on securities 

lending itself sort of treats it as a pretty illiquid market. 

And I think there's pretty broad agreement on that. 

And since there is an illiquid market there, it can 

have effects on the underlying stock prices. If you're 

trying to conduct a short sale, this illiquid market might 

get in the way of that short sale. So not enough people are 

able to do the short sale, so you can have situations where 

prices are too high in the underlying stock market. 

Lots of research has shown this. Some of the 

research has compared prices in the options market to prices 

in the stock market and shown that occasionally prices in the 

stock market can be significantly higher than prices for the 

equivalent thing -- the equivalent combination of options in 

the options market. 

There's a little bit of disagreement about the 

effect of short sale constraints on the underlying price. 

There's sort of one group of research -- and there's evidence 

for both sides, really. One group of research that shows 

that if short selling is constrained we have temporary price 

increases in stocks, and there's another group of research 

that basically shows that as long as everyone knows the 
 

 

 

 

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prices are constrained the stock prices won't get misaligned 

and effectively the constraints will just decrease the speed 

of adjustment and prices won't become efficient. 

CHAIRMAN SCHAPIRO: Jamie, if I could ask maybe a 

final question. What would -- love to hear from each of you 

on this -- what would be the best improvement, whether it's 

by regulation or industry practice, that could be made to 

this market? What's the single thing that's -- I've heard 

transparency, I've heard disclosure, pricing, but what's the 

key thing for us to really try to affect change here? 

MR. DAVIS: The key thing for the investor, I 

think, is an improvement in the alignment of interests 

between the parties involved. I think there's been a real 

imbalance between who benefits and who suffers among the 

various players. 

From our perspective, we seem to be the big loser 

in the entire process, and it was our money in the first 

place that was put out there to buy the stocks that then went 

out on loan. And so I don't know to what extent any of the 

other players are suffering any losses other than reduced 

business, but we have certainly suffered, at this point at 

least, real cash losses and therefore the interests seem to 

be out of balance in the way the agreements are structured. 

MR. DOWNEY: Mary -- sorry, Chairman Schapiro, 

transparency is the key here. If we know, like Professor 
 

 

 

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just mentioned, that he recognizes that there are odd pricing 

and option combos, that's exactly what I told you happens in 

the futures. That is because there's a pressure that only a 

certain number of people know about, and only a certain 

number -- few people control, and it puts pressure on these 

forward values because of the negative rebate rates. 

Transparency is the number one key. They have to 

remain transparent. You can do it through security futures. 

It's very easy to do. We distribute it on our website and we 

can track that fluctuation there. AQS is coming out, and 

they're going to bring some transparency to this product, as 

well, if there is enough participants -- and that's the major 

key -- if there is enough participants. 

And the third thing, and this is going to be a bit 

controversial, but securities lending is really a buy and 

sell of a stock that doesn't have a section 31 fee associated 

with it. And you can, in fact, govern people who are trying 

to loan their stocks out, their general collateral was just 

to gain money to reinvest, if that's still their game, by 

simply putting a fee associated with it, just you'd do with 

any other stock transaction. 

And that will slow down the desire to loan these GC 

names, and then there's also -- there's an embedded forward 

contract that I'm going to get this back in the future. My 

product, I have to pay 4.2 cents or forty-two hundredths of a 
 

 

 

 

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penny per contract. 

You should do the same thing, and that will reduce 

the desire to do these trades in a counter-party risk 

environment, and you would bring this in to a clearing 

operation where mark to market discipline is put into effect 

and you would be able to achieve all of the securities 

lending goals of lending it out, keeping the markets liquid, 

and producing profits for the beneficial owner of the stock. 

Now Irv mentioned something very important, that 

broker dealers today are the only ones who can both borrow 

and lend. I have to disagree. Using the futures market 

today, an individual with a hundred shares of shield, on 

margin, who is now paying an interest rate, and this broker 

dealer is in fact taking that half of a hundred shares, and 

loaning it out at 28 percent, that small customer could EFP 

that transaction on a regulated exchange in a clearing house 

environment, and they can capture that full rate and not cede 

it to the member -- broker dealer. 

So it is available, it's there today, AQS will 

bring something to the market, there will be others coming to 

the market with solutions, OneChicago is just one. It will 

not fit everybody, but it provides solutions that -- and with 

a little bit of effort on the SEC part -- you don't have to 

do much, just promote the idea. 

Right now you -- today, set my margin at 20 percent 
 

 

 

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performance bond. That puts me out of the swap market, which 

is another securities lending. I have requested relief to 15 

percent, in line with options, portfolio margining. I am now 

waiting more than a year for approval. There is nothing I 

see wrong with this. You could, with a very simple act, put 

me into the swaps game, which would put me competitive with a 

securities lending transaction over the counter. 

One more thing that you have to understand is, this 

is tied to portfolio margining. Portfolio margining is an 

interest rate, it's the effective use of capital, and that's 

part of your job, is to regulate in a way that there's 

an -- the efficient allocation of capital across our markets. 

Portfolio margin is hampered today because it doesn't include 

indexed futures. This is a disagreement with the CFTC. 

While not apparent to you now, if you approve that, 

somehow get over this hurdle, the member firms will change 

their systems to allow those types of futures to sit inside 

of the same account as securities. At that time, they will 

do that because the customers will demand it, they want to be 

efficient. At that time you will see more of these over the 

counter trades going in because of that ability to do so. 

MR. KLUBECK: The one thing that I think we could 

do -- David, you said a lot of things that I'd love to talk 

to you about later, and I don't have time to retort some of 

the things that I heard in your comments -- but what I will 
 

 

 

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say is that the securities lending marketplace, I think, a 

lot of talk around transparency and efficiency. I think the 

market is fairly efficient. I do think that it is and does 

apply the rules of supply and demand, basic economic laws. 

What I do think we could change, though, is -- and 

this is probably for a later panel -- we talk about the short 

selling rules, Regulation SHO and the changes that have been 

made over the last couple of years, and I think they've all 

been fantastic rules in terms of helping to make sure that 

securities lending transactions are there to support short 

selling and -- in the marketplace in general. 

I would expand that beyond just the equities 

markets, and I would include in the fixed income markets, 

which theoretically may open up a different can, in terms of 

how that is happening. But I think that the concept of 

shorting as well as borrowing securities, which because 

they're tied together today, should extend into the fixed 

income markets, as well. 

MR. PRIDMORE: I think it's really interesting that 

we're here after a major financial crisis and we're not 

talking about losses that were suffered by the major broker 

dealer defaults that occurred. So what does that tell me? 

That tells me with securities lending the basic fundamentals 

of risk protection from the broker dealer default risk 

are -- worked very well. 
 

 

 

 

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So not all of securities lending is broken. I 

think what has been a problem, clearly, has been the 

investment of cash collateral. And I think that what the 

Commission can do is step forward and make a recommendation 

that people do an independent -- make sure they do an 

independent risk assessment of their securities lending 

program and focus on the investment of cash collateral as one 

of, obviously, the key areas of risk. 

MR. REED: I'd say if there's one thing we can do 

it's to try to support securities lending as sort of a 

background for short selling. I think that the work that 

I've been involved in, along with the work that others have 

been involved in, it's sort of unanimous that short selling 

is probably a force of good in markets generally. 

So to the extent that we can make the securities 

lending transaction easier, transparency is one way to do it, 

but sort of -- to avoid fees and to avoid limits of any kind 

on short selling and securities lending, that would make 

short selling easier and potentially improve market prices. 

MR. BRIGAGLIANO: Well, we have time for a couple 

more minutes. So I want to ask one question to Irving. 

Irving, so how does a borrower going to a broker dealer know 

it's getting a good price on the stock it's borrowing? How 

can it tell whether it should be paying less and it could be 

paying less somewhere else? 
 

 

 

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MR. KLUBECK: Using the basic rules of supply and 

demand, we have relationships with many different lending 

firms, both in the agent lending custodial side of the 

equation, as well as broker dealers who also lend their 

securities. And literally, what we do in the morning is we 

will call and we will contact the counterparties who we might 

be able to borrow securities from, and we will ascertain the 

rates of the rebate rate, or in effect, how much we either 

have to pay or we might receive by borrowing those 

securities. 

If you follow the chain or the good spy novels 

follow the money, the cash is coming from the -- let's say 

again a short seller, given to the broker dealer, the broker 

dealer passes that cash proceeds on to the agent bank, agent 

bank down to the end beneficial owner where the cash gets 

reinvested. 

And so what we're really talking about is how much 

of that cash reinvestment is available back to the broker 

dealer and to the end customer who might be on the short 

side. The laws of supply and demand are, again, if a lot of 

broker dealers are calling looking for the same securities, 

the party in the other side, the potential lenders, they hear 

the noise; they understand that there must be a demand for 

these securities, and they start to raise the spread -- they 

raise the price, if you will. It's not a -- the price of the 
 

 

 

 

 

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securities in the regular trading markets, it's the rebate 

rate. 

And therefore you go from a very small spread -- if 

the stock becomes very illiquid from a securities lending 

standpoint, the supply and demand will force that price down 

and will force suddenly -- we talked about negative rebates, 

especially in a low interest rate environment, negative 

rebates are more prevalent. 

And so what I'll do as a broker dealer is I will 

call 30, 40, 50 counterparts, ascertain their rates and 

whether it's on easy-to-borrow securities or hard-to-borrow 

securities, and then what I will do is I will try and find 

the best price or the highest interest rate back to the 

broker dealer and to my investor. 

MR. BRIGAGLIANO: Well, thank you, Irving. I note 

that in the next couple of panels we'll be taking a deeper 

dive into collateral reinvestment as well as transparency. 

So we've now reached the end of the first panel discussion, 

and I'd like to thank our panelists for their insights and 

candor. We'll have a short break and we'll start the next 

panel promptly at 11 o'clock. Thank you very much. 

(Applause. Brief recess.) 

CHAIRMAN SCHAPIRO: Let's go ahead and get started. 

I'd like to welcome our panel two participants. Before I 

turn this over to Buddy Donohue and Henry Hu, I should note 
 

 

 

 

 

 

 

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for the record -- as I should have at the very 

beginning -- that Commissioner Aguilar is actually joining us 

in cyberspace and participating as well. 

So Buddy and Henry. 

MR. DONOHUE: Welcome back to panel two, which is 

entitled, Securities Lending and Investor Protection 

Concerns; Cash Collateral Reinvestment; Default; Lending 

Agent Compensation and Fee Splits; Proxy Voting. 

I'm Buddy Donohue, Director of the SEC's Division 

of Investment Management. My co-moderator is Professor Henry 

Hu, Director of the SEC's new division of Risk, Strategy and 

Financial Innovation. 

MR. HU: Welcome. 

MR. DONOHUE: As the title suggests, panel two will 

cover a lot of ground. First, we will explore securities 

lending cash reinvestment risk, a risk that very much became 

a reality recently when a number of securities lenders in the 

U.S. experienced unanticipated illiquidity and losses in 

connection with their cash collateral reinvestments. We will 

also explore possible alternatives that might mitigate this 

risk. 

Second, we will briefly discuss the risk of 

borrower default and the protections that exist with respect 

to this risk. 

Third, we will explore lending agent compensation 
 

 

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and fee splits, a topic that received some attention in the 

media last spring. 

And finally, we will look at proxy voting of 

securities on loan. More specifically, we will look at the 

logistical impediments that securities lenders may face when 

they want to vote the proxies of securities on loan, and 

whether the transfer of the proxy votes to securities 

borrowers gives rise to the practice known as "empty voting," 

a subject with respect to which my colleague, Professor Hu, 

is an authority. 

We are fortunate to have a very distinguished panel 

of experts with us today: Patrick Avitabile, Managing 

Director and Global Head of equity trading for Citigroup's 

securities finance businesses; Ed Blount, Founder and 

Executive Director of the Center for the Study of Financial 

Market Evolution; Karen Dunn Kelley, Chief Executive Officer 

of Invesco fixed income, and Executive Vice President of 

Invesco Aim Distributors, Inc.; Bruce Leto, partner at 

Stradley Ronon Stevens and Young, and the Chair of the firm's 

Investment Management/Mutual Funds practice group; Kathy 

Rulong, Executive Vice President of the Bank of New York 

Mellon Corporation and Executive Director of BNY Mellon 

Global Securities Lending; Julia Short, President and CEO of 

RidgeWorth Funds, and Managing Director for RidgeWorth 

Capital Management, Inc.; and Christianna Wood, Chairman of 
 

 

 

 

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the Board of the International Corporate Governance Network. 

Each panelist will now give an opening statement 

not to exceed three minutes. Following the opening 

statements, the panel will receive questions from Chairman 

Schapiro and the Commissioners. We would like to have as 

lively a discussion as possible. Accordingly, please speak 

up if you disagree with another panelist or have something to 

add. 

Patrick, would you like to start us off with your 

opening statement? 

MR. AVITABILE: Good morning, and thank you 

Chairman Schapiro and members of the Commission for the 

opportunity to speak here today. I am pleased to participate 

on behalf of Citi in this roundtable to examine securities 

lending and investor protection concerns. 

I am the Global Head of equity trading for 

Citigroup's securities lending program, and I am responsible 

for trading units in New York, London and Hong Kong. Citi is 

a global financial services company which provides consumers, 

corporations, governments and institutions with a broad range 

of financial products and services. Citi has $11.1 trillion 

of assets under custody servicing clients in more than one 

hundred countries. Citi acts as a custodial and 

non-custodial directed lending agent for a broad range of 

domestic and foreign clients. 
 

 

 

 

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As securities lending has developed into a critical 

element to market liquidity, it has not lost its fundamental 

purpose for lenders: incremental income with limited risk. 

The maximization of revenue, although a daily goal, is 

secondary to the safety of the principle of collateral and 

operational efficiency. 

Open architecture, customization, flexibility allow 

a lender the ability to be consistent with its management 

objectives and risk-reward appetite. Transparency, full 

disclosure, controls, ability to change its lending profile 

in order to market conditions are essential elements of a 

lending program. 

In addition to the topics we will cover on the 

panel, there are additional factors that impact investor 

protection. A central theme for these additional factors is 

communication, and I believe that's why we're here today. As 

new challenges result from market changes in demands, it is 

essential that the lender, their advisors, lending agent, 

borrowing counterparties and regulatory bodies maintain open 

dialogue to make the securities lending financial tool 

responsive to changing market trends, at the same time as 

maintaining the fundamental principles on which this market 

has been established. 

For this reason, lender protection must be built on 

a foundation of continuous lender communication of issues and 
 

 

 

 

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goals. Open dialogue is essential to the effectiveness of 

the agent bank to structure a lending program that meets the 

return objectives of the lender and satisfies the lender's 

individual risk profile. Periodic reviews of the program as 

well as regular customized reporting and daily access to loan 

and investment information ensure transparency and control by 

the lender. 

Finally, maintaining open dialogue will ensure that 

the securities lending program evolves and remains consistent 

with the constantly changing and market-sensitive investment 

philosophy of the lender. Thank you. 

MR. DONOHUE: Thank you, Patrick. Ed. 

MR. BLOUNT: I'd like to thank the Chairman, the 

Commission and the staff for inviting me here this morning. 

I'm the Executive Director of the Center for the Study of 

Financial Market Evolution, which is a fairly long title to 

describe a fairly simple mandate. Our mission is to gather 

and compile and scrub data that will then be presented to 

academics to conduct research into otherwise opaque sectors 

of the market. 

The Center is based here in Washington and we have 

a processing facility in Zurich. The original intention was 

to be able to allow academics to get a robust data set 

instead of the more typical single data set that they were 

conduct their research with. 
 

 

 

 

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It's been a challenge to assemble this organization 

and put it together. Our first project has been to try to 

compile sufficient data to respond to the academic 

allegations that were voiced some three or four years ago 

that activist hedge funds were borrowing securities in order 

to manipulate the proxy votes of corporate targets. 

We spent a great deal of time trying to figure out 

if that could be true by accessing a database that was housed 

at a consulting group that I owned and ran at the time. We 

came up with some initial findings that caused some suspicion 

about whether the academic allegations were true, even though 

we didn't and couldn't refute them. 

We therefore said, well, let's continue to drill 

down, get more data. That project has continued on, and we 

are at the point where we expect by the end of the year we 

will have probably some 90 percent of all the transaction 

data within the U.S. securities lending market, representing 

all the activity between 2005 and 2008. 

The second project, beyond the borrower proxy abuse 

project that we're working on, is an analysis of the dynamics 

of securities lending cash collateral during the recent 

market crisis. For that, we're relying on data that the risk 

management association compiles quarterly from its members 

and presents publicly, but we've been trying to look at it in 

order to determine what may have happened and what rules 
 

 

 

 

 

 

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might be available from that. 

As a personal introduction, my background is that 

I've been involved in securities lending for well over 30 

years, since I was brought from Citibank to Bankers Trust to 

create a securities lending program to buttress the earnings 

of the custody service that was at the time deeply underwater 

in the wake of the DTC immobilization of securities, which 

destroyed the business model of the custodians that had been 

in place for a couple of generations. 

I stayed involved after I left Bankers in 1980 by 

founding a Wall Street consulting firm which was essentially 

systems design, until the early '90s, when we became a 

database research firm, again tracking securities lending but 

also working on cash management and a variety of other 

services. 

We were the first to develop a performance 

measurement system for securities lending and a loan pricing 

service that operated on a daily basis, which I sold as a 

business about a year-and-a-half ago, and then took over 

full-time management of the Center for the Study of Financial 

Market Evolution. 

So thank you again for inviting me today, and I'll 

do whatever I can to shed some light on these issues. 

MR. DONOHUE: Thank you, Ed. Karen. 

MS. DUNN KELLEY: Thank you, Chairman Schapiro and 
 

 

 

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members of the Commission for the opportunity to participate 

in today's panel. My name is Karen Dunn Kelley, and I am the 

Chief Executive Officer, Invesco fixed income. 

Invesco is a leading global asset manager which is 

also publicly traded on the New York Stock Exchange. 

Invesco's operations span 20 countries, serving clients in 

over 100 countries, with approximately $389 billion in assets 

under management as of June 30th. This includes $149 billion 

within the AIM mutual fund complex, which is managed by 

Invesco AIM funds. 

Several of the Invesco entities have been involved 

in securities lending programs throughout the world. The AIM 

funds operate a very large lending program. Invesco AIM also 

manages the cash collateral for a variety and various 

third-party lending agents. I have been involved in the AIM 

fund's security lending program since its inception in 1999. 

It was created as an intrinsic value lending program. The 

funds lend securities through agent lenders and principals 

with Invesco AIM retaining management of the cash collateral 

in all instances. 

My observations today will be drawn from my 

experience with the AIM funds program. We believe securities 

lending continues to play and will continue to play a vital 

role in the healthy functioning of global security markets in 

enhancing liquidity, promoting efficiencies, and facilitating 
 

 

 

 

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trading in equities and fixed income. 

In addition, a properly structured security-lending 

program can provide institutional lenders such as mutual 

funds with incremental portfolio returns without increasing 

significant risk. 

Recent market upheavals which have been affected 

throughout all the industry, however, have highlighted 

certain potential risks associated with the securities 

lending industry that may not have been fully articulated 

during a more typical time period. 

At Invesco, we believe the appropriate role of 

securities lending programs is to generate additional fund 

income without materially increasing the lending fund's risk. 

Consistent with that view, we believe that a prudently 

structured and customized securities lending program should 

be focused on the intrinsic value of the loans as well as 

risk mitigation. 

Implementing a strong securities lending program 

includes several critical components. First, agents and 

lenders must work together to clearly identify and articulate 

the level of risk in which a lender is willing to take. 

Also, that risk must talk about counterparty risk, collateral 

selection as well as guidelines as an important aspect of 

those discussions. Ongoing communication and review of the 

program is also critical. 
 

 

 

 

 

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Prudent lending also requires continued vigilance 

with respect to counterparty and borrower risk. A stringent, 

carefully monitored credit process allows agents and lenders 

to quickly identify and to mitigate potential trouble loans. 

This should be coupled with very strong legal protections as 

well as operational processes. 

Another integral part of a securities lending 

program is a solid set of proxy voting policies and 

procedures. It is essential for the fund to fulfill their 

corporate governance responsibilities as a beneficial owner 

of the lendable securities. Lending funds are obligated to 

have their voices heard on important proxy issues, but doing 

so requires careful attention, coordination and operational 

preparation. 

In summary, Invesco believes that the securities 

lending practice will continue to evolve. All parties must 

remain focused on accountability, communication and 

transparency among beneficial owners, cash collateral 

managers, as well as lending agencies. Thank you very much. 

MR. DONOHUE: Thank you, Karen. Bruce. And would 

you turn off your mics when you're not speaking? It would be 

appreciated. Thank you. 

MR. LETO: Thank you, Chairman Schapiro and members 

of the Commission for allowing me the opportunity to express 

my views today at this roundtable. Mutual funds are 
 

 

 

 

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important participants in the securities lending markets, and 

comprise a significant percentage of lenders. My remarks 

today will be focused from the point of view of representing 

mutual funds and boards in the securities lending process. 

Although I represent several fund families that 

engage in securities lending, this statement reflects only my 

own personal views. 

The Investment Company Act of 1940 does not 

directly address securities lending. It does, however, 

include broad provisions that require good and safe custody 

of portfolio securities, that limit the leverage that funds 

can incur, and that protect funds against conflicts of 

interests with their affiliates. 

The staff of the SEC has provided guidance on the 

application of these provisions to the securities lending 

process primarily in a series of no-action letters, beginning 

in 1972. Securities lending by funds did pre-date those 

letters, however. 

In general, in my view, the current regulatory 

guidance on securities lending is somewhat outdated, and was 

drafted at a time when the securities lending process looked 

somewhat different from what it looks like today. 

Consequently when new wrinkles in the process are identified, 

legal guidance must be drawn from no-action letters and other 

guidance that was drafted before such wrinkles occurred. 
 

 

 

 

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For example, the use of unregistered securities 

lending cash collateral pools is a relatively new phenomenon 

that did not exist at the time that the no-action letters 

were drafted, and that only has been addressed to a limited 

degree through SEC exemptive orders and the rule making 

processes. 

In their oversight of securities lending 

arrangements, fund boards would benefit from updated 

regulatory guidance that takes account of current market 

conditions. Ideally, the updated guidance would be made 

through a notice and comment process, resulting in an 

interpretive release or rule making that has received the 

benefit of comments from fund boards and other industry 

participants. 

The interplay of proxy voting in the securities 

lending process is another area where new or additional 

guidance would be useful. According to SEC staff 

interpretations, in the event management has knowledge that a 

material event will occur affecting a security on loan, the 

directors must call the loan in time to vote or otherwise 

obtain rights to vote. 

In practice, however, management often does not 

have knowledge of material events, because issuers typically 

do not give notice of the matters to be voted upon until 

after the record date. Furthermore, even if the fund were 
 

 

 

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aware of a material matter to be voted on, it may not be in 

the best interest of fund shareholders to recall the security 

in order to vote. Thus the fund and its board are placed 

directly in the crosshairs of two different responsibilities. 

Proxy voting, further, of portfolio securities, is 

generally considered to be part of the investment management 

process rather than a board role. Thus the current standards 

regarding proxy voting in the securities lending area would 

clearly benefit from some updated guidance. 

Existing guidance contemplates oversight of lending 

agents and their fees. For example, the staff has stated 

that the fees to be charged by a lending agent should be 

negotiated between the fund and the lending agent, reduced to 

a contract, and approved by the fund directors. In some very 

old guidance, the staff also has suggested that fund 

directors, in carrying out their fiduciary duty to act in the 

best interests of the fund's shareholders, should determine 

that the fee paid to a securities lending agent is 

reasonable, and also implied that the director should make a 

comparative analysis of the fees charged by various placing 

brokers. 

Affiliated lending agents require even greater 

scrutiny. The SEC staff has provided somewhat more recent 

guidance on how affiliated lending agent arrangements can 

comply with the Investment Company Act of 1940, and the 
 

 

 

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board's responsibility in that regard. 

The SEC staff also has taken the position that an 

affiliated lending agent cannot receive compensation based on 

a share of the lending revenues absent an exemptive order. 

In the past few years, the SEC has not issued those orders, 

presumably out of concern that the bargaining process with an 

affiliate may in some circumstances present an insurmountable 

conflict. 

However, such affiliated arrangements which permit 

revenue sharing may be beneficial for some fund groups. 

Further clarity surrounding the board's responsibility with 

respect to fees in both affiliated and unaffiliated 

securities lending arrangements would be useful. In 

addition, it should be possible for the SEC to adopt an 

exemptive rule or provide some other guidance or interpretive 

release that effectively would address its concerns with 

respect to affiliated securities lending agency arrangements. 

It is unclear from the guidance how much 

flexibility a lending fund has to invest cash collateral. 

While the SEC staff has at various times mentioned that 

collateral could be invested in various specified ways, the 

only definitive statement is that the type of investment for 

cash collateral is a decision for directors of the fund. The 

industry assumes, however, that the SEC requires that cash 

collateral be invested in highly conservative liquid 
 

 

 

 

 

 

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investments. 

Although liquidity is a clear requirement for the 

investment of collateral that may need to be returned upon 

short notice, there may be circumstances where an investment 

company should not be limited to such conservative 

investments. Rather, where consistent with the fund's 

investment program, greater flexibility may be appropriate. 

Of course, in every case the investment of cash collateral 

should be consistent with the fund's stated investment 

policies and prospectus disclosures, including risk 

disclosures. Further guidance in this area also would be 

beneficial. 

Thank you. 

MR. DONOHUE: Thank you, Bruce. Kathy. 

MS. RULONG: Good morning. Before I begin, I would 

like to also thank Chairman Schapiro, the members of the 

Commission, and the staff for inviting me to participate this 

morning. 

My name is Kathy Rulong, and I am the Executive 

Director for Global Securities Lending at BNY Mellon. Prior 

to my experience in securities lending, I spent approximately 

17 years in the capital markets and portfolio and liquidity 

management departments at Mellon Bank. My credentials also 

include a certification in public accounting. 

My employer, BNY Mellon, is a global provider of 
 

 

 

 

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financial services, helping institutions, corporations and 

high-net-worth individuals manage and service their financial 

assets. BNY Mellon operates in 34 countries and serves more 

than 100 markets. 

Among the primary businesses at BNY Mellon is asset 

servicing, which offers clients worldwide a broad spectrum of 

specialized asset servicing capabilities. With $20.7 

trillion of assets under custody and administration, our 

company provides both custodial and non-custodial agent 

securities lending to securities owners. These owners 

include, but are not limited to, domestic and international 

investment funds, public pension plans, ERISA plans and 

registered '40 Act funds. 

The market events of the past 24 months have had an 

unprecedented impact on the securities lending industry. 

Sustained and severe market illiquidity and rapid credit 

deterioration, particularly in the financial sector, 

challenged the collective wisdom of industry participants, 

wisdom which had developed and was broadly accepted for well 

over a decade. 

The essence of this wisdom was that the capital 

markets could be expected to provide near-term liquidity for 

short- to medium-term, high-quality, interest-rate sensitive 

investments in most conceivable circumstances. 

This wisdom carried the industry through several 
 

 

 

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major downturns in the market. But the prolonged and 

extraordinary market disruption of the past two years 

demonstrated that even this conservative approach could be 

severely strained by such unparalleled events. 

The failure of the market has subjected the 

securities lending industry to an unprecedented but warranted 

level of scrutiny by beneficial owners, their agent lenders, 

their investment managers and their respective regulators. 

The course of these events is driving significant, and in my 

mind, positive changes for the industry. 

To an overwhelming extent, beneficial owners 

understand the importance of securities lending to 

efficiently functioning markets and also to the benefit of 

their own bottom line. These beneficial owners want to 

continue to lend their securities. Many, however, have 

reevaluated or are in the process of reevaluating the risk 

profile of their securities lending program and are 

redefining the level of acceptable risk for their company or 

institution. 

Industry consultants are also actively engaged in 

helping their clients with these assessments and the ultimate 

decision making surrounding acceptable risk. This process 

has led to increasing transparency and reporting, related 

both to the loan side of the business and also the lending 

reinvestment portfolios. 
 

 

 

 

 

 

 

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It has also led to a reemphasis of the importance 

of risk-adjusted returns for securities lending programs. It 

is leading to increased interest in the intrinsic value 

approach to securities lending, which presumes a reduced 

level of risk and return in the collateral reinvestment 

portfolio, and therefore focuses attention on the lending 

value of securities on loan. 

As another example, it is encouraging that 

beneficial owners and their agents are reexamining both their 

cash and non-cash collateral requirements in light of recent 

experiences and the types of assets that they are lending. 

In summary, securities lending can add significant 

value to a beneficial owner's portfolio, and can be 

customized to reflect the objectives and risk tolerance of 

the owner. Its contribution to smoothly functioning capital 

markets has been broadly recognized. 

Thank you. 

MR. DONOHUE: Thank you, Kathy. Julia. 

MS. SHORT: Thank you. First and foremost I would 

like to also thank the Chairman and the Commissioners and the 

staff for inviting me today and for putting together this 

roundtable on this important topic. 

My name is Julia Short, I'm with RidgeWorth 

Investments, which is an investment advisor registered with 

the SEC since 1985. We are a money management holding 
 

 

 

 

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company. We have eight style-specific institutional 

investment management boutiques, and approximately $60 

billion in assets under management. 

I serve as President and the CEO to the RidgeWorth 

Funds. In that capacity, I'm responsible for the oversight 

of management of the operations and the administration of the 

RidgeWorth Funds, which would include the securities lending 

program. And I serve on the Funds' board of trustees and I 

serve the Funds' shareholders in that capacity. 

The RidgeWorth Funds are a family of 50 mutual 

funds with approximately $32 billion in assets under 

management across equity, fixed income, asset allocation and 

money market funds. And we have participated through a large 

majority of our equity and fixed income funds in a very 

successful securities lending -- I'll say programs -- since 

2001. So we do believe that done correctly, securities 

lending can be a very good value to shareholders and provide 

incremental value to their fund portfolios. 

My comments today will be related to '40 Act mutual 

funds, and they are my own; they don't necessarily represent 

those of my company nor its affiliates nor the RidgeWorth 

Funds. They are based on my experiences with the Funds as 

well as observations in the industry and conversations and 

dialogue I've had with other industry experts. 

When I thought about the topics -- and we have 
 

 

 

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quite an agenda ahead of us today with many different, 

interesting topics to talk about today -- I think, clearly, 

from my perspective, the largest risk to the beneficial 

shareholders has clearly been identified as the collateral 

reinvestment risks that come with securities lending, and how 

important it is to manage that. So when I thought about how 

the SEC could add value through guidance and recommendations 

around securities lending programs, my comments would be 

geared towards collateral reinvestment. 

There's three areas in particular that I think we 

should take a look at. The first is the investment 

guidelines. Whereas it is required for securities lending to 

be a fundamental policy of any mutual fund that engages in 

securities lending, it's not been my experience to see it 

listed as a primary, a secondary or even tertiary investment 

goal of a mutual fund. 

Therefore I do believe, unless disclosed otherwise, 

the typical investor has the expectation that this is an 

incremental income. And I think it should be handled as 

such. Therefore I do think collateral reinvestment vehicles 

should be geared towards preservation of capital rather than 

incremental yield. 

Secondly, I think disclosure is very important. 

There's a lot of discussion around disclosure today. There's 

going to be a panel talking about transparency. I think it's 
 

 

 

 

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very important to have clear disclosure, and I would caution 

as we go through this that more is not always better. And I 

think it's very important as we go through that at the end of 

the day we are leaving our shareholders with the ability to 

go through the information and walk away with, is this the 

right investment for me knowing my risk profile and what my 

investment goals are. 

The third item that I would talk about -- we don't 

hear a lot about it -- and that's really with the collateral 

reinvestment itself, if you look at the limitations put on a 

mutual fund, up to a 33.3 percent are able to lend in a 

securities lending program. If you take that out -- that's 

based on the total assets of the fund, which includes the 

collateral reinvestment. So theoretically, in a fully 

utilized securities lending program, the equivalent of 50 

percent of the net assets of a mutual fund could be invested 

in a collateral reinvestment vehicle, but yet we don't have 

any discussion around diversification or issuer concentration 

on what could amount to such a large investment in a fund. 

And I think there's risk there that we could use the 

Commission's guidance. 

With that, I'm excited about today, and thank you 

again for the opportunity to participate. 

MR. DONOHUE: Julia, thank you. Christy. 

MS. WOOD: Chairman Schapiro, Commissioners, 
 

 

 

 

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members of the Commission staff and public who are here 

today, my name is Christy Wood, and I'm Chairman of the Board 

of the ICGN. The International Corporate Governance Network 

is very pleased to be here today. 

The ICGN is a global organization dedicated to the 

cause of improving corporate governance standards throughout 

the world. Its members represent investment organizations 

with approximately $9.5 trillion in assets. Over a third of 

our almost 500 members come from the United States and 

represent the leading pension plans and private asset 

managers in the country. 

My own background is that of an institutional and 

mutual fund portfolio manager for over three decades, most 

recently also as the Head of Global Equity at the California 

Public Employee Retirement System, where I was responsible 

for $150 billion of global equity, hedge fund and corporate 

governance program assets. 

To my knowledge, the ICGN has written and adopted 

the only securities lending code for investors. The 20 

institutions who contributed to the code listed on page two 

of our written submission represents some of the largest 

investors in the world. 

This code was written out of concern that lending 

activity had become so important that it was impeding the 

share voting process and interfering with corporate 
 

 

 

 

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governance engagements generally. For the sake of time, I 

will not repeat some of the points made by my co-panelists. 

I would like to make a few different points. 

I must begin by emphasizing that the ICGN is very 

much in favor of securities lending as a practice, as well as 

short selling. We believe that both practices further price 

discovery, market efficiency and liquidity, but we think the 

process needs to be improved. 

Securities lending is now practiced -- as it is now 

practiced -- has wrought havoc on the share voting process 

for public companies. Investors who want to recall 

securities are often unable to in time. There is also double 

counting of shares at annual meetings, and there's been a 

notable lack of communication between portfolio managers and 

lending departments, so that shares supposed to be voted are 

discovered to be out on loan. 

There are a few things that can be done. 

Securities lending has suffered from a lack of transparency, 

and in the marketplace especially to trustees and 

beneficiaries, who believe that mutual fund investors and 

public pension plan clients have a right to know how their 

shares have been lent out for profit, and whether or not 

they've been lent out for profit or whether they've been used 

for stewardship purposes. 

We urge the SEC to require that a light be shown on 
 

 

 

 

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the whole process, so that portfolio managers and, in time, 

beneficiaries know what's going on. The stewardship 

initiatives and commitments should be kept, and an investor's 

lending and voting practices should be public and not 

contradict one another. 

Second, the Commission can improve the 

decision-making process of investors and raise the vote on 

important issues, while reducing the incidences of 

unnecessary recall by requiring companies to post the 

complete agenda well prior to the record date. That way 

shareholders can make an informed decision whether to recall 

if necessary. 

Further, to avoid interfering with lending done for 

the purposes of dividend strips and arbitrages, companies 

should separate record dates from dividend payments and 

shareholder meetings, specifically issuers should not set 

record dates more than 30 dates in advance of the shareholder 

meeting or record date, nor less than 15 days after the 

shareholder meeting or record date. 

These suggestions will facilitate responsible 

voting, improve the lending process and improve transparency 

for everyone's benefit. Thank you for the opportunity to 

comment. 

MR. DONOHUE: Thank you, Christy. Panelists, we 

deeply appreciate the very thoughtful statements that you 
 

 

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have made. Perhaps if the Chairman agrees, we can begin with 

one of the panelists providing a brief overview of how the 

cash collateral reinvestment process works. Following this 

overview, we'll turn the floor over to the Chairman and the 

other Commissioners for questions. So we start off with a 

toss-up. 

MS. RULONG: I can take it, and then when I miss 

something you can fill in for me, Karen. Most or many 

securities loans, particularly in the United States -- and I 

think the earlier panel touched on this -- are collateralized 

with cash, whether it's dollar cash or frequently offshore it 

may euro cash. 

When the lender -- the lending agent -- receives 

that cash, the cash is then invested in an investment, either 

a separate account or some type of a commingled vehicle that 

the beneficial owner has agreed to those investment 

guidelines. The yield that is received from that investment 

vehicle -- again, it can be a separate account, it could be a 

commingled fund -- that yield is the gross revenue that is 

received. From that has to be paid the rebates, which I 

think we talked earlier about rebate. And rebate is the fee 

that is charged -- if there is an interest rate -- a fee to 

be charged on the cash collateral that the borrower has 

given. That is subtracted from the earnings from the 

reinvestment pool, and that net amount is then what is 
 

 

 

 

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distributed between the beneficial owner and the lending 

agent. 

I don't know if there is any other comments there. 

Pat? 

MR. AVITABILE: Thank you, Kathy. Yeah, I'd like 

to just add that from the starting point of when a lender 

decides to lend his securities, he has to make a number of 

decisions, especially if he's dealing with a directed agent. 

The decisions to lend is, one, he's the principal in the 

transaction, and therefore will make those decisions, and one 

of them is what to do with the cash, what to do with the cash 

collateral. 

And those are the investment guidelines that need 

to be created and customized for that particular lender. He 

sets the investment -- the types of investments, the 

duration, the credit quality, the concentration, places 

restrictions on any securities or investments that he does 

not want to include. So it's a very, very detailed set of 

guidelines that the client provides the lending agent. 

Then there's also models, different models on how 

he can operate. He can choose to invest the cash himself, or 

he can choose to have the lending agent follow those 

guidelines, again acting as a directed lending agent. Or he 

can choose to take that cash and have it deposited in a fund 

of his choice, a collective fund of his choice. 
 

 

 

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So there's a number of different models, hybrids 

that he can use in order to manage that cash, but most 

importantly is the fact that those are the client's 

guidelines, they are flexible, he should always have the 

opportunity to amend, to adjust, to change those guidelines 

as market conditions warrant. It's a total open architecture 

type of environment. It could be a separately managed 

account. 

And those are the guidelines that would be 

instituted on a daily basis. Flexibility and reporting would 

be the next thing, total transparency and disclosure on a 

daily basis. The lender should know exactly what investments 

have been purchased to ensure that they are within his 

guidelines. And his guidelines are typically the guidelines 

that are mandated by the fund, so they'll fall within those 

guidelines. 

And there's two checks and balances. One, the 

client is looking at them on a daily basis, and then 

secondly, within the securities lending agent's domain, 

typically they have a compliance officer or someone who is 

actually reviewing those assets on a daily basis to make sure 

that they are in compliance, not to mention the fact that 

there are many systemic controls in the variety of securities 

lending systems that enable those transactions to be 

monitored and controlled adequately. 
 

 

 

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MS. KELLEY: I would just want to add one more 

thing to that, and that is, we get into then the 

conversation, now you've got this -- as Kathy talked 

about -- you've got the loan out, and that creates a level, 

and then there's a spread created. And I think that also the 

other thing that we want to think about as we think about 

cash collateral reinvest is that is the other side of this 

spread. The lend is one side and the cash collateral 

reinvest is the other side. And the lender also has to make 

the decision, do they want the starting point of that 

equation to be what security goes out on loan, or do they 

want the starting point of that equation to be what can the 

cash collateral reinvestment give back in terms of a yield. 

And it's the starting point of that that gets into 

a lot of discussions about intrinsic value lending versus 

other things. And I think that one of the other things that 

is very fair to say -- and I know we spend a lot of time 

talking about the upheaval and market considerations of the 

last year, and there is not anybody who participates in the 

financial markets that was not affected to some degree. 

But I believe one of the panelists in the last 

panel indicated that all lenders had problems, or excuse me, 

all lenders had problems with liquidity and/or cash 

reinvestment pools, and I think that that is maybe a little 

bit broad of a statement, that that is not the case, and that 
 

 

 

 

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many lenders -- in fact, one of the panelists in the last 

panel suggested that they had somebody who started lending in 

the fall of '08, managed the risks very appropriately -- and 

I don't even know who it is -- according to the story, and 

actually got out of the program 100 percent whole. 

So I think that we really do have to recognize that 

there has been a crisis, there has been affected in all 

aspects of the marketplace, not just securities lending, but 

it does not say everybody in securities lending has been 

affected. 

MR. AVITABILE: I would agree with that last 

comment, absolutely. 

MR. DONOHUE: Well, thank you, Kathy, Karen and 

Patrick. Chairman Schapiro. 

CHAIRMAN SCHAPIRO: Thanks, Buddy. I just want to 

make sure we're very clear on this point about -- it sounds, 

you know, like very good practice that the lender has 

tremendous discretion in the design of the lending program, 

that they can be quite specific and quite customized, that 

they get a lot of reporting. Is that true across the board, 

or is that just true with -- in your experience with your 

firms, because I took away from the last panel that there's 

sometimes quite broad investment guidelines for collateral 

that might not quite meet this high standard of customization 

and lender involvement in the decision making. 
 

 

 

 

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MR. AVITABILE: My comments were based on my 

knowledge of what my firm does. I can't speak to other 

firms, but that's how we operate. 

MR. LETO: I can address from my experience, again, 

representing various fund groups and the information that's 

provided to fund groups and fund boards. I think there's a 

distinction to be made between the situation -- well, I guess 

let me back up one second and say that the guidance is that 

if a fund is going to engage in securities lending, that the 

cash collateral investment needs to be done by someone who 

has a section 15-approved investment advisory agreement, or 

through guidelines that are established by the board or by 

the adviser that has that section 15 contract, and then 

provided to the securities lending agent. 

And I think there is a distinction between the 

scenario where a fund group provides specific guidelines on 

specific types of instruments that -- and I think you called 

it the direct investing approach or the directed agent 

approach -- and I think that's where the fund or the adviser 

to the fund says to the lending agent, "We want the 

collateral invested in either a separate account or a pooled 

account for our funds only that can invest in these five or 

six or eight or ten investments." 

But then there's another type, which is quite 

common, and in fact has grown in popularity, I would say over 
 

 

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the last -- in my experience -- five, eight years, which is 

rather than the specific items, which by the way usually come 

from the prospectus of the fund, the lending agent makes it 

easy by providing a menu of options of four or five different 

types of funds, either registered 2a-7 money market funds or, 

ever since 1996, 3(c)(7) unregistered pools which operate 

like funds. And those pools have various offering documents 

with various descriptions of what they can and can't invest 

in. And they have various levels of risk and maturity and 

duration, et cetera. 

And in my experience, typically the Funds -- and 

this may get to your question from the earlier panel about 

why things weren't quite so bad -- but in my experience, the 

Funds typically are investing in either the most conservative 

pool or the second most conservative pool out of a suite of 

four or five different pools. Typically those unregistered 

pools are 2a-7 compliant, or at least state that they are 

2a-7 compliant. 

And I think where the distinction comes is, 

certainly where an adviser has given the specific list of 

securities to the lending agent to invest the collateral in, 

there's tremendous transparency, where at least from my 

experience, I haven't seen the transparency and I cannot 

speak to whether someone at the adviser has gotten the 

information. But where a fund's cash collateral is being 
 

 

 

 

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invested in an unregistered pool, I am not aware of the same 

type of transparency in terms of what the pool's invested in 

being provided certainly to fund boards. Whether it's being 

provided to the adviser, it's really a function of what the 

offering circular for the pool states will be the normal 

release of portfolio information. 

CHAIRMAN SCHAPIRO: So some of the difference may 

be mutual funds just do this differently than pension funds 

or other potential lenders. 

MS. WOOD: I was going to make that observation. I 

think there are different practices in the mutual fund 

industry, where there's more -- potentially more transparency 

all up the line. 

And I think my other point that I was going to make 

was, while there is plenty of reporting, I'm sure, available, 

the question is to whom. And I think that's a problem with 

reference to whether it's a back office or a front office 

individual, and where exactly the accountability lies for the 

risk being taken. 

So I would say in the pension plan world, where I'm 

a little bit more familiar, I would say in the best staffed 

and largest pension plans, again, you know, the transparency 

doesn't go very far -- deep into the organization. And so 

those that are monitoring risk -- for example, I think most 

of the risk management systems that are available in the 
 

 

 

 

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pension plans today don't take into account the risks 

necessarily being taken in securities lending portfolio. 

I think that's a fundamental structural flaw. So I 

think there are different practices in different parts of the 

investment world. 

COMMISSIONER WALTER: Can I follow up? We've 

talked some just now and in the earlier panel about why funds 

did better, mutual funds did better. Can we talk a little 

bit about your analysis of what caused the losses with 

respect to cash reinvestment, and in particular I'm 

interested in -- I think we all are interested in -- several 

items, whether it's intrinsic value versus volume, security 

finance kind of an approach; whether it was declining 

reinvestment rates; whether there were reinvestments that 

subsequently became illiquid and were downgraded even though 

they were liquid and of high quality when purchased, or any 

other causes that you see for the problems that occurred. 

MS. SHORT: I think, going back to actually both 

questions, there are definitely differences in securities 

lenders, based on the sophistication and their capabilities 

of looking at the program holistically and looking at the 

risk that's intrinsic to the program. 

I think as we look back over the course of the last 

few years, another issue that the SEC is dealing with right 

now is directly correlated to what we saw in the collateral 
 

 

 

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reinvestment, and that is coming out with the comments we all 

just submitted around money market reform. And, you know, 

even for funds that have their collateral reinvestment 

invested in 2a-7 funds, they certainly weren't without risk 

during this period of time. 

And I think those two items correlate very much 

together as we look to improve metrics around 2a-7 so we 

don't have those -- a repeat of those types of issues. We 

were seeing the same thing over in the collateral 

reinvestment pools. 

From a mutual fund perspective, I do think -- as 

has been indicated -- perhaps more conservative approaches 

were taken to the collateral reinvestment. At the same time, 

they did fall in the form of 2a-7 funds, as well as 3(c)(7) 

private placement funds, and in some cases joint or 

separately managed accounts that were all run as dollar 

NAV-type funds and type accounts. 

The level of transparency available in those would 

differ depending on the structure that was available then for 

the adviser and the board to look at and review, and also 

based on the disclosures that the underlying asset manager of 

that asset was willing to provide, because they have 

different requirements. And as we all know, people are 

willing to provide their holdings and their information on 

different frequencies when not required to do so. 
 

 

 

 

 

 

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So when we look back through the investments that 

were made, and we go back four or five years, we saw a lot 

more of these enhanced cash liquidity vehicles that were 

coming into popularity, that did maintain a dollar NAV, but 

then that they were able to provide an incremental yield 

greater than a 2a-7 fund by taking perhaps some incremental 

duration risks and going a little bit further and longer out 

the curve. 

So within those vehicles, although they were 

investing in many of the same types of securities that 2a-7 

funds were investing in -- for example the structured 

investment vehicles we've all heard about and gone through 

over the last couple of years and have made numerous press 

releases -- you're seeing similar type of vehicles in these 

enhanced cash, but they were able to go out for a longer 

period of time, so a lot of the issues --

COMMISSIONER WALTER: Can I ask you one follow-up 

question about that? 

MS. SHORT: Sure. 

COMMISSIONER WALTER: Was there sufficient 

transparency into the valuation of those vehicles so that 

people actually knew they would support a dollar NAV? 

MS. SHORT: I can only speak from my experience, 

and I could say from my experience, yes. I think it was an 

interesting time, too, though, because you could get into a 
 

 

 

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whole discussion on valuation during that time period, and 

how meaningful some of the valuations were when you're in an 

illiquid market. You know, it's kind of one right 

off -- right on top of the other -- but there might be other 

experiences. 

COMMISSIONER WALTER: Isn't there also an inherent 

tension between using the dollar-per-share price model and 

elongating the maturity of the underlying investments that 

really doesn't work as well? 

MS. SHORT: Absolutely, and I think that's what 

occurred over the last couple of years. And you saw most of 

these products no longer exist today because of that very 

tension that existed between those two synergies. I would 

say during the time that people were investing in those they 

thought it was a suitable investment. There had not been 

these types of issues and there was no precedent to think 

that there would be. And I think the intentions of people in 

general were very positive, and they were looking for 

incremental yield. 

However, there was an inherent risk. I think the 

industry has learned a lot from that. Where I do think SEC 

has an important role is preventing a recurrence of that, 

because our industry tends to have a short memory, and there 

is the ability to repeat ourselves in a surprisingly short 

period of time. 
 

 

 

 

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MR. BLOUNT: Could I add another perspective to 

that as well? The data that's available to describe that 

period which is provided by the RMA shows a fairly -- an 

extremely unusual time, where the securities lending markets 

reflected the turbulence that was taking place in the broader 

market system. But if you look at the data for securities 

lending in particular, especially the cash pools, there was a 

dramatic run up of about 90 percent in the total value of the 

pools in the second quarter of '08, which is after Bear was 

absorbed by Morgan. 

That 91 percent jump actually was followed by a 

three-quarter drop of 60 percent in the value of the pools, 

which took place because of falling market values, 

deleveraging of the hedge funds and a variety of changes 

which put pressure on the cash pools. The cash pools which 

had jumped were now collapsing. 

So the investments that were in those pools were 

being stressed by the need to sell them off in order to repay 

the cash collateral to the borrowers who were lining up in 

order to get their cash back, because they were deleveraging. 

So many of the instruments that were put in those 

pools originally, and which had been considered to be 

reasonable assets, suddenly were not only under tremendous 

stress but they were themselves being subjected to pressures 

in their own valuation markets, because some of those 
 

 

 

 

 

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instruments traded beyond securities lending pools, as well. 

So there was kind of a feedback loop that was 

taking place that put the cash pools under pressure at the 

same time the assets were under pressure. So part of it, 

though, was simply a reflection of the overall turbulence in 

the market at the time. 

One of the other things that happened, when we talk 

about intrinsic value, is the cash managers for the 

securities lending programs in the fourth quarter of '08 

actually went negative intrinsic value across the board, 

meaning they were paying borrowers to leave balances in the 

pools to avoid having to sell off those assets. Fortunately 

they had instruments that could still provide the yield. The 

yields were still relatively high enough to be able to allow 

them to pay those rebates. 

CHAIRMAN SCHAPIRO: Could I follow up on that? So 

was it European experience where I understand they accept 

securities, equities in other securities as collateral much 

more than they accept cash. Was their experience different 

as a result of that through the financial crisis? 

MR. BLOUNT: There's not as much data available on 

the European market, but the common understanding is that the 

pain wasn't as great. 

CHAIRMAN SCHAPIRO: So can you expand -- or can any 

of you expand on that a little bit -- and talk about the 
 

 

 

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relative benefits of accepting securities versus cash, in 

this context, or why it developed differently even in Europe 

than in the United States? 

MS. RULONG: I'll just comment on non-cash a little 

bit, because there has been, certainly in the European 

markets, a move back to some extent to non-cash. They had 

traditionally, offshore, had been more dominated by non-cash, 

and really had started to accept cash more recently than in 

the U.S. 

And we've seen a increased desire on the part of 

clients in the U.S. to do non-cash lending, as well as the 

borrowers have shown an increased desire to also give us 

non-cash rather than cash. And I think the key there that 

everyone has to be very cognizant of, if you don't have a 

borrower default, then every day the non-cash collateral 

should re-price, and if there's a problem in any of that 

collateral, that will be replaced or it will be 

increased -- the amount of collateral will be increased if 

the value of the securities you have have gone down. 

But in the event that you do have a borrower 

default, that non-cash collateral coming back to valuation, 

it's absolutely critical, one, that that collateral is very 

diversified and that there's proper valuations within that 

collateral. And the industry uses third parties to hold the 

collateral for us, tri-party agents. 
 

 

 

 

 

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And so it's -- certainly those of some of the 

things on non-cash that we're looking at to make sure that 

there is a sufficient level of diversity on the securities 

that we're taking, that we also have better valuations of 

those securities that we're taking, and also looking at 

correlations. 

So if you're lending equities and you want to take 

equities, there is probably a very strong correlation between 

the two, and it makes a lot of sense to do that and reduces 

your risk. If you're lending Treasuries, and you're thinking 

of taking equities, that is a totally different analysis that 

you have to do, because in the event you have an issue, 

you're going to most likely have your Treasuries rise in 

value and those equities falling. 

So I think the events of the last year, 

year-and-a-half, have certainly required all of us -- and I 

think we all are doing our -- we've stepped back and we've 

looked at our experiences, both the beneficial owners, the 

agents and independent investment managers, as well. 

MR. AVITABILE: And I'll just -- I'd like to just 

add to that. As Kathy was saying, about the non-cash 

collateral that comes out of the U.K., OECD government, that 

tends to be the most popular form of non-cash collateral 

that's being posted today. 

And equities, many cases some of the non-U.S. 
 

 

 

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beneficial owners will take equities as collateral. As she 

said, there's price correlation, there's also a high level of 

diversification, so you can limit the concentration in any 

one issue. And it has an exchange traded price at the end of 

the day. 

The other thing is, is that one of the oldest 

models, I guess, in the U.K., is the delivery by value model, 

the DBV, which is a model similar to the tri-party, where the 

security is lent versus cash, sterling, but that sterling is 

converted into a basket of equities. And again, it's a 

menu -- it's menu driven, much like the tri-party agents here 

in the United States have. You can choose the FTSE-100, 250, 

you can choose the different ones. You can have 

different -- apply different concentration risks. And it's 

been a very successful model that's worked. 

So certainly as the industry continues to explore 

equities as collateral, it would also be good to look at how 

the U.K. has done it and the successes that they've had with 

that. But as Kathy says, it makes a lot of sense if you're 

doing equities versus equities because of the price 

correlation, and you would to that by market as well, so U.S. 

versus U.S., France versus France, and that type of 

situation. 

MR. BLOUNT: I have to be -- I feel compelled to 

take kind of an opposite view on that, or maybe inject 
 

 

 

 

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another caution. It sounds intuitively appealing that there 

would be, as you said, a probable correlation. And I would 

assume there probably is a correlation, but if you look 

through the trade to the hedge funds that are borrowing the 

equities and putting up equities as collateral, many of them 

are involved in pairs trading, where there's an expectation 

that they're actually going to move in different directions. 

So it may be that the collateral that's put up is 

the long side that they expect to rise, the short side may 

move in a different direction, so that you're not actually 

going to be getting the kind of correlations that you would 

hope. 

So before endorsing an overall blanket 

recommendation for equities as collateral, I would think that 

it would be worthwhile to impose some requirements that the 

correlations actually be proven, and tested as well, in an 

illiquid market where they could go quite the opposite 

direction. But it does sound intuitively appealing. 

MS. RULONG: And I'll just agree with what you 

said, and I think that's why -- the analysis is being done, I 

think, by beneficial owners as well as agents, around -- and 

we've had now hopefully the perfect storm that we won't see 

again for a long, long time, but we have that data to use. 

But we've found that, you know, if you get enough 

granularity, you get enough margin, that coming up with the 
 

 

 

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right parameters, that you can look at different types of 

collateral for various types of loans. 

COMMISSIONER PAREDES: One of the things we heard 

last panel and this panel as well, at least the last panel by 

implication, is the question of risk management on the lender 

side -- spotting and identifying what the risks are, and 

there's an enhanced appreciation in light of recent events. 

And of course trying to figure out what to do about 

it -- some of that discussion was also suggested in context 

of pension plans versus mutual funds. 

An offshoot of that, of course, is the question 

about to what extent do the lenders and different lenders 

have the leverage to actually impact what the terms of the 

loan look like, in terms of pricing, but also in terms of the 

ways in which the collateral can be reinvested. I guess in 

some sense the ultimate leverage is, is you can decide not to 

lend. And to the extent there is value created, everybody is 

losing a piece of that. 

But I'm curious to hear a little bit more 

specifically, based on some of your experiences and 

discussions with other folks, how that discussion takes 

place, and particularly now, if you're somebody who is on the 

lender side, and you have these concerns, how the dynamic 

might be changing or might be expected to change in the 

future. 
 

 

 

 

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MS. DUNN KELLEY: I'll just start that off. From 

the lender side, I think first and foremost, you have to 

make -- and this was alluded to in the last panel as 

well -- is your lending program going to be philosophically 

from an investment activity, or is it going to be -- and they 

talked about the back office, or front office-back 

office -- but is it an investment activity, and should it be 

looked at that way versus not. 

I think very much, and from other things that we've 

heard on the panel, many of the mutual funds view it as an 

investment activity. You then said, well, how do you look at 

the risks and mitigate the risks? Well, in the discussion 

between yourself and your lending agent -- I mean, you have 

the right to interview, put out RFPs and decide who your 

lending agent is going to be, so then you pick a lending 

agent that you can create a customized program that fits your 

reinvestment needs, fits your collateral needs, fits your 

program, and from there you then have identified the risks. 

And the next step to that is to create the 

mechanisms for what will be the communication, the 

transparency and the accountability in terms of creating the 

reporting that does make sense, so that you can answer those 

risks. 

So again, along the path, you've got many 

opportunities to set this up. I will tell you that the other 
 

 

 

 

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side of the coin is, I cannot speak to what happens to 

others -- I can just speak to my experience, but that is the 

experience. And if you look at it from an investment 

activity, you really go through all the same bells and 

whistles that you'd go through in any investment activity, to 

say is this appropriate for my product, how do I do it and 

how do I either mitigate or -- as Bruce said -- maybe certain 

funds can take greater risk in collateral reinvestor 

products. 

So I'm not suggesting -- I can tell you how we do 

it. We mitigate the risk. But there could be a different 

risk profile. But if you take it from that aspect, you can 

take it through the entire curve and create the appropriate 

reporting so that you can mitigate those risks. 

I will tell you, and Kathy said we had a perfect 

storm last year -- I'm not suggesting to you that a perfect 

storm will not create problems and upheaval, but I am saying 

that you can certainly get your hands around what your issues 

are in a timely and appropriate fashion. 

MR. DONOHUE: I'm mindful of the time here. We 

have a half hour left to cover the last three topics, so if 

we could, I'd like to move on to default risk. And I'd ask 

one of the panelists to please explain what is meant by 

default risk. 

MR. AVITABILE: I'll take this one. Default risk 
 

 

 

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has, in my mind, two different categories. One, there is the 

default, as far a bankruptcy. Okay, you're lending 

securities, you're taking collateral, whether it be cash or 

non-cash collateral. And like in the case of Lehman, one 

morning you wake up to do mark to markets and they default, 

okay, they're no longer there. 

The second one is more of a daily default, and this 

is all outlined in a client's agreement. It's called the 

"events of default." An "events of default" could be as 

simple as a broker doesn't mark to market that day -- their 

operations, their systems are down, they can't mark; okay, a 

broker fails to return the security; he's defaulted on a 

recall. 

So there's a number of things that would be listed 

in your agreement that would be the events of default, and 

then primarily you have as the ultimate default would be the 

bankruptcy. 

You have a number of layers of protection that are 

built in the securities lending program when you're dealing 

with a directed agent. Certainly first you choose your 

counterparties. There's typically a list of counterparties 

that's approved by the lending agent, as far as its credit 

worthiness, but within that list, clients can either choose 

to eliminate, only lend to a few or many of those broker 

dealers, and they can choose to set their own credit limits 
 

 

 

 

 

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against each one of those counterparties. So they have full 

discretion on who they're lending to. 

Secondly, it's the collateral. It's the collateral 

that's coming in, which would be that you're looking to that 

in a default situation, and then the mark to market -- every 

day that collateral and that loan is mark to market daily. 

And lastly, in many cases, particularly in the 

United States, most lending agents provide an indemnity 

against borrower default. And simply stated, that means that 

in the event of the default, in the event of Lehman, when 

we've taken the collateral to go out and buy the securities, 

and if the security prices were higher than the collateral 

that we had, assuming there weren't any losses in the 

collateral, then that difference would be covered by the 

lending agent. 

So that's an indemnity that many of the clients 

have against the default. So there's these different layers 

of protection that exist in a default situation. 

CHAIRMAN SCHAPIRO: Could I just ask if others have 

comments on whether those are sufficient protections against 

default, or are there other things we should be thinking 

about? 

MR. BLOUNT: I think there's a couple of loopholes 

in the contracts. Thinking back to a study that we conducted 

about five or six years ago, from an investor protection 
 

 

 

 

 

 

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standpoint, one of the sensitivities is the grace period that 

the agent has in order -- within which to declare an event of 

default, and the nature of the conditions that would trigger 

that grace period. 

I think that's the weakest part of it. But there's 

not necessarily one way or the other to go on it, because if 

the agent is forced to declare a default by some formula, it 

might not be the best time -- it might be better to let the 

borrower slide a little bit longer, because then you trigger 

all kinds of multilateral netting requirements which could 

force them to liquidate their entire portfolio. 

But if the investor is going to look at one part of 

that, it would be, in my opinion, the grace period. 

MR. AVITABILE: I would agree with him, and that's 

typically discussed at the time of negotiating the agreement, 

and many times it's part of the agreement. 

MR. LETO: I would also point out that the 

indemnification is not uniform. I mean, it's certainly the 

predominant model, but it's a negotiating point. In the 

spread -- or the split -- you get a better split if there's 

not an indemnification clause. 

MR. DONOHUE: Well, I guess with that we can move 

on to topic three. 

MR. AGUILAR: Buddy, do you mind if I ask a 

question? 
 

 

 

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MR. DONOHUE: Oh, no, no. I'm happy to hear your 

voice! 

MR. AGUILAR: In between coughing, I've had it on 

mute. Took me a second to unmute it. There's been a lot of 

discussion, which I've appreciated, about the processes and 

the safeguards that exist, but it's unclear to me whether 

since many people speaking seem to be '40 Act knowledgeable 

or involved in institutions that are heavily '40 Act, it 

wasn't clear to me how much that is in fact a widespread 

practice through the industry, that it would apply whether or 

not you're '40 Act. 

And I guess I'd like some thoughts as to whether or 

not some of the practices and processes that have been 

discussed seem to be endemic to non-'40 Act institutions as 

well. And if I could also perhaps get a little bit of feel 

of the industry and how much of that perhaps is '40 Act, how 

much is outside the '40 Act. I mean, I've seen numbers of 

industries at the end of 2008 it was like $2.5 trillion and 

as high as $5 trillion a couple years before that, but it's 

unclear to me how much of that would be under the '40 Act, 

how much of that would be outside of the '40 Act, and whether 

or not the safeguards and controls and oversight that we've 

been hearing would seem to be -- unstated would seem to be 

'40 Act practices, how much of that is throughout the 

industry. If I could get some feel for that, that would be 
 

 

 

 

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helpful to me. 

MS. WOOD: This is Christy Wood. I'd like to just 

respond not to the question of the split on the industry 

assets, I wouldn't be an expert to opine on that, but I do 

feel some expertise to opine on the pension fund world. 

And I would say that many pension plans are thinly 

staffed and don't have the ability to necessarily pay for 

talent that is at the top of the market. While there have 

been some of this changing, I guess I would say that you have 

a lower-level expertise and I think most pension plans are 

very thinly staffed and the level of expertise there, in 

terms of entering into these types of contracts. And then in 

addition to that, the transparency up to the fiduciaries, the 

trustees and maybe even some of the portfolio mangers, is not 

an exact clear path. 

So I would say that, in my observation, the pension 

plan world suffered more than its fair share of losses last 

year, and I think some of the cash collateral that they were 

invested in, I think they were surprised that it was riskier 

than they thought. And in some instances, I think, you know, 

they were reaching for yield and unknowingly aware of the 

risks. So I would say that the experience throughout the 

industry is not consistent. 

MR. BLOUNT: I can suggest where the data is 

available to answer that question -- this is Ed Blount. The 
 

 

 

 

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firm that I sold two years ago tracks the participation of 

mutual funds, '40 Act funds, pension funds, insurance 

companies and the like in the securities lending markets. 

You have a panelist on the next panel who has probably access 

to that data. 

But just generally, as I recall, mutual funds, '40 

Act funds tend to have relatively low participation relative 

to their total portfolios, but because their portfolios are 

so large, they tend also to be fairly large players in the 

securities lending markets. The pension funds, both public 

and private, are far more active in securities lending, 

probably 85 percent, 90 percent of pension funds are involved 

in securities lending programs, and their utilization rates, 

the value that they put on loan is much higher. 

But because their assets are smaller than mutual 

funds, they tend to be about the same. So it's relatively 

lower participation and bigger funds, and mutual funds more 

participation on the pension funds. 

MS. RULONG: Just one quick comment. I think part 

of the question -- and this is Kathy Rulong -- part of the 

question was that, are the same mitigants available to the 

non-'40 Act funds that are available to '40 Act funds in 

securities lending programs. 

And I think -- I think I can actually probably 

speak for the industry. I know it certainly is true with us, 
 

 

 

 

 

 

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that any of the mitigants, whether it's the daily mark to 

markets, whether it's the reporting to clients, the 

availability of reporting to clients, that is all equal 

across the entire program, doesn't matter what type of client 

you are. 

MR. AVITABILE: I agree with that. 

MR. DONOHUE: Well, switching topics for the panel, 

what are the different types of lending agent compensation? 

MR. BLOUNT: Well, a quick response would be that 

generally the agent takes a share of the earnings, if it's a 

cashed-based program, a share of the earnings from the cash 

pool after rebating the bulk of it to the borrower. 

But that's only a quick answer. The return to the 

lending agent is a function of the relationship that -- as a 

bank, in particular -- that the bank has with the institution 

that's providing the loan, which really dates back to the 

origins of the securities lending business itself. 

Securities lending was modeled on the ADR business, 

where banks as ADR issuers would produce an ADR in advance of 

the delivery of the ordinary shares overseas. They wouldn't 

charge a fee for that, they would just provide that service 

in order to get the issuance fee. 

Over time, that evolved, because therefore they 

gave the business away for the overall relationship. It was 

not on a collateralized basis, but there was no cash. In the 
 

 

 

 

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'80s and then into the '90s, cash became much more prevalent, 

so it became almost like an escrow account -- you'd rebate 

the yield on the escrow and split it. 

But really the value of -- for most banks, the 

value of securities lending is in supporting other services 

and becoming part of the overall relationship, even though 

it's a split-based business. 

MS. SHORT: I would just layer on to that. I 

think, too, I like to oversimplify things, by my earlier 

comments on disclosures, and if you really look at a 

securities lending program, I think there's -- and you look 

at the parties, I think when we talk about compensation, 

we're mainly talking really about, to a large degree, the 

split between the agent and the lender. 

So if you think about the components of 

compensation, and we can easily divide them into two 

primary -- one we'll call the reinvestment spread, which is 

that cash collateral reinvestment, the other the intrinsic 

spread, which is usually based on the rebate rate and some 

measurement, usually the fed funds rate or some form that 

it's measured against. 

And we look at those, well, if we put the two 

together, we're going to get the gross spread or the gross 

income generated by the program. And typically firms will 

work with their lending agent to come up with a suitable 
 

 

 

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split of those assets. The thought of the split of the total 

gross spread is thought to incent the lending agent as well 

as to, frankly, attempt to align both motivations for 

participating in the program. And those can range, depending 

on how they're negotiated. 

MS. WOOD: I would just like to add a couple of 

comments on the topic of compensation. A statement was made 

in the last panel that I think 70 percent to 80 percent of 

the profit went to the beneficial owner. And I don't think I 

would agree with that characterization. In fact, I think it 

really obscures the prime broker's role in the entire lending 

circle and relationship, and I think the prime brokers are 

making significantly larger profits than the beneficial 

owner, first of all. 

And secondly, I think we wouldn't necessarily 

concur on the 70-80 split, even between the beneficial owner 

and the lender -- sorry, and the agent. I think this is an 

area where more transparency is needed, and I would strongly 

encourage the Commission to require more transparency so 

clients, I think, have a better idea of where the profits are 

being made, because I think it varies widely from institution 

to institution, and their sophistication levels are widely 

variable as well. 

COMMISSIONER AGUILAR: If I could ask another 

question, because there's been discussion of what happens 
 

 

 

 

 

 

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with the splits on profits. What's the situation when there 

happens to be a loss on the cash collateral investment? What 

happens with the losses, do lending agents share in that as 

well, or they only share in the upside? 

MS. RULONG: It's Kathy again. Because the -- you 

have to look to the contract that is signed with the 

individual client. So where the client takes responsibility 

for the reinvestment risks in the portfolio, if there are 

sales or defaults on securities within that portfolio, those 

are at the risk of the beneficial owner in most cases. 

MR. AVITABILE: And I'll add that it's typically 

made very clear in the agreements that are signed with the 

beneficial owner. 

MR. BLOUNT: And I think I'd add that it's not a 

decision the bank can actually make, because the Federal 

Reserve has rules. And if the banks were to indemnify 

against losses, they'd have to reserve capital, which in most 

cases would make their programs unprofitable. But it's a 

Federal Reserve capital requirement. 

MR. AVITABILE: And to add, we need to keep in mind 

that the lending agent is a directed lending agent, and the 

principal in the agreement is the ultimate lender. 

MR. DONOHUE: Bruce, a question for you. Are there 

any checks on what a mutual fund can pay a lending agent? 

MR. LETO: There is some guidance. Again, it comes 
 

 

 

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out of the old, no-action letters. There is a statement in 

sort of the original sort of grandfather of the no-action 

letters that says that the fees have to be negotiated between 

the fund and the lending agent, reduced to contract and 

approved by the fund's board. 

There are some other statements in a couple of the 

other letters that talk about the directors having the 

fiduciary duty that requires them to determine if the fees 

are reasonable and based solely on services rendered. 

And then there's a fair amount of guidance in the 

affiliated securities lending agency arrangement. There was 

one particular no-action letter that's actually more 

recent -- I think it's from '94 to Norwest Bank -- which 

talks about the board having fiduciary obligation to ensure 

that the compensation is not excessive. And that 

statement -- it's a little unclear whether that statement is 

broad enough to encompass affiliated as well as unaffiliated 

lending arrangements, but the one that was actually in front 

of the staff at that point was an affiliated arrangement. 

And then there are, in that same letter, there's 

guidance related to reviewing quarterly the specific 

affiliated lending arrangement and the fees that are being 

paid. And then there, again, from that same letter is a 

comment that to the extent that an affiliated agent is used, 

the affiliated cannot receive revenue-based compensation. 
 

 

 

 

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So that's kind of the guidelines that come out of 

the SEC guidance. I would say that -- and this probably goes 

back maybe eight years ago, nine years ago, around 2000, 

2001, so this is even before the discussions again began with 

respect to securities lending in '04 and '05 -- but the 

inspection staff would typically review securities lending 

arrangements and there was a fair amount of information that 

would be required, at least stated in the comment letters, 

that would be required to be given to boards. And most of 

that information, actually, did relate to the fees. 

And so it's kind of interesting -- you know, we're 

spending a lot of time talking about what the collateral is 

invested in, but to the extent that there were issues that 

were raised on inspection with respect to the securities 

lending process, at least from my experience, it related to 

the supervision of the fees. 

COMMISSIONER WALTER: Does it strike any of you 

that there is a lack of alignment between the lenders and the 

lenders' agents, and is there anything that should be done 

either in a regulatory sense or in a business sense to bring 

that back into line, like a sharing on the downside? The 

more I listen, the more it strikes me that there are too many 

parties going in too many different directions might be one 

of the issues that we've had. 

CHAIRMAN SCHAPIRO: I'd love to hear the answer to 
 

 

 

 

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that, and maybe with an additional point, which is, if you 

are a pension fund of a smallish governmental entity, so 

don't have very sophisticated staff or enough staff, how do 

you know if you're getting a good deal on the fee split and 

the compensation arrangements? How do you know -- what can 

you benchmark your relationship with a lending agent against? 

MS. WOOD: Well, I'd like to say that you don't 

know. I think that you rely heavily on vendors who may not 

be entirely aligned with your interests. And I think it's 

very difficult to know exactly what's going on. 

And that's why I argue for transparency, and I 

think along the lines of Commissioner Walter's question, I 

think perhaps one of the things the Commission could consider 

is some alignment of interest, where there is not just 

sharing on the upside in profits, but to the extent that 

there are losses, that not just the beneficial owner 

participates in that. And I think that would certainly 

create a different relationship. 

MR. AVITABILE: And just to add to that, I think 

that the RFP process is a great way to be able to take in 

various bids from multiple lending agents. And that could 

be -- you could have as many as 20 or 30 participants in that 

RFP process. 

Now, as you mentioned, Chairman Schapiro, it's 

possible that there's no one in the pension area that has the 
 

 

 

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time to even do this or to look at this. So in that case, 

they may need to hire a consultant to take them through and 

walk them through the RFP process, which is a way of 

basically getting the best -- finding out what the span of 

ranges are for fees and for all services. That's comparing 

cash reinvestment as well as fees, what they do on proxy 

voting. 

And the consultants typically will help -- will be 

able to at least guide them on the right questions to ask, 

especially for funds that are small, like you said, 

governmental agencies, that are just not familiar with it; 

they need some place to go, they need to go to a 101 session 

and understand what to ask. Sometimes they just don't know 

what questions to ask, and they need to be able to do that, 

and one way is through a very, very thorough RFP process. 

MR. BLOUNT: There is a sort of a knee-jerk amongst 

smaller funds to look only at the split, whereas, 

historically a very attractive split, say 80 percent of the 

returns, could look like a good deal even though a 60 percent 

split for a fund from an agent who has the ability to 

distribute more loans could be much better. So the 60 

percent of a more productive program could be better than 80 

percent of a less productive program. 

Then the next part is, you have to do a 

risk-adjusted analysis. If it's a concentrated program that 
 

 

 

 

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goes only to one counterparty, then they're subject to the 

liquidity exposure that comes from that. So it's not an easy 

task. 

MR. HU: I'm afraid we have to move on to the last 

topic, topic four, and I've been authorized to only go a few 

minutes beyond the 12:30. We've seen today with a typical 

stock lending transaction, so far as the company whose shares 

are being loaned is concerned, the borrower owns the shares, 

including the voting rights associated with those shares. 

And how does this relate to proxy voting, the 

fourth topic, in terms of this panel? Well, in a number of 

ways, and at the most elementary way, with a typical stock 

loan agreement, the borrower holds those votes without having 

any economic ownership, while the lender has the economic 

ownership but doesn't have the votes. 

So this is one example of what can be referred to 

as a decoupling of the economic interest of voting rights. 

And absent Federal Reserve or other constraints, at least 

potentially this might result in a pretty extreme version of 

empty voting. 

So I wanted to start at this most elementary level, 

and briefly work our way up. I want to direct two related 

questions to the entire panel, a toss up. Who controls the 

voting rights as to the shares on loan? Is it always the 

borrower? And second, what difficulties might there be in 
 

 

 

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terms of the lender somehow lending those shares, yet 

managing to keep the voting rights; you know, what are the 

difficulties with those kinds of arrangements? I throw these 

two related questions out to the panel. 

MS. WOOD: Well, I would like to say that you've 

put forth, I think, a very interesting proposition, that is 

that perhaps there are some structural modifications to the 

industry where the beneficial owner, who has the economic 

interest primarily, has the ability to continue to exercise 

their rights, even after the security has been borrowed. 

I think many industry participants have said that 

this is perhaps too difficult, not able to be accomplished. 

But I think that this is a central issue, which is obviously 

of concern to investors. For example, the change -- the 

Commission has significant rules on how majority owners can 

behave if they own 60 percent or 70 percent of a company, for 

example, and if they're not independent and they may be on a 

board, for example. 

Yet they can lend their shares to other parties who 

can vote on their behalf and nobody -- that's entirely 

opaque. And there are, I think -- there are a lot of 

potential abuses, I think, to voting, because of the lack of 

transparency and lack of mechanics to be able to see what's 

going on. This is an issue, certainly, of primary concern to 

investors. 
 

 

 

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MR. LETO: To address your first question, which is 

who controls the voting, it's my experience -- again based on 

my practice -- that the borrowers do control the voting, and 

that while there are -- while it's a little bit easier now, 

because there are some mechanisms that have developed through 

third parties to give the information in terms of the types 

of items that are going to be on the ballots to the lenders, 

but it's still quite imperfect. 

When this issue became really in the vanguard I 

guess early 2007, my experience is that most of the clients 

were kind of sitting there scratching their heads, saying, 

how are we going to do this, because you do have this issue 

of the record date. And unless it's some major issue like 

the Hewlett-Packard merger, or whatever, where you know 

there's going to be a vote that's coming up, and so it's just 

a question of when the management there strikes the record 

date, it's very, very difficult to figure out when these 

items are going to come up. 

It's my understanding that the companies like Glass 

Lewis and RiskMetrics did develop a product over the next 

year or two -- so let's say in the beginning of '08 -- that 

searches all sorts of things, including the broker search 

cards that are required of issuers. But even that's 

discretionary, because you're not required under SEC rules to 

say what the items are that are going to be voted upon, 
 

 

 

 

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you're only required to give notice to the broker -- to 

solicit a number of beneficial owners that the broker 

represents in order to get the proxy statements, et cetera. 

So what was explained to me was that it's still 

maybe 40 percent of those items are identified. So answering 

that part of your question, I think it's still quite 

difficult to figure that out. 

COMMISSIONER WALTER: Christianna, ICGN has said 

that when securities are recalled for voting or recalled, the 

borrower will try to find out the reason for the recall and 

may be resistant to returning the securities if it's for 

voting reasons with some sense that there may be threats not 

to borrow again if the lender does that. Can you flesh that 

out? Is that an accurate statement of what you said? 

MS. WOOD: Yes. We have found that a number of the 

members of the ICGN, some of them large pension plans -- and 

I think this was part of the source of our concern and why we 

came out with a code of best practice, that in fact there are 

economic consequences to recalling votes, and some of the 

parties associated with the recall process did make attempts, 

from time to time, to discourage beneficial owners from 

recalling the securities. 

And then I think there was also concern that if 

there was too much recall activity, there would be later 

consequences for those investors, in terms of the economics 
 

 

 

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if they would be able to negotiate for their lending program. 

And I think that we did put that in our written response, and 

we have found that from the survey that we did throughout 

this decade -- I think we began in 2003 and did research 

through 2005 and then updated our research in '07. 

COMMISSIONER WALTER: If you concentrate, I'd like 

to get your reaction, too, on the duty that many of the 

lenders were talking about owed to their shareholders, their 

pension plan participants, to vote in the best interests of 

those people. And if you have a program that runs into these 

kinds of problems and you can't vote, how is it that as a 

legal matter those duties are being fulfilled? Does it lead 

you to a point where your lending program has to be modified 

in a fashion that potentially even might make it unworkable? 

MS. WOOD: Well, I'd be happy to respond to that. 

First of all, let me say that most pension -- public pension 

plans have a stewardship program, and they consider 

corporate governance and corporate stewardship to be among 

the most significant duties that they have to execute on 

behalf of public pensioners. After all, they're dealing with 

the public capital, and there is a higher duty of care that I 

think trustees of these plans feel that they need to execute. 

Just speaking on behalf of some of them, I 

think -- so my own experiences from the largest pension plan 

in the country, where we identified well in advance which 
 

 

 

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votes we wanted to vote on, and then we lent out the rest of 

the securities. But we had to have a very sophisticated 

program by which we do that. 

And even then, sometimes, we find among our members 

who contributed to the Code that they would frequently arrive 

at a meeting only to find out that they had a fraction of the 

shares that they thought they were able to vote. And so I 

think there's a significant amount of confusion and even 

internally to organizations of pension plans about the recall 

process and the consequences for recall potentially for the 

economics of the program. 

The other thing I guess I would say is, the biggest 

disconnect is with the trustees of the plan, I would tell 

you, not just in the lending practice, but the recall 

practice and really how much is actually being voted. I can 

just say, frequently in discussing this with other large 

institutions, I think they always looked at what the gross 

number of shares they had was. No one ever netted out what 

was being lent. 

And I think there is significant confusion that 

transparency could fix here, and I think that if you go to 

the beneficiaries which are the public pensioners themselves, 

they, I think have a right to know how much of the shares are 

being used for profit and are going into the return streams, 

frequently of the returns in the pension plans. 
 

 

 

 

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And I think this is another point which I would 

take issue with. Sometimes the profits of the lending 

program would be embedded into fixed income returns, or 

returns due to other securities programs. And I think that 

there's some confusion there as well, and I don't think that 

is necessarily right and proper. 

But I do think people need to know how much of the 

securities are being voted for stewardship purposes and how 

much of the securities are being lent out, and I think right 

now there is no transparency there in most public plans. 

MR. AVITABILE: I'd like to just add to that. A 

couple of things that's been mentioned, the first being, it's 

our view that clients, regardless of whether they're pension 

funds, mutual funds, should have the option to vote the 

proxy, okay -- granted that when they lend the security, if 

it's held over the record date by the borrower, they give up 

that right based upon the way the mechanism works today. 

However, if they choose to want to vote that proxy, 

they should be able to have that right, and there should be a 

process in place that allows them to do that. And this may 

just be very simple, but the process is relatively easy by 

taking in feeds from data sources of announcements, of proxy 

vote announcements, taking that in, matching them against 

your system, matching them against the client's inventory 

that wants to vote the proxy, and that would tell you if it's 
 

 

 

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out on loan or not. 

For example, if you get a proxy vote into -- coming 

in 10 days prior, 10 business days prior to the vote itself, 

if the security is not out on loan, you can configure your 

system to be able to immediately restrict it from loan. If 

it is out on loan, your next port of call would be to 

reallocate it with someone who doesn't want to vote the 

proxy, and then thirdly you would recall it. 

As far as recalls, this hasn't been our experience 

where a broker would say, "Well, I don't want to borrow from 

that lender," because quite frankly, they don't know who it 

is. It's on an omnibus basis. And that was the whole 

purpose of the ALD. The ALD is the disclosure of the 

lender's name, who they are, is done with the credit areas of 

those firms. On a trader-to-trader basis, there is 

absolutely no disclosure of who that lender is. 

We call up for a recall, it's a recall regardless 

of if it's a sale, regardless if a client just feels like I 

want my security back, I don't want it out on loan for 

whatever reason, or he's going to vote the proxy. If the 

recall doesn't settle on time, providing that we've 

had -- again, the issue that we see right now is the 

announcement, when the issuer makes that announcement. If he 

makes it in ample time, you can have a recall period and then 

you could do an automatic buy in. You can buy in the 
 

 

 

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security and have another three days and have the additional 

three days to settle that. So you can get that security 

back, because the agent lender is working on behalf of the 

principal counterparty, which is the lender. 

Now there are times when you can't get it back 

because the issuer announces it today for tomorrow. So 

you'll do your best, you'll call up the broker and ask, and 

then sometimes he can get it back, because he'll borrow from 

someplace else. But if it's a tight security, a special 

security, maybe a bit illiquid, those may fall outside. 

Also lenders should have the option to vote all the 

proxies or just the material proxies or create a subset, a 

list of securities that they wish to vote the proxy on. And 

typically in the services that -- the outside vendor services 

that you would have, it would list the different categories, 

and you can show that menu to the underlying client, and that 

under client can say, okay, I will vote categories one, two, 

three, four, five, when that category is attached to the 

proxy -- okay, I won't vote -- I don't care about the admin, 

I don't care about the changing in the color of the building 

or whatever that is, I don't want to vote those. 

So it can be very customized, there can be a 

process. It's not perfect today. It can be better, because 

there's some that fall outside of it, because of the 

announcement dates. I think that's maybe something that, you 
 

 

 

 

 

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know, as an industry we need to kind of figure out how it 

works. I don't think that when the security is out on loan 

it's the borrower who votes the proxy, because the borrower, 

the prime broker has probably settled somebody's short sale. 

So it's Mrs. Jones in Kansas City that owns the security now, 

and that's going to be voting the proxy. 

And so I think based on the mechanisms that we have 

in place, we can make it work to a certain extent, but 

there's more to do. 

MS. KELLEY: May I add a few things to that, as 

well. 

MR. HU: Briefly, please. 

MS. KELLEY: Just on a more practical basis, I 

would want to say that -- and again, we've had a lot of 

discussion between pension funds and '40 Act funds, and I 

don't want anybody to think I'm opining up here that '40 Act 

funds are more sophisticated than pension funds because I 

know a lot of very sophisticated pension funds. 

But from a very practical basis, our proxy voting 

policies are married to our securities lending policies, and 

what we do is we do utilize these outside sources to get the 

most up-to-date, most integral information on proxies. They 

then go to our proxy committees, where investment 

professionals as well as administration and legal and 

compliance professionals sit, and we do in fact take that 
 

 

 

 

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very seriously and look at the proxies and decide whether or 

not we are going to vote them. 

And additionally, knowing that the question was 

going to come up today as we were vetting through the 

process, I actually went to the operations department and 

said, did you -- when you've recalled loans to vote them, 

have you ever had repercussion from the borrower or from the 

lending agent saying, no, you won't be able to lend again, so 

on and so forth, and they said in 100 percent of the cases 

they have never had that experience, and that actually we 

have gotten the loans back and we have voted them to the 

manner in which we had opted to vote them. 

So I just wanted to, on a practical basis, give you 

our experience there. 

CHAIRMAN SCHAPIRO: This might be a silly question, 

but couldn't you contract with the borrower to vote the 

shares in accordance with your instruction without calling 

them back, and that could be done on a next-day basis, 

instead of having to worry about record date and whether you 

have sufficient notice? 

MR. LETO: That actually was something that was 

done in at least one case, because there's a no-action letter 

that specifically says that meets the standards from the 

letters from, I don't know, '78 or something like that. But 

it's my understanding that it's just not done that way 
 

 

 

 

 

 

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currently, but it certainly is permissible and it, in fact, 

it was at least at one point a recognized practice to actual 

contract for that. 

COMMISSIONER WALTER: Does that work when it's Mrs. 

Jones in Topeka who owns the shares now? I mean, you've got 

two -- you could potentially really have two people, and 

probably not infrequently, who want to vote the same shares. 

MR. LETO: It might not. 

MR. BLOUNT: That's exactly the problem: it's been 

delivered out, there's a new owner. 

MS. RULONG: I think it's important to make sure 

that for the -- just on the topic of double voting, that the 

custody records that we keep are very exact on what shares 

are available to the beneficial owner to vote, and what 

shares have left the bank under a loan. So those records are 

within the custody systems of the major custodians. 

The other real quick thing is, just RFPs, we talked 

a little bit before about RFPs, frequently if not almost all 

the time have questions about proxy voting and what are the 

abilities, and Patrick went through those. But what are our 

abilities to notify of when a proxy is coming up, and then to 

get the shares back. So it is becoming very active topic for 

beneficial owners. 

COMMISSIONER WALTER: I can ask lots more 

questions, but I thought you might want to ask some, Henry. 
 

 

 

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MR. HU: Well, I guess one of the -- very, very 

briefly, I mean, the question relates to how empty voting 

relates to all this proxy stuff, right. Traditionally, for 

hundreds of years, when you think of shares, you think of the 

possession of a package of economic voting and other rights, 

as well as disclosure and other obligations. 

And today the foundational assumption can no longer 

be relied on, that you can now possible to decouple the 

traditional link between voting as well as other rights on 

shares and economic interests, quickly, cheaply, on a large 

scale. 

And so for now it's possible for an investor to 

hold significant voting power while having limited, no or 

even perhaps negative underlying economic ownership. And so, 

one of the questions relates to how securities lending 

relates to kind of empty voting, right, so that we 

already -- you all already referred to the record date 

capture strategy, that absent Regulation T or other 

constraints, you just borrow the shares just before the 

record date and then return it afterwards, or possibly in 

terms of securities lending in terms of it servicing the 

hedging needs, ultimately, of the derivatives dealers, 

offering equity swaps or put options to outside investors who 

want to reduce their economic exposure while retaining full 

voting rights. 
 

 

 

 

 

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So in the very, very few minutes we have remaining, 

I'm kind of curious in terms of what some of the things might 

be done to address these kinds of issues, assuming that it 

makes sense to address these issues. Ed. 

MR. BLOUNT: If I can -- I guess underlying the 

importance of the issue that you raise, for the integrity of 

the corporate governance system itself, but then step back 

and point out how difficult the challenge is to identify. 

And whether this is widespread or not, if there are 

even a few cases where the vote is being manipulated somehow 

in the securities lending markets, that would be sufficient 

to demand a call for action of some kind. 

The problem that we face, no matter how much data 

that we have, is that it's not sufficient to merely track an 

increase in activity across the record date, because there 

are some extremely good alternative explanations for why that 

activity may exist, probably the most significant of which is 

that it could be that broker dealers are trying to borrow 

shares back from loans that they previously made but they 

don't wish to break in order to get their margin long holders 

the right to vote. Or it could be banks that are borrowing 

back shares in order to get their own customers the right to 

vote. 

So a spike, especially when it's tracked from one 

provider, one lending agent, could not -- could in fact not 
 

 

 

 

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be suggestive of manipulation, but rather rectification -- a 

remediation of the process. 

No matter how much data is available, there could 

be cases that slip through the cracks. Having now worked 

with this problem since you raised it some years ago, I think 

my conclusion is that we will probably find -- and I'm kind 

of getting in advance of the findings -- that this is not a 

widespread problem, but it still could be a problem. 

And what we may end up saying is that there are 

certain issues that appear to have given indications of 

suspicious action. And it could be just at the margin -- you 

know, 51 percent could be enough to swing a vote, so we're 

not talking about a big spike in the securities lending 

market. 

But if we can identify perhaps with those who are 

tracking materiality and activity, those votes, where there 

has been something suspicious, it could be possible to give 

to the examiners or to someone else on a retrospective basis 

a short list of names, so that they could go in and 

investigate and see whether or not these shares were in fact 

borrowed for the proper purpose. 

I don't think you can get ahead of it. You can't 

say you can or cannot do this, but you can check it after the 

fact, and that might be a chilling enough step to take that 

it would prevent people from manipulating. 
 

 

 

 

 

 

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MR. HU: Well, we have now reached the end of the 

second panel discussion on securities lending. I wish to 

thank all our panelists for their insights and candor. We 

will now have a slightly less than 60 minute lunch break 

before the start of our third panel. The third panel will 

start at approximately 1:30 p.m. or just a little bit after 

that. 

Thank you all. 

(Lunch recess.) 

MR. BRIGAGLIANO: -- Aaron Gerdeman is a Senior 

Vice President at Sungard. He manages product development 

for Sungard's Astec Analytics. Chris Jaynes is the co-Chief 

Executive Officer of eSecLending. Mike McAuley is a Senior 

Managing Director and the Chief Product Officer for State 

Street's Securities Finance Division. Jeff Petro is Vice 

President and Head of Taxable Money Market Trading at 

Federated Investors. Shawn Sullivan is the Global Head of 

Prime Services at Credit Suisse. 

Greg, would you like to start us off with your 

opening statement? 

MR. DePETRIS: Thank you, Jamie. Thank you, 

Chairman Schapiro, Commissioners and SEC staff for providing 

us the opportunity to appear here today. We've been 

encouraged by both the Commission's and the industry's 

thoughtful consideration of structural evolution in the 
 

 

 

 

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securities lending market, and we're honored to be here now 

for a more detailed discussion with such a distinguished 

group of co-panelists. 

Quadriserv is a privately held company whose owners 

include representatives from each segment of the securities 

industry, supply, value and delivery chains, including 

borrowers, lenders, intermediaries, market makers, global 

exchanges and technology companies. 

Our goals reflect the simple objectives of nearly 

all marketplace innovation. To quote former Chairman Levitt, 

the underlying essence of a market is to be a place where 

buyers and sellers come together. Every other feature of the 

market, whether crafted by tradition or technology, exists 

only to serve that purpose. 

To that end, we have developed and now operate a 

central market for securities lending. The market is 

comprised of an anonymous, publicly accessible electronic 

price discovery mechanism, the introduction of central 

counterparty guarantee -- the introduction of a central 

counterparty to guarantee credit and payment risk, an a 

straight-through processing platform that connects the DTC 

settlement and the primary operators of industry-ride 

reconciliation services. 

We believe that this centralized structure will, as 

it has in so many areas of the capital markets, complement 
 

 

 

 

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existing OTC practices, provide dramatic improvements to the 

investing public, and allow new efficiencies to grow the 

market overall. 

This panel is charged with contemplating specific 

concepts for which definitions are important. When we talk 

about electronic platforms, we're talking about an 

infrastructure and price discovery mechanism that resembles 

what I just described. 

When we talk about central counterparties, we're 

talking about strong, reliable and highly-rated central 

counterparties with histories of unblemished risk management 

and broad industry participation. And when we talk about 

transparency, we mean price transparency such that all 

borrowers and lenders, including end users, can publish the 

price at which they are willing to transact, see the price at 

which they've transacted and make that information public to 

all market participants. 

Operating transparency is such that all borrowers 

and lenders transact in a standardized instrument, subject to 

common and universally applicable operating standards. And 

risk transparency is such that all market participants are 

subject to commonly understood, robust and universally 

applicable risk management standards. 

Transparency, electronic platforms, central 

counterparties and accountability share productive histories 
 

 

 

 

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in nearly ever corner of our capital markets, precedence that 

looking forward should be instructive and a cause for 

optimism. 

Over the last 15 years, structural and 

technological enhancements to the markets for cash equities, 

equity derivatives, foreign exchange, fixed income, futures 

have led to improved liquidity, increased volume, reduced 

costs for public investors, and a reduced cost of capital for 

publicly traded companies. 

Each of these market segments was unique, and each 

traveled a distinctive path to relative efficiency. 

Importantly, along the way, however, participants were 

careful not to mistake idiosyncratic product features as 

limiting characteristics of the evolutionary process. 

Discerning these distinctions will be important, as similar 

develops take place in the securities lending market. 

The natural market system was imbued with a 

fundamental American ideal, that fostering competition 

through innovation would help preserve the world's preeminent 

capital market structure. We have succeeded in fulfilling 

that ideal in large part because as innovators we don't stop 

at the question, is it good enough, but rather ask the more 

difficult question, can it be better. 

We're here today not because the securities lending 

isn't good, but because we think it can be better. Thank 
 

 

 

 

 

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you, and I look forward to your questions. 

MR. BRIGAGLIANO: Christine. 

MS. DePETRIS: Thank you, Chairman Schapiro and 

members of the Commission for the opportunity to be here 

today. I am pleased and honored to represent Brown Brothers 

Harriman on this important topic. Brown Brothers Harriman is 

a private partnership established in 1818, and serves clients 

globally through three businesses: investor services and 

markets, investment management, and banking and advisory. 

Our firm was founded and has operated on the 

principle of protecting the long-term best interests of our 

clients. I commend and thank the Commission for examining 

the topic of transparency and the securities lending industry 

in the context of its place in the capital markets and with a 

view toward long-term stewardship. 

The securities lending market is a developed market 

that operates in a well-established base of legal principles 

and standardized operating procedures. ERISA, the Investment 

Company Act of 1940, Rule 15c3, Regulation T, Regulation SHO, 

Rule 204T, agency lending disclosure, along with the capital 

framework recommended by the Basel committee are a few 

examples of regulations that ensure appropriate transparency 

and integrity to loan participants and to regulators. 

Central counterparties serve an important function 

in the clearance of standard and discrete transactions, 
 

 

 

 

 

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however the CCP structure raises issues, when its duties 

extend beyond clearance, and when support of the transactions 

it is clearing involves ongoing administrative complexity. 

Unlike the clearance exchange traded securities of 

commodity contracts, a securities loan is not a discrete 

transaction, yet rather a continuing commercial relationship. 

The ability to effectively manage a loan as a set 

of ongoing obligations between a borrower and a lender is 

critical to ensuring the interests of beneficial owners are 

protected and that the overall integrity of the loan market 

is preserved. 

We believe that one of the lessons of the last 18 

months in the structured asset market is that treating the 

loans as fungible commodities comes at the expense of 

appropriate loan administration. 

Lending relationships can be effectively managed by 

a bilateral relationship between lender and borrower, 

entailing sufficient end-to-end transparency to allow for 

individual attention to origination, collateralization and 

liquidation on default. 

The mediation of a CCP could change an identifiable 

bilateral obligation into a new species of derivative 

dependent upon a limited number of market makers for 

performance and underguarded by guarantee funds already 

committed to other purposes. 
 

 

 

 

 

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The only aspect of lending that is asserted to be 

more transparent under the CCP proposals is loan pricing. We 

should not confuse price publicity with transactional 

transparency when assessing CCP models. Any losses 

experienced by lenders of securities over the last 20 years 

have been the results of loss in the investment of cash 

collateral. 

If there is a need for enhanced transparency, it is 

transparency between agent lenders and beneficial owners, to 

one the source of compensation for securities loans, and 

particularly whether this compensation entails cash 

investment and its attendant risks, and two, further 

education, communication and disclosure regarding the risks 

and nuances of lending to ensure it does not impede nor 

detract from the investment policy or objective of the fund. 

I urge that we proceed with caution before 

considering an alternative -- before considering altering an 

industry that has operated efficiently and evolved 

collaboratively over a 20-year period in the face of broker 

dealer bankruptcies, currency crisis, and perhaps the 

ultimate test, the events of 2008. Thank you. 

MR. BRIGAGLIANO: Thank you, Christine. Aaron. 

MR. GERDEMAN: Thank you. Thank you, Chairman 

Schapiro, Commissioners, Commission staff, and my fellow 

panelists. It's good to be here with you all discussing 
 

 

 

 

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these important topics in securities lending. If I may, I'd 

like to focus my topics -- my topics on transparency in 

securities lending. 

In my work over the past nine years, providing 

benchmarking and price discovery services to the industry, 

I've seen the market grow ever more transparent, and that has 

been a good thing. 

Today we have a competitive marketplace in which 

borrowers and lenders vie for business, aggressively 

negotiating loan rates for hard-to-borrow stocks. Large and 

small service providers, both the established and the 

upstarts alike, compete on price and quality of service. 

Institutions who wish to lend their securities for additional 

income can select from numerous routes to market. 

And these different types of lending programs can 

be quantitatively aligned to the investors' goals and risk 

appetites. Regular benchmarking allows these institutions to 

compare the performance of their lending programs to their 

own expectations, as well as to their peers' results in the 

wider market. These advances in the industry's 

competitiveness, the market's efficiency and accountability 

for performance have been made possible in part through 

transparency. 

Far from completely opaque, the securities lending 

market now boasts large data sets of daily borrowing and 
 

 

 

 

 

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lending activity, covering millions of loans and the vast 

majority of the U.S. market. This market data provides 

essential transparency to borrowers and lenders as they 

negotiate loan rates, to investment managers as they evaluate 

their securities lending programs, and to analysts conducting 

market research. 

Anyone in the securities lending space who wants to 

be in the know taps into this market data. One positive 

outcome from the market's recent turmoil is that we see more 

and more institutions requesting analysis of their lending 

programs and discussing their securities lending strategies 

in detail at their board meetings. 

That increased attention by many institutional 

investors may serve them and ultimately the entire securities 

lending industry well by further promoting accountability, 

transparency and efficiency in the market. 

Thank you. 

MR. BRIGAGLIANO: Thank you, Aaron. Chris. 

MR. JAYNES: Thank you. I'd like to thank the 

Chairman, members of the Commission and staff for inviting us 

all to participate here today. Briefly, some background on 

eSecLending. We are a Global Securities Lending agent, 

managing securities lending programs for large institutional 

investors, pension funds, mutual fund companies, other asset 

management companies. And we provided in a different -- or 
 

 

 

 

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an alternative route to market or approach to the traditional 

custody lending programs that were really the dominant route 

to market when we formed about 10 years ago. 

Our aim is to provide investors with greater 

control over their programs, greater transparency into the 

way their programs were managed, and introduce competition 

via an auction process to try to better both determine 

allocations to borrowers and tools to market, but also to 

provide better pricing transparency to the ultimate loans or 

agreements that are being negotiated. 

I'll give some brief background on the history of 

our firm, which I think is going to be important to provide 

better context to some of our thoughts on how we think the 

industry can move forward. 

We were formed originally in 2000, but we grew out 

of an asset management firm, where the origin of our company 

started in the late '90s, where we were an asset management 

firm looking at creating lending structures for some of our 

own internally managed mutual fund and commingled trust 

products. 

And when we looked at the industry, we saw it as a 

investment process, a trading process, but not an operational 

or a custody process as had been widely, I think, recognized 

at that time. However, when looking at it as an investment 

process, we noticed lots of things that we were used to 
 

 

 

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seeing and become accustom to in the investment management 

world were really not prevalent or widely accepted in 

securities lending. 

Things like performance measurement, things like 

benchmarking, things like monitoring performance and 

switching providers based on performance of the underlying 

agent, use of multiple providers, use of specialists who can 

add value in certain asset classes -- all these things have 

been used for many years in the investment management world 

really didn't exist in lending. And so we looked to create a 

different process that we thought could provide beneficial 

owners with greater control over the program, greater 

transparency into how things ultimately were operated. 

Now if we look at how we think the 

investment -- the industry could move forward to benefit 

investors, I think there are really two key misperceptions or 

views in the market that are slowly changing, but I think 

need to change more dramatically. 

The first is that, again, lending is not a custody 

function, it's not an operational function, it's an 

investment function. It needs to be treated as such. There 

were some panelists earlier who mentioned some great success 

in managing through some of the crises last fall. In both of 

those stories, they were done so by managing programs as an 

investment process, by changing and reacting to the market as 
 

 

 

 

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things changed, not passively sitting by and letting the 

market change without doing anything. 

Secondly is this notion that the market or the 

product isn't something you need to pay attention to, again 

prevalent misconception over the years. It was sold as 

agents, as something you didn't need to pay attention to. It 

was purchased and ultimately used by beneficial owners as a 

market you didn't need to pay attention to, and I think 

clearly with the money that's being made, with the risks that 

are being taken, that mindset needs to change and beneficial 

owners need to take accountability and need to look at how to 

structure programs; need to look at how they can manage 

things in concert with their agent to more effectively manage 

and mitigate those risks. 

MR. BRIGAGLIANO: Thank you, Chris. Mike. 

MR. McAULEY: Chairman Schapiro, members of the 

Commission and staff, thank you for inviting me to 

participate today. One housekeeping matter, in addition to 

my State Street duties, I'm also the current Chair of the 

Risk Management Association Committee on Securities Lending. 

My comments here today, unless I indicate otherwise, will be 

in my State Street capacity. 

Just have some brief comments on the topics of our 

panel. Transparency, with regard to the operation of 

securities lending programs, is critical in allowing 
 

 

 

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participants to make appropriate judgments. We fully support 

transparency by securities lending agents, and believe that 

the industry standards in this regard are currently very 

high. 

With regard to electronic platforms and exchanges, 

the majority of our U.S. equity loans are electronically 

executed through a centralized industry utility that also 

provides automated contract compare and billing services. We 

execute loans of specials, or harder-to-borrow stocks or U.S. 

equities through bilateral negotiations, because we believe 

that is the best method to obtain the optimal value and terms 

for our lending clients. 

All of our clients' loans of U.S. equities are 

electronically cleared and settled, delivery versus payment, 

within the DTCC and the DTC's stock loan tracking system 

provides automated income tracking and payment. Accordingly, 

we believe that the current electronic trading system served 

the industry well in the execution, clearing and settlement 

space. 

Securities lending is an ongoing transaction that 

does not end at settlement. Almost all of the process of a 

securities lending transaction takes place post trade. This 

includes substitute payments, corporate actions, mark to 

markets, contract compare, billing, billing collection, 

rerates, collateral substitutions, reallocations, recalls, 
 

 

 

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returns, and buy-ins. 

All of the risk inherent in the securities lending 

transaction arises in this post-trade environment. 

Accordingly, it is our view that the securities lending 

market would benefit from focusing on further automation in 

the post-trade space rather than attempting to change the 

current execution environment that already is heavily 

automated, is focused on delivering value to beneficial 

owners, and presents little or no risk. 

With respect to a central counterparty, we would 

support changes that would allow agent lenders and their 

clients to utilize the OCC's existing central counterparty 

for securities lending or any other mechanism that allow 

innovation of bilaterally negotiated loans to a central 

credit intermediary as another alternative for distribution 

of our client's securities, provided this mechanism did not 

result in increased costs, operating risk or liability for 

post-trade processing and provided the benefits of lower 

credit risk for beneficial owners and reduced capital 

charges. 

With respect to other benefits, we believe a number 

of changes to the bankruptcy laws, accounting rules and stay 

procedures would improve securities lending for beneficial 

owners by making it easier for agent lenders to engage in 

multiparty netting across products and to execute closeout 
 

 

 

 

 

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procedures without concern of having stays imposed. 

In addition, we also believe that allowing U.S. 

dealers to pledge baskets of highly liquid U.S. equities as 

collateral would provide benefits to all parties in the 

lending transaction, and would allow beneficial owners to 

diversity their collateral options and provide them 

additional options for managing risk. Thank you. 

MR. BRIGAGLIANO: Thank you, Mike. Jeff. 

MR. PETRO: Thank you. Thanks to the Commission for 

inviting Federated to the table. We've heard excellent 

representation from mutual funds today, so I thought I would 

actually change things a bit and just be simplistic. 

I work for an extremely conservative mutual fund 

company which manages over $400 billion in assets; $330 

billion of that is money market funds, so we do simple. I'm 

part of a team of portfolio managers, credit analysts and 

traders where there's a natural friction that already exists 

between the process of the money management of the money 

market funds. So that credit process is already there for 

us. 

My number one job is to provide liquidity at par 

every day to every shareholder. And my shareholders and my 

customers happen to be the sec lending portfolio managers, 

the board, my shareholders. Ultimately they are all my 

customers. My job is to have the policies, procedures and 
 

 

 

 

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the risk parameters to be set in place so then we can be 

successful and I can really -- I can sort of drive the 

outcome and the environment of securities lending at our 

firm. 

But this in no way our core business. Our core 

business is running equities, running fixed income, running 

money market funds. Securities lending is alpha generation 

for us, and every portfolio manager knows that and the board 

knows that. So I have to set up the risk parameters for what 

I think is the least amount of risk with the most reward. 

What I probably don't do as well is I don't lend 

securities. I don't foresee myself having an operation in my 

firm that I'm going to lend securities, so I do trust that 

the operation that my third party lenders are going through 

meets the same rigorous standards from the standpoint of 

policies, procedures, risk management that I do in my own 

2a-7 funds. 

I am an expert on cash management, though, so I 

take full responsibility for that. I feel the transparency 

is from top down. Transparency is what the board knows, what 

the shareholders know, what the portfolio managers know. 

Everybody needs to know exactly where the risks and rewards 

are, and that's my job to bring that to them. 

I feel different, maybe, than other people, but I 

feel like I'm in the right product -- but I feel I'm in the 
 

 

 

 

 

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right product for the right reasons. We know why we're in it 

and we know what our expectations are. 

MR. BRIGAGLIANO: Thank you, Jeff. Shawn. 

MR. SULLIVAN: Thank you, Chairman Schapiro. I 

appreciate the opportunity of being here today. My name is 

Shawn Sullivan, and I'm a Managing Director at Credit Suisse, 

and I run the firm's financing books, which include 

securities lending. 

When asked about transparency, I think about risk 

and price. Three years ago the Commission took action to 

require full counterpart and data disclosure which would 

allow investors, agents and broker dealers to make informed 

trading decisions around counterparty risk. In response, the 

industry developed the agency lending disclosure initiative. 

This calls for the electronic transfer of all stock loan data 

so true counterparty risk can be assessed. 

Price transparency. It's important to note that 

the easy-to-borrow securities make up over 90 percent of the 

securities lending market. These securities are readily 

available. The rates on the easy to borrows are 

pre-negotiated between the agents, the vesters and the broker 

dealers. These rates are quoted off well-established 

benchmarks and spreads that have been agreed upon. 

Additionally, there are venders that will share 

price information. Many investors are using these pools of 
 

 

 

 

 

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data to mark to market their securities lending program to 

ensure they're getting fair value. 

It has been suggested that requiring broker dealers 

to pre-borrow securities before executing a short sale would 

curtail fails to deliver. Credit Suisse does not believe 

that a pre-borrow requirement is necessary, especially on 

easy-to-borrow securities for which there is ample supply. 

Additionally, the regulatory requirements enacted 

pursuant to Regulation SHO and Rule 204 have achieved the 

goals of facilitating timely settlement. The actions of the 

Commission have dramatically reduced fail to delivers in 

today's market. 

Electronic platforms. Electronic platforms are 

absolutely essential to the growth of our market, while also 

maintaining a controlled environment. There are many vendors 

that provide automated tools, which is allowing the market to 

scale and become volume insensitive. 

These solutions, combined with significant IT 

investment by both agents and broker dealers, limit manual 

intervention, and more importantly, investor risk. Stock 

loan has truly evolved over the last 10 years. A vast 

majority of all stock loan transactions are today executed on 

these electronic platforms. 

Central counterparts. Central counterparts have 

many forms and will perform many different functions. Every 
 

 

 

 

 

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market is different, and the design of a CCP is only useful 

if it truly addresses the unique characteristics inherent in 

the securities lending market. 

I don't know of a proposal today that will actually 

meet these requirements, however I have no objection to 

exploring the possibility. More importantly, the use of a 

CCP should be voluntary and based on the value that it 

brings. Thank you. 

MR. BRIGAGLIANO: Thank you, Shawn, and thank you 

to all the panelists for a very thoughtful and provocative 

opening statements. Do the Chairman or any of the 

Commissioners have a question currently? 

CHAIRMAN SCHAPIRO: Jamie, let me start with one. I 

was struck when I read -- I think it's Greg's 

submission -- that talks about the objectives and benefits of 

a CCP, and they really do mirror very much what we're all 

working on in the over-the-counter derivatives space, in 

terms of providing transparency, preventing fraud and abuse, 

efficiency, minimizing systemic risk, providing risk 

management tools. 

And I sort of heard mixed support, and I definitely 

heard some non-support for the idea of CCP, so I'd love to 

get just a little more of your thoughts on central 

counterparties in this space from any of you. 

MS. DONOVAN: I'm happy to start. From our 
 

 

 

 

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perspective, just by way of background, our program 

predominately represents asset managers, '40 Act funds in the 

U.S. and collective managers globally. And historically we 

have always operated in an intrinsic value program. 

And I think what we heard from other panelists was 

that key to the success of '40 Act managers, particularly in 

the States, has been the ability to customize and manage the 

risks. And our experience has been, is that '40 Act managers 

particularly, and beneficial owners generally, tend to like 

to manage their risk themselves, rather than outsource it. 

Our clients want to see through an intermediary, 

and I said, they trust their own risk management rather than 

delegating that. They want to be active participants in a 

securities lending transaction, they don't want to be 

consumers. And in some ways, the concept of a CCP model 

would inhibit our clients' ability to customize and manage 

those very risks with which they have the greatest concern. 

CHAIRMAN SCHAPIRO: So if you put aside your 

particular firm's customers and maybe put aside '40 Act 

managers -- because I think one of the things we learned from 

this morning is that the '40 Act companies have done things a 

little bit differently -- would you have the same view with 

respect to other lenders, pension funds, state and local 

governance? 

MS. DONOVAN: I guess it depends on how we're going 
 

 

 

 

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to define performance and risks. If we look at what the four 

main risks are on a securities lending transaction, we look 

at counterparty, we look at collateral and reinvestment, we 

look at operating risk and we look at legal attacks and 

regulatory risk. 

I think we have to ask ourselves, does the CCP 

model solve for any of those risks, and more importantly, 

over the last 20 years, has any -- has the securities lending 

industry presented any type of systemic risk as a result of 

the activity and as a result of borrower defaults in some of 

the extenuating market circumstances that we've experienced. 

And I think if you dig further and look into those 

issues, the answer to that question is no. So from our 

perspective -- and I'm speaking broadly across the 

market -- we, from an operating perspective, we may be 

solving for a problem that perhaps doesn't exist. From a 

pricing perspective, I would say that we -- as some of my 

other panelists agree -- we would certainly support some type 

of mechanism that would ensure greater price publicity. 

But I think looking -- taking it further to a CCP 

model, which is going to mutualize risk in some way, it's 

probably not in the best interest of beneficial owners. 

MR. McAULEY: This is Mike McAuley. I would agree 

with those comments. I think if we look at what brought us 

to this discussion, it's certainly the events of the last 
 

 

 

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couple of years. And where did the problems arise in the 

securities lending, well, the main problems arose when the 

cash collateral reinvestment side. The lending side 

performed well. 

And if you look at a business model where we 

currently have two intermediaries between the ultimate 

beneficial owner and the user of the security, a CCP simply 

adds a third intermediary which increases the cost of that 

transaction. 

So the question is really, is the increased cost of 

that transaction worth the additional credit intermediation, 

the third credit intermediation, because currently there 

exists two right now with the indemnification of the agent 

lender. So what is the value that we're getting out of 

putting a third intermediary into the business model when I 

think the industry showed that it could handle the events of 

the last couple years on the securities lending side, on the 

transactional side. 

MR. SULLIVAN: I would also add that I would think 

a CCP would most likely reduce liquidity in the marketplace. 

Currently, beneficial owners have full disclosure on the 

counterparts they're dealing with, and that was by a mandate. 

And if you're dealing with a CCP, you're not necessarily 

going to know who is on the other side of that transaction; 

you don't know what their habits are. 
 

 

 

 

 

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And the securities lending market takes the 

know-your-customer concept to the next level and beyond. 

There's significant conversations that are had about recalls, 

about proxy voting, the different tax regiments. There's so 

many nuances within the securities lending market that a CCP 

would really have to be an extraordinary mechanism in order 

to be useful. 

MR. PETRO: And from the standpoint of being the 

beneficial owner, it's important that we do know who that 

ultimate counterparty is, because it's part of our 

risk-weighted monthly committee to know -- obviously not the 

hedge fund, but who our counterparty is after the lender. 

And without that information, we're not sure where our 

biggest risk lies, and then also with the indemnification 

from the third-party lender. 

MR. DePETRIS: This will be probably a long-winded 

response, but I'll try to take them in order. To Chris' 

point, I think it is important to think about kind of 

risk-weighted or kind of relative risk performance. 

The question is, kind of, where is the return and 

where is the risk? And I think that that's an important 

consideration in any discussion about a central counterparty. 

At the end of the day, the central counterparty's job is to 

guarantee default and to guarantee payment in specific cases. 

And so, clearly, as we think about counterparty 
 

 

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risk, you need to be clear about where the counterparty risk 

relationships are. And it's important to -- from the 

beneficial owner standpoint to know that those agent-lender 

obligations or agent-lender disclosure reporting doesn't 

change. At this point, unless there's a change to the ERISA 

law itself, the only eligible counterparty to a securities 

loan would be the broker dealer. 

So unless that changes and it becomes an actual 

clearing corporation, everything needs to stay the same. So 

the risk element, if we want to look at that, is really going 

to be from the broker dealer intermediary to the clearing 

corporation. In the case that we're talking about -- and 

it's difficult to kind of generalize here, because there's 

only one reference point -- in the case of the Options 

Clearing Corporation, as an example, which is a AAA-rated 

clearing corporation, the largest derivatives clearing 

organization in the world, that risk under Basel II is a zero 

risk rate. 

So the actual counterparty risk, if you want to 

talk about kind of systemic impact of that distributed risk, 

is a positive impact on that. So from the standpoint of 

reward, then -- and if you want to take the counterparty risk 

and the default risk -- and you can kind of debate the value 

of that -- and then kind of lay that back into other risks, 

cash reinvestment risk, the rewards then are the revenues 
 

 

 

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earned from taking those risks. 

So from the standpoint of the role of the central 

counterparty -- and again, I think to Shawn's point he made 

before is completely valid -- it's important to separate the 

distinction between the credit function an the price 

discovery function. They are not one and the same. And from 

the standpoint of providing price discovery -- and again to 

Shawn's point that 90 percent of those assets may have little 

need for the price discovery function -- 10 percent of them 

do. 

The point is, for the 10 percent of those assets 

that do have the value, it's important to optimize that 

value. So in all cases where there was an overwhelming 

demand and a lack of supply, the auction market mechanism is 

probably the best price discovery mechanism. 

The role of the central counterparty, then, is to 

grow the universe of potential bidders in that auction and 

remove the potential bottleneck or the potential credit 

constraint of the universe of demand. And so from the 

standpoint of reward, then, as you calculate that risk -- the 

risk component, the reward is, what is the best value for the 

asset and the most likely or the most -- the optimal way to 

get that value is to increase the universe of bidders to pay 

the best price. So I think that it's an important 

consideration talking about risk reward. 
 

 

 

 

 

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MR. BRIGAGLIANO: Another question from 

Commissioners? 

COMMISSIONER PAREDES: I'm actually curious to 

maybe try to get a little more back-and-forth on this 

particular point, and whether or not there any responses to 

what was just said, and then perhaps likewise back. 

MS. DONOVAN: Thank you for that invitation. I 

guess what I would offer is, when we're talking about 

CCPs -- we do need to separate the discussion from price 

publicity and price transparency from the operating aspects 

of the transaction, because traditionally defined, the CCP 

will become the sole counterparty to the beneficial owner, 

and the CCP will also be the one responsible for providing 

all post-trade maintenance and in reporting. 

And I think what's important to note 

is -- continuing on a point Shawn had made -- that liquidity 

is fragile in this market. We have a market where the 

objectives and the motives from the demand and the supply 

side are not aligned, meaning that beneficial owners -- this 

isn't -- this is optional, they are not required to 

participate in lending, there is nothing about their 

investment policy nor their fiduciary responsibility that 

compels them to lend to ensure their investment objectives 

are met. 

Conversely, you have hedge funds who need to short 
 

 

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securities, they need to borrow in many ways to fulfill their 

fiduciary responsibility and the objectives of their 

investment plans. My point for saying that is that unless 

this is constructed in such a way that the beneficial owner 

feels that they can customize, they can see through, they can 

control the activity, I think you would have a significant 

pullback in liquidity from the beneficial owner perspective. 

COMMISSIONER WALTER: Could you, in effect, have 

your cake and eat it too by having a CCP be available and 

letting businesses that did not have a great desire to 

customize gravitate towards it, while leaving the 

customization process -- I mean, the same thing may be 

happening in the over the counter derivatives market. I 

gather the suggestion that you're making is that there's such 

a need to customize there is not enough business left over 

that is of -- that is not of that sort, but I'd appreciate it 

if you would comment on that. 

MS. DONOVAN: Well, I think if we think about the 

operating aspects of the securities lending transaction, in 

many ways they are quite standardized. And my broader 

question would be is, what problem are we trying to solve for 

through the CCP operating model, operationally, because if we 

look at how the securities lending industry dealt with the 

Lehman default recently, and historically if we look back at 

Drexel, if we look back at Barings Brothers, if we look back 
 

 

 

 

 

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at the Asian currency crisis, note there was no systemic risk 

that was ever incurred as a result of an -- for securities 

lending transaction operationally. 

So that's the question that I pose, is what 

operational problem are we solving for with the CCP? And 

particularly in light of clients, given post-Lehman Brothers, 

who are looking for greater transparency and greater control. 

MR. McAULEY: This is Mike McAuley, and I'd just 

like to add to that. I think we have to separate again the 

discussion about a central counterparty from the discussion 

about an exchange or an electronic trading platform. I think 

that's where the discussion of price discovery comes in. 

There is an existing CCP for securities lending at 

the OCC, and I think that there could be what you described 

if it -- some of the rules were changed to allow it to be 

easily used by agent lenders or beneficial owners in a way 

that you could have bilateral negotiation, you could novate 

that loan to the central counterparty and maintain the 

bilateral credit relationship, but with an additional 

intermediation of the CCP. 

But those are the things that I think need to be 

discussed, and I think that, you know, something potentially 

could be done in a way that would gravitate some people to a 

CCP model. 

CHAIRMAN SCHAPIRO: What would you say are the most 
 

 

 

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important aspects of the securities lending process, the 

whole process, that need to be automated or need further 

automation? 

MR. McAULEY: I think if you look 

historically -- put 2008 aside and cash collateral 

reinvestment -- many of the agents here would feel the same 

way, but one of the biggest risks is corporate actions, and 

is there a way to automate the corporate action process in a 

way that reduces loss? I think that's probably one of the 

highest risks that certainly agent lenders face in the 

processing of securities lending. 

The recall process, there's been instituted just 

recently automated recalls, and to make that -- to put more 

focus on that and allow that to be * more automated in a way 

that everybody would use that procedure, I think would add 

further automation. I think we could -- there's places that 

could use additional automation that we can focus on, I 

think, focusing on the trade, if you want, the trade 

environment and settlement environment which works well now, 

and as Christine mentioned, really presents no risk, I think 

would benefit by focusing on that post-trade environment. 

MR. SULLIVAN: Most of the mark-to-markets -- and 

that's where your most exposure is for your 

counterpart -- are executed automatically and probably have 

cleared by 7:30 in the morning, and we're talking about 
 

 

 

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hundreds of thousands of mark to markets per probably broker 

dealer. 

So it's highly automated. I think that's the most 

important -- as far risk is concerned -- is that beneficial 

owners like a choice. They want to deal with highly 

credit-worthy counterparts that they know can withstand a 

market disruption. And when you have -- an OCC is a CCP, and 

it has never gained any traction, and it hasn't gained any 

traction because it doesn't address those concerns of having 

a choice. 

If there's a default if you're not marked, there's 

going to be a loss, there won't be any reduction in the loss, 

that loss will just be spread out amongst the participants. 

And if you have more bidders in the process, you're most 

likely going to have a deterioration in the credit quality of 

the counterparts, and that's something that a beneficial 

owner does not want to be exposed to. 

MR. DePETRIS: I'd just say that, number one, 

there's a significant difference in the nature of the margin 

being collected. So as opposed to the over-the-counter 

margin, the 2 percent standard margin over the counter, the 

CCP-based margin regime is risk based, it's got -- it's a 

tiered margin regime with a lot of 

considerations -- volatility, the balance sheet of the actual 

broker-dealer member. 
 

 

 

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But all of that aside -- and the fact that as a CCP 

in the default scenario there has never been an issue, 

obviously, there. But more importantly, I think, and Shawn's 

point about the reconciliation is a good one, the 

multilateral reconciliation process does happen 

automatically, it does happen efficiently. 

And importantly, I don't think we're talking here 

at all about an either/or scenario, we're talking about two 

complementary market structures, one hopefully kind of either 

offsetting benefiting or being kind of integrated with the 

other over time. And in that -- in the CCP world, that 

reconciliation is happening once. It's happening in the 

morning once for all participant members of that CCP. So the 

reconciliation point, the point of failure, all of that is 

reduced dramatically. 

MR. JAYNES: I think one other quick point. You'd 

mentioned a potential hybrid solution where certain clients 

all go toward the CCP, other clients all go away from the CCP 

to bilateral. I think there's a different kind of hybrid 

solution where assuming the CCP can actually add value in 

certain markets or certain sectors, we and our clients would 

certainly look to trade certain of our securities through 

that mechanism if we could be comfortable with credit, if we 

could be comfortable that we were getting a better price from 

a risk return, and we would continue to trade bilaterally 
 

 

 

 

 

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with other markets and other sectors and otherwise. 

So I don't think it's an all or none; I don't think 

we have to wake up one day and say, every single one of our 

loans suddenly now has to go through a CCP. Where CCPs can 

add value, where they can show better risk return to clients, 

we as agents ought to be looking at utilizing those. And 

that isn't proven today. 

Certainly advancements are being made, and we'll 

look at that, but we don't view it as an all or none, we view 

it as a potential -- another tool that we can use to improve 

returns and ultimately improve results for our client base. 

CHAIRMAN SCHAPIRO: Jamie, I have one last question 

on my end. Several of you said, let's separate the use of a 

CCP from price transparency. And so any comments you have on 

the sufficiency of price transparency would be very helpful 

to us. We heard a lot about that this morning, and it was 

maybe one of the top three issues that was raised. 

MR. GERDEMAN: Thank you for the question, 

Chairman. I might start off answering by also answering some 

of the questions that were brought up a bit earlier. So I do 

apologize. I'll just bear off course for just a second. 

Starting with price transparency -- someone brought 

up an example of Sears Holding, and I'll just use that as an 

example of the kind of transparency on prices that does exist 

today in the market. 
 

 

 

 

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In the data that we track within the lending pit, a 

cooperative of transaction data -- it's an end-of-day 

compilation of millions of transactions that occur in the 

securities lending market. And across that, the average 

rebate rates, at the end of day yesterday, were just 

under -20 percent. So that's about a 20 

percent -- roughly -- fee that borrowers on an intrinsic 

level are paying to -- for the right to borrow that security. 

And then I would also mention that there is some 

transparency outside of prices. We talked briefly about -- I 

think there was a question regarding the market share of '40 

Act funds, and so on, in the size of the market. And mutual 

funds do account for about 10 percent of loan volume, but 

they do count for a larger portion of lendable assets, about 

25 percent. And previous panels touched on why that might 

be, restrictions on lendable amount and so on. 

Finally, compensation splits among agents -- 60 

percent of mutual funds see splits ranging between 75 percent 

and 80 percent, they keep that much revenue, and that's just 

talking about mutual funds. And this kind of data we provide 

through our research reporting. 

To more directly answer your question -- thanks for 

being patient -- the kind of transparency I alluded to for 

your trading desks in securities lending is that end of day, 

next morning, security-by-security detail about the various 
 

 

 

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rebate rates in the marketplace, as well as loan volumes, 

distribution of counterparties on an anonymous basis, showing 

essentially trends in market color in the securities lending 

space. 

MR. McAULEY: I'd also just like to comment on 

that, as well. We've heard a lot about transparency 

throughout the discussions, and I think to frame a 

discussion, we have to define what we mean by transparency, 

because there's different kinds of transparency. And even 

within that -- so I think we have to, in that definition, it 

has to be, what is it that we want to be transparent, and to 

whom do we want it to be transparent to. 

If we talk about price discovery, I think -- or 

price transparency, there's levels even within that. So are 

we talking about the price that the beneficial owner charges 

the broker dealer to borrow the security? Or are we talking 

about the price that the broker dealer charges the end user 

of the security to borrow the security or to use that 

security in a short sale? Or are we talking about the 

combined price? 

And even within that, there's further -- you go 

further, deeper -- are we talking about the price that an 

index fund might get to lend a security versus a fund that is 

actively traded. I think other people on other panels have 

mentioned that the price isn't just a function of supply and 
 

 

 

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demand. A lot of price is determined by the individual 

characteristics of the lender and the borrower. 

So -- and those can include things like how they're 

structured, how they're managed, what their risk appetite is. 

So a particular lender who is willing to take a certain kind 

of collateral, securities collateral, say equities as 

collateral if we're talking about a non-U.S. transaction, 

might get paid a different rate to borrow the same security 

that someone who wants Treasuries as collateral will get 

paid, because Treasuries, typically in the market, are costly 

to finance, and therefore cost the dealer more to borrow the 

security if they demand -- if the underlying beneficial owner 

demands type of collateral. 

So price will fluctuate as individual beneficial 

owners adjust their risk appetites or set limits on their 

programs as it relates to collateral or other things, and 

there's a lot of other factors like that. So I think, as we 

talk about price transparency, we have to recognize that 

price isn't just a function of supply and demand. 

MR. SULLIVAN: I would also add that when it comes 

to the hard-to-borrow market, there is no shortage of 

competition amongst broker dealers trying to get as much of 

an allocation as they possibly can. And the agent leaders, 

in their fiduciary role, extract value. There is constant 

conversations and negotiations that go back and forth every 
 

 

 

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day trying to get best price. 

My firm contributes to -- contributes its stock 

loan data and prices to two vendors, and the beneficial 

owners have that data if they subscribe to it, and they can 

see if their agent lender is getting a fair price. 

And as far as the other side of a prime broker or 

broker dealer's price transparency is concerned, we provide 

downloads of information on all the hard-to-borrow securities 

that we have to offer, as well as the rates. So before we 

get a telephone call, our customers know pretty much where 

the market is. They can either -- they can get a push list 

that we will give them outlining all the securities, or they 

can log on to our system and automatically get that data. 

MS. DONOVAN: I would offer -- just as we spoke 

about the CCP model and separating the pricing or 

transactional components to the operating components, I would 

offer the reverse as we speak about performance measurement, 

meaning -- a question or a comment was asked in the last 

panel, how do I benchmark my performance. Perhaps the 

question should be, how are you defining performance, and is 

performance a function of the appropriate balance between all 

the risks, how is your agent managing all the risks that are 

in lending, as we -- the four risks that we spoke about 

previously, in addition to ensuring that they're getting an 

appropriate return based on the parameters that you've set 
 

 

 

 

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forth in the program. 

So in many ways as -- we seem to have broken this 

discussion of performance just down to the pricing of the 

loan transaction, when in many ways what we would encourage 

is that for beneficial owners to step back and create a 

policy around lending that's consistent with their overall 

investment objectives. 

And what's important to that, too, is that 

beneficial owners have to have access to all the risk and 

return information about securities lending. So agent 

leaders need to ensure greater transparency and communication 

and education around here are the risks, here are the return 

dynamics. And then perhaps beneficial owners can construct a 

program that's consistent with their investment objectives, 

and then set performance criteria around that. 

MR. DePETRIS: I just want to add to that. I think 

that the definition of price transparency sounds complicated, 

and it is in a lot of ways. And so one way to think about 

the central counterparty and to think about the price 

discovery mechanism is to say that for some subset of the 

market there's no confusion, there is simply a standard 

credit, the best available credit anywhere. 

There is a price discovery process -- everyone 

participates. There's public bidders, there's public offers, 

there are intermediaries, and every element of the supply and 
 

 

 

 

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value chain. And from a benchmarking standpoint it's very 

easy to understand that definition, and maybe we can take 

some of the mystery out of it. 

MR. GERDEMAN: One more point on the topics you 

brought up, Chris, on benchmarking. It is important to go 

beyond just the price. That's an important element, 

obviously, because it's one of the levers that a lending 

program can pull to increase revenue, but of course the 

events of the past year or so showed that it's not 

necessarily the only tool, and it highlighted the reverse 

side of that spread, which is the investment premium sought 

in the cash collateral. 

So in any benchmarking analysis, the beneficial 

owner, the institutional investor participating in a 

securities lending income, needs to consider the multitude of 

factors that were mentioned, not just the rebate rate or the 

price on the loan or even your portfolio in aggregate, but 

the yield and the investment range in your cash collateral 

program, your counterparty borrower distribution. 

Of course you don't want to be too concentrated 

among one broker dealer as a borrower, and liquidity 

constraints such as loan turnover rates and so on. So all of 

these different factors do need to be considered in addition 

to price, but price is definitely important. 

MR. BRIGAGLIANO: Aaron, we heard Shawn talk about 
 

 

 

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some of the data that his firm pushes out -- pricing data, 

and you've commented that there is significant data 

available. Do you have a sense that other firms, most other 

firms, all other firms do the kinds of things that Shawn was 

talking about in terms of giving data to vendors so that when 

you acquire data from a vendor you can see the whole market? 

Do you have the whole universe? 

MR. GERDEMAN: Many of the -- especially the 

largest institutions, intermediaries in this market 

participate in one or two or however many data exchanges. 

It's mutually beneficial -- the whole is greater than the sum 

of the parts, and that rule of thumb is true here, as well. 

But like Shawn alluded to, if you look at the 

market rates that we aggregate, there's no one rate for a 

securities loan. We do publish weighted average rates, we 

publish ranges, you know, high-low across the market, 

different distribution metrics. And we have to publish that 

distribution because there is no one rate. It depends on 

the -- let's say the expected length of the loan, right -- is 

this loan coming -- the security coming from a stable 

portfolio, maybe like an index fund, or is it an actively 

managed fund that makes more frequent sales forcing recalls? 

All of these factors are considered by the 

professional traders on the stock loan desk who take all of 

that information. Part of it is the information that I try 
 

 

 

 

 

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to provide through price discovery processes, but the other 

part of the information is how -- they know their customers 

best and they're trying to execute for the most revenue 

possible. 

MR. BRIGAGLIANO: Christine, is there any way that 

price publicity could be enhanced? I think you mentioned 

that there could be some additions there. 

MS. DONOVAN: Sure, it can always be enhanced. And 

I don't have any particular recommendations, but I would say 

we would be supportive of further progress and type of 

electronic exchanges that promote a price publicity. 

But to Aaron's point, we do think there are many 

mechanisms now that allow not only traders representing 

beneficial owners, but beneficial owners when reporting to 

their boards to access information that can support 

appropriate benchmarking. 

MR. BRIGAGLIANO: Any of the Commissioners, or 

the --

CHAIRMAN SCHAPIRO: I have a little bit of an 

off-the-wall question, and it comes from a gnawing concern I 

have, that we've talked about while there really isn't 

systemic risk here, and there's great risk management here 

because parties know their counterparty and they are not 

concentrating positions and they are understanding the 

creditworthiness and all the different levels of risk, and of 
 

 

 

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course we've just been through a period where we thought all 

those things were true in lots of other aspects of our 

financial markets. 

So is there anything you can tell me that's 

different here -- I know we haven't had the crisis, but we've 

had the collateral reinvestment issues, for sure; we haven't 

had a major crisis of securities lending -- what can you say 

to us that suggests we shouldn't be worried profoundly about 

this anyway just because it hasn't blown up yet? And I'm 

sorry if that's a little bit of an unfair question, but I'd 

love to hear your thoughts on that. 

MR. SULLIVAN: I would say that as a broker dealer, 

I'm borrowing securities and I am posting as collateral a 

superior asset, cash. In addition, I'm posting a margin of 

anywhere from 2 percent to 5 percent. And in a crisis, I 

think it's well accepted that equity markets would most 

likely fall in a scenario where there's a default, and as a 

result the defaulting counterpart is holding the inferior 

asset, the stock, that's falling, and has the cash which 

happens to be the best asset you could possibly have, and 

they could buy back those assets at a discount, and would 

have access cash on hand after the default. 

MR. JAYNES: I think clearly that some of the 

checks and balances that have been put in place in the 

market, particularly in the case of Lehman, worked very well. 
 

 

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And I don't think any of us can sit here and say nothing can 

ever go wrong again. Clearly none of us can make that 

statement, though I think the industry has built in lots of 

different checks and balances to try to make sure our default 

or counterparty default doesn't happen. 

I think back to the earlier point, though, about 

viewing this as an investment function, there still does need 

to be a mindset shift, I think, in this industry. If we're 

all now increasingly recognizing it and viewing it as an 

investment function and a trading function, I think there are 

still big pockets of the market that have learned it as a 

custody function, learned it as an operational function, and 

don't view it in the way they should in treating it as 

investment function. 

And where there's risks, there's risks, I think, in 

not viewing it properly and therefore not taking the steps to 

put in risk controls, not taking the steps to actually 

understand -- you know, if you talk about transparency, 

transparency around how my program is structured, what is my 

agent doing, how is my agent generating those returns, what 

risk am I taking to get those returns, those are all logical 

and good questions that any investor should take, and those 

that treat it as an investment function, ask those types of 

questions -- I think historically there's been others who 

have just said, I don't pay attention, send me the check at 
 

 

 

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the end of the month, and so they're unaware of some of the 

risks, they're unaware of even how the returns are being 

generated. 

And we, as an industry, need to do a better job on 

both the agent side as well as the -- I think the investor 

side to try to recognize this product for what it is and 

treat it accordingly. There's clearly developments going on 

in that, there's clearly been improvement in that, from 

better benchmarking data, from better education, from wider 

recognition of this as an investment product. But we still 

have a ways to go, and I think we all collectively need to 

help continue to push that -- the market forward and get that 

misperception kind of changed once and for all. 

MS. DONOVAN: In response to your question, 

Chairman, if you look at this industry, and your concern 

is -- your question is a good one, how can we ensure that 

something won't blow up in the future. I would suggest that 

we look at what are the four main risks in the product. 

We've got counterparty risk, we've got collateral 

and reinvestment risk, we've got operating risk and we've got 

legal, tax and regulatory risk. So if we look at those four 

main risks, the questions are, is there a solid foundation 

with regard to the legal operating platform of the 

transaction, and are the operating procedures such that it 

can facilitate an event of default in the case that one 
 

 

 

 

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happens. 

I think we've seen that that has happened with 

Lehman. To Shawn's point, yes, it's a collateralized 

transaction in a margin, however you need that collateral to 

buy in that replacement security, so the liquidity and the 

stability of the collateral is important. 

It would be our position that if you look back in 

the history of this industry, the last time the industry had 

a -- there were losses incurred, it was in 1994, it was as a 

result of structured assets, inverse floaters specifically, 

that were purchased in securities lending collateral pools, 

and that's how clients incurred losses. 

So I think the attention needs to be on collateral 

and reinvestment. We've talked a lot in other panels about 

perhaps equities as collateral in other forms. I would urge 

us to look at that proposal very, very carefully. Again, 

it's collateral, and in the case that it's cash collateral 

it's the reinvestment of that cash collateral. And if any 

weakness has been exposed in the last 20 years, it's really 

been in that risk. 

MR. McAULEY: I'd also like to add, I think one of 

the things that gives me comfort is the credit risk 

management. When you look at a central counterparty, and 

that's kind of what we're comparing it to here, certainly the 

risk gets mutualized among the clearing members or the 
 

 

 

 

 

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participants. 

Well, to some extent that occurs in securities 

lending already -- not necessarily a full 

mutualization -- but through the credit process, and through 

the client's ability to tailor their program, their 

securities loans are spread over many borrowers. They're not 

concentrated in specific borrowers and credit limits are set. 

In addition, you add that to the credit process 

that the agent lenders go through, because they're providing 

an indemnification, so they have to protect themselves as 

well, and they place limits. So that level and that 

spreading of risk occurs already, and I think to the extent 

that there's a loss, it's going to be focused in a particular 

area, but it's not with respect to the entire portfolio of 

the client, because that risk has been spread and it's been 

capped by credit limits. 

MR. BRIGAGLIANO: Well, that brings our third panel 

to a conclusion, and we appreciate the comments and efforts 

of all the panelists. And let's reconvene at 2:55 for our 

fourth and final panel of the day, the Future of Securities 

Lending. 

(Brief recess.) 

MR. BRIGAGLIANO: Welcome back to our last panel of 

the day, entitled The Future of Securities Lending and 

Potential Regulatory Solutions; Market Evolution; the SEC's 
 

 

 

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Role Filling Regulatory Gaps. I'm Jamie Brigagliano, and 

with me is my co-moderator, Buddy Donohue, the Director of 

the Division of Investment Management. 

MR. DONOHUE: In our wrap-up panel today, we will 

explore the following topics: How are securities lending 

practices likely to evolve; What factors will most influence 

the growth or contraction in securities lending; Does the 

securities lending market represent a regulatory gap; Should 

the SEC have an enhanced role in the oversight of securities 

lending; Would investors benefit from greater SEC oversight; 

And, are there particular regulatory reforms the SEC can 

pursue that would better protect investors with respect to 

securities lending? 

MR. BRIGAGLIANO: Once again, we are very fortunate 

to have a very distinguished panel of experts with us. 

Sticking with the format that we have been using, I'm going 

to ask the panelists to introduce themselves and to provide a 

very brief opening statement. When the panelists are 

finished, we'll proceed directly to the substantive topics, 

with the Commissioners asking questions, panelists 

responding, and we look forward to a lively discussion. 

Accordingly, panelists should not hesitate to comment on 

remarks or observations from other panelists, so by all means 

speak up. 

Before we begin, I'd like to welcome and introduce 
 

 

 

 

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our panel. Leslie Nelson is a Managing Director in Global 

Securities Lending at Goldman Sachs. Rick Ketchum is the 

Chairman and CEO of FINRA. John Nagel is the Deputy General 

Counsel and Head of Global Compliance for Citadel Investment 

Group, L.L.C. And Mark Faulkner is the Founder and Head of 

Innovation at Data Explorers. 

Les, do you want to start us off? 

MR. NELSON: Certainly. Chairman Schapiro, 

Commissioners, I'd like to thank you and the Commission staff 

for the invitation to participate in the roundtable. I'm 

honored to have been invited to be part of this panel on the 

future evolution of the securities lending market and to 

discuss the regulatory landscape as it relates to the market 

and the business of securities lending. 

I've been involved in securities lending at Goldman 

Sachs since 1990, and have had the opportunity to be active 

in this business during a period of unprecedented growth and 

development. I have also been privileged to have worked as 

part of industry groups that have helped this market develop, 

often with an open, constructive dialogue with members of the 

Commission staff as well as with SROs such as FINRA. 

We in the industry appreciate this dialogue and the 

opportunity we have today and tomorrow to do a deep dive with 

you on securities lending and related matters. Long gone are 

the days when securities lending operated in the background, 
 

 

 

 

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and we are happy to be at the table to help answer questions 

and provide information. 

Some of the growth in the securities lending market 

that I just mentioned has been reversed over the course of 

the last year as a result of market conditions and the impact 

that these conditions had on hedge funds, the largest source 

of demand for securities borrowing. 

Market value declines, coupled with changes in 

trading strategies employed by some hedge funds, caused the 

value of securities on loan to decline, a trend which is 

beginning to reverse itself. 

It is interesting and somewhat paradoxical to note 

that we have never seen as much urgency in our securities 

borrowing activity as we do today, since we now operate in 

the equities market in the United States in what is 

essentially a zero-fail tolerance environment as a result of 

Reg SHO and more specifically Rule 204. Rule 204 has been 

undeniably effective in bringing U.S. equity fails to levels 

that are truly de minimis. 

As the panel proceeds, we can certainly discuss in 

more detail how demand, supply and regulatory action can move 

the market to contract or expand in the future. With this as 

background, we are in a position to discuss how the 

securities lending market might evolve. The evolution of the 

securities lending market in the U.S. in the near term is 
 

 

 

 

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likely to be most influenced by a combination of recent 

market events and regulatory changes that may occur in the 

future. 

With regard to market factors, two that affected 

securities lending over the course of the recent financial 

crisis are likely to be the most impactful. The first of 

these was the serious impairment of some of the cash 

collateral pools in which securities lending cash collateral 

was invested. 

The second issue related to the degradation in the 

financial condition of several broker dealers, most notably 

Bear Stearns and then the failure of Lehman Brothers, which 

raised counterparty concerns. As our panel proceeds, I hope 

that we can discuss how these two factors have already 

influenced the securities lending market and what may happen 

in the future. 

The regulatory framework for securities lending in 

the United States is the second major theme of this panel. 

This market has been highly -- is highly regulated and has 

been for many years. There are a whole host of regulations 

that have provisions directly aimed at securities lending. 

These included Regulation T of the Federal Reserve system, 

Exchange Act Rule 15c3-3, Exchange Act Rule 15c3-1, Reg SHO, 

and ERISA. 

The SEC and SROs have broad regulatory authority 
 

 

 

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over the broker dealers that participate in securities 

lending. The Federal Reserve and other banking regulators, 

such as state banking departments, have regulatory authority 

over banking institutions that act as agent lenders. These 

agents, some of which are custodians and others which are 

non-custodial agents, provide the bulk of the liquidity in 

the market, lending on behalf of their beneficial owner 

clients. 

With respect to regulatory developments, I hope 

that we will have an opportunity to discuss an area where the 

SEC could pursue regulatory reform that would impact 

securities lending practices. This relates to prime 

brokerage, where action is pending to replace the 1994 prime 

brokerage no-action letter with one that has been modified to 

take into consideration client compliance with Reg SHO in a 

prime brokerage setting. 

Specifically, the new no-action letter would 

require that prime brokers report to executing brokers client 

behavior as it relates to incorrect order marking, that is, 

long versus short and vice versa, and non-compliance with 

locate requirements in order to assist the executing broker 

in determining whether it is reasonable to rely on the client 

with respect to order marking or locate compliance. 

While this change would put more of a burden on 

broker dealers, as opposed to things like pre-borrows or 
 

 

 

 

 

 

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so-called hard locates, we feel that this would be the most 

effective way to stop abusive naked short selling, to the 

extent that it is taking place. 

Thank you again for the opportunity to participate 

this afternoon. 

MR. BRIGAGLIANO: Thank you, Les. Rick. 

MR. KETCHUM: Thank you very much. And let me 

thank you, Jamie, Buddy, from the staff and as well, Chairman 

Schapiro and Commissioner Walter and Paredes for taking the 

time today and allowing me to be with you. 

I will start with hopefully an acknowledgment of 

reality, that we at FINRA, just as you at the SEC, believe we 

need to know and understand a great deal more about the 

securities lending market. We don't come pretending to be an 

expert or to have a clear understanding of every regulatory 

action that may be appropriate with respect to this, and 

indeed found the last panel highly valuable from an 

information standpoint. 

But I do have a few reflections that hopefully 

you'll find interesting and perhaps somewhat different than 

what you've heard again and again today. 

I guess to start with would be the experience that 

FINRA has had through both itself and through our legacy 

organizations in recent years in the area of securities 

lending. And we have found problems with firms, particularly 
 

 

 

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those firms that have used finders to help match borrowers 

and lenders. These finders were not associated with the 

broker dealer and were not required to be registered, unlike 

traders or registered representatives in other pieces of the 

business. 

Our legacy organization, NYSE Regulation, found 

that employees of members firms were skimming profits from 

their broker dealer employers by paying the finders a fee for 

services that were never performed. As a result, FINRA took 

enforcement action against numerous firms and individuals 

that, with the tremendous help of the SEC, eventually led to 

numerous criminal convictions. 

I mention this not from the standpoint that this is 

not an area that I think there's been substantial reaction to 

by the firms since these actions, but it does demonstrate an 

overall concern from a control standpoint, and it led to our 

Information Memo 532 to alert firms to those potential 

regulatory problems. 

I think the point just made earlier is a 

significant point, again, to look at; sort of approaching it 

from a regulatory standpoint, I'll look at it perhaps in a 

slightly different way. Indeed, we have seen, just as noted, 

a significant reduction in open-borrow balances over the last 

two years and reductions with respect to securities available 

for loan. Agree that that has created a great deal of 
 

 

 

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pressure on firms, particularly in the environment of the 

temporary rules and the shift in Reg SHO. 

And I would remark on one reaction to that that 

causes us particular concerns, which has been some of the 

steps that has resulted in some retailization of the 

securities lending marketplace. Until recently, firms did 

not borrow from custodial customers, especially retail 

customers, because of the requirements of the SEC's customer 

protection rules tended to make this type of borrowing more 

inefficient. 

But in the new environment, with the recent 

pullback in stock lending, firms are increasingly attempting 

to borrow from retail customers, who are seen as essentially 

the last large untapped source of additional securities. And 

since the customer protection rules never really contemplated 

this retailization, most of the rules around borrowing 

fully-paid securities from customers do not focus on any of 

the customer protection issues you would expect to be in 

place. 

I think that raises a number of issues with respect 

to retail customers, including the loss of SIPC protection, 

the loss of voting rights, unfavorable tax treatment for 

payment in lieu of dividends, and just the general concerns 

with respect to potential conflicts in the part of brokers 

adopting those programs. 
 

 

 

 

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None of that is not to say that firms have not 

generally been responsive in trying to provide disclosures in 

those areas, but we do see that as sparking the need, and we 

are looking hard at the possibility of additional rulemaking 

in that area to ensure that firms understand their disclosure 

obligations. 

I guess the second area, and certainly not novel 

from what you've heard today, that strikes us as one well 

deserving additional attention from a regulatory standpoint, 

is -- and I know that this is not new from what has been said 

today -- that this area continues to not be currently 

regulated like a marketplace, but today continues to be 

treated -- and as noted before, thought of with respect to 

many of the participants, --- although perhaps not with 

respect to many others -- as an operational function. 

That results in -- that, in part, relates to the 

fact that each transaction is negotiated bilaterally, but 

done so without full transparency or participation of other 

market participants. Yet it seems to me that securities 

lending operates in a very similar way to OTC securities 

markets, with the price albeit not necessarily the only 

relevant piece of information, but the price still remaining 

the rebate for a stock. 

And in the situation particularly where the stock 

is hard to borrow, the availability and the lack of 
 

 

 

 

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availability of this information, I would suggest, does cause 

real risk for -- at a minimum -- bad decisions being made by 

investors. 

It does seem to me, therefore, that there would be 

a great deal of value in stepping back in a variety of other 

areas to try to rethink on the model and ask whether the 

types of questions that the Commission and we at FINRA 

traditionally worry about with respect to organized 

marketplaces, don't have some substantially greater relevance 

to how this market works today. 

I think that's particularly true in a world today, 

given the -- well, it may loosen up again -- an environment 

where firms can no longer rely solely on finders to bring 

them buyers for borrowed stock, and an environment where 

there are retail participants which has largely existed 

through unpublished rates, and a lack of transparent dealings 

between counterparties, it does not create an efficient, 

transparent model for persons to evaluate value in the 

securities lending marketplace. 

It's always been my belief that when market 

participants have knowledge of supply, demand and related 

pricing in an open market, the cost of financing will be set 

by the demand-and-supply equilibrium, and the market will 

operate more efficiently. 

In light of that, I think we'd suggest that 
 

 

 

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regulators, at least, and particularly from the SEC 

standpoint, should look closely at the value of taking steps 

to increase security market lending transparency. Certainly 

with respect to the over-the-counter market generally, one 

way to have done that has been to cautiously approach things 

from the standpoint of trade reporting or information 

reporting, one way or another. 

But also, I think important to note, that as market 

participants have become more aware of some of the market 

efficiencies, electronic markets have begun matching 

borrowers and lenders, and that provides both transparency 

and opportunity for the market to operate efficiently and a 

reduced risk from the standpoint of counterparties, all of 

which strikes us as a value certainly to consider in how this 

market moves forward. 

In addition to improving transparency, I think we 

need to collectively look back and ask how we oversight this 

market. In marketplaces generally you use market 

surveillance to oversight markets, you don't use strictly 

examination tools and the like. And the question, if there 

were more valuable information, how effectively to identify 

situations where a customer may not have received a good 

price or where may not have received the type of disclosure, 

again strikes me as something that is worth thinking about. 

And then finally, as I indicated before, with our 
 

 

 

 

 

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concerns with respect to the retailization market, we believe 

that to better protect investors we should institute 

protections for non-institutional retail customers who 

participate in the market, somewhat similar to a suitability 

requirement. And we will be proposing a rule that would 

provide structure around fully-paid lending. 

So again, I thank you very much for the chance to 

be here today, and I look very much forward to hearing the 

insights of the other panelists. 

MR. BRIGAGLIANO: Thank you, Rick. John. 

MR. NAGEL: On behalf of Citadel Investment Group, 

I'd like to thank the Commission and the staff for the 

opportunity to be here today. At Citadel, we have over 19 

years of experience as an active securities lending market 

participant. 

And to support our private fund and market making 

businesses, we've built infrastructure that allow us to deal 

directly with the primary sources of securities loans, supply 

and demand, rather than rely entirely on intermediaries. 

Based on this experience, we believe that a well-functioning 

securities-lending market benefits all investors. 

Owners of securities can generate additional income 

or obtain financing by lending securities. Securities 

lending also contributes to tight bid-offer spreads and 

market liquidity by enabling the orderly settlement of short 
 

 

 

 

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sales. 

At the Commission's May Short Sale Roundtable, I 

explained Citadel's view that short selling benefits all 

investors and our economy by promoting liquidity and price 

discovery, and serving as a risk management tool for 

investors. 

While the securities lending market has made great 

strides in recent years, we believe there is still 

substantial work to be done before the securities lending 

market can reach its full potential. Despite its growing 

size, the securities lending market remains relatively opaque 

because there is little centralized collection or 

dissemination of loan pricing data. 

Many securities loans are still bilaterally 

negotiated between market intermediaries on the phone or by 

email and each party to a securities loan generally faces the 

credit risk of the other party for the duration of the loan. 

Until recently, no centralized venue existed where borrowers 

and lenders could readily find each other and transact 

directly. 

In many respects, these challenges are analogous to 

the challenges facing the over-the-counter derivatives 

markets. We applaud the Commission's efforts to increase 

transparency -- the transparency and efficiency of the OTC 

derivatives markets and encourage the central clearing of 
 

 

 

 

 

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standardized derivatives contracts. 

Similar considerations apply in the securities 

lending markets where central counterparties could reduce 

bilateral credit risk and foster rigorous and consistent risk 

management practices. The development of electronic trading 

platforms for securities lending is also important and may 

lead to similar increases in transparency and reductions in 

transaction costs. 

Experience shows that centralized markets are more 

competitive and greater competition makes markets more 

efficient. The securities lending market is in an important 

part of our capital markets. The Commission should encourage 

the modernization of the securities lending market and enable 

more direct interaction between borrowers and lenders. This 

would reduce the cost of borrowing, increase returns to 

securities lenders, increase market transparency, and reduce 

the overall risks of securities lending. Thank you. 

MR. BRIGAGLIANO: Thank you, John. Mark. 

MR. FAULKNER: Thanks very much. On behalf of Data 

Explorers, I'd like to thank the Chairman, the SEC and the 

staff for inviting us to address you today. I think this 

roundtable and tomorrow's is going to be hopefully a very 

useful source of opinion and comment on these very important 

markets. 

I'm Mark Faulkner. I'm the Founder and the Head of 
 

 

 

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Innovation at Data Explorers. Data Explorers is a privately 

held company that for many years has been gathering OTC data 

on the securities lending markets and making that available 

to a global client base ranging from issuers, investors, 

agents, principals and hedge funds. The volume of the data 

we gather has peaked in the past, but is now around about $11 

trillion worth of information gathered daily available for 

loan, representing 120,000 securities. Today the balance is 

around about $2 trillion out on loan, about 45,000 securities 

there. This information represents the holdings and lending 

activity of about 22,000 funds on a global basis. 

The securities lending business, as you've heard 

earlier on today, and I'm sure you'll hear again tomorrow, 

plays a pivotal part in the liquidity and efficiency of the 

capital markets. Without it, prices would be wider and 

positions less liquid, to the detriment of investors. 

Securities lending balances today are in excess of 

$2 trillion. The industry generates, we estimate, about $15 

billion per annum for the 25,000 or so funds actively lending 

inventory through the marketplace -- quite an important 

number, quite a significant number, and not including the 

premium charged -- very reasonable premium we heard 

yesterday, or earlier on from Shawn, charged by prime brokers 

to the hedge funds. I'm sure John would agree. 

The securities lending balances today are about 50 
 

 

 

 

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percent below their peak, which was reached in May of 2008. 

We believe that looking at the conditions in the market, it 

might take three to five years for those balances to be 

reached again. 

We would encourage this regulator and regulators 

around the world caution with regard to over-regulating the 

activity, which has really dramatically self-adjusted in 

light of the scale of leverage and activity in the financial 

markets globally. 

Recent history does suggest that regulation made in 

haste is regretted at leisure, as you're outgoing Chairman 

would have acknowledged during his "greatest regret" 

interview, Madam Chair. 

With justification, the U.S. government has been 

and may still be the largest securities lender in the world, 

and how they withdraw from this market and how they do that 

could be quite an interesting challenge for the markets to 

address, both in repo and securities lending terms. 

Securities lending can be an excellent proxy for 

short selling activity, and it's very important, however, as 

you've distinguished between these two different roundtables, 

securities lending is not short selling and short selling is 

not securities lending. There might be no need or some need 

to regulate more or less both or neither or one of these 

activities. 
 

 

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Investors globally do benefit from making 

well-informed decisions, and short-side intelligence is an 

important information tool for them. Madam Chairman, you 

asked earlier, I believe, a question along the lines of, 

since specials may be trading so expensively, to what extent 

might asset managers choose to buy specials to benefit from 

the increased income that they might derive by lending them. 

I think the answer to that question is, it's highly unlikely 

that they would do so. If you do believe the academic 

research, the short-selling community is quite well informed, 

and as they develop a short sale position, they tend to 

benefit from that economically. So, yes, you might benefit 

by lending, but I think it's unlikely that investors buy 

specials to benefit from lending them. 

However, I think it's very important that they do 

understand what's going on in the short side of the market, 

as well as they do, perhaps, in the long side of the market. 

Anthony Bolton, President of Fidelity International, writing 

in July in the FT, said that regulators should recognize the 

skill with which some hedge funds read the approaching 

disaster last year and try to learn something from them. The 

best hedge funds, and I'm lucky to be joined on the panel 

with two of them, represent a body of well-informed investors 

who have done extensive work on the risks of both individual 

companies and the financial systems as a whole. We can learn 
 

 

 

 

 

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from this community. 

So what lessons have we learned? Well, I think we 

can say looking forward that the institutions of the world 

will be focusing more on risk and risk-adjusted returns from 

their securities lending programs, not just how much money 

they might be making. 

Regulators should actively encourage investors and 

participants to share risk and return information and to 

quantify and understand the risk positions better. Reporting 

really does need to improve in the area in securities 

lending, and we welcome some of the initiatives there. 

Recent realized and unrealized losses have 

predominantly come from cash reinvestment, not securities 

lending. Securities lending is a term sometimes 

unintentionally used as a collective noun. Securities 

lending is one transaction, cash reinvestment is another. It 

is important not to combine these two distinctly different 

activities under one banner. 

For example, in Europe and Canada, and elsewhere in 

the world, much of securities lending market does not involve 

cash collateral or a reinvestment at all, and these lenders 

have typically avoided large losses in the recent times. 

Counterpart risk, as the Lehman Brothers default 

demonstrated, has typically been well managed by the 

securities lending. I won't sort of go over the last panel, 
 

 

 

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but legal agreements, positive margins, tri-party services, 

collateral diversification, independent mark to markets have 

insulated the classic securities lending side of the 

equation. It's important to consider counterpart risk in its 

proper context. It is possible that it's possibly been 

overemphasized by some at the moment. 

An open-mindedness from regulators around the world 

towards collateral flexibility might help, and it certainly 

might help the U.S. avoid past expensive mistakes. By 

encouraging a regime in which cash has been the predominant 

form of collateral, the U.S. regulators have inadvertently 

encouraged many practitioners to build cash balances, which 

in turn have driven earnings in the good times and losses in 

the bad times. 

This encouragement has distorted behavior to the 

potential detriment of all investors engaged in this 

activity, many of them -- as we heard this morning -- who 

were unfortunately not able to understand the risks being 

taken in their name. 

Lending cross-subsidization between investors is 

another issue that the regulators might want to look 

at -- inter and intra-fund family lending. 

Cross-subsidization has crept in to many business models and 

become almost unavoidable. Volume lending, to the extent 

that it still exists, has led in some circumstances to an 
 

 

 

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inefficient allocation of business balances, cash risk and 

return. 

The securities lending industry, in common with 

many areas of financial markets, has historically exhibited 

far too much dependency upon the rating agencies. Madam 

Chairman, we welcome your interest in the rating agencies and 

expect new business models to develop over time. We really 

think that the people selling the risk shouldn't pick up the 

tab, the people owning and buying the risk should be picking 

up the tab. We welcome your initiative in that area. 

One further thing to say about the work that's been 

done by the Federal Reserve, the juxtapositioning of many 

bundled services within one might call super banks is 

concerning us. Custody, clearance, tri-party, collateral 

management, securities lending, prime brokerage, repo, cash 

management and execution have created many -- very few 

organizations that may be viewed as too big to fail, but 

because they have so much information and so much access to 

what's going on in the market, they're not going to fail, 

they know too much to fail. We think that potentially there 

are significant conflict of interest issues here. 

In the future, potentially there should be a 

greater role for independent utilities and exchanges or some 

non-transactional participants in areas such as clearance, 

custody, reporting, exchange, et cetera, et cetera. 
 

 

 

 

 

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With the above in mind, the diversification of 

counterparts and independent collateral processes and 

providers rather than a concentration of services limited to 

a small number of super banks might be the preferable 

outcome. 

In summary, securities lending is an integral part 

of the capital markets, and not just about the support of 

short selling. There is a significant amount of transparency 

available to investors, practitioners and regulators already 

regarding securities lending and short selling. However, if 

there was one area that requires focus from all participants, 

including the regulators, it is cash collateral. That's 

where the risks have arisen and manifested themselves to the 

significant detriment of investors. 

You asked earlier, Madam Chairman, where would you 

focus, what would be the major area of concern? That's the 

one to focus on. Thank you very much. 

MR. BRIGAGLIANO: Thank you, Mark. Questions from 

the Commission? 

CHAIRMAN SCHAPIRO: Thanks, Jamie. Thank you all 

very much. This issue of cash versus non-cash collateral 

really, I think, is very interesting to us. And since the 

non-cash collateral hasn't brought with it the same kinds of 

problems that we've had with cash reinvestment, do any of you 

see a trend in the U.S. towards the European model of 
 

 

 

 

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non-cash collateral? 

MR. FAULKNER: I think to the extent that -- it 

depends who you're asking. If you're asking the borrowers, 

they'd very much like that to be the case, because they 

typically happen to be long inventory that they'd like to, 

for want of a better of word, recycle as collateral. 

To the extent that some of the owners of assets, 

because of their regulatory environment, are unable to take 

non-cash collateral, and perhaps be able to take equities --

there's a limitation at the moment -- but I think it would be 

welcomed by the market. There are independent tri-party 

providers that can support this activity on a global basis, 

they do so already, and I think it would be a very beneficial 

trend if it were to be adopted. 

The data in America -- our data in Europe is 

somewhat misleading, because people can point to an increase 

in cash collateralization in the grandest terms in Europe 

over recent years. We would argue that that data is slightly 

misleading in that it probably points to the success of the 

exporting of the U.S. global custodian cash reinvestment 

model, and that the indigenous European business has been 

somewhat swamped by the bubble, if you like, of the exporting 

of the U.S. cash model. 

So the answer to the question is, I think it would 

be a very positive development if it were to be able -- if 
 

 

 

 

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the market here were to be able to take more securities as 

collateral. 

COMMISSIONER WALTER: And what do you see as the 

countervailing disadvantages or risks to moving in that 

direction? 

MR. FAULKNER: Ignorance, as always; taking one big 

position; lending bonds and taking one equity, those types of 

things. But quite a lot of the issues have been worked out. 

It's not all good news in Europe. There were people that 

lost money in Europe, and what they tended to lose money on 

was a trade that I think Kathy Rulong was talking about 

earlier on, which was the sort of collateral upgrade 

transaction, which was basically lending Lehman Brothers 

bonds and taking equities as collateral, which really didn't 

work. 

MR. NELSON: If I could just chime in on the 

question of the move or non-move of the U.S. market to 

non-cash collateral. We haven't seen an appreciable move in 

that direction, however we're still sort of in the aftermath, 

and actually the effects of the impairment of the cash 

collateral pools has not ended yet. 

And in fact, what was alluded to this morning, in 

the first panel, is that there has been as a result of 

the -- some of the paper in these cash collateral pools, 

there was a real desire on the part of the cash managers not 
 

 

 

 

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to have to liquidate investments in those pools. 

So various arrangements were put into place to 

allow the cash managers to maintain stable cash balances. 

And if this market is going to move to a more non-cash 

collateralized balance, it's going to come when those cash 

collateral pools have all worked out their issues, they're 

fully liquid, they've been wound down. And we do believe 

that there would be increased interest by beneficial owners 

in receiving non-cash collateral. 

Being able to provide equities as collateral would 

be something that the broker dealer community would be in 

favor of generally. Treasuries, at some points in time, are 

extremely expensive for us to borrow, so it pushes us in the 

direction of providing cash. To the extent that we have a 

broad range of non-cash collateral options, which would still 

be marked to the market everyday, and subject to the same 

risk control, we think it would be a benefit both to the 

broker dealers and the beneficial owners. 

CHAIRMAN SCHAPIRO: Les, short of moving from cash 

to non-cash collateral, are you seeing other -- are you 

seeing changes in the composition of cash collateral pools 

now? 

MR. NELSON: Well, we don't necessarily have a lot 

of visibility into the specific investments. What we are 

seeing -- because the phenomenon that we experienced 6 to 12 
 

 

 

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months ago was that the rebate rates being paid on 

easy-to-borrow securities were extremely high, and that was 

reflective of the fact that the agents wanted to maintain the 

balances and were competing for the balances with broker 

dealers so they would not have to liquidate securities in 

their pool. 

The best data point that we have that these 

collateral pools are working themselves out is there's been a 

dramatic decrease in that rebate rate that's being paid on 

easy-to-borrow securities. 

MR. FAULKNER: Can I just make a comment about the 

portion of the collective noun securities lending revenue 

that's generated from cash and from non-cash. At times, as I 

believe one of the panelists observed earlier on, in the 

recent past most securities lending on a global basis was 

being done for nothing, because as Les suggested, so high 

were the rebates being paid to hold on to the cash that we 

ended up with a situation where lending wasn't profitable at 

all, if you looked at the lending -- the intrinsic 

value -- for many people, for many organizations, because of 

the, sort of -- for want of a better 

word -- cross-subsidization between above- and below-the-line 

profits, above being the reinvestment profitability and below 

being the intrinsic value. 

I think it's also important to say that there are 
 

 

 

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many different kinds of securities lending programs. Just as 

asset managers have different styles and follow different 

markets and different capabilities, you can do business with 

organizations that focus almost entirely if not entirely on 

the lending fee, the intrinsic value of lending assets, have 

smaller balances, smaller utilizations, but may do very well 

at getting the right price for the securities which they're 

lending. 

There are other styles of lending where it's more 

about volume, it's about generating cash returns in addition 

to securities-lending returns. Sometimes those different 

strategies aren't well articulated and are bought by people 

that don't necessarily understand where the money is being 

made, how it's being made and how the different strategy 

impacts their risk profile. Just another argument that backs 

up many of the people's arguments today that this should be 

an asset management activity not a back-office activity. 

To go one step further, why do mutual fund managers 

typically -- have they done better than pension fund 

managers -- because they're asset managers, it's what they 

do. It's more of a -- it's closer to the front office than 

the back office. It's what they do. 

COMMISSIONER PAREDES: One of the points, if I 

heard correctly, earlier, Mark, you had mentioned was the 

extent of self-adjustment taking place -- I think it was the 
 

 

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phrase that I'd heard. If you could just maybe share -- and 

maybe the rest of the panelists, as well -- what some of the 

self-adjustments are that you've seen, and those that you 

anticipate that perhaps haven't come to pass yet but that 

folks are considering or that discussions are underway with 

respect to, all which gets at the question of, even if 

there's not a regulatory change ultimately in any respect, 

what's the industry going to look like in the future given 

the lessons learned from the past? 

MR. FAULKNER: Well, if I could kick this one off. 

I think maybe John might be able to talk a little more from a 

hedge fund demand side of the business. What I'm really 

suggesting is that in a world which deleveraged, in a world 

which several funds didn't make it, in a world where capital 

and balance sheet were being more properly or highly priced, 

positions shrank. Securities lending is often a hedge for a 

long position, which weren't being put on, so they therefore 

didn't put the short on. Businesses shrank. There were 

fewer new issues. There was a time when there were virtually 

no restructurings other than sort of fire sales of companies 

in desperate trouble, and people weren't taking positions. 

And so we've seen the world become, for want of a 

better, a smaller place, which I think is right-sized, for 

want of a better word. I'm certainly adapting to being on 

this side of the Atlantic by using that term. 
 

 

 

 

 

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The other thing to say is, the investment 

performance of the capital markets, and equities in 

particular, has shown this world to be a less-short place. 

The average hedge fund is net long, not short, and that's 

good news, because they might be making a little bit of money 

now. 

So basically, in line with the market conditions, 

the securities lending business has adjusted. And also the 

short-term regulations have encouraged people to really think 

twice about getting short in the past, and that's what's been 

happening. John, I don't know if you've got --

MR. NAGEL: I certainly agree. I mean, I would say 

we've seen an intense focus throughout the industry on 

liquidity risk and credit risk, which I think until the last 

couple of years people paid a lot less attention to. And in 

terms of -- we certainly don't have the issue of the cash 

reinvestment program, but we certainly read the reports of 

what happened. 

I can tell you, we've always focused a great deal 

on modeling liquidity risk and modeling the credit risk of 

counterparties, and I think from one end of the industry to 

the other, that's become an area of focus. And we think 

those lessons have been valuable, although very painful. 

As I mentioned in my opening remarks, we do think 

that a central counterparty, which now exists in -- the 
 

 

 

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Options Clearing Corporation offers a central clearing 

counterparty solution. We think that offers a -- it's one 

option. I'm certainly not arguing that that should be the 

only available way to transact securities loan -- everything 

shouldn't be centrally cleared -- but we're happy to 

see -- with a central clearing counterparty you have 

consistent risk management practices, consistent credit 

practices. 

And one of the benefits of that is that we saw in 

the crisis last year, whether it was because of rumors or 

because of concerns real or sometimes not real, credit lines 

would get pulled -- either everybody pulls credit lines from 

everybody or everybody pulls credit lines from one particular 

market participant, and with a central counterparty, it's a 

more consistent framework at a predictable process, so we 

don't have this kind of volatility, I would call it, in terms 

of lines being pulled and creating disruptions. 

MR. KETCHUM: the only thing I'd really add to 

that -- that was a great point -- is that having the 

regrettable feature of age and having gone through this since 

Latin American bank crises in the '70s through the crash in 

LTCM and a variety of other things, the world tends to focus 

on becoming more liquid and less leveraged after crises 

pretty well. 

Now, none of us have lived through this type of 
 

 

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crises, and I do believe that much will be learned, certainly 

with respect to the business of securities lending, where 

participants didn't focus nearly to the degree they should 

have on risk, though I would probably save my concern -- my 

conclusion that the world is a less-short, less-leveraged 

place to the next time we go through a 10-year bull market 

and check it then. 

And in between I would just recognize the important 

points that those who know far more than I do here, which is 

that in between there will be a great pressure to find stock, 

and that means both that -- as I indicated before -- there 

will be an effort to turn over every frontier where the 

securities is available -- with respect to people who may be 

less rather than more sophisticated, have learned less rather 

than more lessons with regard to it -- and the other piece 

is, it is a great thing to recognize and an important thing 

to recognize that the separate transactions of reinvestment 

create meaningful risk that have cost people a lot. 

And, personally, from a FINRA standpoint or my own 

personal one, I think firms are exceptionally capable of 

managing the risk with respect to equity collateral, and 

probably should be considered, but I don't think we should 

consider ourselves if the risk that were described there 

really do exist. And when you move from a cash reinvestment 

risk to a management of concentration positions and equities, 
 

 

 

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firms that have not been doing this on this side of the pond, 

as opposed to Europe, need to rethink their supervisory 

provisions and how they basically look at the business if 

they're going to do it successfully. 

CHAIRMAN SCHAPIRO: Rick, would you think that 

given the -- which is a little frightening -- retailization 

of securities lending and the increasing role of unregistered 

finders who may or may not be honest brokers in this process, 

given those two events, would you think that a central 

counterparty kind of structure that the last panel talked 

about -- I don't know if you had the ability to hear 

that -- would be an investor protection as opposed to a 

systemic risk protection feature? 

MR. KETCHUM: Well, I start generally with a strong 

belief in the value of central counterparties. I think 

points made in the last panel with respect to the more 

diffuse nature of this and perhaps less systemic risk strike 

me as generally right, although I note they basically were 

saying don't worry, as long as the market goes down, we're 

fine, but markets can also spike up and people can be exposed 

the other way and go broke. 

But I do think, yes -- the short answer would be it 

does seem to me that both from a transparency and a systemic 

risk standpoint that there is a significant benefit to such 

systems, or at least creating an environment where there 
 

 

 

 

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aren't barriers to those systems and where there are 

appropriate incentives and persons who participate in them 

are appropriately rewarded from recognizing that they operate 

in that environment. And I think all those things are 

usually, and I would think here, great public policy tools. 

MR. FAULKNER: Could I just say, this idea that 

some guy sitting in his boxers in his bedroom can find stock 

better than a regulated broker dealer should be something 

that you should stop letting regulated firms do. The idea 

that finders are necessary for the efficient operating of a 

market is completely misguided, and I think that they should 

be -- that one of the things that you might want to consider 

is prohibiting regulated firms from using the services of 

unregulated finders. I just don't see what value they add, 

and I see no need for them to be part of the market 

structure. 

On a second point --

MR. KETCHUM: If I can -- I really endorse that, at 

a minimum, if there are finders -- I don't tend to question 

whether a business model may or may not have value, but if 

there are finders, I see no reason why they don't need to be 

registered broker dealers. 

MR. FAULKNER: And if anyone is watching on the 

Web, my name is John Smith from Ohio. (Laughter.) And the 

other thing, on the retailization of the marketplace, I think 
 

 

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that just proves to the fact that broker dealers with margin 

lending boxes and that capability and that potential source 

of supply have looked at that as being a better, more stable, 

higher -- a better economic source of inventory, perhaps, in 

recent times than in the past. 

And they've been resistant to putting balances with 

lending agents, that perhaps they didn't feel they needed to, 

they actually wanted to borrow easy stock and difficult stock 

from the retail boxes that they have in place. To the extent 

that there might be need to be some more scrutiny of that 

activity, I'm not in a position to comment, but I think 

that's the explanation, is that if you've got the inventory 

available within your margin lending business and you don't 

necessarily want to put that balance out on the street, if 

you like, that's where people have been looking to do 

that -- do more business of that kind. 

MR. NELSON: Mark, let me -- there's a difference, 

though, between utilizing customer margin securities in a 

rehypothecation structure than there is to borrowing 

fully-paid-for securities. I think we do some of that 

borrowing of fully-paid-for securities, and I don't think our 

attorneys have been -- have actually been -- our attorneys 

have been more concerned about that, have applied the same 

customer protection rules and other elements of the market to 

that activity. Maybe they were looking into the future. 
 

 

 

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But I think there's a well-established regulatory 

framework that says that when you're borrowing from a 

non-broker dealer you have to do the things that 15c3-3 

requires you to do. You have to collateralize them at least 

at 100 percent, you have to self mark -- you don't wait for 

them to issue the mark. If you owe them collateral, you give 

them collateral. You have to give them a statement of what 

it is that they're lending to you. You have to discuss with 

them what the fee is going to be. You have to give them the 

appropriate reporting. 

So it actually is quite -- I think the regulations 

are quite explicit in terms of what it is we need to do, 

including things like not being able to deliver securities 

lending collateral directly to their brokerage account. You 

have to deliver that collateral away. So in fact the 

standards that I think exist within the current regulations 

are quite strict with respect to what it is we need to do 

when we borrow from one of our retail or private wealth 

management clients. 

MR. DONOHUE: Les, this is probably a question for 

you, but John you may know. I don't know the answer on this. 

This is why I'm going to ask the question. I was 

always -- my experience has always been on the side that's 

lending, not the side that's borrowing. In light of what 

happened with some of the lenders and their utilization of 
 

 

 

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the cash collateral, are the borrowers starting to put limits 

on what the lenders can do with the cash collateral when they 

get it? Is it something you're starting to worry about? 

MR. NELSON: I guess we worry about it in the 

background. However, the securities lending contracts are 

quite clear with respect to who bears liability for that 

investment. And it really is -- and it was pointed out this 

morning by the agents -- that it is, in fact, the beneficial 

owner that's lending securities that has the authority to 

direct the cash collateral manager with respect to the 

collateral reinvestment criteria and the acceptable 

instruments and so forth that bears the risk. 

So we believe that's a well-established legal 

principle, but we are, I think, just more -- we've always 

been attentive to our counterparty risk. And in the wake 

of -- as a result of agency lending disclosure, where we have 

complete transparency within our credit groups as to who the 

principals are on the other side, I think our primary concern 

is credit exposure. The cash collateral reinvestment risk is 

really theirs to bear. 

I think that when we are dealing with the large 

agent lenders, that concern is not as great as it might be if 

we're dealing with someone that's small in the market. A 

good counterpoint to that is when we borrow from our clients, 

our so-called retail clients, we rarely give them cash 
 

 

 

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collateral. We give them, usually, U.S. Treasury securities, 

because they don't have the ability to manage a collateral 

reinvestment program and earn a return on that. So we remove 

that as a component of the transaction so that it is not an 

issue for us. 

MR. DONOHUE: One of the reasons why I raised the 

question was that there is at least one example where an 

insurance company took the collateral and invested it in 

highly-illiquid securities, and then really lacked the 

ability to unwind the positions. I was just wondering how 

folks were dealing with that, or whether that was a one-off. 

MR. NAGEL: I think -- I certainly agree in 

general, as a consumer of borrowers as we are, our focus is 

on credit risk. And in terms of dealing directly with the 

agent banks, our relationship and interactions are with the 

agent bank. And so it's really not our place to tell the 

ultimate lender what they can or can't do with any cash 

collateral we put up. 

I would say, though, it is a very important part of 

this market to understand who your counterparty is, in terms 

of appreciating what the recall risk is, are you going to be 

able to get the stock -- if you borrow a stock, are you going 

to be able to keep that borrow on. And so those are the 

kinds of things we focus on. But in terms of collateral we 

put up, by contract, it's theirs to do with as they see fit, 
 

 

 

 

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and we would see that in terms of the role of the agent bank 

or whoever is dealing with the ultimate lender of securities. 

MR. FAULKNER: Given what's happened in recent 

time, they might benefit from some advice from the investment 

banking community. Could I just come back to a question -- I 

was reminded of something that was asked this morning, which 

I think is important, about borrowing shares and voting 

shares. And a question came up along the lines of, would it 

be possible for the lender to tell the borrower what to do 

with the shares if there was a vote coming up. 

I think the question was meant to be sort of just 

lobbed up there for somebody to say something along the 

following lines, which was, you can't really do that, because 

the borrower doesn't have the shares; they've borrowed them 

for a purpose, to settle a transaction in the market, to do 

with a settlement, a hedge, an on-lend to somebody else. So 

they can't be told what to do with the shares because they 

don't have them anymore. And that was just, I think, an 

important point. 

MR. NELSON: And I would just add that Reg T is 

quite clear in the United States that it is not a permitted 

purpose for us to borrow securities in order to permit 

non-owners to vote those shares. 

And some of the activity that has been cited in 

academic studies about increase in borrowing activity, as a 
 

 

 

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proxy record date is being approached, is really explainable 

by the fact that we -- when we rehypothecate customer 

securities, when it gets close to the date of a vote, we try 

to reduce to possession and control as many of those 

positions as possible so our clients can vote. So there 

would be -- we would be replacing rehypothecation of customer 

securities with explicit borrowers. 

A contributing factor generating volume at that 

point in time are the beneficial owner clients of the agent 

lenders that have directed their agent to get securities back 

so they can vote them. We get a recall, we have to go out 

and find some other source to borrow it. So there would be 

an uptick in the level of borrowing activity. 

That has been explained in some academic papers as 

a vote manipulation scheme or Exhibit A, but in fact has 

nothing to do with that and just has to do with trying to 

give the owners the rights to vote, because it is clear in 

Reg T that we only can borrow securities if we have a 

delivery. And a broker dealer, the way it controls votes is 

it allocates votes based on ownership and the ownership of 

shares on its records and how many shares it has in its 

possession. And it does not have the ability -- we do not 

give voting rights to non-owners as a result of having excess 

securities in the box. 

MR. FAULKNER: And just to add that nobody likes 
 

 

 

 

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surprises in the financial world. Borrowers don't like being 

recalled when they may have been indicated to them that the 

stock was stable and not callable for voting purposes. 

So there are economic consequences of regularly 

calling securities back. Callable stock is less attractive 

and earns less money in the lending market. I was very 

surprised to hear that people were put under specific 

pressure and almost threatened when they recalled stock to 

vote. But it's not at all surprising to me that there is a 

different price which to be paid for what is effectively more 

callable securities. 

Very often when a recall happens at late notice, it 

can get very expensive for the borrower or the person that's 

shorted that security, and they're under tremendous economic 

pressure. But it's not forgivable for them to sort of force 

that back through to the lender. 

On the note of the ICGN's call for clearer 

understanding and more explicit pre-advice of voting 

information, and what might be a sensitive issue to 

facilitate less surprising recalls, I think that's a 

fantastic idea. And also the idea of perhaps moving 

voting -- removing voting and dividend payments from one 

another is an extremely positive suggestion which we would 

endorse, too. 

CHAIRMAN SCHAPIRO: Do any of you have a sense of 
 

 

 

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how well the recall mechanics work, and the extent to which 

there are recalls for votes? We got lots of different 

information this morning, but I didn't come away with a clear 

sense of this is a frequent thing that stock is recalled for 

voting purposes. 

MR. NELSON: Well, I would say, Chairman Schapiro, 

that it's sometimes difficult for us to get the transparency, 

for want of a better word, as to why securities are being 

recalled. We understand, though, as a borrower, that --

as opposed to any other right with respect to a security --

one of the things that in a securities lending transaction 

contractually the borrower is making the lender whole with 

respect to any distributions on the securities on loan. 

The right that we cannot manufacture is the right 

to vote. So we take very seriously a recall that we get when 

it's approaching record date for a vote or we're being told 

by the lender or the lending agent that the reason they're 

recalling the security is because they want to vote that 

security. And we try to then source supply from alternative 

supply sources in the market where they are intending not to 

vote. So we can't make the lender whole for the vote, so we 

really want to get it back if a lender wants it. 

And I know of no -- and it was alluded to this 

morning -- retribution that borrowers exact towards or direct 

towards lenders that are recalling for the right to vote. We 
 

 

 

 

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want them to participate in the market, and if they want to 

vote, we want to get the securities back to them for them to 

vote. 

CHAIRMAN SCHAPIRO: And then do you -- does the 

lender bear the cost of your locating shares to get the vote 

back to them, or do you bear the cost? 

MR. NELSON: No, we bear the cost of that. 

MR. FAULKNER: It's also worth stressing there was 

a call, which is understandable, for more transparency 

between securities lending activity and stewardship 

activities within organizations. And I think, again, an 

excellent idea, but not one that a regulator needs to be 

getting involved in. This is about an IT decision. This is 

about data that's available daily to organizations that lend 

some portion of it, the appropriate portion of it, probably 

not who is borrowing it at what rate, but that certain 

amounts of securities are on loan and not in the depo, 

available for voting. 

I think some of the stress that's been historically 

developing between corporate governance departments and 

securities lending departments has been the very significant 

loss of face when an organization has perhaps pledged to 

management their support on an important corporate issue, and 

then not being able to deliver that. And that's clearly made 

people feel very uncomfortable and angry and disappointed. 
 

 

 

 

 

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And the transparency that's been called for there 

is something that doesn't need any regulation, it just needs 

a little bit more wiring and better communication within 

organizations that lend. 

MR. DONOHUE: Unfortunately, that's all the time 

that we have today. I'd like to thank all of our panelists 

and the Commissioners for the entire day. We certainly have 

a lot to consider going forward, and I'd now like to turn the 

for over to Chairman Schapiro for closing remarks. 

CHAIRMAN SCHAPIRO: Thank you, Buddy, Jamie and 

Henry, who was with us this morning, for your great work in 

moderating our panel discussions today. As I begin these 

very brief closing remarks, I first want to extend my sincere 

thanks and those of my colleagues to our distinguished 

panelists, those up on the stage right now, but throughout 

the day. 

We do appreciate your willingness to take time from 

your busy schedules to join us for what has been a 

substantive and I think highly-informed discussion of very 

important issues. We appreciate that so many of you traveled 

to Washington -- some, like Mark, from very considerable 

distances in order to be with us today. 

And I also want to thank my colleagues on the 

Commission and also Commissioner Aguilar, who is joining us 

from cyberspace, for participating today. 
 

 

 

 

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The Commission is charged with protecting investors 

from potential abuses and manipulation while ensuring that 

the regulations governing the securities markets promote 

efficiency, liquidity and capital formation. And this charge 

really serves as the foundation of our assessment of 

securities lending. 

We're committed to closely reviewing the benefits 

and pitfalls of securities lending, and I do think that 

today's very candid discussion of often very differing 

viewpoints will be really instrumental in informing our 

consideration of the securities lending market and our 

assessment of whether changes can be made to enhance investor 

protection. 

We really are so fortunate to have been able to 

gather such a distinguished and varied group of professionals 

who have provided insights and recommendations in the areas 

of securities lending, and we do look forward to tomorrow's 

panels as well. 

Before we conclude, I do want to thank the staff, 

members of the SEC, who really made this possible. There are 

countless professionals who worked behind the scenes on this 

roundtable to do everything from posting website materials to 

preparing signs and setting up the stage, and even greeting 

the panelists and guests as you arrived this morning. And we 

do appreciate all of their efforts. 
 

 

 

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I would like to specifically acknowledge the core 

team of people who have devoted very substantial time, energy 

and effort to creating this informative roundtable. Liz 

Sandoe, Ned Rubenstein, Doug Scheidt, David Bloom, Jeff 

Dinwoodie, Katrina Wilson, Andrea Orr, Tory Crane and 

Josephine Tao. So thank you all very much from your hard 

work, and once again, thank you so much to all our panelists 

for your significant contributions today. 

Thank you. 

(Whereupon, at 3:59 p.m., the roundtable was 

adjourned.) 
 

 

 

 

 

 

 

 

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 20 _________________________ _____________________________ 

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PROOFREADER'S CERTIFICATE 

In the Matter of: SECURITIES LENDING & SHORT SALE 

Witness: Roundtable 

File Number: N/A 

Date: Tuesday, September 29, 2009 

Location: Washington, District of Columbia 

This is to certify that I, Don R. Jennings (the 

undersigned), do hereby swear and affirm that the attached 

proceedings before the U.S. Securities and Exchange 

Commission were held according to the record and that this is 

the original, complete, true and accurate transcript that has 

been compared to the reporting or recording accomplished at 

the hearing. 

(Proofreader's Name) (Date) 
 

 

 

 

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REPORTER'S CERTIFICATE 

I, Jon Hundley, reporter, hereby certify that the foregoing 

transcript of 207 pages is a complete, true and accurate 

transcript of the testimony indicated, held on September 29, 

2009, at 9:36 a.m. in the matter of: Securities Lending and 

Short Sale Roundtable. 

I further certify that this proceeding was recorded by me, 

and that the foregoing transcript has been prepared under my 

direction. 

Date: __________________________ 

Official Reporter: __________________________ 

Diversified Reporting Services, Inc.