[Federal Register Volume 65, Number 80 (Tuesday, April 25, 2000)]
[Notices]
[Pages 24242-24245]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-10264]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42704; File No. SR-DTC-00-04]


Self-Regulatory Organizations; the Depository Trust Company; 
Order Granting Approval of a Proposed Rule Change Relating to the 
Profile Modification Feature of the Direct Registration System

April 19, 2000.
    On February 28, 2000, The Depository Trust Company (``DTC'') filed 
with the Securities and Exchange Commission (``Commission''), pursuant 
to section 19(b)(1) of the Securities Exchange Act or 1934 
(``Act''),\1\ a proposed rule change. Notice of the proposal was 
published in the Federal Register on March 15, 2000.\2\ The Commission 
received five comment letters in response to the proposed rule 
change.\3\ The Commission is publishing this order to grant approval of 
the proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No 42504 (March 8, 2000), 65 
FR 14003.
    \3\ Letters from Stephen J. Dolmatch, Executive Vice President, 
General Counsel, and Secretary, Chase Mellon Financial Group (April 
3, 2000); John Cirrito, Chief Operating Officer and Managing 
Director, ING Barings (April 5, 2000); William Talbot, Vice 
President, Pershing (April 5, 2000); Jerome Clair, Chairman, 
Securities Industry Association (``SIA'') Operations Committee, SIA 
(April 6, 2000); Larry E. Thompson, Managing Director and Deputy 
General Counsel, DTC (Apri 7, 2000); Charles V. Rossi, Division 
President, EquiServe Limited Partnership (April 19, 2000).
---------------------------------------------------------------------------

I. Description

    The Profile Modification System (``Profile''), a feature of the 
Direct Registration System (``DRS''), is an electronic messaging system 
that allows a DTC participant (i.e., generally a broker-dealer) or a 
DRS limited participant (i.e., a transfer agent) \4\ to submit 
instructions to transfer investors' book-entry position from one to the 
other.\5\ The primary purpose of DTC's filing is to modify Profile by 
incorporating the use of an electronic screen-based indemnification. As 
described more fully below, the inclusion of the electronic 
indemnification in Profile enables DTC to make DRS fully operational 
and available for use by qualified issuers, DTC participants, and DRS 
limited participants. DTC's filing also establishes the procedures 
governing the use of Profile in the Participant Terminal System 
(``PTS'') \6\ and specifies the fees connected with the use of Profile.
---------------------------------------------------------------------------

    \4\ For a description of DRS limited participants, refer to 
Securities Exchange Act Release No. 37931 (November 7, 1996), 61 FR 
58600 (November 15, 1996).
    \5\ For a description of DRS and Profile, see Securities 
Exchange Act Release No. 35038 (December 1, 1994), 59 FR 63652 
(concept release relating to DRS); Securities Exchange Act Release 
No. 41862 (September 10, 1999), 64 FR 51162 (September 21, 1999) 
(order approving implementation of the Profile Modification feature 
of DRS); Securities Exchange Act Release No. 42366 (January 28, 
2000), 65 FR 5714 (February 4, 2000) (order approving an 
interpretation of an existing rule pertaining to DRS).
    \6\ DTC's procedures governing the use of Profile in PTS are 
attached as Exhibits 3 and 4 to DTC's filing. Copies of DTC's 
proposed rule change and the attached exhibits are available at the 
Commission's Public Reference Section or through DTC. In addition, 
DTC understands that the DRS Committee is developing guidelines to 
the use of DRS. When such guidelines have been approved by the DRS 
Committee, DTC will work with the DRS Committee to implement the 
guidelines. Members of the DRS Committee include representatives 
from the American Society of Corporate Secretaries, Corporate 
Transfer Association, Securities Industry Association, Securities 
Transfer Association, and DTC.
---------------------------------------------------------------------------

A. Background

    Since 1996 when the New York Stock Exchange, Inc. (``NYSE'') and 
the National Association of Securities

[[Page 24243]]

Dealers, Inc. modified their listing criteria to permit listed 
companies to issue securities in book entry using DRS in lieu of 
issuing certificates, there has been a steady growth in securities 
issued through DRS. There has also been a corresponding increase in the 
movement of share positions from investors' accounts at DRS limited 
participants to DTC participants' accounts at DTC.\7\ In connection 
with the movement of DRS share positions, DRS limited participants have 
been processing thousands of hard copy transaction advices \8\ or other 
written instructions to transfer DRS positions.
---------------------------------------------------------------------------

    \7\ Movements of share positions within DTC from DRS limited 
participants' accounts to DTC participants' accounts is done through 
the use of ``free deliver orders.'' In 1999, the volume of DRS-
related free deliver orders exceeded 183,000 transactions. In 
comparison, the volume of DRS-related free deliver orders in 1998 
was 87,148 transactions.
    \8\ Transaction advices are statements indicating account 
positions or activity. DRS limited participants generally require 
the transaction advices before they will move a DRS position from 
the books of the issuer to the account of a DTC participant at DTC.
---------------------------------------------------------------------------

    There is substantial evidence to indicate that this paper-based 
processing of transaction advices, which is currently required by DRS 
limited participants to transfer DRS position, is labor intensive and 
slow. Without Profile, an investor or a DTC participant acting as an 
investor's agent, must have the transaction advice medallion signature 
guaranteed and physically delivered to the DRS limited participant. 
When the transaction advice is received, the DRS limited participant 
determines that the signature guarantee is valid and enters the 
information into its system to process the instructions. Only after the 
DRS limited participant completes its processing is the investor's DRS 
position moved to the DTC participant's account at DTC. In addition, 
since the information contained on the transaction advice is not 
standardized throughout the industry, investors (or DTC participants 
sending the transaction advices on behalf of their customers) do not 
always provide the correct or complete information necessary to process 
the instruction thereby further slowing the transfer of DRS account 
positions.
    The DRS Committee, the industry committee responsible for designing 
DRS, has been working through the various legal and processing issues 
in an effort to reduce the handling of hard copy documents associated 
with processing transactions advices and to develop an electronic 
indemnification mechanism to replace the physical signature 
guarantees.\9\ In January 1999, the DRS Committee approved Profile's 
system specifications, which included a screen-based indemnification, 
and authorized DTC to proceed with the development of Profile.\10\ DTC 
completed production on Profile on June 15, 1999.\11\
---------------------------------------------------------------------------

    \9\ Supra note 6.
    \10\ DRS Committee meeting minutes of January 12, 1999. Minutes 
of the DRS Committee meetings are available from DTC.
    \11\ DTC filed and the Commission approved a rule change that 
attempted to resolve an impasse that had developed between DTC 
participants and DRS limited participants regarding the use of 
Profile, including the use of an electronic indemnification. The 
rule change barred DRS limited participants from making additional 
securities issues eligible for DRS until after January 15, 2000, if 
DRS limited participant had not agreed to implement Profile by 
September 15, 1999. Securities Exchange Act Release No. 41862 
(September 10, 1999), 64 FR 51162. DTC subsequently filed an 
interpretation of its rule change to clarify that a DRS limited 
participant implemented Profile when it entered into a written 
agreement with DTC stating that it would continue to use DRS, 
including Profile, when Profile became operational. Securities 
Exchange Act Release No. 42366 (January 28, 2000), 65 Fr 5714 
(February 4, 2000).
---------------------------------------------------------------------------

    After DTC began development of Profile according to the agreed upon 
specifications, issues arose as to whether the screen-based 
indemnification provided sufficient protection to address perceived 
risks and liabilities to investors, DRS limited participants, and 
issuers. Some members of the DRS Committee contended that a more 
comprehensive indemnification agreement between DTC participants and 
DRS limited participants was needed. In addition, these members 
asserted that guarantors (i.e., the initiators of the instruction to 
move an investor's position) should subscribe to surety bond coverage 
that would specifically cover DRS transactions in the event that a 
guarantor refused or failed to satisfy a claim that the transfer was 
unauthorized.\12\ Since physical signature guarantees are administered 
through industry programs such as the Securities Transfer Association 
Medallion Program (``STAMP'') and the NYSE's Medallion Stamp Program 
(``MSP''), several DRS Committee members suggested that these industry 
groups should extend their current programs to include the use of an 
indemnification agreement and surety bond to cover the use of an 
electronic indemnification in DRS transactions.
---------------------------------------------------------------------------

    \12\ These members of the DRS Committee also raised several 
other concerns, including such things as the need for a formal 
claims process and an education program.
---------------------------------------------------------------------------

    Over the past year the DRS Committee, in coordination with STAMP 
and MSP, has attempted to reach consensus on an indemnification 
program. To date, the parties have not reached consensus. In the 
meantime, issuers have continued to put additional investors into DRS 
even though Profile remained inoperable due to the lack of an 
electronic indemnification.

B. DTD's Profile and Electronic Indemnification

    In making Profile operational, DTC will require the use of a 
screen-based indemnification until such time as an electronic guarantee 
program is established. Under the rule change, a DTC participant and 
DRS limited participant will submit investors' instructions 
electronically via DTC's PTS or via the Computer-to-Computer Facility 
(``CCF''). Profile will provide the same information set out in the 
transaction advice by requiring a DTC participant or DRS limited 
participant to enter specific information, including the investor's 
account registration, tax I.D. number, DRS account number with the DRS 
limited participant, CUSIP number, and number of shares to be 
transferred. DTC participants and DRS limited participants will use the 
information provided through Profile to ensure that beneficial 
ownership does not change when there is a share movement.
    A DTC participant submitting a Profile instruction to a DRS limited 
participant will agree to a PTS screen indemnity substantially in the 
following form:
    (1) Participant represents that it has authority and consent for 
the request appearing on the following screen from either (a) the 
registered owner on the participant's record or (b) a third party who 
has actual authority to act on behalf of the registered owner on 
participant's records, and that all information shown is accurate and 
complete, except that, with respect to the taxpayer identification 
number included in such information, to the best knowledge of 
participant, such information is accurate and complete;
    (2) Participant indemnifies the issuer, its transfer agent and 
their respective officers, directors, shareholders, employees, agents, 
representatives, subsidiaries, parents, affiliates, successors and 
assigns against any breach of such representations in connection with 
the transaction that is the subject of such request.
    Upon receipt of an instruction, a DRS limited participant will 
indicate whether the transaction is approved or rejected. For rejected 
instructions, the DRS limited participant will supply reject codes that 
will indicate the reason for rejecting. When the DRS limited 
participant approves a DTC participant's instruction for the movement 
of an

[[Page 24244]]

investor's share position, the DRS limited participant will move the 
investor's position from a position on the DRS limited participant's 
books to a position in the DTC participant's account at DTC. Using 
Profile, DTC participants can view the status of all transaction 
instructions submitted to DRS limited participants for processing. 
Profile will provide an aging status of up to thirty business days for 
all instructions that are neither accepted nor rejected (i.e., open 
items) in an effort to avoid duplicate submissions. After thirty 
business days, these instructions will be deleted.
    A DRS limited participant may also submit an instruction for the 
movement of an investor's position from the investor's broker-dealer's 
DTC participant account to a position on its books. For rejected 
instructions, the DRS limited participant will supply reject codes that 
will indicate the reason for rejecting. If the DTC participant approves 
the instruction, then the DTC participant must submit a withdrawal by 
transfer (``WT'') instruction which will move the investor's position 
from the DTC participant's account at DTC to an account at the DRS 
limited participant.\13\
---------------------------------------------------------------------------

    \13\ In such a situation, the DTC participant will use an ``S'' 
indicator with the WT instruction that will instruct the DRS limited 
participant to establish a DRS account for the investor.
---------------------------------------------------------------------------

    A DRS limited participant submitting an instruction to a DTC 
participant will agree to a PTS screen-based indemnity substantially in 
the following form:
    (1) Transfer agent represents that it has authority and consent for 
the request appearing on the following screen from either (a) the 
registered owner on the transfer agent's records or (b) a third party 
who has actual authority to act on behalf of the registered owner on 
the transfer agent's records, and that all information shown is 
accurate and complete, except that, with respect to the taxpayer 
identification number included in such information, to the best 
knowledge of transfer agent, such information is accurate and complete;
    (2) Transfer agent indemnifies the participant and its officers, 
directors, shareholders, employees, agents, representatives, 
subsidiaries, parents, affiliates, successors and assigns against any 
breach of such representations in connection with the transaction that 
is the subject of such request.
    In the event that an electronic guarantee program is established, 
Profile will be able to accommodate it. Until an electronic guarantee 
program is established, DTC's procedures will reflect the existence of 
the screen-based indemnity. DTC will not operate a screen-based 
indemnification and an electronic medallion program simultaneously.
    The fees DTC will charge for DRS transactions are the fees agreed 
upon by the DRS Committee.\14\ DTC will charge DTC participants a fee 
of 31 cents per submitted instruction and charge the receiving DRS 
limited participant a fee of 9 cents for that instruction.\15\ DRS 
limited participants will be charged 40 cents for each instruction 
submitted.\16\
---------------------------------------------------------------------------

    \14\ See DRS Committee meeting minutes of January 29, 1998, and 
October 16, 1998.
    \15\ The 9-cent fee is to cover DTC's cost of developing a CCF 
linkage between DTC and DRS limited participants. Securities 
Transfer Association representatives on the DRS Committee requested 
the development of a CCF linkage.
    \16\ There is no CCF development fee when a DRS limited 
participant submits an instruction to move an investor's position 
from the books of a broker-dealer to its own books, because the SIA 
representatives on the DRS Committee have not requested and DTC has 
not built a CCF linkage between DTC and DTC participants. In 
addition, DTC participants will be charged the fee for WTs when a 
share position is moved to a DRS limited participant's records.
---------------------------------------------------------------------------

II. Comment Letters

    The Commission received six comment letters.\17\ The SIA, Pershing, 
and ING Barings support the implementation of Profile and the use of a 
screen-based electronic medallion until such time as the industry 
reaches consensus on an alternative electronic guarantee program. These 
commenters believe Profile will offer investors a secure and efficient 
electronic facility that will enable them to move their securities in a 
secure, timely, and efficient manner. The SIA also added that Profile 
would offer an electronic facility similar to that used for many years 
by institutional investors and by the mutual fund industry to move 
securities. Furthermore, the SIA and ING Barings believes that the use 
of Profile will be critical to further compress the settlement cycle.
---------------------------------------------------------------------------

    \17\ Supra note 3.
---------------------------------------------------------------------------

    ChaseMellon Financial Group and EquiServe Limited Partnership, both 
commercial transfer agents, support DRS but raised concerns regarding 
Profile and the use of an electronic indemnification. The commenters 
contend that Profile will not offer the protection against unauthorized 
transfers and potential losses arising from such transfers. Both 
transfer agents note that in existing signature guarantee programs the 
transfer agent receives physical evidence of the investor's 
authorization of the transfer, but in DRS transfers using Profile, the 
transfer agent will transfer the investor's position based solely on an 
electronic instruction from the broker-dealer. In an effort to resolve 
these perceived deficiencies, the commenters offer several suggestions 
including (1) a requirement that guarantors (i.e., either the DTC 
participant or the DRS limited participant that sends the instruction 
to move an investor's position to its books) obtain a surety bond 
similar to those used in current signature guarantee programs and (2) 
changes in the language used in the screen-based language to provide 
additional protection for transfer agents. In addition, ChaseMellon 
believes that the fee structure should be changed to establish parity 
between the fees paid by DRS limited participants and those paid by DTC 
participants and should require the initiator of the instruction to pay 
for all DTC fees.\18\ EquiServe also suggested that the claims 
procedures be in place before Profile is made available.
---------------------------------------------------------------------------

    \18\ In its letter responding to ChaseMellon's comments, DTC 
indicated that the DRS Committee agreed upon the fees DTC will 
charge for instructions through Profile. DTC also indicated the 
screen-based indemnification language that DTC will use in Profile 
modeled on the language agreed upon by the DRS Committee. Finally 
DTC noted that its procedures will accommodate an electronic 
guarantee program if such a program is established.
---------------------------------------------------------------------------

III. Discussion

    Section 17A(b)(3)(F) of the Act \19\ requires that the rules of a 
clearing agency be designed to promote the prompt and accurate 
clearance and settlement of securities transactions and to remove 
impediments to and perfect the mechanism of a national system for the 
prompt and accurate clearance and settlement of securities 
transactions.\20\ As set forth below, the Commission believes that 
DTC's proposed rule change is consistent with its obligations under 
section 17A(b)(3)(F).\21\
---------------------------------------------------------------------------

    \19\ 15 U.S.C. 78q-1(b)(3)(F).
    \20\ The prompt and accurate clearance and settlement of 
securities transactions includes the transfer of record ownership of 
securities. 15 U.S.C. 78q-1(a)(1)(A).
    \21\ The Commission also notes that when enacting Section 17A, 
Congress set forth its findings that the prompt and accurate 
clearance and settlement of securities transactions, including the 
transfer of record ownership, is necessary for the protection of 
investors; inefficient procedures for clearance and settlement 
impose unnecessary costs on investors; and that new data processing 
and communication techniques create the opportunity for more 
efficient, effective, and safe procedures for clearance and 
settlement. 15 U.S.C. 78q-1(a)(1)(A), (B), and (C).
---------------------------------------------------------------------------

    The primary purpose of Profile is to provide a prompt and accurate 
mechanism for the transfer of an investor's book-entry position between 
the investor's broker-dealer and the transfer agent for the issue. 
Investors desiring to transfer their positions will not longer be 
subject to a multi-step,

[[Page 24245]]

paper-based process that is labor intensive and slow and that often 
results in transfer delays. Using Profile, DTC participants and DRS 
limited participants will send automated and standardized instructions 
which should reduce the possibility that an instruction to move an 
investor's position will contain erroneous or incomplete information. 
Because Profile will eliminate the need for paper in transferring an 
investor's positions, Profile should also greatly reduce the 
possibility that an investor's instructions to move her position will 
be misplaced or lost.
    In order to implement a more efficient manner in which to move an 
investor's position than is currently available using the paper-based 
DRS processing, DTC has decided to make Profile fully operational by 
using a screen-based indemnification until on an electronic guarantee 
program is established. Although some transfer agents and issuers do 
not believe that the screen-based indemnification provides sufficient 
protection against fraudulent transfers or potential losses resulting 
from such transfers, that view does not appear to be held by all 
transfer agents, issuers, or broker-dealers. Many industry participants 
believe that Profile using the screen-based indemnification provides 
sufficient protection and have expressed their intention to use it.
    As the Commission has stated in prior orders dealing with DRS and 
Profile, participation in DRS by issuers and DRS limited participants 
is not mandatory.\22\ Issues regarding risks and liabilities to issuers 
or DRS limited participants are internal business issues and should be 
addressed prior to an issuer's, transfer agent's, or DRS limited 
participant's decision to participate or participate further in DRS.
---------------------------------------------------------------------------

    \22\ Supra note 5.
---------------------------------------------------------------------------

V. Conclusion

    On the basis of the foregoing, the Commission finds that DTC's 
proposal to modify Profile to include an electronic screen-based 
indemnification is consistent with the requirements of the Act and in 
particular with the requirements of Section 17A of the Act and the 
rules and regulations thereunder.
    It is Therefore Ordered, pursuant to section 19(b)(2) of the Act, 
that the proposed rule change (File N. SR-DTC-00-04) be and hereby is 
approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\23\
Margaret H. McFarland,
Deputy Secretary.
---------------------------------------------------------------------------

    \23\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

[FR Doc. 00-10264 Filed 4-24-00; 8:45 am]
BILLING CODE 8010-01-M