Document ID: SEC-2008-0476-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: The Depository Trust Co.
Posted Date: 2008-03-27T04:00Z

[Federal Register: March 27, 2008 (Volume 73, Number 60)]
[Notices]               
[Page 16403-16405]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr27mr08-91]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57542; File No. SR-DTC-2007-11]

 
Self-Regulatory Organizations; The Depository Trust Company; 
Order Approving Proposed Rule Change, as Modified by Amendment No. 1, 
To Amend Its Operational Arrangements as It Applies to Structured 
Securities

March 20, 2008.

I. Introduction

    On September 7, 2007, The Depository Trust Company (``DTC'') filed 
with the Securities and Exchange Commission (``Commission'') proposed 
rule change SR-DTC-2007-11 pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'').\1\ The proposed rule change 
was published for comment in the Federal Register on November 26, 
2007.\2\ The Commission received four comments to the proposed rule 
change.\3\ On December 14, 2007, DTC filed Amendment No. 1 to the 
proposed rule change.\4\ The proposed rule change, as Modified by 
Amendment No. 1, was published for comment in the Federal Register.\5\ 
The Commission received one comment to Amendment No. 1.\6\ For the 
reasons discussed below, the Commission is approving the proposed rule 
change, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 56795 (November 15, 
2007), 72 FR 66009.
    \3\ Simon Griffiths, Vice President, JP Morgan (December 10, 
2007); Tom Migneron, Principal, Edward Jones (December 11, 2007); 
Dan W. Schneider, Baker & McKenzie LLP, Counsel to the Association 
of Global Custodians, Chicago, Illinois (December 12, 2007); Norman 
Eaker, Chairman, Securities Industry and Financial Markets 
Association, Operations Committee, Gussie Tate, President, 
Securities Industry and Financial Markets Association, Dividend 
Division, and Thomas Hamilton, Vice Chairman, Securities Industry 
and Financial Markets Association, MBS and Securitized Products 
Division Executive Committee (December 19, 2007).
    \4\ As explained below, Amendment No. 1 replaced and superseded 
the original filing in its entirety. Amendment No. 1 removed 
reference to the imposition of a processing fee on January 1, 2008, 
and corrected the identity of the party that will identify an issue 
as conforming or non-conforming and will submit a written 
attestation giving the reason for non-conformance.
    \5\ Securities Exchange Act Release No. 57283 (February 6, 
2008), 73 FR 8384.
    \6\ Carol A. Jameson, Vice President and Senior Counsel, The 
Depository Trust Company (March 5, 2008).
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II. Description

    DTC's Operational Arrangements is a contractual agreement between 
DTC, issuers, and paying agents that outlines the procedural and 
operational requirements for an issue to become and remain DTC 
eligible. The proposed rule change amends DTC's ``Operational 
Arrangements Necessary for an Issue to Become and Remain Eligible for 
DTC Services'' (``Operational Arrangements'') as it applies to 
Structured Securities in order to: extend the deadline by which paying 
agents of such securities must submit periodic payment rate information 
to DTC; establish Structured Securities classifications; establish an 
exception processing fee applied to certain Structured Securities whose 
features prevent paying agents from complying with the extended 
deadline; and provide that DTC track and make publicly available 
reports on paying agent performance as it relates to timeliness and 
accuracy of Structured Securities payment rate information submitted to 
DTC.
    A Structured Security, such as a collateralized mortgage obligation 
or asset-backed security, is a bond backed by a pool of underlying 
financial assets. The underlying assets generally consist of 
receivables such as mortgages, credit card receivables, or student or 
other bank loans for which the timing of principal payments by the 
underlying obligors may be variable and unpredictable. A Structured 
Security may also incorporate credit enhancements or other rights that 
affect the amount and timing of payments to investors.
    Communication of periodic payment rates of principal and interest 
(``P&I'') to the end investors in Structured Securities depends on 
application of

[[Page 16404]]

stringent time frames for information reporting and significant 
interdependencies among servicers of the underlying assets, 
specifically trustees, custodians, paying agents on the securities, 
DTC, and the financial intermediaries that act on behalf of the 
investors. Given the complexity of structure and calculations of cash 
flow from the underlying assets through the issuer to the end investor 
and given the interdependencies on timeliness and accuracy of 
performance throughout the chain of servicers and intermediaries, 
timely and accurate submission of payment rate information on 
Structured Securities may be difficult to achieve. As a result, payment 
rates typically are announced late on a significant number of issues, 
and the number of post-payable adjustments made to correct inaccurate 
payments resulting from inaccurate payment rate information is higher 
than for any other security type. Furthermore, the volume of P&I 
payments for Structured Securities processed through DTC has grown 
rapidly in recent years and currently represents approximately 25% of 
all P&I payments processed through DTC. Incorrect and late payment rate 
reporting causes increased operations processing costs, inefficient 
cash management, and loss of income.
1. Extending the Deadline for Reporting on Payment Detail
    Currently, the majority of Structured Securities have features that 
prevent paying agents from being able to meet the current Operational 
Arrangements payment rate reporting deadline. DTC is amending the 
Operational Arrangements to require that the payment notification 
regarding Structured Securities be provided to DTC by the paying agent 
preferably five business days but no later than one business day prior 
to the payable date.\7\ In addition, DTC is extending its current 
processing deadline for receipt of payment rate files from 7:00 p.m. to 
11:30 p.m. The extended reporting period deadlines should allow paying 
agents to provide payment rates in a timely and accurate fashion for a 
majority of Structured Securities issues and should permit the 
securities to remain eligible for DTC's services while still providing 
DTC with adequate time to process the information and make timely 
payments to its participants.
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    \7\ Prior to this filing, payment notifications regarding 
Structured Securities had to be provided to DTC by the paying agent 
preferably five business days but no later than two business day 
prior to the payable date.
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2. Securities Classifications
    Due to the complexity of certain Structured Securities, it is 
anticipated that the paying agents for certain issues will still not be 
able to meet the amended Operational Arrangements requirements for 
timely payment rate reporting even with the extended reporting 
period.\8\ Therefore, DTC is categorizing Structured Securities as 
``conforming'' or ``non-conforming.'' Non-conforming Structured 
Securities will be issues for which the underwriter and paying agent 
have concluded that the security has features that will likely preclude 
the paying agent from submitting payment rate information to DTC in 
conformity with the requirements of the Operational Arrangements. The 
conforming/non-conforming identification will be made at the time the 
security is made eligible at DTC. For each Structured Securities 
underwriting that the underwriter and paying agent identify as non-
conforming, the underwriter and paying agent shall submit a written 
attestation giving the reason(s) why the paying agent will be unable to 
submit payment rate information to DTC in conformity with the 
requirements of the Operational Arrangements. DTC will in turn identify 
non-conforming Structured Securities to participants and other relevant 
parties and will add an indicator to the appropriate DTC systems 
functions to denote non-conforming securities. Paying agents also shall 
be required to evaluate their entire portfolio of Structured Securities 
that have previously been made eligible and are currently on deposit at 
DTC to identify non-conforming securities.
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    \8\ Although approximately 15% of Structured Security issues 
currently fail to have rates submitted to DTC in a timely manner, it 
is estimated that approximately only half of these have structural 
impediments to meeting the new requirements. Late reporting in other 
instances is believed to be curable by improved servicing and 
reporting on the securities.
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3. Exception Processing Fee Applicable to Non-Conforming Securities
    Late payment rate reporting leads to increased costs to DTC and to 
servicers and intermediaries. In order to recoup the increased 
processing costs, DTC is imposing an exception processing fee to the 
managing underwriter of each non-conforming issue at the time of 
underwriting. No exception processing fee will be charged retroactively 
for issues already on deposit at DTC prior to the implementation of the 
fee. The exception processing fee of $4,200 per CUSIP was calculated 
based upon anticipated additional costs of P&I processing for non-
conforming Structured Securities.\9\
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    \9\ The fee was filed with the Commission as part of DTC's 
annual establishment of fees. Securities Exchange Act Release No. 
34-57193 (January 24, 2008), 73 FR 5614.
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    The aggregate net amount of the exception processing fees will be 
allocated and rebated on a pro rata basis annually to the DTC 
participants for whom DTC processed Structured Securities P&I 
allocations. For each participant, DTC will compare the participant's 
total number of allocations to the total number of all participants' 
allocations, and the resulting percentage would be applied against the 
total exception processing fund with the resulting amount being rebated 
to the participant. The total exception processing fund will be the sum 
of all exception processing fees less DTC's cost to administer the 
program.
4. Evaluation and Publication of Paying Agent Performance
    DTC will track and evaluate paying agent performance with regard to 
timeliness and accuracy of payment rate reporting on Structured 
Securities and make these evaluations available to DTC participants and 
to the public. The purpose of these evaluations is to identify poor 
reporting and payment performance by paying agents.
    DTC plans to expand its paying agent evaluation reports (``Report 
Cards'') that are currently used to compare rate submission performance 
and accuracy of Structured Securities paying agents. Currently the 
Report Cards are only distributed among the paying agents being 
compared. DTC will now make the Report Cards available on its Web site. 
The Report Cards will track and will report on a monthly basis 
performance by paying agent with respect to the number of 
collateralized mortgage obligations and asset-backed securities 
announcements processed, the number of late and amended announcements, 
the payment dollars, late payment dollars, the number of payments, and 
the number of late payments. Timeliness of payment rate notification on 
non-conforming Structured Securities will not be included in the Report 
Cards. With respect to all the other items set forth above, paying 
agent performance information for both conforming and non-conforming 
Structured Securities will be included in the Report Cards.

III. Comment Letters

    The Commission received five comments to the proposed rule 
change.\10\ Four of the comment letters

[[Page 16405]]

were from industry participants, and one was from DTC in response to 
the other four comment letters. While all of the four industry 
commenters generally supported the proposal, two raised issues or 
sought clarification about the proposal.
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    \10\  Supra notes 3 and 4.
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    The comment letters submitted by JP Morgan and Edward Jones both 
expressed their support for the: (1) Extension of the deadline for 
reporting on payment detail, (2) creation of the conforming and non-
conforming securities classifications, (3) creation of the exception 
processing fee for non-conforming securities, and (4) evaluation and 
publication of paying agent performance.
    The comment letter written on behalf of the Association of Global 
Custodians expressed its support for the: (1) Creation of the 
conforming and non-conforming securities classifications and (2) 
evaluation and publication of paying agent performance. Although the 
commenter expressed support for the extension of the deadline for 
reporting payment detail, the commenter stated that DTC should monitor 
paying agent performance to determine if the reporting of payment 
detail trends toward last-minute reporting or if the extended deadline 
does not correlate with a reduced incidence of errors and adjustments. 
Although the commenter expressed support for the creation of the 
exception processing fee for non-conforming securities, it suggested 
that the aggregate net amount of the exception processing fee should be 
rebated to participants based on their transactions in non-conforming 
securities only rather than to participants based on their transactions 
in all Structured Securities.
    The comment letter written on behalf of the Securities Industry and 
Financial Markets Association expressed support for the: (1) Extension 
of the deadline for reporting on payment detail and (2) evaluation and 
publication of paying agent performance. Although the commenter 
expressed support for the creation of the conforming and non-conforming 
securities classifications, it requested guidance on the criteria to be 
used to determine whether a Structured Security is non-conforming, 
whether an issue's classification can be changed, and when the 
classification determination will be required to be submitted to DTC. 
The commenter questioned whether it was appropriate to require the 
underwriter to sign the classification attestation rather than allowing 
the underwriter to rely on the paying agent's attestation.
    While the Securities Industry and Financial Markets Association 
expressed support for the creation of the exception processing fee, it 
questioned whether the underwriter is the appropriate party to pay the 
fee. It stated its belief that the costs created by late and erroneous 
submissions from conforming issues should not be borne by non-
conforming issue underwriters. The commenter also suggested that the 
aggregate net amount of the exception processing fee should be rebated 
to participants based on their transactions in non-conforming 
securities only rather than to participants based on their transactions 
in all Structured Securities.
    In its comment letter, DTC stated that the criteria for 
categorizing an issue as ``non-conforming'' would consist of a general 
good-faith expectation, based on information available at the time, as 
to whether it is anticipated that DTC's deadlines for submission of 
rate information will be met. It also stated that both the paying agent 
and the underwriter will be responsible to sign the classification 
attestation and that imposing the exception processing fee on the 
underwriter is equitable and consistent with DTC's general practice. 
Finally, the commenter confirmed that while it will allocate exception 
processing fee revenue pro rata to DTC participants for whom DTC 
processed any Structured Securities, it will review the policy toward 
the end of 2008 to determine whether future allocations should be 
directed to participants based only on their transactions in non-
conforming securities.

IV. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a registered clearing agency. In particular, 
the Commission believes the proposal is consistent with the 
requirements of Section 17A(b)(3)(F),\11\ which, among other things, 
requires that the rules of a clearing agency are designed to remove 
impediments to and perfect the mechanisms of a national system for the 
prompt and accurate clearance and settlement of securities 
transactions. The Commission finds that by enabling more Structured 
Securities to be DTC-eligible and by helping to make the reporting of 
information about Structured Securities more accurate and timely, the 
proposed rule change, which should make the communication of payment 
rate information on Structured Securities quicker and more efficient, 
is consistent with this statutory obligation.
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    \11\ 15 U.S.C. 78q-1(b)(3)(F).
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IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposal is consistent with the requirements of the Act and in 
particular with the requirements of section 17A of the Act \12\ and the 
rules and regulations thereunder.
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    \12\ 15 U.S.C. 78q-1.
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    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\13\ that the proposed rule change (File No. SR-DTC-2007-11), as 
modified by Amendment No. 1, be, and hereby is, approved.\14\
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    \13\ 15 U.S.C. 78s(b)(2).
    \14\ In approving the proposed rule change, the Commission 
considered the proposal's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).

    For the Commission by the Division of Trading and Markets, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E8-6256 Filed 3-26-08; 8:45 am]

BILLING CODE 8011-01-P