Personnel Compensation of directors, officers and staff Conflicts of interest Recruiting methods and proper preemployment investigation of credentials Benefit plans Vacation schedules and adherence thereto Accounting and Auditing Audits and examinations by outside directors and their auditors Adequacy of accounting and internal auditing procedures; application of computer techniques Requests for confirmations from customers; verification programs Administration and Operations Adequacy of records, systems and controls; vault operations Emergency preparedness measures, including reconstruction of Assets held by others than the bank itself, including collateral* Performance as fiduciary, and compliance with pertinent statutes, regulations and agreements Procedures for voting proxies and handling related material Proper maintenance of files and records Controls established to effect collection and credit of interest and dividends Timely investigation of differences * Operations concerned with pledged securities are noted to determine the effectiveness of controlling such assets for the account of the pledgor and pledgee. Where such securities are not in possession of the bank a review is made of the system of controlling these items, and where necessary direct confirmations are required to check the controls established over said securities. Note: The New York Clearing House banks and others sought and received clearance from the New York State Banking Department, the Comptroller of the Currency and the Federal Reserve before fully participating in the broker-bank collateral loan program at CCS, Inc. under which collateral for broker loans is held outside of the pledgee bank. 20-306 749 pt. 5 Others Violation of statutes Exposure to surcharge Complaints from customers The security afforded to those by whom the bank's engagements are held Such other matters as may be prescribed by the regulatory authority The Federal Reserve and New York State banking authorities are required to make at least one examination each year of each bank and trust company supervised. Each director of the institution examined is notified of the completion of the examination reports which must be presented at the next Board of Directors meeting. The bank must report to the regulatory authority action taken by its Board in response to recommendations and criticisms contained in the examination report. Examinations by these banking authorities are thorough; a recent joint annual examination of one large New York City bank by New York State and Federal Reserve examiners took a total of approximately 2,400 mandays of regulatory staff time, excluding time devoted to the bank's foreign branches.* The Federal Reserve Banks, as fiscal agents of the United States, have for many years issued, registered, redeemed and paid interest on securities of the U.S. Treasury and other agencies of the federal government. They also hold securities owned by banks, some of which are pledged for various purposes. The Federal Reserve System also has experience in actually operating interregional depositories-their 12 Federal Reserve Banks-and a bookentry system. *It is anticipated that the New York State Banking Department and the Federal Reserve Bank of New York will make their annual examination of DTC on a joint basis, as they do with respect to a number of other banks in New York. The nature of the examination will be similar to that indicated. above. Book-Entry Experience of the Federal Reserve In 1921, the Federal Reserve Banks introduced facilities for making telegraphic transfers of Treasury securities between such banks in the 12 Federal Reserve districts. This was in reality the first nationwide system of interconnected regional depositories. In 1965, this wire transfer facility was significantly enlarged when the Federal Reserve Bank of New York entered into an arrangement with several banks in New York City under which such banks opened with it clearing accounts for Treasury securities. The establishment of these clearing accounts permitted the participating banks to "settle" once a day, on a net basis, their wire transfers as custodians for out-of-district banks. This system was later extended to include the settlement of wire transfers of Treasury securities among all participating banks. In 1968, all the Federal Reserve Banks instituted a book-entry system for the custody of Treasury securities owned by member banks, by governmental agencies and by agencies of foreign banks. A distinguishing feature of this system is that it does not merely immobilize issued and outstanding certificates-it eliminates most of them. The Federal Reserve Bank of New York subsequently expanded this system to include Treasury securities held by member banks for their dealer departments and for all non-bank dealers; it has recently announced the expansion of the system to include such securities held by member banks in trust and customer accounts as well as securities of various agencies of the federal government. It is expected that, based on the New York Federal Reserve Bank's experience, this expanded book-entry system will shortly be adopted by the other Federal Reserve Banks. The Federal Reserve Bank of New York currently holds some $150 billion of Treasury securities in its certificateless system (1972 Annual Report). The other Federal Reserve Banks hold another $30 billion. The system routinely handles 15,000 or more transactions per week with a market value of as much as $25 to $30 billion. As a result, the value and number of Treasury securities out "on the street" have been vastly reduced and should, before this year is out, be further reduced.* The experience which the Federal Reserve has in operating its security depository and in operating a telegraph or wire securities transfer system, a form of "interface", provides a substantial body of knowledge and expertise as does its current development of techniques for more rapid payments and movement of funds. It will also provide additional assurance to banks located in states other than those in which depositories are located. H.R. 5050 Does Not Provide for a Regulatory Climate H.R. 5050 grants to the SEC alone the power to register depositories (Section 17A(c)), to review their rules (Section 17A(d) (2-8)) and amendments thereto (Section 7A(k)), and to examine depositories (Section 17A(0)) even if the depositories are chartered as banks or trust companies and subject to the extensive supervision and examination that accompanies this status. In addition, the SEC is empowered to prescribe all depository rules (Section 17(g)) and SEC consultation with federal bank regulatory authorities including the Federal Reserve System is referred to only in the most general terms (Section 17A(p)(2)). Although this regulatory structure does not by its terms prohibit supervision and examination by banking agencies as described above, it places in the SEC ultimate control over many matters which are important to the supervisory capability of a banking agency. Moreover, H.R. 5050 requires the SEC to duplicate regulatory matters, such as examination, which are already the concern of banking agencies. Not only might this duplication lead to conflict and uncertainty, but the extensive and overriding authority of the SEC could also result in depositories being regarded as an arm of the securities industry. This would not encourage, and may well discourage, the use of depositories by "fiduciary" institutions. *Page 44 of the Federal Reserve Bank of New York Annual Report for 1972 states: number of definitive securities handled declined 25.6 per cent. . . as a result of the continued expansion of the book-entry procedure and the government securities clearing arrangements." 64 the Moreover, three specific provisions of H.R. 5050-those regarding access, disciplinary relationships, and management participation-need revision. Access Section 17A(d)(2) of H.R. 5050 requires that all registered brokers, dealers, members of national securities exchanges, associations, clearing agencies, depositories and investment companies, and all banks, be eligible participants under the rules of a depository, subject only to (i) the posting of a bond or deposit bearing a reasonable relationship to risks and (ii) denial of participation for the duration of a suspension or expulsion from another depository or clearing agency. Only potential participants other than those listed above may be restricted on the basis of operations capability, financial condition and conviction of certain crimes. Since depositories are essentially mutual service organizations, they will be no sounder than their participants. Moreover, financial and operational risks engendered by the inclusion of participants unable to meet reasonable standards of solvency, operational competence and character will directly affect all other participants. Yet, under H.R. 5050 considerations of operations capability, financial condition and prior criminal activity or affiliations may not be weighed in considering the largest group of users, enumerated above. It is difficult to conceive of another industry in which solvent, competent and reputable members must, by law, stand at risk of the incompetent, insolvent or disreputable. Although it is recognized that each of the entities listed in categories A through D in Section 17A(d)(2) is subject to some degree of regulation which may be concerned with its operational capability, financial condition and lack of criminal activity, such regulation is not concerned with, for example, an entity's operational ability to interface with a depository. In the absence of a violation of depository rules, the proposed structure requires a depository to rely upon various regulators to assure that operational capability and financial ability are present in the participants, notwithstand |