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considerable effort, developed the CUSIP numbering system and a standard description system.
The Committee also established a technical group, known as the Securities Imprinting and Processing Task Force (SIP), to develop plans for the various pieces of paper involved in securities processing. This task force included representatives from all sectors of the securities industry including government regulators. The task force studied the stock certificate and its accompanying documents for two and a half years and, in June 1969, it published an interim report recommending a man/machine-readable card stock certificate. The recommended certificate could be processed both by punch card equipment and OCR equipment. The SIP report also recommended that preliminary steps be taken immediately to implement its recommendations.
Not long after this report was released, the New York Clearing House Association, the exchanges, and the National Association of Securities Dealers established the Banking and Securities Industry Committee (BASIC) to develop interindustry plans to solve the paperwork problem. As a result, the SIP Task Force decided to publish a final report and to become inactive.
In its final report, SIP re-emphasized its support of a man/machine-readable card certificate. It proposed and recommended a standard man/machine-processable transfer instruction form, batch control ticket, broker comparison form, and security transaction record. It also recommended the development of a Financial Industry Number System better known as FINS numbers.
During the past three years BASIC has developed on an inter-industry basis a number of recommendations to improve securities processing including the immobilization of securities certificates in regional securities depositories linked together in a nationwide book entry system. To further this objective, banking and securities industry representatives from New York, Chicago, and California in 1971 formed the National Coordinating Group for Comprehensive Securities Depositories. This Group is working on solutions to the problems of interfacing regional depositories so that participants in one can deliver to participants in any other by book entry.
The progress of New York Central Certificate Service, one of the three regional depositories, has been substantial. It was spun off from Stock Clearing Corporation and is now a wholly owned subsidiary of the New York Stock Exchange. Shortly it will be succeeded by the Treasury Depository Trust Company, a limited purpose trust company chartered by the State of New York. The Trust Company has become a member of the Federal Reserve System.
CCS's program has not been limited to structural change. Operationally it has made significant strides forward. During calendar year 1972 over eight million transactions were completed by book entry without the physical delivery of certificates. At the end of February 1973 more than one and one-half billion shares, with a market value of approximately $5.5 billion were on deposit with CCS. These shares represent more than 2,800 securities issues. Currently there are 294 participants in CCS as follows: 270 broker/dealers, five clearing corporations, and 19 banks. The bank participants are really just beginning to place customer securites in the depository.
The depository's capacity is being expanded to accommodate 9,000 securities is. sues and at least 600 participants.
Since 1971 the depository has operated a broken loan program which included at the end of February 1973, 167 broker/dealers and 58 bank pledges. Forty of these banks are outside New York City located across the country.
CCS has taken a number of steps to improve efficiency and recently contracted on a trial basis with a number of banks in other cities to open depository facilities so participants could deposit securities in these regional locations and receive immediate credit on CCS's books.
The Pacific depository and the Midwest depository efforts are also moving forward.
Two statutory amendments are necessary in most states before entities organized under their law can utilize fully the depository system. The ABA, BASIC, and others have been working in the states for such change; and the needed legislation has been enacted in many states, particularly in the larger moneycenter states. The primary task, we have found, is education.
The transfer agent depository concept is in operation in one bank. The bank's responses to all the legal and operational problems involved have been reviewed and accepted by the Boston Stock Exchange. One company is using this system at the present time. In the first three weeks of operation 29 per cent of the company's accounts deposited their securities in the depository.
We believe these developments demonstrate that the banking and securities industries recognize clearly the need for action to avoid another paper crunch and are committed to doing the job necessary within the current regulatory framework.
These developments also reveal the course which should be followed if Congress decides legislation is necessary. The private sector has proven itself capable of developing solutions; and the problem, if any, is one of implementing standards for efficient interchange of information between the various elements involved in securities processing.
The ultimate objective in modernizing securities processing should be the elimination of the stock certificate. However, there are many obstacles to be overcome before this objective is achieved, and it may take many years. As an imme diate objective, the ABA supports the continued development of a regional depository system to immobilize as many stock certificates as possible.
The Association supports the establishment of a depository in geographic area where there is economic and operational justification. Internal operating procedures of such depositories do not need to be standardized, but it is essential that standards be developed, implemented, and enforced to permit the efficient interchange of information between depositories, banks, brokers, and transfer agents. These standards should include man/machine-processable documents and computer-to-computer transmissions.
As suggested, significant progress has been made to date toward the establishment of a regional depository system and in the development and implementation of securities processing standards. Additional work, however, still remains. A national group comprised of qualified representatives from the banking and securities industries should complete the development of this system and its needed standards, including a procedure to eliminate to the maximum extent possible the need for delivering certificates between individual depositories. Regulation of this system should be accomplished by review of securities processing operations for adequate control, auditing, and conformity to standards. Regulatory authorities should not stipulate nor unreasonably restrict an organization's internal systems, procedures and staffing nor should they limit an organization in executing its management responsibilities.
Turning now to Title IV of H.R. 5050, the ABA believes its approach is wrong, and it may bring present progress toward a paperwork solution to a halt. It fails to recognize existing regulatory structures and would result in dual federal regulation. It lumps all institutions, bank and nonbank, together and treats them uniformly.
Banks have been serving corporations as transfer agents for many years. Many of these relationships involve small local corporations and small banks. On the other hand, many involve the largest corporations in the country and the largest banks. Some banks will be agent for only a handful of corporations, while others serve a large number. Also, because of the rules of the major stock exchanges, there are many co-transfer agent relationships between banks and corporations, All of these bank operations are now subject to the regulatory jurisdiction of the three federal banking agencies and the state banking agencies. Banking is the most closely regulated industry in our nation. Annually the federal banking agencies make unannounced examinations of the banks under their jurisdiction. In addition, all state-chartered banks are subject to state examinations which may be conducted in conjunction with the federal examination. The attention given to stock transfer operations by examiners has not been uniform ; but since the paperwork crunch, bank examinations have included an inspection of transfer operations and performance. There is a new appreciation of the responsibilities of a transfer agent.
If the SEC were given complete authority over transfer agent banks, to prescribe rules and regulations and to enforce them, including examination, as provided by H.R. 5050, it would in no way reduce the responsibility of the banking agencies. Consequently, there would be a dual system of rules and regulations, renorts. recordkeeping requirements, and examinations.
The federal banking agencies over the years have developed a regulatory scheme based on their statutory authority and the nature of the banking business. Similarly the SEC has developed a completely different regulatory scheme based on the authority granted to it by Congress and the nature of the securities industry. Banks have been very conscious of their responsibilities to their corporate customers and the public and, as indicated earlier, have provided leadership in solving the paperwork problem. If an unnecessary double layer of regulations is imposed, it could so complicate and increase the cost of a bank's transfer operations that the movement of banks out of the stock transfer business may increase. The Association does not believe this would be a desirable trend for the securities industry. Congress in enacting securities laws has traditionally recognized the unique character of banks and the expertise of the banking agencies and has either exempted banks or granted the regulatory authority to the banking agencies.
The purpose of regulation must always be to serve the public interest. The ABA believes this objective would best be served by leaving with the banking agencies primary regulatory authority over the transfer agent activities of banks. But where banks interface with elements of the securities industry and a central authority seems necessary for operational compatibility, it should be the SEC. Otherwise banks should be regulated by banking agencies.
To be more specific, we recognize the need for one agency to establish minimum general standards for compatibility of transfer facilities with other facilities in the securities handling process, and this agency should be the SEC. Standards of performance of transfer functions relate primarily to internal operations, but they also may have a direct impact on others in the securities handling process. So we would not object to the SEC sharing with the banking agencies joint authority to establish such standards. The Comptroller of the Currency has said that he believes this is a realistic solution in this area. In the areas of safekeeping and custody of securities and funds, recordkeeping, reports, examinations, and enforcement, the banking agencies should have sole authority over transfer agents that are banks. Transfer agents that are not banks should be subject to SEC authority in each of these areas. In all cases the SEC and the banking agencies should consult before issuing rules or regulations affecting transfer agents.
Registration may be desirable for nonbank transfer agents, but the Comptroller of the Currency testified last year that, considering the nature of bank regulation, a registration statement would serve no supervisory purpose. In conclusion, the progress being made through the depositories in reducing the number of stock transfers required lessens the need for new legislation to regulate transfer agents. But if legislation is enacted, it should recognize that transfer agent banks are already subject to supervision by the banking agencies, and the regulatory authority should be divided as set out above.
Another major concern of banking is the treatment of depositories. If a depository system is to have significant impact in immobilizing certificates, banks must place securities held in a fiduciary or other capacity in the custody of depositories. Banks are held to the highest standard of care in the protection of trust assets, and they cannot be expected to place such assets in depositories unless they have the utmost confidence in their operations and management.
Under H.R. 5050, depositories have the flavor of strictly securities institutions because they would be registered and regulated solely by the SEC. It is our belief that banks would more readily participate in depositories with regard to trust assets if depositories more closely resembled banks and provided the security of bank regulation and bank examination. It was this belief that led the New York, Chicago, and California banking and securities communities to the decision to charter each of the three depositories as a trust company under local banking law and to seek membership in the Federal Reserve System. Thus the depositories will be subject to the same standard of care in handling securi. ties as its bank participants.
More specifically the ABA believes shared authority is again the best approach for regulation if Congress decides legislation is necessary. The SEC should have authority over the registration of all depositories and share with the Federal Reserve authority over their rules. The SEC should have authority to establish standards of compatibility and standards for reasonable nondiscriminatory access. The Federal Reserve System, on the other hand, should have authority over member bank depositories relative to custody and safekeeping of securities and funds, apportionment of ownership among users, disciplining of bank participants, and examinations and enforcement. Nonbank depositories should be subject to SEC supervision in all areas.
There is one facet of H.R. 5050 which we believe is particularly undesirable. Under the bill each depository is required to be a self-regulatory entity in that its rules must provide for disciplining participants and officers, directors, and employees of participants. In addition, the SEC on its own initiative could reach officers, directors, and employees of depository participants. These provisions, if enacted, would almost guarantee nonparticipation by banks. Few, if any, bank managements would subject themselves individually as well as their directors, officers, and employees to disciplinary action by a depository or the SEC,
In conclusion, the ABA believes the fact that each of the three depositories is expected to become a member of the Federal Reserve System lessens the need for federal legislation. However, if the Congress decides to act, it should divide the authority as set out above requiring consultation and close cooperation between the SEC and the Federal Reserve. The Federal Reserve System is uniquely qualified to examine and to otherwise share regulatory authority over depositories because of its own book entry system for government securities.
The promulgation of rules by one agency and the enforcement by another is by no means unique. The banking agencies today enforce rules and regulations prescribed by more than 10 other federal agencies-for example, the Department of Housing and Urban Development, the Department of Justice, and the Office of Civil Defense. Such a division of authority helps eliminate conflicting regulation. If all authority over depositories were given to the SEC as provided by H.R. 5050, it would result in the same dual regulatory situation as has already been discussed with regard to transfer agent banks.
The Association supports the study of the use of nominee or street names and the provisions of Section 408 relating to state and political subdivision taxes.
The Association also recommends the adoption of some administrative provisions and a few technical revisions. Adequate time should be given for persons affected by the bill to file registration statements; and if they are performing a covered function on the date of enactment, they should be allowed to continue to perform the function while the registration is pending. The 180 days in proposed Section 17A (a) (1) is unrealistic if tied to the date of enactment. The regulatory agencies should be directed within a reasonable time to promulgate forms and procedures for the filing of registration statements, and the 180-day period should begin with the issuance of final regulations. Also, national banking associations should be permitted, with the approval of the Comptroller, to invest a limited amount in the stock of one or more depositories. This is for the purpose of encouraging banks to place trust assets in depositories.
The definitions of "clearing agency," "depository," and “transfer agent" should be tightened up. As presently drafted, the exemption of lending, fiduciary, correspondent, and safekeeping functions of banks, brokers, and other financial institutions includes only those functions commonly performed by them on the date of enactment. This may unduly restrict the normal growth of services performed by banks and other financial institutions.
When securities are filed by issue in a trust department and transactions result in book entry debits and credits, is the bank serving as a “transfer agent” or a “depository' as these terms are presently defined ? All these questions should be settled by carefully limiting the language of these definitions to include only activities which need to be regulated to effectuate the purpose of developing an integrated national system for the prompt and accurate processing and settlement of securities transactions.
Similarly, the definition of depository should be precise enough to exclude transfer agent depositories. Considerable time, money, and effort have been devoted by at least one bank to the development of this concept, and it now serves one corporation in this capacity. This concept is close to the certificateless concept in that share issuance and transfer are by bookkeeping entry only even in the case of individual shareholders. Such depository function is closely related to the transfer agent function, and thus depositories should be regulated the same as transfer agents. This would not cause any coordination problems because the SEC would have full authority to require operational compatibility.
In summation, The American Bankers Association opposes the enactment of Title IV of H.R. 5050 as introduced. It believes, however, that with the changes discussed above a workable measure can be developed which would serve the public.
[From the Wall Street Journal, Sept. 12, 1973)
NASD To PROPOSE RULES TO TIGHTEN BROKER STANDARDS
ASSOCIATION SEEKS TO REDUCE SECURITIES LAW VIOLATIONS AND FREQUENT
(By a Wall Street Journal Staff Reporter) WASHINGTON.—After months of study, the National Association of Securities Dealers is proposing rules to tighten the currently loose standards for companies entering the industry through the association.
The chief aims are to cut down on securities laws violations and on the high level of brokerage-firm liquidations.
The rule proposals, which two NASD committees have been working on since last spring, have been approved by the board of governors of the NASD, the selfregulatory arm of the over-the-counter stock market. The proposals will be announced later this week and sent to NASD member firms for comment.
Generally, the proposed rules would limit the reentry into the industry of principals and officers of firms that have been liquidated through Securities Investor Protection Corp., a government-backed agency that insures investor accounts. The proposals also would establish minimum experience levels for officials of new firms and give the NASD power to limit their business, depending on the qualifications.
The NASD is inviting comments from its 3,700 member firms until Oct. 6. Before they can take effect, the proposals must be approved by NASD members and cleared by the Securities and Exchange Commission. NASD officials expect final approval late this year.
In a letter to NASD members being sent with the proposals, the organization says it has been concerned that most of the liquidations in the 212 years SIPC has been in existence were of relatively young firms.
“A predominant reason for many failures has been incompetent and inexperienced management, marginally financed firms and persons of questionable repute being part of management,” according to a letter to NASD members from Frank J. Wilson, NASD senior vice president for regulation. Sixty-four of SIPC's 68 liquidations in 1971–72 were NASD members; 80% of the 64 were in business less than five years.
In many of those firms, officers engaged in trading or underwriting activities without prior experience. Currently, anyone who passes certain NASD tests and meets the minimum net capital requirements can form a securities firm. NASD officials say there have been instances of individuals being involved in more than one liquidation. Some principals of firms liquidated by SIPC immediately form new concerns and join the NASD. In fact, there have been some instances of individuals organizing a new brokerage firm prior to the demise of their old one, according to Mr. Wilson.
These practices wouldn't be allowed under the rule proposals. Principals and officials of firms liquidated at the request of SIPC who were involved in the activities that led to the firms' financial difficulties would be prohibited from being associated with NASD members, unless they are exempted by the association's board.
The proposals also call for firms applying for NASD membership to have at least two principal officials with a minimum of three years experience in the preceding five years in a supervisory or managerial capacity with a NASD member. The NASD could waive this rule if an applicant has superior business background.
The proposals also would let the NASD evaluate the qualifications of applicants and impose restrictions on their business activities. For example, a firm wouldn't be allowed to engage in trading or underwriting activities unless it could demonstrate it had personnel capable of handling those activities. A firm with employees of minimal experience could be limited to the distribution of mutual fund shares, an area that doesn't require as much customer protection as making markets in stocks, according to the letter to NASD members. Individuals whose activities are restricted could appeal to the NASD board, the SEC or the courts.
Mr. Moss. Mr. Ware?
rash act on the part of the rest of you—but let's assume the group in this room this morning should decide to organize a depository and the group would qualify as to business experience and integrity, et cetera. But the group also decided they would not seek to become a bank. How would you have that group regulated and enforced, by the Federal Reserve, the SEC, or a combination, as you have suggested in your testimony?
Mr. Bevan. It should be under the regulatory authority of the SEC as provided by S. 2058. We think this is a proper approach.