ANSWERS TO QUESTIONS OF THE SUBCOMMITTEE ON SECURITIES TO THE SECURITIES AND EXCHANGE COMMISSION

1. Section 6 of S. 3412 would empower the Commission to prescribe minimum standard for the performance of transfer agents. Witnesses testified before the Subcommittee that the Commission should have the power to prescribe standards of "compatibility" for transfer agents, but not performance or personnel standards. These same witnesses, however, had difficulty distinguishing between performance and compatibility standards.

a. Should the Commission be empowered to set deadlines for the performance of transfer functions?

Answer. Yes. There, of course, may be differing standards or requirements depending upon the type of transaction involved.

b. Should the Commission be empowered to compel the use of uniform forms and procedures by transfer agents, if they are developed?

Answer. If the uniform forms and procedures which have been developed are generally acceptable to users and have been approved by the Commission, the Commission should have the authority to require their use, where uniformity will contribute to improving the operation of the transfer function.

c. Should the Commission be empowered to set minimum standards of safekeeping of securities and funds in the custody of transfer agents?

Answer. Yes.

2. In the hearings held on May 9, 10 and 11, there was a considerable division of opinion concerning whether the Commission should have the power to regulate securities depositories. Although Chairman Casey's prepared statement does reconfirm the Commission's position taken in S. 3412, Mr. Casey also stated "we would be prepared to see the bill modified further to give the bank regulators authority over the security, safekeeping and financial responsibility of depositories."

a. Does the Commission, or do bank regulatory agencies, have the greater capability for regulating securities depositories?

Answer. The Commission has had greater experience in regulating depositories, all depositories being adjuncts of self-regulatory organizations. The bank regulatory agencies have had greater experience in assuring standards of safekeeping. The thrust and purpose of the Commission's bill is to guide the development of a modern securities transfer and payment system. This requires the integration of depository participation in securities movement and transfer with other aspects of the securities transfer process (execution, clearance, transfer and payment), and it seems clear that the Commission presently has greater experience and capability in this area. However, it is not necessary for the Commission to be the sole regulator of depositories, and, with regard to certain aspects of depositories, notably their safekeeping function and their financial condition, the oversight of bank regulators may be appropriate and desirable. To the extent a bank regulatory agency conducts a program designed to insure financial responsibility of a depository, which is itself a bank, the Commission would like to be able to defer to that agency's expertise and manpower to insure protection of the assets of users.

b. Are there certain essential functions of depositories which the Commission feels it must have the power to regulate? If so, please enumerate those functions. Answer. The functions of depositories over which the Commission feels it should have jurisdiction include such matters as receipt and recordation of securities, the delivery of certificates, the effectuation of delivery and transfer by bookkeeping entry, processing of dividends, proxies and corporate mailings, stock loan programs, collateral loan programs, uniformity of forms, membership, and operational compatibility of depositories with other financial entities.

c. As to these essential functions, does the Commission intend to regulate all depositories if S. 3412 is enacted, regardless of corporate form?

Answer. The standards applicable to depositories should be uniform to the extent feasible regardless of corporate form.

3. There has been some concern that Sections 10(a) and 11(a) of S. 3412 would empower the Commission to defer to state banking authorities in regulating those depositories which take the form of state banks.

a. Is this the intention of these provisions?

Answer. Sections 10 (a) and 11(a) of S. 3412 are designed to avoid duplicate regulatory oversight and undue burden on banks. In this regard, to the extent that state banking authorities have developed programs of inspection, examina

tions and enforcement over banks performing transfer, depository and clearing functions, the Commission would seek to rely on these efforts regarding their financial condition and safekeeping functions. The primary responsibility for regulating the operational functioning of depositories which are banks should not, however, rest with state banking authorities, but with an agency which has regulatory power over related aspects of the securities transfer function. The Commission should have a basic inspection right over depositories and clearing agencies to see that the primary objectives of this Act are being met.

b. Has the Commission any present intention of making such arrangements if the bill is enacted?

Answer. See answer to c. below.

c. Have any assurances been made to any persons that Sections 10 (a) or 11 (a) will be interpreted in a particular way if S. 3412 is enacted? If so, what is the nature of such assurances?

Answer. The Commission has given no assurances as to the interpretation of Section 10 (a) and 11(a) nor has the Commission entered into any understanding with any person regarding what arrangements may be made for participation and supervision of these entities.

4. The Subcommittee received testimony from the Banking and Securities Industry Committee suggesting certain amendments to S. 3412. Does the Commission have comments regarding such proposed amendments?

Answer. The Commission believes that while the amendments to S. 3412 recommended by BASIC, involving a state system of regulation of depositories, recognized the ultimate authority of the Commission over depositories their suggested regulatory approach was cumbersome.. BASIC has recently suggested a modification of its initial proposal for amendments to S. 3412 which, again recognizing the Commission as the ultimate authority over depositories, designates the Federal Reserve as the "appropriate regulatory authority." These most recent suggestions of BASIC regarding participation of the Federal Reserve in the regulation of depositories are being examined by the Commission.

5. Some of the witnesses who testified before the Subcommittee took the view that a distinction must be made between clearing agencies and depositories in establishing a regulatory framework. Yet, the witnesses were generally unable to articulate functional, substantive differences between the two kinds of entities regardless of corporate form.

a. Are the definitions of "clearing agencies" and "depositories" contained in Section 3 of S. 3412 mutually exclusive?

Answer. It is possible for an entity performing security processing functions to fall under both the definition of “clearing agency” and “depository” by virtue of the services performed by it. The functions are interrelated. As a matter of information, the Midwest Stock Exchange Clearing Corporation has a safekeeping facility for its members. The National Clearing Corporation, moreover, contemplates a similar service by the end of 1972. Additionally, the Boston Clearing Corporation provides such a service for its foreign broker-dealers, and it also has several American broker-dealers in its system. The Pacific Coast Stock Exchange and the PBW Exchange also perform similar services for their specialists.

b. Is the present Central Certificate Service a clearing agency or a depository under S. 3412? Assuming that plans to recast CCS in the form of a state trust company are implemented, will CCS then be a clearing agency or a depository? Answer. At present, both the Central Certificate Service of the New York Stock Exchange and the Pacific Securities Depository of the Pacific Coast Stock Exchange arrange for the deposit and withdrawal of securities by participants, and CCS provides for the transfer of securities by book entry among participants. PSD shortly plans to also provide transfer by book entry. As such they are depositories as defined in S. 3412. If CCS and PSD are spun off by their parent stock exchanges and become separate entities still performing these same services they would continue as depositories under S. 3412. Because CCS is operated by the Stock Clearing Corporation and PSD is operated by the Pacific Coast Stock Exchange Clearing Corporation, CCS and PSD are depositories closely affiliated with clearing agencies. If, when CCS and PSD are spun off, they assume any of the functions presently performed by their affiliated clearing agencies, CCS and PSD would then be both a depository and a clearing agency as those terms are defined in S. 3412.

c. Does the Commission feel that it is wise from a regulatory standpoint to distinguish between clearing agencies and depositories?

Answer. Although it is possible for depositories and clearing agencies to be separately controlled entities, in view of the close interrelationship of these func

tions as well as the essential desirability of uniformity in the processing of transactions and the need for a national system, it is believed that the regulation of these entities should not be separated.

6. S. 3412 appears to contain no provisions empowering the Commission to disapprove proposed rule changes of clearing agencies, depositories or transfer agents or to require amendment of such rules. S. 3297, on the other hand, does give the Commission such powers with regard to "clearing agencies." Does the Commission support those provisions of S. 3297 which do confer such powers? Answer. S. 3412 contemplates direct rule making authority by the Commission over depositories, clearing agencies and transfer agents, whereas the framework of S. 3297 suggests that the Commission, rather than promulgating its own rules, would review and approve or disapprove of rules of such entities. Both approaches are workable although it would appear that somewhat more flexibility is found in S. 3412. In addition, while the provisions of S. 3297 are more explicit with regard to the power of the Commission to disapprove proposed rule changes of these entities, the Commission would have the power under S. 3412 to disapprove rule changes of depositories, clearing agencies and transfer agents to the extent they were inconsistent with the rules promulgated by the Commission under S. 3412.

7. Sections 5 and 6 of S. 3412 appear to give the Commission power to make direct regulations concerning agencies, despositories, and transfer agents. a. Would the Commission's rules pursuant to Sections 5 and 6 of S. 3412 be promulgated without regard to existing rules of clearing agencies, depositories and transfer agents?

Answer. No. Clearly, it would be undesirable for the Commission to exercise its rule making authority without considering existing rules. Nevertheless, S. 3412 would confer upon the Commission the power to promulgate rules, consistent with the authority given the Commission in Sections 5 and 6 thereof, which could have the affect of overriding rules of these entities.

b. Is the approach taken in S. 3412 intended to be different in effect from the self-regulatory procedures established under the Securities Exchange Act of

1934?

Answer. Yes. As we have pointed out, the present self-regulatory procedures are too cumbersome. What is contemplated in S. 3412 is that the Commission would be given the power to issue rules governing the operations of depositories, transfer agents and clearing agencies without going through a circuitous procedure as exemplified in Section 19 (b) of the Securities Exchange Act of 1934. c. If S. 3412 is intended to depart from the present pattern of self-regulation, what are the peculiar characteristics of the process of clearing and settling securities transactions which suggest such a departure?

Answer. As the regulation of securities processing would involve interrelated functions controlled by many different entities an original rule making approach would achieve more effective regulation.

8. What specific concerns prompted the Commission to include Section 12 in S. 3412?

Answer. The Commission included Section 12 in S. 3412 to insure that information furnished to it by depositories, clearing agencies and transfer agents which is proprietary in nature or important to the safekeeping functions of these entities would remain confidential.

a. Would such concerns be met by the language contained in Section 12 of the House version of the bill, (H.R. 14567) ?

Answer. H.R. 14567 puts the burden on the various participants in this regard and would also increase the workload of the Commission. As the Commission will be receiving a great deal of information and must decide on a case by case basis whether or not to disclose the information this could become quite onerous. b. Would such concerns be met by the language contained in Section 7 of H.R. 14826, introduced by Congressman Moss on May 8, 1972?

Answer. H.R. 14826 sets forth the same basic scheme as H.R. 14567. Thus, the same comments apply here as well.

9. What is the purpose and intended effect of Section 13 of S. 3412?

Answer. Section 13 is primarily designed to exempt from the bill foreign entities whose activities are confined to foreign securities. The transactions in question must all take place outside of the U.S. This follows a pattern set by Congress in Section 30 (b) of the Securities Exchange Act of 1934.

10. What is the purpose and intended effect of Section 14 of S. 3412? Is Section 14 designed to effect a change in the procedures for adoption and review of Commission rules from the procedures which now exist under the Securities Exchange Act of 1934 as amended? If so, why?

Answer. The purpose of Section 14 is to give the Commission effective rulemaking authority in this area. As has previously been alluded to, this power is vital to the implementation of an effective national system. Under the Securities Exchange Act the power of the Commission is limited by Section 19 (b) whereas, in Section 7(a) of the Securities Investor Protection Act of 1970, Congress saw fit to clothe the Commission with the same authority as in Section 14 of S. 3412. 11. The operative provisions of S. 3412 are inapplicable to "exempted securities." This would exclude obligations of the United States, and of state and local governments. Is it the Commission's position that there are no current problems in clearing and settling transactions in these "exempted securities?" If problems do exist, what are the Commission's recommendations for dealing with them? Answer. S. 3412 was designed to parallel the Securities Exchange Act of 1934 in respect of securities transactions subject to its provisions. Thus, exempted securities, principally obligations of the United States and municipals, were excluded from coverage. The Commission does not have extensive information regarding the settlement of transactions in exempted securities. The Commission is, however, studying certain sales and trading practices in municipal securities but has not as yet formulated specific recommendations for the regulation of such practices. Congress may wish to consider whether state and local debt obligations should continue to remain without the purview of the Commission's regulatory jurisdiction.

12. Section 5 of S. 3412 uses the term "reasonable nondiscriminatory access." S. 3297, on the other hand, provides that, subject to certain conditions, “clearing agencies" must be available for use by every broker-dealer making use of interstate commerce, by other clearing agencies, and by such other classes of persons as the Commission may from time to time designate. Is the term "reasonable non-discriminatory access" intended to have the same meaning as these provisions of S. 3297, or does it have a different meaning?

Answer. The concept of "reasonable non-discriminatory access" as used in S. 3412 confers upon the Commission somewhat more flexibility in defining proper access than would the comparable provisions in S. 3297. For instance, it is not clear at this time whether access should be conditioned upon a "specified geographical basis" as S. 3297 would appear to suggest.

Senator WILLIAMS. Thomas Phelan, president of the Pacific Coast Stock Exchange, has been listed as our next witness.

We appreciate your being here again with us, Mr. Phelan. We are making you a regular cross-country traveler, aren't we?

STATEMENT OF THOMAS P. PHELAN, PRESIDENT, PACIFIC COAST STOCK EXCHANGE; ACCOMPANIED BY C. J. DELAHUNTY, PRESIDENT, PACIFIC COAST STOCK EXCHANGE CLEARING CORP.

Mr. Phelan. That is right.

Senator WILLIAMS. You were in Washington anyway at this time? Mr. PHELAN. Well, I asked to appear today because it fit my schedule of being back here this week. Thank you very much.

My name is Thomas Phelan, president of the Pacific Coast Stock Exchange.

With me is Christopher Delahuntv, president of the exchange's wholly owned subsidiary, the Pacific Coast Stock Exchange Clearing Corp.

We sincerely appreciate the opportunity to present to you today the views of the Pacific Coast Stock Exchange on three very important bills affecting securities clearance and settlement.

I believe that the views of the Pacific Coast Stock Exchange should be of particular interest to your subcommittee, because we operate the Nation's most modern and innovative system for the clearance and settlement of securities transactions. The net-by-net clearing system, which has been in operation on our exchange for 12 years, eliminates physical receipt and delivery for 80 percent of all transactions entered for comparison in our clearing corporation.

Our securities depository, which has now been in operation about 6 months, is a natural outgrowth of the net-by-net clearing system. The depository, currently holding securities valued at approximately $450 million, further reduces the need for physical receipt and delivery of securities. Though our depository is smaller than New York's CCS, it incorporates design features absent in CCS which we believe provide useful regulatory safeguards. In the Pacific depository, customer fully paid securities are segregated, both physically and in an accounting sense, from other securities. Securities pledged by brokers to several major banks are held by the depository as pledgeholder, with separate subvaults being maintained for each participating bank. The depository also maintains a segregated account for broker's loanable securities. The close integration of the depository with the Pacific Coast Stock Exchange Clearing Corp. allows the clearing corporation to borrow from brokers securities held in this loanable account, paying the brokers the value of the security, and using the security to satisfy the needs of its members to obtain delivery of the security.

Though our clearing corporation and depository have already resulted in substantial reductions in processing costs for participating brokers, we expect to improve our system and expand its coverage in becoming a unit of the national system of regional depositories. The seven-man National Coordinating Group for Comprehensive Securities Depositories, of which I am a member representing the securities industry on the Pacific coast, has made significant progress toward including within the depository, securities held by banks and other institutions, and by bringing banks and other institutions into the clearing corporation as participants.

Toward this end, we have been cooperating actively with major west coast banks in planning the inclusion of the bank fiduciary securities in the depository. A working committee composed of representatives of five major west coast banks and the Pacific Coast Stock Exchange met during January and February of this year to plan for increased bank participation in the depository. In March, the members of this committee made their recommendations to the Policy Committee composed of senior executive officers from each of the five banks and myself.

The report called for certain changes in State law to permit fiduciary securities to be kept in the depository. The report suggested that similar to the New York approach, the depository be spun off from the Pacific Coast Stock Exchange Clearing Corp., and operated by a corporation in which the Pacific Coast Stock Exchange, participating broker-dealers, and participating financial institutions would share in ownership.

The Policy Committee approved the report, and the participating banks joined the Pacific Coast Stock Exchange in signing a memoran