THE ADMINISTRATOR OF NATIONAL BANKS, Senator HARRISON A. WILLIAMS, Jr., U.S. Senate, Washington, D.C. DEAR SENATOR WILLIAMS: Reference is made to your letter of April 12, 1972, requesting the views of this office on S. 2551, S. 3297 and S. 3412, currently before your subcommittee. S. 3412 and S. 3297 are designed to effect somewhat similar reforms in the present system of securities transfers. S. 3297 would require the registration of securities-clearing agencies subject to the supervision of the Securities Exchange Commission. S. 3412, sponsored by the SEC, is somewhat more far-reaching in that it would set up a system of registration of both clearing agencies and transfer agents. Further, S. 3412 would require the SEC, after consultation with the appropriate regulatory agencies, to establish minimum standards for the performance of transfer functions, measures, and personnel standards for safe handling and custody of securities and funds, and operational compatability of the transfer agent with other persons in the securities handling process. The bill provides for the administration of these standards, and the requirements which it would establish pertaining to registration, by the Federal bank regulatory agencies as to transfer agents which are banks, and by the SEC as to other transfer agents and as to all clearing agencies. The formal registration which S. 3412 would require of bank transfer agents with the appropriate federal bank supervisory agency would be largely superfluous, because it would not be necessary or even complementary to the existing system of on-the-spot supervision of these activities. If it is deemed essential, however, that the bill treat all transfer agents evenhandedly, regardless of their basic supervisory structure, we do not object. While this office had been of the opinion that standards for transfer agents should be established jointly by the appropriate supervisory agencies, we have concluded, because of the strongly held conviction of the SEC that such a system would be unworkable, not to suggest an amendment of the bill in this regard. For the same reason, this office has not suggested that the supervision of clearing agencies which are trust companies be conferred upon the appropriate federal banking agency. Further, we understand that the SEC has no wish to engage in such supervision of banks as this bill would confer any longer than as is necessary to meet the current stock transfer problems on an interim basis until a more comprehensive solution can be achieved. Accordingly, this office will not object to S. 3412 and believes it to be preferable to S. 3297 because of its more comprehensive scope. We believe that S. 2551 embodies an imaginative approach to resolve in a reasonable manner the problems stemming from the basic inability to reconcile current means of evidencing ownership of securities with modern-day requirements and capabilities. A permanent solution to this problem must be devised and initiated in the near future, we believe. It would appear to us that such a solution must involve the elimination of the certificate of ownership. Thus, we approve of the end sought by S. 2551, to establish a certificateless means of securities ownership. We feel that such an endeavor should be subject to the guidance of the SEC, as the bill would require. Further, we are of the opinion that the solution of the numerous questions which would be involved with regard to the modifications of the existing relationships and functions of the many parties, which presently are intimately involved in the securities ownership and transfer process, should be subject to the advice and direction of a group reflecting the viewpoint of these parties, such as the bill would establish in the National Commission on Securities Laws. Within the framework of the foregoing general propositions, we are uncertain at present as to whether the mechanism which S. 2551 would establish is the best possible means to resolve the problem, and suggest that the Committee give extensive study to this question; specifically, we believe that before another quasigovernmental corporation is established, the need for such an additional entity, rather than utilization of existing agencies, should be clearly established. Care ful evaluation should be made of the potentialities of utilization of the SEC, or a combination of existing agencies, to perform the functions which the bill would place in the proposed National Securities Corporation. Sincerely, WILLIAM B. CAMP, Comptroller of the Currency. STATEMENT OF BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM The Board welcomes this opportunity to present its views on S. 2551 (National Securities Corporation Act), S. 3297 (The Securities Industry Paperwork Modernization Act), and S. 3412 (Securities Transaction Processing Act of 1972). All of these bills seek to prevent a recurrence of the recent operational crisis experienced by the securities industry, and to provide a regulatory basis for developing an efficient national system for clearing and settling securities transactions. To accomplish these objectives, S. 2551 would establish a new federallychartered National Securities Corporation and a Commission on Uniform Securities Laws. The Board believes that the objectives of all three bills can best be served by broadening the authority of the Securities and Exchange Commission as S. 3297 and S. 3412 would do, rather than by creating a new federally-chartered corporation. S. 3297 would clarify and supplement the statutory authority of the Securities and Exchange Commission to regulate clearing and settlement of securities transactions; would give the Commission the power to supervise the evolution of a national network for clearance and settlement of securities transactions; and would direct the Commission to take steps to eliminate the negotiable stock certificate as a means of settlement of securities transactions among broker-dealers and certain other financial institutions by December 31, 1976. Sections 1 and 2 of S. 3297 would authorize the Commission to regulate the time and method of making settlements, payments, and deliveries and of closing accounts. This authority might appear to overlap or supersede the Board's authority to regulate securities credit under section 7 of that Act. We believe it desirable to make clear that the authority of the Commission and the Board do not conflict in this area. This might be done by adding a proviso about as follows: ". . . Provided, That nothing herein shall be understood as affecting the authority of the Board of Governors of the Federal Reserve System, pursuant to section 7 of the Securities Exchange Act of 1934, to prescribe rules and regulations with respect to the extension, maintenance, or arranging of credit to purchase or carry any security, or as authorizing the Commission to prescribe such rules or regulations." Section 3 of S. 3297 would define "clearing agency" in a way that would include a depository. Inasmuch as the functions of a "clearing agency" and a "depository" are separate and distinct, it would seem more desirable to define these entities separately as does S. 3412. We believe it also desirable to make clear, as S. 3412 does, that the definition of "clearing agency" is not intended to cover Federal Reserve Banks, Federal Home Loan Banks, or any other Federal instrumentalities, nor to cover privately-owned banks or other financial institutions merely because they perform lending, fiduciary, correspondent, or safekeeping functions. Section 4 of S. 3297 would empower a clearing agency to determine the qualifications of an officer, director, employee, or agent of a participant. If a bank becomes a participant by reason of securities transactions involving its trust department, this section might appear to empower a clearing agency to determine the qualifications of all of the officers, directors, employees, or agents of the bank. It is assumed that this result is not intended and could be avoided by restricting this authority to officers, directors, employees, or agents who deal directly with a clearing agent. Section 4 of S. 3297 would also require the Securities and Exchange Commission on or before December 31, 1976, to take steps to bring about the elimination of the negotiable stock certificate as a means of settlement among broker-dealers of transactions consummated on national securities exchanges. It is understood that this provision will not, however, deprive an individual investor of his right to demand and hold a negotiable stock certificate as proof of title. The Commission would also be directed to make recommendations to the Congress for further legislation to eliminate the negotiable stock certificate. The Board is in accord with the objectives of this provision and, based on the Federal Reserve's experience in the automation of the government securities market (see attached memorandum from Richard A. Debs, Vice President, Federal Reserve Bank of New York), believes that it will be a constructive step. In the establishment of a "certificateless" society, one of the first problems that must be faced, of course, is to create a sound legal framework. In this connection, the Congress may wish to consider the establishment of a Commission on Uniform Securities Laws, along the lines proposed by S. 2551, which would either report directly to the Congress or act as an advisory committee to the Securities and Exchange Commission. S. 3412 is somewhat similar in approach to S. 3297. For example, both bills require clearing agencies and depositories to register with the Securities and Exchange Commission. However, S. 3412 would extend the Commission's regulatory authority to cover transfer agents and registrars, and would empower the Commission to make rules concerning the form of certificates issued by publicly held corporations. In view of the importance that transfer agents and registrars play in the operation of the securities market, the Board favors inclusion of this additional authority. S. 3412 would grant authority to the Commission to adopt regulations regarding the performance of functions by transfer agents. Responsibility for enforcing compliance with these regulations would be assigned to the three federal bank supervisory ageicies as to transfer agents that are banks. The Board strongly supports these administrative arrangements, which follow precedents established by Congress in previous legislation. All nonbank transfer agents would be supervised by the Securities and Exchange Commission as would all clearing agencies and depositories. With respect to depositories that are subject to supervision by a federal bank supervisory agency, the Subcommittee may wish to consider adopting the administrative arrangements which the bill applies to transfer agents that are banks. Section 12 of S. 3412 provides that as regards transfer agents, the portion of a registration statement containing information regarding its rules and procedures shall be available for public inspection, but that all other information filed with the regulatory agency may be exempt from the disclosure requirements of title 5, section 552 of the United States Code. Since the identity of the issuers and issues of securities for which a transfer agent is acting is generally public knowledge, an appropriate modification of this section to provide for public availability of this information (which would be contained in a registration statement) is suggested. In conclusion, the Board welcomes the efforts of your Subcommittee to provide a regulatory basis for the development of an efficient national system for the clearance and settlement of securities transactions. We hope that legislation along the general lines of S. 3297 or S. 3412, with the modifications we have suggested, will be enacted. THE PROGRAM FOR THE AUTOMATION OF THE GOVERNMENT SECURITIES MARKET (By Richard A. Debs, Vice President Federal Reserve Bank of New York) This memorandum outlines the development and current status of the Federal Reserve-Treasury program for the automation of the Government securities market, including the book-entry procedure for Government securities. OBJECTIVES AND SCOPE The ultimate objective of the program is a fully automated Government securities market, in which the pieces of paper representing Government obligationsincluding both Treasury and Federal Agency obligations-have been eliminated and replaced by computerized book-entries, and in which transactions in such book-entry securities are effected by means of wire messages-including computer-to-computer communications-through high-speed lines directly linking computer terminals on the premises of each major market participant throughout the country. In general, the program was designed to improve the efficiency of operations in Government securities. It is intended to reduce the time, money, personnel, and space required to handle the increasing volume and velocity of transactions in Government securities, and at the same time, to ensure adequate controls and reduce to a minimum the risk of loss or theft of such securities. The benefits of the program will be available to all owners of Government securities-whether they be primary dealers or private individuals-through the member banks, which will be qualified to open book-entry accounts at their Federal Reserve Banks and to deposit any or all of their customers' securities in such accounts. Thus, all owners of Government securities may, if they so desire, arrange to have their securities converted into book-entry form by depositing them with a member bank, which in turn will deposit the securities in its book-entry account with its Reserve Bank. In this respect, the program provides a substitute for the physical custody of Government securities. In addition, and just as important, for those banks and bank customers which are active participants in the Government securities market-such as the primary bank dealers and the primary nonbank dealers, through their clearing banks-facilities will be available for effecting central market transactions in such securities through Federal Reserve wire systems. In this respect, the program provides a means for moving the book-entry securities throughout all segments of the Government securities market, with the speed and in the volume necessary to ensure the effective functioning of the market. Historically, the automation program has comprised two separate, but parallel, lines of development. The first was the development of facilities for transferring and clearing securities transactions among the major participants in the market, beginning with the New York money center banks and the establishment of the Government Securities Clearing Arrangement. The second was the development of the book-entry procedure itself, which began with the conversion into bookentry form of Treasury securities owned by country member banks and held in safekeeping at their Reserve Banks. More recently, there has been a third related development of significance for the System-the creation of the Reserve Bank checklist procedure, developed as a transitional measure to deal with the immediate problem of Government securities thefts, pending the longer-term solution offered by the automation program. WIRE FACILITIES AND CLEARING ARRANGEMENTS The basic concept of transferring Government securities by means of wire messages has existed for many years in the "CPD" wire facilities maintained by the Treasury and the Federal Reserve Banks, which permit wire transfers between most Federal Reserve offices. Under this system, the commercial bank sender of a security delivers it to the local Federal Reserve office, which then retires the security and sends an appropriate wire message to another Federal Reserve office, which in turn issues a new security, which is then picked up by the ultimate recipient of the transfer message. The clearing arrangement carries this basic concept further in three important respects: (1) instead of requiring the delivery and pickup of a physical security for each transfer, the transfers are debited or credited to a bank's "securities clearing account"-with appropriate cash entries to its reserve account-and only one delivery of securities is necessary at the end of the day, and only in the net amount due to or due from the bank; (2) the major commercial banks having a large volume of such transactions are linked by wire directly with their Reserve Bank, permitting them to transmit transfer messages from terminals on their premises; and (3) as the final step in a money-market center, the major commercial banks are linked with each other, through a Reserve Bank computer switch, permitting them-and their customers, including the nonbank primary dealers to effect transactions among themselves, thereby providing each of them access to the other major participants in the Government securities market through their own terminals. The first experiments with clearing procedures were initiated in New York City in 1965, and resulted in the establishment of the Government Securities Clearing Arrangement, which now includes 12 participating member banks. Over the years and particularly since the installation of the System's Culpeper switch and the Sigma 5 computer switch at the New York Reserve Bank-the arrangement has been expanded to the point where it now handles virtually all types of transactions in the Government securities market, in any volume that may be required. As an example, during 1971, a year of transition to the use of the new computer equipment, there were about 470,000 transactions effected through the Clearing Arrangement, totaling $710 billion. Last month alone, there were more than 50,000 transactions, totaling $99 billion. Studies are now in progress for developing clearing procedures at other Reserve Banks. The San Francisco Reserve Bank has been operating a net settlement procedure for CPD transfers with the Bank of America, and the Chicago Reserve Bank has been exploring the possibility of a similar procedure with its larger member banks. Other Reserve Banks have been considering the possible use of such procedures at some future date, as increasing volume may warrant it. The importance of such procedures lies not only in their immediate benefits, but even more important, in the potential for integrating a clearing arrangement with the basic book-entry procedure. BOOK-ENTRY PROCEDURE In essence, the book-entry procedure is a new legal system, created by Federal regulations having the force of Federal law (e.g., Subpart O of Treasury Circular No. 300), under which the piece of paper representing a Government obligation may be eliminated, and the obligation recorded on the books of a Federal Reserve Bank. The first phase in the development of the procedure began in 1968, when it was established as a substitute for the physical custody of Treasury securities in the safekeeping accounts maintained by the Reserve Banks for country member banks. Although the procedure was made available to all member banks at that time, until recently most of the largest money-center banks did not utilize the procedure, primarily because of burdensome tax reporting requirements. Since 1968, there has been a gradual extension of the procedure to additional types of securities accounts. The process has been gradual because the conversion of each class of security account has presented new and different legal problems, tax questions, and operational complications. These are reflections of the fact that for centuries the law, commercial practices, and traditions governing transactions in securities have been based on the possession of a piece of paper having intrinsic value. Under the book-entry procedure, that piece of paper no longer exists. By the end of 1970, most of the different types of safekeeping accounts maintained at the Reserve Banks had been converted to book-entry form. The next phase of the program contemplated an extension to Government securities held outside the Reserve Banks, including in particular the securities of the primary dealers both bank dealers, which involved certain tax questions, and nonbank dealers, which involved in addition the question of their legal status as customers of clearing banks. Beyond that phase, the program aimed at covering all securities held by member banks for any third party. The overall plan for the conversion of these types of securities accounts envisaged a program of several years' duration. However, the timetable was greatly accelerated by the "insurance crisis" in the Government securities market early last year, which resulted from the abrupt emergency of the problem of securities thefts. SECURITIES THEFTS AND CHECK LIST PROCEDURE The problem of securities thefts is in large part rooted in the difficulties of the financial community in coping with the vast amounts of paper required by traditional methods of operation. During the past year, the matter has been the subject of close study by Congressional committees, the Securities and Exchange Commission, and the financial community itself. The studies continue, and will no doubt result in basic changes in existing procedures in the banking system and in the securities markets, some of which will come about as a result of Federal legislation. The Federal Reserve has an interest in many aspects of this problem and its proposed solutions, but for present purposes it should suffice to note only those relating directly to the Government securities market. The problem of securities thefts first came to public attention in connection with Government securities. Within a matter of weeks at the end of 1969, $17 million in Government securities were reported stolen from three New York banks. By the end of that year, a national total of approximately $30 million in losses had been reported to the Treasury, and the losses continued at the same high level in 1970. In view of the magnitude of the problem, it was clear that the Federal Reserve System had a direct interest in the matter. Apart from the responsibilities of the Reserve Banks as fiscal agents of the United States, the System had an immediate concern in the problem as it affected the banking system, and also as it affected the performance of the Government securities market. It was also clear that while the book-entry program offered a long-term solution as a means of preventing thefts, there was an immediate need to assist in recovering securities already stolen. |