[Federal Register Volume 59, Number 33 (Thursday, February 17, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: X94-10217]
[[Page Unknown]]
[Federal Register: February 17, 1994]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 240 and 249
[Release No. 34-33608; International Series Release No. 635; File No.
S7-24-91]
RIN 3235-AE42
Large Trader Reporting System
AGENCY: Securities and Exchange Commission.
ACTION: Reproposed rulemaking.
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SUMMARY: The Commission is reproposing Rule 13h-1 and Form 13H under
Section 13(h) of the Securities Exchange Act of 1934 (``Exchange
Act''). Rule 13h-1 was initially proposed by the Commission in Exchange
Act Release No. 29593 (August 22, 1991), 56 FR 42550 (August 28, 1991).
Reproposed Rule 13h-1 would establish an activity-based identification,
recordkeeping, and reporting system for large trader accounts and
transactions. Reproposed Rule 13h-1 also would establish a definition
for large traders and require such large traders to file Form 13H with
the Commission. Registered broker-dealers would be required to maintain
transaction records for each large trader account and report
transactions upon the request of the Commission or a self-regulatory
organization (``SRO'') designated by the Commission. Reproposed Rule
13h-1 would fulfill the goals of the Market Reform Act of 1990
(``Market Reform Act'') by providing the Commission with the
information necessary to reconstruct trading activity in periods of
market stress and for enforcement or other regulatory purposes, without
imposing undue burdens or costs on market participants.
DATES: Comments must be received on or before April 18, 1994.
ADDRESSES: Persons wishing to submit written comments should file three
copies with Jonathan G. Katz, Secretary, Securities and Exchange
Commission, 450 Fifth Street, NW., Washington, DC 20549. All comment
letters should refer to File No. S7-24-91. All comments received will
be available for public inspection and copying in the Commission's
Public Reference Room, 450 Fifth Street, NW, Washington, DC 20549.
FOR FURTHER INFORMATION CONTACT: Julio A. Mojica, Assistant Director,
(202) 272-7497, Nicholas T. Chapekis, Special Counsel, (202) 272-3115,
or Cameron D. Smith, Staff Attorney, (202) 272-5418, Division of Market
Regulation, 450 Fifth Street, NW., Washington, DC 20549.
SUPPLEMENTARY INFORMATION:
I. Introduction
The Commission is reproposing Rule 13h-1 to implement the large
trader reporting provisions of the Market Reform Act1 and section
13(h) of the Exchange Act.2 The Large Trader Reporting System that
would be established by reproposed Rule 13h-1 was initially proposed in
Securities Exchange Act Release No. 29593 (August 22, 1991), 56 FR
42550 (August 28, 1991) (``Proposing Release'').
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\1\Public Law 101-432, 104 Stat. 963 (1990).
\2\15 U.S.C. 78m(h) (1990).
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The Proposing Release chronicled the fundamental changes in
participants, information systems, and investment techniques that have
shaped the securities markets during the last decade.3 As a result
of these changes, today's securities markets are global in nature and
characterized by large foreign and domestic investors that rapidly
trade large quantities of securities, for themselves and others,
throughout the world. During this period of change, the securities
markets have experienced an increase in activity and the potential for
volatility.
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\3\See Proposing Release, 56 FR 42550.
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The legislative history accompanying the Market Reform Act noted
the Commission's limited ability to analyze the causes of the
significant market declines of October 1987 and 1989.4 The
Commission's inability to analyze trading activity was attributed to
its lack of specific statutory authority to gather broad-based samples
of investor trading information. To resolve this problem, Congress
provided the Commission with specific authority to establish a large
trader reporting system.
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\4\See generally Senate Comm. on Banking, Housing, and Urban
Affairs, Report to accompany the Market Reform Act of 1990, S. Rep.
No. 300, 101st Cong. 2d Sess. (May 22, 1990) (reporting S. 648)
(``Senate Report'') and House Comm. on Energy and Commerce, Report
to accompany the Securities Market Reform Act of 1990, H.R. Rep. No.
524, 101st Cong. 2d Sess. (June 5, 1990) (reporting H.R. 3657)
(``House Report'').
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In the Proposing Release, the Commission proposed rules that
defined the term large trader, required the disclosure of a large
trader's identity and accounts to the Commission or others, and
provided for the assignment of unique identifying numbers to large
traders. The proposed rule also required broker-dealers that carry
large trader accounts to maintain records of identified large trader
transactions as well as transactions of those persons who have not
identified themselves, but whom the broker-dealer knew or had reason to
know were large traders. In addition, the proposed rule required
broker-dealers to report large trader transactions in machine-readable
form through the industry's existing electronic bluesheet system to the
Commission upon request.
The Commission solicited comments on various aspects of the
proposed rule, including the definition of a large trader, the
identifying and reporting activity thresholds, exemptions, Form 13H
filing requirements, execution time recordkeeping and reporting, and
the proposed rule's application to foreign entities. The Commission was
particularly sensitive to the burdens imposed by the proposed system
and sought alternatives that would reduce such burdens and still
accomplish the objectives of the Market Reform Act.
The Commission received 77 written comments on the proposed
rule.5 In addition, members of the Division of Market Regulation
met on numerous occasions with the Securities Industry Association
(``SIA''), the American Bankers Association, the Intermarket
Surveillance Group (``ISG''), the Securities Industry Automation
Corporation (``SIAC''), and two broker-dealers, to answer questions and
discuss issues related to the operation of the proposed system and its
impact on market participants.6
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\5\The comment letters and the Division of Market Regulation's
summary thereof have been placed in the Commission's public files.
See SEC File No. S7-24-91.
\6\Memoranda summarizing the Division of Market Regulation's
meetings with these entities have been placed in the Commission's
public files. See SEC File No. S7-24-91.
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While generally supportive of the goals of the Market Reform
Act,7 the commenters expressed concern that the proposed rule
would be unduly burdensome and costly. The commenters generally sought
clarification of ``who'' would be a large trader, ``what'' information
must be disclosed on Form 13H, and ``when'' Form 13H or trade report
information must be submitted. These concerns were manifested in
specific questions and comments regarding the rules for aggregation,
the definitions of ownership and control, the scope of Form 13H
information, and time frames for filing Form 13H. The commenters also
addressed the identifying activity level, exemptions, and the duty to
supervise compliance with the proposed rule. Finally, the broker-dealer
community raised several concerns regarding the technical aspects of
the reporting requirements for execution times, multiple large trader
identification numbers (``LTID''), and the time frame for submitting
trade reports.
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\7\Comments were received from seven types of market
participants and regulatory organizations, which may be grouped as
follows: 12 broker-dealers; 24 investment advisers; 13 industry or
professional associations; 8 banks or trust companies; 6 regulatory
organizations; 4 law firms; and 9 other affected market
participants.
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The reproposed rule has been revised to incorporate many of the
suggestions made in the comment letters. These provisions are intended
to clarify the operation of the reproposed system and reduce the costs
associated with all aspects of the reproposed rule. The changes found
in the reproposed rule would: (1) Clarify the definition of a large
trader and provide a flexible concept of aggregation; (2) increase the
identifying and reporting activity levels; (3) reduce the scope of
information captured on Form 13H; (4) streamline Form 13H filing and
updating requirements that include an inactive filing status; (5)
provide more informative and detailed instructions to Form 13H; (6)
reduce the recordkeeping and reporting requirements for LTIDs; (7)
provide special reporting requirements for execution times; and (8)
provide a safe harbor for the duty to supervise.
The reproposed rule also addresses today's complex global trading
environment and attempts to maintain a level playing field between
broker-dealers and banks, both domestic and foreign. The Commission has
endeavored to maintain an equal competitive environment between these
entities by imposing requirements on custodians or nominees of omnibus
accounts. These duties include: (1) Form 13H filings; (2) confidential
and limited disclosures to the Commission or others; and (3) limited
duties to disaggregate and assure compliance with omnibus account
identification requirements.
Essentially, the reproposed large trader reporting system would
require that a person that falls within the definition of a large
trader would file Form 13H with the Commission. Upon receipt of Form
13H, the Commission would assign an LTID to the large trader. After
receiving a LTID, large traders would contact their broker-dealers and
inform them of their number and all accounts to which it applies.
Thereafter, the large trader only would be required to file an updated
Form 13H annually. The broker-dealers carrying the large trader's
accounts would maintain records of the trades for the account. These
broker-dealers would electronically report transactions upon receiving
a request from the Commission. Broker-dealers also would be required to
supervise compliance with the reproposed rule by their customers.
Fundamentally, the burdens that would be imposed on large traders
by the reproposed rule would include: (1) Filing Form 13H (See Sections
III.B.1. and 2.); (2) disclosing it's LTIDs to broker-dealers (See
Section III.B.3.); (3) updating Form 13H annually (See Section
III.B.1.); and (4) providing additional information when the Commission
requests (See Section III.B.5.). The burdens imposed on broker-dealers
would include: (1) Maintaining records of transactions effected for
large trader accounts (See Section III.C.); (2) electronically
reporting large trader transaction information when the Commission
requests (See Section III.D.); and (3) supervising their customers'
compliance with the reproposed rule (See Section III.E.).
The specific changes to the proposed rule and several examples of
how they would affect the reproposed system are discussed below. The
Commission believes that the reproposed rule accomplishes the
objectives of the Market Reform Act by creating an effective market
reconstruction tool, minimizing burdens and costs, and maintaining a
fair competitive environment among markets and market participants.
II. Solicitation of Comments
The Commission believes that the modifications and additions found
in the reproposed rule would significantly reduce the burdens and costs
of the proposed system without impeding its effectiveness and,
therefore, would accomplish the objectives of the Market Reform Act. As
discussed below, the Commission staff has engaged in extended
discussions with market participants and securities information
processors, and many alternatives have been identified. The Commission
has incorporated in the reproposed rule those alternatives that it
believes would accomplish the objectives of the Market Reform Act.
Because the changes to the proposed rule are significant, the
Commission seeks comments on any aspect of the reproposed rule and,
specifically, comments that relate to the: (1) The identifying activity
level; (2) other means to assure that natural persons who were not
intended to be large traders are not affected by the reproposed rule;
(3) the use of the Depository Trust Company's (``DTC'') Institutional
Delivery System (``ID System''); (4) the rules for aggregation of
accounts; (5) Form 13H and Schedules; (6) the supervisory safe harbor;
and (7) the plan for implementing the transaction reporting system.
Finally, the Commission invites comments as to whether there are more
cost-effective alternatives to the reproposed rule or system that would
provide similar benefits, including particular alternatives that adopt
a different structure. The Commission also continues to solicit
specific comments that explore the relative costs and benefits of the
reproposed system generally, or any other alternatives. Furthermore,
because of the time that has elapsed, comments that identify any new
information technologies that accomplish the objectives of the Market
Reform Act and minimize costs to a greater extent would be appreciated.
With respect to the reproposed identifying activity level, the
Commission solicits comments on the appropriateness of the new
thresholds. The new identifying activity level, combined with certain
exemptions from the definition of a transaction and the new inactive
status, were designed to minimize the impact of the reproposed rule on
natural persons that infrequently trade in a magnitude that may warrant
imposing the added regulatory burdens of the reproposed system. The
Commission would welcome comments regarding any other means for
eliminating the impact of the reproposed rule on these types of
persons. In particular, the Commission solicits comments on whether a
separate identifying activity level for natural persons or an exemption
for natural persons that effect less 1,000,000 shares or fair market
value of $25 million in a calendar day, would be a more appropriate
means for minimizing the impact of the Rule.
The ID System is an electronic communications and book-entry
settlement system through which most large institutional investors,
their brokers or advisers, or their custodians or nominees confirm and
settle trades.8 As discussed below, the ID System has been
incorporated into the reproposed rule to reduce its burdens in three
respects. Under the reproposed rule, the use of numbers assigned by DTC
to ID System participants would: (1) Be incorporated into the Schedules
to Form 13H by permitting their use in lieu of LTIDs; (2) minimize the
amount of communication among members of an investment complex that
would be necessary to complete Form 13H and fulfill the LTID disclosure
requirements; and (3) establish a limit on the number of identification
numbers that would be required to be maintained for each account, and
reported for each transaction, by broker-dealers.
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\8\See DTC Participant Operating Procedures, Section M, ID
System Procedures (April 1983). DTC also has established a similar
system for international institutional activity called the
International Institutional Delivery System (``IID System''). See
Securities Exchange Act Release No. 27545 (December 18, 1989) 54 FR
53017 (December 26, 1989). The IID System varies from the ID System
in that it does not provide a mechanism for automated book-entry
settlement. DTC has proposed enhancements to the ID System that
would unify existing ID and IID Systems into an ``Interactive ID
System.'' See Securities Exchange Act Release No. 33010 (October 4,
1993), 58 FR 53007 (October 13, 1993); and DTC An Interactive Option
for the Institutional Delivery System, Memorandum to Participants
and Other ID Users (March 31, 1993).
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The Commission specifically solicits comments on the
appropriateness and feasibility of these proposed uses of the ID
System. The Commission would welcome comments that identify other ID
System information or procedures that would reduce the burden of the
reproposed rule without diminishing its effectiveness for accomplishing
the objectives of the Market Reform Act.
With respect to the reproposed rules for aggregation of accounts
and Form 13H, the Commission solicits comments on additional
simplification or means for reducing the burden of determining who is a
large trader and completing Form 13H. The Commission also solicits
comments on the appropriateness of the supervisory safe harbor.
Finally, the Commission solicits comments on whether a proposed plan
for implementing the transaction reporting requirements would be
feasible.
III. Discussion of the Reproposed Rule
A. Application and Scope
The fundamental scope and application of the reproposed rule is
established by the definition of a large trader. The definition of a
large trader and its separately defined terms were found in paragraph
(f) of the proposed rule. These definitions have been reorganized into
paragraph (a) of the reproposed rule in order to clarify the
fundamental application and scope of the reproposed rule. As mentioned
above, many of the comments raised concerns that generally may be
described as a question of ``who is a large trader.'' The terms of the
reproposed rule essentially would provide that every person who effects
aggregate transactions reaching the identifying activity level, through
accounts carried by a registered broker-dealer, which are aggregated
based on ownership or control, would be a large trader.
1. Definition of a Large Trader
The term large trader, as defined in paragraph (a)(1) of the
reproposed rule, would mean every person who, for an account that he
owns or controls, effects transactions for the purchase or sale of any
publicly traded security or securities by use of any means or
instrumentality of interstate commerce or of the mails, or of any
facility of a national securities exchange, directly or indirectly by
or through a registered broker or dealer in an aggregate amount equal
to or in excess of the identifying activity level. The reproposed
definition of a large trader closely tracks the definition provided in
Section 13(h)(8)(A) of the Exchange Act.9
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\9\ See 15 U.S.C. 78m(h)(8)(A) (1990).
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The reproposed rule varies from the proposed rule and statutory
definition only to the extent that the phrase ``* * * for an account
that he owns or controls * * *'' has replaced the phrase ``* * * for
his own account or an account for which he exercises investment
discretion * * *''10 The Commission believes that this
modification does not change the proposed definition of a large trader,
but merely clarifies the interrelationship between the definition of a
large trader and its separately defined terms.
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\1\0 See Proposing Release, 56 FR 42561 (proposed text).
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The definition of a large trader remains dependent upon the
definitions of a person, account, ownership, control, publicly traded
security, transaction, the identifying activity level, and the rules
for aggregation. The Commission believes that the modifications to the
proposed definitions of these terms address the questions raised by the
commenters, clarify the proposed rule, and narrow the proposed
definition of a large trader.
a. Definition of a person. The definition of a person found in
paragraph (a)(2) of the reproposed rule varies only slightly from the
proposed definition.11 The lone modification to this definition
would be the deletion of the term ``trust'' and the addition of the
phrase ``persons, entities, partnerships, or other groups acting as a
trustee.'' The addition of this phrase addresses a legal issue raised
by a private pension trust, which asserted that a trust may not be
deemed a person because it does not have a present ability to act
(e.g., effect transactions) separate from its trustee. The Market
Reform Act intended that trusts of all types be included in the
definition of a large trader.12 The definition of a person
contained in paragraph (a)(2) of the reproposed rule would assure that
all trusts, through their trustees, are included within the definition
of a person and thus may be large traders.
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\1\1Id.
\1\2See Proposing Release, 56 FR 42552, at n. 26 and
accompanying text.
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b. Definition of an account. Paragraph (a)(3) of the reproposed
rule would add a definition for the term ``account or accounts.'' This
term was not defined in the proposed rule and the comments received
from banks, investment advisers, and other non-broker-dealer market
participants exhibited substantial confusion in this respect. The
Commission believes that this confusion led the commenters to
incorrectly interpret ``who'' the Commission intended to be included
within the definition of a large trader. These commenters appear to
have believed, incorrectly, that the accounts of ``small'' trust or
advisory customers would become large traders, with all of the duties
attendant thereto, by virtue of the fact that a large trader exercised
control over such accounts.
The Commission, therefore, is proposing new paragraph (a)(3) that
would define the term account or accounts to mean each proprietary and
customer account maintained or carried by a registered broker or
dealer, which is disclosed or undisclosed to such broker or dealer as
to ownership, and for which books and records are required to be kept
in accordance with the provisions of Rule 17a-3 under the Exchange Act.
This definition would clarify that only accounts maintained or carried
by broker-dealers under the Exchange Act would be subject to the
reproposed rule.
c. Definition of ownership. The definition of ownership would be
narrowed and reorganized in paragraph (a)(4) of the reproposed rule.
The apparent breadth of this definition received extensive comments,
especially with respect to its impact on the proposed rules for
aggregation and the information required to be provided on Form
13H.13 The Commission also received many comments on the proposed
inclusion of custodians or nominees within the definition of ownership.
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\1\3 See infra Sections III.A.2. and III.B.2., for a discussion
of the reproposed rules pertaining to aggregation and Form 13H,
respectively.
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The Commission believes that the commenters failed to understand
that the concept of ownership is focused on the ``accounts of a
person.'' The Commission, however, acknowledges that the proposed
definition of ownership, combined with the rules for aggregation, may
support some of the sweeping interpretations of the proposed definition
of a large trader expressed in the comments. These commenters broadly
interpreted the proposed definition of ownership and the rules for
aggregation to require: (1) The aggregation of individual accounts of
all employees, officers, directors, controlling shareholders, and
partners with their large trader corporation, trust, or partnership,
irrespective of such individual's role in the trading decisions of the
large trader entity; (2) the accounts of all parent, subsidiary, and
affiliated companies within a holding company structure to be
aggregated by and with each parent, subsidiary, or affiliate; and (3)
the accounts of wholly unrelated large trader entities to be aggregated
due to common directors, controlling shareholders, partners, or
trustees. In response to these comments, the Commission has revised the
proposed definition of ownership.
i. General definition. The definition of ownership, as reproposed
in paragraph (a)(4), would provide that an account of a person shall be
deemed to be owned or under common ownership of the person in whose
name an account is maintained, or custodian or nominee that maintains
an omnibus account, and any other person who has more than a 10 percent
financial interest in the equity in the account or accounts of such
person. This reproposed definition of ownership would incorporate
existing rules, procedures, and practices that require broker-dealers
to maintain the name and address of the beneficial owner of an account
and would be interpreted consistently with such rules, procedures, and
practices.14
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\1\4See Rule 17a-3(a)(9)(i) under the Exchange Act, 17 CFR
240.17a-3(a)(9)(i).
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The reproposed rule states that ``an account of a person'' would be
deemed to be owned or under common ownership, thus emphasizing that the
primary focus of the concept of ownership would be the ``accounts of a
person,'' and not ownership of the person itself. Accordingly, under
the reproposed rule, accounts maintained in the name of a parent,
subsidiary, or affiliate would be deemed to be owned by that parent,
subsidiary, or affiliate. This focus would be made evident in the
reproposed Schedules 6a and 6b to Form 13H.
The focus on accounts also would address those comments that deemed
the accounts of employees, officers, directors, controlling
shareholders, and partners to be owned by their respective corporation
or partnership, irrespective of such individual's role or lack thereof,
in the trading decisions of the large trader entity. The reproposed
rule would eliminate the sweeping nature of the proposed definition by
providing that an account is owned or under common ownership of the
entity.
ii. Custodians or nominees. As discussed in the Proposing Release,
institutional investors engage the services of different investment
advisers and executing broker-dealers, yet the trades effected by these
persons may be settled and the investment assets may be deposited
centrally with one custodian bank, trust company, or broker-dealer that
is sometimes referred to as a prime broker.\15\ The Commission
believes, based upon its experience with broad-based trade
reconstructions, that the increased size and specialization of market
participants has led to the increased use of these multi-layered
accounts. Typically, these accounts fragment or obscure the information
about large trader accounts and activity that the Commission needs to
analyze market trading.
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\15\See Proposing Release, 56 FR 42554, at nn. 47-49 and
accompanying text.
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Substantial comments were received with respect to the inclusion of
custodians or nominees within the definition of ownership. The
commenters all questioned the appropriateness of including passive
custodians or nominees. These commenters argued that passive custodians
or nominees, which merely act as a conduit for delivery/receipt versus
payment (``DVP/RVP'') settlement of transactions, should not be
included within the definition of a large trader. However, the comments
regarding custodians and nominees acknowledged that many custodians or
nominees act as a discretionary agent or fiduciary for the execution of
trades and thus may be large traders that control accounts owned by
other persons.
The inclusion of custodians and nominees also caused broker-
dealers, banks, and trust companies to question the capture of multiple
LTIDs for a single account or transaction. These commenters asserted
that the cost of keeping and reporting multiple LTIDs, for a single
account or trade, would be unduly burdensome.\16\ It also was suggested
that the capture of multiple LTIDs may cause duplication or distortion
of total reconstructed trade activity. Many of these commenters also
noted the possible applications of the ID System. Lastly, the
commenters confirmed that, in these multi-layered accounts, the
participants usually do not have knowledge of each other's activities
and, individually, none of the participants may know or have access to
all of the information that the Commission needs to analyze market
trading activity.
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\16\See infra Section III.C.2. and III.D.3., for discussions of
the reproposed LTID recordkeeping and reporting requirements,
respectively.
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The Commission believes that the inclusion of custodians and
nominees in the definition of ownership would serve three important
purposes. First, it would assure that banks and broker-dealers, both
foreign and domestic, are treated consistently under the reproposed
rule. Second, it would assure disclosure of the appropriate LTIDs for
each account. Finally, the inclusion of custodians and nominees would
enable the Commission to efficiently characterize trading activity.
The problem that the Commission has sought to address with respect
to custodians and nominees is its inability to obtain information about
the ultimate or actual beneficial owners and controllers of omnibus
accounts or accounts otherwise undisclosed as to ownership. Although
the number of these accounts may be small in relation to fully
disclosed accounts, the Commission believes that the nature of large
trader activity causes a significant percentage of this activity to be
effected through these accounts. Accordingly, the definition of
ownership in the reproposed rule would include only those custodians or
nominees that maintain omnibus accounts or accounts otherwise
undisclosed as to ownership.
These changes would work in conjunction with the other
modifications to the definition of ownership to assure that the fully
disclosed owner of an account, or the custodian or nominee of an
omnibus account, is deemed to be the owner of that account, not the
broker-dealer, bank, or trust company that acts only as an agent for
settlement of transactions effected through a fully disclosed account.
Moreover, reproposed Schedule 8 to Form 13H has been designed to
capture information about a custodian or nominee large trader and the
undisclosed large traders that effect trades in or through his omnibus
accounts, not small or otherwise infrequent traders whose trades may be
effected through such accounts. Reproposed Schedule 8 is designed in a
manner that the Commission believes would approximate existing ID
System practices and procedures for maintaining such information.\17\
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\17\Essentially, the ID System captures information regarding
the capacity of the participants to a multi-layered account.
Participants are grouped and numbered as agents, broker-dealers,
institutions, and interested parties. The term ``Agent'' is defined
as the entity appointed by the buyer and seller to clear their
trades. The term ``Broker-dealer'' means the entity that executes a
trade on behalf of the buyer or seller. The term ``Institution''
means those parties that initiate the trade as buyer or seller, on
its own behalf or on behalf of another. Finally, the term
``Interested Party'' is defined as those entities, other than the
Agent or Institution, which receive a confirmation because they have
a role to play in the settlement of a trade. It is important to note
that these capacities are not mutually exclusive and one participant
may perform the tasks associated with any number of these
capacities. See ID System Directory, Volume X, Number 9, September
1992.
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The Commission believes that the revisions to the reproposed
definition of ownership would significantly clarify the obligations of
persons that own and/or act as custodians or nominees for large trading
accounts. The Commission also believes that the reproposed definition
of ownership would minimize the burden of the identification
requirements on such large traders.
d. Definition of control. As with the definition of ownership, the
commenters uniformly criticized the sweeping impact of the proposed
definition of control when combined with the proposed rules for
aggregation. Some commenters questioned whether merely controlling the
accounts or trading of a large trader would, by itself, cause such
controller to be a large trader.
Many of the commenters also indicated that the persons or entities
that control trading activities usually have the most knowledge of
large trader accounts, activity, or objectives and, therefore, should
be the focus of the identification requirements. Finally, one commenter
questioned the appropriateness of the inclusion of limited
discretionary investment authority within the definition of control.
This commenter asserted that the definition of limited discretion would
force broker-dealers to aggregate the activity of all customers for
whom they executed not held orders.\18\
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\18\Not held orders relieve the executing broker of
responsibility with respect to the time and price of execution, if
the broker uses ``brokerage judgment'' when executing the order. See
e.g., New York Stock Exchange (``NYSE'') Rule 123A.44, NYSE Guide
(CCH) 2123A. Not held orders may be characterized as: (1) defensive
orders required by brokers in times of unusual market volatility
(i.e., fast markets); or (2) consideration provided by a customer to
a broker for the commitment of capital or expertise in the execution
of large ``block trades.'' See e.g., NYSE Rule 127.10, NYSE Guide
(CCH) 2127 (definition of block trade).
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The definition of control has been modified in paragraph (a)(5) of
the reproposed rule.\19\ These revisions would emphasize that the focus
of the reproposed concept of control is ``control of the accounts of a
person,'' not control of the person itself. The reproposed rule also
would provide that the owner of an account, as well as any person with
full or limited discretion over an account, is deemed to control that
account.
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\19\See Proposing Release, 56 FR 42561 (proposed text).
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The reproposed rule would clarify that a person's mere exercise of
control over a large trader's accounts or transactions, without
effecting the requisite level of transactions, would not cause such
person to be a large trader under the reproposed rule. Additionally,
new paragraphs (a)(5)(i) and (ii) of the reproposed rule would add the
definitions of full and limited discretionary investment authority
suggested in the Proposing Release.\20\ With respect to the execution
of not held orders, the Commission would interpret their execution to
not fall within the reproposed definition of control.
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\20\See Proposing Release, 56 FR 42553, at nn. 34 and 35.
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Finally, the reproposed rule would acknowledge that persons who
control accounts usually are in possession of most of the information
required by Form 13H and required to be disclosed to broker-dealers.
Accordingly, reproposed Schedules 7a and 7b to Form 13H and the
reproposed LTID disclosure requirements would be specifically designed
to capture and disclose information regarding fully disclosed or
omnibus accounts controlled by a large trader.
The Commission believes that these requirements take into account
the existing industry practices and procedures for the maintenance of
such information. The Commission also believes that the changes to the
proposed definition of control would clarify the obligations of large
traders who control accounts owned by others and would minimize their
burdens.
e. Definition of a transaction. The definition of a transaction or
transactions provided in paragraph (a)(7) of the reproposed rule, also
would clarify and narrow the scope of the definition of a large trader.
The modifications to this definition address technical issues raised in
the comments regarding the inclusion of cancellations, corrections, and
exercises or assignments of option contracts, within the meaning of the
term transaction or transactions.
The reproposed rule states that the term transaction or
transactions would mean all transactions in publicly traded securities,
including cancellations, corrections, exercises, and assignments.\21\
The definition of publicly traded securities found in reproposed
paragraph (a)(6) would be unchanged, and would mean any national market
system security as defined in Rule 11Aa2-1 under the Exchange Act.\22\
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\21\See infra text accompanying n. 67, for the impact of this
definition on the trade reporting requirements of the reproposed
rule.
\22\17 CFR 240.11Aa2-1. A national market system security is any
security that is subject to an effective real-time transaction
reporting plan filed with the Commission, and includes all
securities listed on a national securities exchange and all National
Association of Securities Dealers, Inc., Automated Quotation System
(``NASDAQ''), National Market System (``NMS'') securities. See
Proposing Release, 56 FR 42552, at text accompanying nn. 16-19.
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New paragraph (a)(7)(i) of the reproposed rule was added to exclude
from the term ``transaction'' certain activity commonly posted to
customer accounts by clearing broker-dealers and passive custodians or
nominees. This paragraph would exclude from the definition of a
transaction any journal or bookkeeping entry made to an account to
record or memorialize the receipt or delivery of funds or securities
pursuant to the settlement of a transaction.
Three new exclusions to the term transaction also have been added
in paragraphs (a)(7)(v), (vi), and (vii) of the reproposed rule. These
exclusions track the trading objectives or characteristics, identified
in the Proposing Release, of small or otherwise infrequent traders that
the Commission did not intend to be included in the definition of a
large trader.\23\ These new exclusions would include: (1) Transactions
effected by a court appointed executor, administrator, or fiduciary
pursuant to the distribution of a decedent's estate; (2) transactions
effected pursuant to a court order or judgment for distribution of
property in a marital proceeding; and (3) a qualified plan or trust
rollover afforded favorable tax treatment under section 402(a)(5) of
the Internal Revenue Code.\24\
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\23\See Proposing Release, 56 FR 42551, at n. 12 and
accompanying text.
\24\26 U.S.C. 402(a)(5) (1988).
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It should be noted that the exclusion for transactions of a
decedent or marital estate would include only those transactions
effected pursuant to the distribution or liquidation of such estates
and would not include transactions effected pursuant to the continuing
administration or investment of such estate's assets. The distinction
drawn between the distribution and the administration of an estate
pursuant to a court order acknowledges that court appointed fiduciaries
may be authorized to invest and reinvest in securities for many years.
The Commission believes that the exclusion of such estates from the
identification requirements of the reproposed rule would be
inappropriate.
The Commission believes that these new exclusions from the
definition of a transaction would indirectly exempt a significant
number of those small or otherwise infrequent traders that were not
intended to be large traders under the Market Reform Act. Moreover, the
Commission believes that the definition of a transaction would reduce
the impact of the reproposed rule on registered broker-dealers.
f. Identifying activity level. The Commission expressly solicited
comment on the appropriateness of the volume, market value, exercise
value, and time period proposed for the identifying activity level.
Generally, the commenters felt that the threshold was too low and
recommended higher levels that ranged from a low of 200,000 shares and
$10 million, to a high of 5 million shares and $50 million. A few
commenters suggested that only market value should determine large
trader status, while others suggested that market price, rather than
exercise price, would be more appropriate for valuing options. Finally,
many of the commenters expressed support for a calendar day measure
because of the inherent difficulty of aggregating transactions effected
in different time zones.
The definition of the identifying activity level contained in
paragraph (a)(8) of the reproposed rule would increase and change the
thresholds contained in the proposed rule from 100,000 shares to
200,000 shares and fair market value of $2 million, and from a fair
market value of $4 million to $10 million. The Commission believes that
the addition of the $2 million fair market value requirement to the
fundamental share volume threshold would act as a floor to minimize the
impact of the reproposed rule on those persons that effect transactions
in lower priced securities. The Commission solicits comments on whether
this new element of the identifying activity level would be
appropriate. The Commission also solicits comments regarding the
effectiveness of the new identifying activity level for minimizing the
impact of the reproposed rule on natural persons that infrequently
trade large amounts of publicly traded securities.
The time period for aggregating transactions also would be changed
from a 24 hour period to ``a calendar day where the account is
located.'' The Commission would deem a calendar day to be a 24-hour
period starting at 12 a.m. and ending at 11:59 p.m. An account would be
deemed to be located at the principal place of business of the broker-
dealer, not where the customer or registered representative servicing
the account is located. Finally, the provisions regarding program
trading are reproposed without changes in paragraphs (a)(9) and
(10).25
---------------------------------------------------------------------------
\2\5See Proposing Release, 56 FR 42552, at text accompanying n.
15.
---------------------------------------------------------------------------
The Commission continues to believe that the capture of significant
trading activity concurrently with program trading activity is
essential for accomplishing the purposes of the Market Reform Act. The
Commission has balanced this need against the burden of capturing the
information and believes that the reproposed identifying activity level
would strike an appropriate balance. The Commission also believes that
the reproposed identifying activity level would establish a relatively
simple and bright-line threshold that would be squarely within the
activity-based mandate of the Market Reform Act.
2. Aggregation of Accounts and Transactions
Section 13(h)(3) of the Exchange Act authorizes the Commission to
prescribe rules governing the manner in which transactions and accounts
shall be aggregated, including the basis of ownership or
control.26 The commenters uniformly criticized the proposed rules
for aggregation as overly broad and inflexible. Generally, these
criticisms were levied by diversified financial service holding
companies whose affiliates, subsidiaries, and divisions engage in
related and unrelated trading activities. As discussed above, much of
this criticism emanated from the definitions of ownership and control.
---------------------------------------------------------------------------
\2\6See 15 U.S.C. 78m(h)(3) (1990).
---------------------------------------------------------------------------
These commenters argued that the mandatory nature of the proposed
rules would cause overlapping and duplicative aggregation among the
various entities within a holding company structure. The commenters
made a variety of recommendations, including a flexible approach,
approaches designed to meet the needs of the specific commenter, an
``acting in concert'' approach, and the elimination of the concept of
aggregation. The comments regarding aggregation highlight the
complexity of designing a simple and efficient large trader system that
accommodates the different corporate structures and business practices
of large traders. The proposed aggregation requirements, however, were
intended to deter non-compliance by prohibiting a person or group of
persons from splitting activity among many broker-dealers, accounts,
and transactions for the purpose of avoiding the identification
requirements of the proposed rule.
a. General Description. The rules for aggregation have been
reorganized into paragraphs (c)(1) and (2) of the reproposed rule to
distinguish the requirements for the aggregation of accounts and the
aggregation of transactions, respectively. The rules for the
aggregation of transactions found in reproposed paragraph (c)(2)
contain only minor changes that reflect the reorganization of the
proposed rules.27
---------------------------------------------------------------------------
\2\7See Proposing Release, 56 FR 42561 (proposed text).
---------------------------------------------------------------------------
The focus of the reproposed rule would be the ``aggregation of
accounts owned or controlled by a person.'' Paragraph (c)(1)(i) of the
reproposed rule would implement a new flexible approach to the
aggregation of accounts by permitting, but not requiring, the
aggregation of accounts that are owned or controlled or under common
ownership or control of a person, which independently would be a large
trader. Conversely, paragraph (c)(1)(ii) of the reproposed rule would
require aggregation of accounts of a person who independently would not
be a large trader.
In order to assure compliance and deter the use of this flexible
approach to circumvent the reproposed rule, new paragraph (c)(1)(iii)
would provide that, under no circumstances, shall a person or group of
persons acting in concert toward a common investment objective be
permitted to disaggregate accounts in order to avoid the identification
requirements of the reproposed rule. Finally, reproposed Form 13H and
Schedules have been redesigned to explain and facilitate the various
choices that large traders may make with respect to aggregation.
b. Disaggregation. The concept of disaggregation would be
reorganized into paragraph (c)(3)(i) of the reproposed rule. The
reproposed rule provides that the Commission may require a large trader
to disaggregate accounts or transactions in any manner and authorizes
the Commission to require the submission of additional transaction or
other information relating to transactions reported under the
reproposed rule. To assure that the Commission's requests for
disaggregation are reasonable, however, the reproposed rule would
require the Commission to consider the operational capabilities of the
large trader when making a request for disaggregation.
The Commission's efforts to assure the credibility of the
reproposed system would require the imposition of certain duties on
omnibus large traders. These duties would include supplying information
that would facilitate analysis of market trading activity. The duties
would arise from, and pertain to, the disaggregation and identification
requirements.28 These duties are found in paragraph (c)(3)(ii) of
the reproposed rule and would only apply to those large traders that
maintain, or effect transactions through, omnibus accounts carried by a
registered broker-dealer. The obligations imposed on these large
traders would be to establish systems and procedures designed to assure
compliance with the disaggregation and identification requirements and,
in particular, assure that the information regarding omnibus accounts,
disclosed to the Commission on reproposed Schedules 7b and 8, is
accurate and complete.
---------------------------------------------------------------------------
\2\8See infra Section III.E., for a discussion of the
supervisory safe harbor for broker-dealers.
---------------------------------------------------------------------------
Systems and procedures designed to assure compliance with the
identification and disaggregation requirements that are substantially
comparable to those described in reproposed paragraph (f) would be
deemed to be in compliance with reproposed paragraph (c)(3)(ii).
Systems and procedures designed to assure that Schedules 7b and 8 are
accurate and complete may include recordkeeping procedures triggered by
the opening of new accounts and prescribing how, or for whom, a given
omnibus account may be used. These systems and procedures are not
intended to affect the existing disclosure practices and procedures
between broker-dealers and banks or trust companies.29
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\2\9Custodian or nominee large traders generally are required to
maintain and report information to their respective regulatory
authorities that is similar to that required on these Schedules.
These large traders, however, are not normally required to disclose
proprietary information (e.g., customer lists) to competitors or
other non-primary regulatory authorities.
---------------------------------------------------------------------------
The need to impose these duties on omnibus large traders results
from the undisclosed nature of omnibus accounts. The Commission
believes that the obligations found in reproposed paragraph (c)(3)(ii)
would be necessary to assure the effectiveness and credibility of the
large trader system. The Commission also believes that these
requirements would establish consistent duties with respect to omnibus
accounts maintained by banks or broker-dealers.
c. Aggregation examples. A diversified financial services holding
company, for example, may engage in all forms of banking, corporate
finance, and trust services in addition to the full range of broker-
dealer activities, such as proprietary trading, market making,
brokerage execution, and clearing services for retail and institutional
customer accounts. This holding company also may provide discretionary
and non-discretionary investment management services for retail and
institutional customers, as well as for affiliated and unaffiliated
investment companies, pension funds, and insurance companies.
Under the reproposed rules for the aggregation of accounts, the
holding company is permitted to formulate its own methodology for
filing of Form 13H.30 For example, it may file a single Form 13H
that would include accounts of all its owned or controlled and commonly
owned or controlled persons, divisions, subsidiaries, and affiliates.
In the alternative, the holding company may file separate Form 13Hs for
its divisions, subsidiaries, and affiliates that independently would be
a large trader. Finally, the holding company may file a separate Form
13H for individual traders or trading desks which also would
independently qualify as a large trader.
---------------------------------------------------------------------------
\3\0See infra Section III.B.2., for a discussion of Form 13H and
instructions.
---------------------------------------------------------------------------
In another example, a diversified broker-dealer that engages in
investment banking, proprietary trading, discretionary and non-
discretionary investment management services, and clearing and custody
services may also adopt its own methodology for the filing of Form 13H.
First, the broker-dealer could file a single Form 13H for all of its
activities. Second, the broker-dealer could file separate forms by
dividing its activities along the three large trader capacities and
then further subdivide each capacity in a fashion that best suits its
business needs. Accordingly, this broker-dealer may wish to file one
Form 13H for each proprietary trader due to operational considerations,
two Form 13Hs for its investment management subsidiary due to
confidentiality considerations (e.g., one for affiliated investment
company accounts and one for other managed accounts), and for
supervisory considerations, one Form 13H for all of the omnibus
accounts for which it acts as custodian/nominee only.
The Commission believes that this flexible approach to aggregation
would accommodate the needs of the greatest number of large traders in
the least burdensome manner possible. The Commission also believes that
the reorganization and revision of the reproposed rules for aggregation
would clarify the reproposed definition of a large trader.
Nevertheless, the Commission solicits comments on whether there are
other more effective means for aggregating accounts that would
accomplish the objectives of the Market Reform Act.
B. Identification Requirements for Large Traders
Section 13(h)(1) of the Exchange Act authorizes the Commission to
prescribe identification requirements for large traders for the purpose
of monitoring the impact of large transactions on securities markets
and to assist the Commission in the enforcement of the Exchange
Act.31 The Commission is specifically authorized to require large
traders to provide it with the information deemed necessary or
appropriate to identify large traders and all accounts in or through
which large traders effect transactions.32 The Commission also is
authorized to require large traders to disclose their large trader
status to the registered broker-dealers that carry the accounts through
which they effect transactions.33 The Commission is reproposing
Rule 13h-1(b) and Form 13H to implement these provisions of Section
13(h)(1) of the Exchange Act.
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\3\1See 15 U.S.C. 78m(h)(1) (1990).
\3\2See 15 U.S.C. 78m(h)(1)(A) (1990).
\3\3See 15 U.S.C. 78m(h)(1)(B) (1990).
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1. Form 13H Filing Requirements
Paragraph (b)(1) of the reproposed rule provides that each large
trader shall file Form 13H with the Commission in accordance with the
instructions contained therein. The filing requirement for Form 13H is
the most significant burden imposed on large traders by the reproposed
rule. The time for filing Form 13H is contained in new paragraphs
(b)(1) (i) and (ii) of the reproposed rule.
The Commission recognizes that, due to the nature of many large
trader's business activities, much of the information required by the
proposed form may change daily. Accordingly, new paragraph (b)(1) of
the reproposed rule would eliminate the proposed requirement that a
large trader file a Form 13H every time the ``information contained
therein becomes inaccurate for any reason.''
Paragraph (b)(1) of the reproposed rule would require a large
trader to file Form 13H within 10 business days after it first effects
transactions that reach the identifying activity level and within 60
calendar days after the end of each full calendar year thereafter. It
should be noted, however, that a large trader would still be required
to disclose its LTID or ID System number when a new account is opened
during a calendar year.34 The Commission believes that the
reproposed Form 13H filing requirements would substantially reduce the
frequency of filings and accomplish the purposes of the Market Reform
Act.
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\3\4See infra Section III.B.3., for a discussion of the duty to
disclose large trader status.
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2. Form 13H and Instructions
The Commission received many negative comments about Form 13H. The
majority of the commenters argued that the proposed Form 13H and
Schedules were duplicative or burdensome, and would be required to be
filed too frequently. The commenters made various suggestions to
eliminate or reduce the burdens of the proposed form. These suggestions
included: (1) eliminating the listing of certain types of
accounts;35 (2) incorporating information contained in other
Commission filings by reference; (3) limiting the number of officers,
directors, and partners for whom information must be provided; and (4)
redesigning the proposed Schedules to capture the particular
information possessed by each of the three basic types of large trader
(i.e., owner, controller, or custodian/nominee).
---------------------------------------------------------------------------
\3\5These comments argued that the proposed Schedules,
especially proposed Schedule 5, should not require a large trader
that controls accounts to list the fully disclosed accounts of small
or otherwise infrequent traders that it controls or the undisclosed
sub-accounts of persons for whom trades are effected through an
omnibus account.
---------------------------------------------------------------------------
a. General description. The Commission is reproposing a
substantially revised Form 13H, Schedules, and Instructions. The
revisions to proposed Form 13H reflect the modifications to the
definition of a large trader and LTID disclosure requirements and
incorporate other recommendations made in the comments. As discussed in
the Proposing Release, the information disclosed on Form 13H would be
exempt from disclosure under the Freedom of Information Act (``FOIA'')
pursuant to Section 13(h)(7) of the Exchange Act.36 A few
commenters questioned the apparent lack of a similar exemption for the
transaction information reported under the proposed rule. Section
13(h)(7) provides that ``any information required to be kept or
reported'' is exempt from disclosure under FOIA. Therefore, transaction
information reported under the reproposed rule also would be exempt
from disclosure under FOIA. The Commission believes that the non-
disclosure of such information also may be covered by other existing
Commission rules.37
---------------------------------------------------------------------------
\3\615 U.S.C. 78m(h)(7) (1990). See Proposing Release, 56 FR
42554 at text accompanying nn. 50-52.
\3\7See e.g., 17 CFR 200.80(b)(3), (4)(iii), (5), (7), and (8).
---------------------------------------------------------------------------
The cover page to reproposed Form 13H would remain substantially
unchanged except for the exclusion of the amended filing requirement,
the addition of an inactive filing status, and the capture of
applicable LTID or ID System numbers. Item 1 to Form 13H also would be
unchanged, except for minor changes that conform with the reproposed
definition of a person.38 The remaining Items and Schedules of the
proposed form have been substantially revised in the reproposed Form
13H.
---------------------------------------------------------------------------
\3\8See supra Section II.A.1.a., for a discussion of the
addition of persons or entities acting as a trustee to the
definition of a person.
---------------------------------------------------------------------------
Reproposed Item 2 to Form 13H would implement a new exemption from
the filing requirements of reproposed Item 4 for persons and entities
regulated by the Commission by allowing the incorporation by reference
of information already on file with the Commission. The Commission
anticipates that some of the most common registrations or filings that
large traders may list in reproposed Item 2 would include: Form BD;
Form ADV; Forms 3, 4, or 5; Form 10-K or 10-Q; and Form U-4.
The Instructions to reproposed Item 2 also would inform large
traders that the listed registrations and filings should reflect the
registrations of all other large traders and persons whose accounts the
large trader has decided to aggregate into its Form 13H. Finally, the
reproposed Instructions would inform large traders that Item 4 and the
appropriate Schedule must be filed for those persons who are not
registered with the Commission and whose accounts have been aggregated
with a ``registered person.''
The Schedules to reproposed Item 4 also have been refined to
capture only minimal descriptive information about the persons who own
or control a large trader corporation, partnership, limited
partnership, or trust. For the most part, the collection of addresses,
telephone and facsimile numbers, and regulatory information has been
eliminated. The terms ``officer and partner'' also have been changed in
the reproposed Schedules 4b and 4c to ``executive officer'' and
``limited partner that is the owner of more than a 10 percent financial
interest in the accounts of the large trader.'' The term ``executive
officer'' would be deemed to mean ``policy-making officer'' and
otherwise would be interpreted in accordance with Rule 16a-1(f) under
the Exchange Act.39 As suggested in the comments, these changes
should substantially reduce the number of persons for whom such
Schedules must be prepared and filed under the reproposed rule.
---------------------------------------------------------------------------
\3\917 CFR 240.16a-1(f).
---------------------------------------------------------------------------
Reproposed Item 5 to Form 13H would facilitate the new flexible
rules for aggregation. Item 5(a) would require the large trader to list
all commonly owned or commonly controlled persons whose accounts are
aggregated into the particular Form 13H that independently would be a
large trader (i.e., aggregated accounts). Conversely, Item 5(b) would
require the large trader to list all other commonly owned or controlled
large traders that independently filed Form 13H and that could have
been, but were not, aggregated into the particular large trader's Form
13H (i.e., disaggregated accounts). Again, the reproposed Instructions
would caution large traders that the information supplied in Item 5
must accurately reflect their choice for aggregation or disaggregation
of accounts.
The reproposed Schedules to new Items 6 through 8, which gather
account information, address the concerns expressed in the comments and
reorganize, substantially reduce, or eliminate much of the information
regarding a large trader's accounts that may have been captured by the
proposed Schedules. These reproposed Schedules have been completely
redesigned to require the identification of only one contact person for
each Schedule and establish a ``single-line-item'' type of account
listing. The reproposed Instructions indicate that the proposed
qualifications for designated contact persons would be retained without
meaningful changes. The reproposed Instructions also advise large
traders that they may submit internally produced lists of accounts,
provided that such lists contain all required information in a format
substantially similar to the applicable Schedule.
The new account Schedules also have been reorganized to track the
three capacities in which a large trader may act with respect to a
given account (i.e., owner, controller, or custodian/nominee). The
reproposed Schedules would capture different combinations of large
trader capacities, based upon the large trader's knowledge of accounts
and the extent of beneficial ownership disclosure made to the carrying
broker-dealer. Reproposed Schedules 6a and 6b would be used by those
market participants who own accounts.
Reproposed Schedules 7a and 7b would be used by market participants
who control accounts owned by others. These Schedules have been
redesigned to indicate that accounts controlled by the large trader
that are owned by small or otherwise infrequent traders would not be
required to be specifically listed on these Schedules. Instead,
reproposed Item 2 of Schedule 7a would capture general information
about fully disclosed ``non-large trader'' accounts controlled by the
large trader (i.e., the total number of such accounts and broker-
dealers carrying them). If applicable, information regarding other
large traders whose activity may be controlled by the large trader
through one of the listed accounts would be provided in reproposed Item
3 of Schedule 7a and Item 2 of Schedule 7b.
Lastly, Schedule 8 would be used by those broker-dealers, banks,
and trust companies that market their clearing or depository services
independently from their other brokerage or investment management
services. It should be noted that reproposed Schedules 7b and 8
incorporate the ID System to the extent that they permit a large trader
to list the applicable ID System numbers or LTIDs of the custodian or
nominee for an omnibus account and other interested parties (i.e.,
owners and controllers). The Commission believes that, due to the wide-
spread use and automated nature of the ID System, most of these numbers
are routinely communicated among, and maintained in an automated
fashion by, market participants. The disclosure of other large traders
required by these Schedules would provide an important and common basis
for disaggregation.
Rarely would a large trader be required to complete all five of
these reproposed Schedules. The Commission believes that such a filing
probably would occur only if a diversified financial services company
decided to aggregate the accounts of all of its divisions,
subsidiaries, or affiliates into a single Form 13H filing.
The complexity of the Form 13H disclosures under the reproposed
rules would be greatest for a single aggregated filing and would become
progressively less complex for multiple Form 13H filings. Generally,
the large trader's organizational structure and business practices,
combined with the reproposed requirements of Item 2, Item 5, and the
account Schedules, would dictate the complexity of a Form 13H filing.
The number of LTIDs that would be assigned varies directly with the
number of Form 13H filings. The commenters indicate that some broker-
dealers and large traders may prefer to be assigned many LTIDs for
supervisory purposes while others may prefer a single LTID for
confidentiality reasons. In this respect, the SIA suggested that a
broker-dealer be permitted to use its LTID for the confidential
numbered accounts of its customers. Similarly, a few commenters,
primarily foreign financial services holding companies or universal
banks, asserted that the LTID disclosure requirements may cause them to
breach ``Chinese Walls'' between investment banking, investment
advisory, market making, or brokerage units. The Commission believes
that these entities would be able to avoid this result under the
reproposed rules by carefully aggregating or disaggregating accounts.
The Commission acknowledges that excessive aggregation or
disaggregation of commonly owned or controlled accounts may increase
the overall costs and burdens on large traders and the Commission. The
probability of receiving a request for disaggregation, and the cost
thereof, also would vary directly with the extent of aggregation chosen
by a large trader. The Commission would remind all market participants
to evaluate their business practices and weigh the costs and benefits
of aggregation or disaggregation in light of all the considerations
outlined above.
The Commission believes that perhaps the most important revisions
to proposed Form 13H are the reproposed set of General and Special
Instructions.\40\ These new Instructions provide answers to many of the
specific questions raised in the comments. The Instructions provide all
of the pertinent definitions, the rules for aggregation, and examples
of who would be a large trader and what information must be provided on
Form 13H. The reproposed Instructions also provide guidance and cross-
references to the reproposed rule, other related instructions, and
particular burden reducing features or alternatives of reproposed Form
13H. Accordingly, the Commission would encourage all market
participants to carefully review the reproposed General and Special
Instructions for Form 13H before completing and filing Form 13H.
---------------------------------------------------------------------------
\40\See infra Appendix A.
---------------------------------------------------------------------------
b. Form 13H Examples. Assume a trustee for a large pension fund is
not registered with the Commission and personally manages 75% of the
pension's assets. Assume further that the pension trustee delegates
full discretionary investment authority over the remaining 25% of the
pension's total assets to several investment advisers (e.g., a growth
stock adviser, an index arbitrager, and a portfolio hedging
strategist).
This pension trustee would be required to complete one of the
reproposed Schedules to Item 4 depending on the organizational type of
the trustee (i.e., individual, corporation, or partnership). With
respect to the 75% of the pension's total assets that the pension fund
trustee personally manages, he would be deemed to own and control the
accounts and would know the carrying broker-dealers and account
numbers. The pension fund trustee, therefore, would list these accounts
on reproposed Schedule 6a.
Depending on the nature of the delegations of authority to each of
the advisers, the pension trustee may not know the broker-dealers the
advisers use to execute trades or maintain accounts. Accordingly,
reproposed Schedule 6b has been designed to capture the information
that the pension trustee knows (i.e., the advisers' names, addresses,
numbers, and type of delegation), and reproposed Schedules 7a and 7b
would capture the information in the possession of the adviser (i.e.,
carrying broker-dealer, account number, disclosure of ownership, and
other large traders).
Assuming that the advisers are large traders and were registered
with the Commission, they would list Form BD or ADV in Item 2 of their
Form 13Hs, and therefore, would be exempt from the requirements of Item
4. It should be noted that if any of these advisers is not a large
trader, then such adviser would not file Form 13H under the reproposed
rules. In such cases, the Commission would be able to identify and
contact the non-large trader adviser, if necessary, through the
information provided by the pension trustee on its Schedule 6b to Form
13H.
In addition, assume that the trustee of the pension fund also
engages the services of a prime broker, bank, or trust company to act
only as the custodian or nominee for omnibus accounts that are owned
and controlled by the pension trustee or owned by such trustee and
controlled by the different advisers. In this case, the pension fund
trustee would list on its Form 13H the omnibus accounts for which he or
she is the owner and controller on Schedule 6a and the delegations of
investment discretion on Schedule 6b. The advisers that control the
pension fund's trading through the omnibus accounts would list such
accounts on Schedule 7b of their Form 13Hs.
The prime broker, bank, or trust company acting only as custodian
or nominee for all of the omnibus accounts (i.e., the custodian or
nominee large trader) would list such accounts, carrying broker-dealer,
and the relevant controllers on reproposed Schedule 8. It should be
noted that if the omnibus account custodian or nominee also controlled
these accounts, in whole or in part, then it would complete Schedule 7b
instead.\41\ The custodian or nominee large trader would be in
possession of the information required by Schedule 7b or 8, for the
following reasons. First, it is the carrying broker-dealer's customer
with respect to the omnibus accounts and, therefore, would be required
to complete a new account application and provide all other information
requested by the broker-dealer with respect to settlement instructions
and the persons authorized to effect transactions through the accounts.
Second, the various advisers and the trustee of the pension fund, to
the extent that he or she controls transactions, would be required by
the reproposed rule to disclose such information to the prime broker,
bank, or trust company acting as custodian or nominee.\42\ Finally, if
the custodian bank or trust company was an issuer of publicly-traded
securities, it may list Form 10-K or 10-Q in Item 2 and would not be
required to complete Item 4 on its Form 13H.
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\41\Of course, if the pension trustee retained the prime broker,
bank, or trust company to act only as agent for settlement of its
fully disclosed accounts, then such agent would not be deemed to own
such account and would not be a large trader required to file Form
13H and Schedule 8.
\42\See infra Section III.B.3., with respect to this required
disclosure under reproposed paragraph (b)(2)(ii).
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Another example of how the reproposed Schedules to Form 13H may be
applied would be where a registered investment adviser for a mutual
fund complex chooses to file one Form 13H, covering all of the accounts
controlled for affiliated or unaffiliated investment companies.
Assuming that each mutual fund independently would be a large trader,
they would be listed in Item 5(a) of the adviser's Form 13H. The Form
ADV of the adviser and each investment company's registration statement
or periodic reports also would be listed in Item 2 of the adviser's
Form 13H. If the accounts through which the adviser effects
transactions are fully disclosed as to ownership by a particular
investment company within the fund complex, the adviser would complete
Schedule 7a. Alternatively, if such accounts do not disclose the
particular investment company for whom the adviser is effecting
transactions (i.e., are maintained on an omnibus basis), then the
adviser would complete Schedule 7b.
The Commission believes that the revisions to the reproposed Form
13H and Instructions would dispel many of the misconceptions regarding
the information that would be required to be disclosed on Form 13H. The
revised Schedules to Form 13H also minimize the burdens of the
reproposed rule by utilizing existing ID System practices and
procedures for disclosure and maintenance of information among large
traders and other parties to multi-layered accounts. The Commission
specifically solicits comments on the appropriateness of all the
changes found in reproposed Form 13H and Schedules.
3. Disclosure of Large Trader Status
Many of the commenters expressed concerns that the proposed
disclosure requirements would cause overlapping, confusing, or
unnecessary disclosures by more than one large trader for a given
account. The broker-dealer commenters also indicated that the cost of
modifying automated brokerage accounting systems to maintain and report
multiple LTIDs for a single account or trade would be substantial.
The reproposed rule would retain the proposed LTID assignment
system43 and would modify the duty of large traders to disclose
their LTIDs and accounts to broker-dealers. The reproposed rule also
would require similar disclosures of information to custodians or
nominees and large traders that control transactions.
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\4\3Upon filing Form 13H a large trader would be assigned an
LTID by the Commission. See Proposing Release, 56 FR 42553, at text
immediately following n. 37.
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Reproposed paragraph (b)(2)(i) would require a large trader who
controls a fully disclosed account or the custodian or nominee for an
omnibus account to disclose its LTID and accounts to the carrying
broker-dealers. Hence, under the reproposed rules, each large trader
account should have only one LTID number associated with it, namely the
LTID number of the controlling large trader or of the custodian or
nominee large trader.
The Commission notes that the reproposed definition of control
states that an account would be controlled by the owner of the account.
Consequently, if an account is controlled only by its owner, then the
owner would be required to disclose its LTID to the carrying broker-
dealer. This duty also would apply to fully disclosed accounts of small
or otherwise infrequent traders whose accounts are controlled by large
traders, even though these accounts would not be listed on the
reproposed Schedules to Item 7.
Paragraph (b)(2)(i) of the reproposed rule would effectively
eliminate the majority of situations where multiple LTIDs would be
disclosed to a broker-dealer for a single account. The Commission
believes that the only situation where more than one LTID would be
disclosed to a broker-dealer for a single account would be where more
than one large trader controls transactions in an account that is fully
disclosed as to ownership. These situations would include fully
disclosed accounts controlled by their owner and another adviser or
such accounts controlled by two or more advisers.
Reproposed paragraph (b)(2)(ii) would require a large trader who
controls omnibus accounts to disclose its LTID or ID System number to
the broker-dealer or large trader acting as the custodian or nominee
for such account. Similarly, reproposed paragraph (b)(2)(iii) would
require a large trader that owns accounts but has delegated full or
limited discretionary investment authority to another person to
disclose its LTID or ID System number to such person. These duties are
coordinated with the filing requirements for Schedules 7a, 7b, and 8 to
reproposed Form 13H.44
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\4\4See supra Section III.A.2.b., for a discussion of the
omnibus account identification and disaggregation duties that attach
to the filing of Schedules 7b and 8.
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The Commission acknowledges that reproposed paragraphs (b)(2) (ii)
and (iii) may cause multiple LTIDs or ID System numbers to be disclosed
to custodian or nominee and controlling large traders, respectively.
The Commission believes that these required disclosures of large trader
status would not be overlapping or unnecessarily burdensome and would
utilize existing ID System practices and procedures. The Commission
also believes that these disclosure requirements would minimize the
amount of communication among members of an investment complex that
would be necessary to complete Form 13H. Moreover, these changes to the
proposed rule would conform with the various rules and regulations that
require financial institutions of all types to identify the beneficial
owners of accounts, confirm trades, and maintain possession and control
of customer funds and securities.
The Commission believes that the revisions to the reproposed rules
for disclosure of large trader status incorporate many of the
recommendations made by the commenters and reduce the burdens imposed
on market participants. The Commission solicits comment on this use of
the ID System and whether other ID System procedures or information
would further the purposes of the Market Reform Act.
4. Inactive Filing Status
In the Proposing Release, the Commission specifically solicited
comments on various means of minimizing the impact of the proposed rule
on small or otherwise infrequent traders. The Commission received many
comments in this respect and all were supportive of minimizing the
impact of the proposed system on small or otherwise infrequent traders.
Many of the commenters suggested that an annual activity threshold
could be used to limit the impact of the proposed system on infrequent
large traders. The commenters did not identify any common trading
objectives or characteristics of small or infrequent traders that may
inadvertently become large traders, other than those suggested in the
Proposing Release.45
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\4\5See Proposing Release, 56 FR 42551, at nn. 12-14 and
accompanying text.
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The reproposed rule would implement a new ``inactive filing
status,'' pursuant to paragraph (b)(3) of the reproposed rule. This new
paragraph provides that large traders whose aggregate transactions
during the previous full calendar year, which do not reach the
identifying activity level and an aggregate calendar year total of
2,000,000 shares or fair market value of $30,000,000, shall become
inactive upon filing Form 13H. This threshold would incorporate the
identifying activity threshold and would add an ``aggregate calendar
year activity threshold.'' Aggregate calendar year activity would be
computed in accordance with the rules for aggregation of transactions
found in paragraph (c)(2) of the reproposed rule.
The reproposed Instructions explain that this new inactive status
would be invoked by checking the appropriate box on the cover page when
filing an annual Form 13H for the calendar year in which the large
trader was inactive. Once a large trader has made an ``inactive
filing,'' he would be exempt from the reproposed annual filing
requirements contained in paragraph (b)(1)(ii) and the LTID disclosure
requirements of paragraph (b)(2). However, if an inactive large trader
subsequently effects transactions that reach the identifying activity
level, then the large trader again would be required to reactivate its
large trader status by filing Form 13H within 10 business days. The
reproposed Instructions indicate that such ``reactivated large
traders'' would retain the LTID initially assigned to them by the
Commission.
The Commission believes that this new inactive filing status would
eliminate the burdens of the identification requirements on small or
otherwise infrequent traders and, therefore, would accomplish the
objectives of the Market Reform Act. Nevertheless, the Commission
solicits comments on whether this new provision would adequately reduce
or eliminate the impact of the reproposed rule on natural persons that
infrequently effect large trades. The Commission also solicits
suggestions for other means of eliminating the burden of the reproposed
rule on natural persons.
5. Other Information
Paragraph (b)(4) of the reproposed rule has been added to the
identification requirements to assure that the Commission has the
authority to obtain, from time to time, other descriptive or clarifying
information regarding accounts, or transactions effected through
accounts, identified on Form 13H. This new paragraph would provide the
Commission with the express authority to obtain other information from
large traders that is not otherwise disclosed on Form 13H and may be
crucial for understanding or analyzing information collected through
the system. The Commission believes that the reproposed rule would not
be unduly burdensome and would assure that the Form 13H filing
requirements accomplish the objectives of the Market Reform Act.
C. Recordkeeping Requirements for Brokers and Dealers
Section 13(h)(2) of the Exchange Act authorizes the Commission to
prescribe recordkeeping requirements for large trader activity that it
deems necessary or appropriate in the public interest, for the
protection of investors, or otherwise in furtherance of the purposes of
the Exchange Act.\46\ The Commission also is authorized to conduct
reasonable periodic, special, or other examinations of all records
required to be made and kept pursuant to the Rule.\47\ Paragraph (d) of
the reproposed rule would implement the recordkeeping provisions of
section 13(h)(2) of the Exchange Act.
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\46\See 15 U.S.C. 78m(h)(2) (1990).
\47\See 15 U.S.C. 78m(h)(4) (1990).
---------------------------------------------------------------------------
1. General Requirements
The general recordkeeping requirements, which contain minor changes
from the proposed rule,\48\ would provide that every registered broker-
dealer that carries accounts for itself or others shall make and keep
records of transactions effected directly or indirectly by or through
such broker or dealer for all large traders. In addition, as
specifically authorized by the Market Reform Act, the reproposed rule
also would require that broker-dealers keep records of transactions for
each person such broker or dealer knows or has reason to know is a
large trader based on transactions effected by or through such broker
or dealer. Further, paragraph (d)(4) of the reproposed rule would
provide that such records shall be kept for a period of three years,
the first two in an accessible place, in accordance with Rule 17a-4(b)
under the Exchange Act.\49\
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\48\See Proposing Release, 56 FR 42560 (proposed text).
\49\17 CFR 240.17a-4(b).
---------------------------------------------------------------------------
The reproposed rule would explicitly provide that only registered
broker-dealers that carry accounts for themselves or others would be
affected. The term ``registered broker-dealer'' is defined in Section
3(a)(48) of the Exchange Act as a broker or dealer registered or
required to be registered pursuant to Section 15 or 15B of the Exchange
Act.\50\ Executing broker-dealers and prime brokers that do not carry
large trader accounts would not be subject to the recordkeeping
requirements of paragraph (d) of the reproposed rule, notwithstanding
that these persons may perform other specific tasks for large traders
and may be large traders. The Commission believes that these
modifications would clarify the applicability of the general
recordkeeping requirements of the reproposed rule.
---------------------------------------------------------------------------
\50\See 15 U.S.C. 78c(a)(48) (1988).
---------------------------------------------------------------------------
2. Elements of Transaction Information
Paragraph (d)(2) of the reproposed rule would provide the elements
of information required to be maintained for all transactions. The
Commission believes that these elements incorporate, to the extent
possible, existing recordkeeping requirements under the Exchange Act
and SRO rules for the electronic bluesheet system and, thereby,
minimize the burdens imposed on registered broker-dealers.
Due to changes to the LTID disclosure requirements, the
recordkeeping requirement for LTIDs found in paragraph (d)(2)(x) of the
reproposed rule would now require a broker-dealer to maintain only the
LTID of the controllers of a fully disclosed account, or the custodian
or nominee of an omnibus account. In addition, paragraphs (d)(2)(v) and
(d)(2)(vii) of the reproposed rule have been modified to incorporate
suggestions made by the commenters. Paragraph (d)(2)(v) has been
modified to include the designation of exercises or assignments of
option contracts. Paragraph (d)(2)(vii) has been modified to clarify
that the personal accounts of officers, directors, or employees of a
broker-dealer are not required to be aggregated with accounts owned or
controlled by such broker-dealer.
In addition, the reproposed rule includes three new elements that
the Commission believes are necessary to reduce the burden of
maintaining multiple LTIDs and execution times. First, paragraph
(d)(2)(xi) of the reproposed rule would provide that broker-dealers
must maintain the ID System numbers of agents, broker-dealers,
institutions, and other interested parties otherwise maintained for the
account for which a transaction is effected.\51\ The use of ID System
numbers would have the effect of limiting the number of LTIDs that a
broker-dealer must maintain and report with respect to a given account.
The Commission understands that broker-dealers currently maintain these
ID System numbers in their automated name and address records.\52\ The
Commission specifically solicits comments on the appropriateness of the
use of ID System numbers and whether other information, systems, or
procedures may further reduce the burden of multiple LTID
recordkeeping.
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\51\See supra n. 17, describing ID System participants.
\52\These automated records, and the ID System numbers contained
therein, provide the data processing mechanism for the automated
issuance of affirmations (i.e., confirmations) to the respective
parties to an ID System trade. Under the proposed Interactive ID
System, a Standing Instructions Database (``SID'') is planned to be
implemented. This database would establish a standing repository for
customer account and settlement information furnished by
institutions, agents, and broker-dealers. This information would
include the customer name, agent for the customer, the agent's
internal account number, and interested parties. When entering trade
data to the ID System, a broker-dealer could simply refer to account
designations contained in the SID, and the system would
automatically add details (e.g., customer name, agent, and
interested parties) to the confirmations of the trade. The
Commission notes that, absent large trader recordkeeping and
reporting requirements, the proposed SID may eliminate the need for
broker-dealers to maintain this information in their internal
records. See Securities Exchange Act Release No. 33010 (October 4,
1993), 58 FR 53007 (October 13, 1993).
---------------------------------------------------------------------------
Second, paragraph (d)(2)(xii) of the reproposed rule would provide
that broker-dealers must maintain the code, identification, or sequence
number assigned to a transaction that was routed or effected through an
automated order routing system maintained by an SRO, such as the NYSE
SuperDOT system. These numbers are uniformly maintained and used by
broker-dealers and SROs to route reports of executed transactions to
the appropriate broker-dealer branch offices or to research the status
of unexecuted orders. The Commission would use these numbers to ``link
or match'' transaction reports to the applicable SRO audit trail, in
order to determine or verify the reported execution time.
Finally, paragraph (d)(2)(xiii) of the reproposed rule would
establish a miscellaneous or unspecified field that would provide the
Commission with flexibility to accommodate future changes or problems.
This flexibility also could be used to facilitate specific requests
that would reduce the burdens of the reproposed system for a given
broker-dealer. The Commission believes that the reproposed
recordkeeping requirements would assure that the information necessary
to accomplish the objectives of the Market Reform Act would be
maintained. The Commission also believes that these reproposed
requirements would reduce burdens substantially.
D. Trade Reporting Requirements of Brokers and Dealers
Section 13(h)(2) of the Exchange Act specifically authorizes the
Commission to require registered broker-dealers to report transactions
that equal or exceed the reporting activity level effected by or
through such broker-dealer for persons who they know are large traders,
or any persons who they have reason to know are large traders on the
basis of transactions effected by or through such broker-dealers.\53\
The Commission also is authorized to require broker-dealers to report
transactions to the Commission or an SRO designated by the Commission
on the morning following the day on which the transactions were
effected or otherwise immediately upon request of the Commission or
designated SRO. Further, the Commission is authorized to require that
such transaction reports be transmitted in any format that it may
prescribe, including machine-readable form. The Commission is
reproposing paragraph (e) to implement the transaction reporting
provisions of Section 13(h)(2) of the Exchange Act.
---------------------------------------------------------------------------
\53\15 U.S.C. 78m(h)(2) (1990).
---------------------------------------------------------------------------
1. General Requirements
The general reporting requirement would provide that every
registered broker-dealer that carries accounts for large traders, or
other persons for whom records must be maintained, shall electronically
report transactions in machine-readable form and in accordance with
instructions issued by the Commission. Transaction reports would be
required to contain all elements of information for transactions
effected through accounts carried by such broker-dealer for large
traders and other persons for whom records must be maintained, which
equal or exceed the reporting activity level. The Commission continues
to propose that transaction reports be transmitted through the existing
electronic bluesheet system.\54\ The special reporting requirement for
trades of ``unidentified large traders,'' has been reorganized without
changes into paragraph (e)(5) of the reproposed rule.
---------------------------------------------------------------------------
\54\See Proposing Release, 56 FR 42557, at text accompanying nn.
85-86.
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2. Reporting Activity Level
The Commission expressly solicited comment on the appropriateness
of the proposed reporting activity level. Generally, the commenters
felt that the threshold was too low, and eight recommended higher
levels that ranged from a low of 5,000 shares and $200,000 to a high of
100,000 shares and $5 million. In response to these comments, the
proposed reporting activity level has been modified.
The reporting activity level contained in paragraph (e)(2)(i) of
the reproposed rule would increase the thresholds contained in the
proposed rule from 1,000 to 2,000 shares, and from a fair market value
of $40,000 to $100,000. The reproposed rule also would add a ``calendar
day where the account is located'' time frame, which would address
today's global trading environment.55 As noted in the Proposing
Release, the reproposed rules for aggregation would not apply to the
reporting activity level.56
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\5\5 For example, a registered investment company whose
portfolio is composed of international securities may enter orders
to effect transactions in domestic, European, and Asian securities
markets. These orders may be effected on different calendar days
where the account is located because of the various time zones in
which the markets are located. As a consequence, the Commission
notes that it may need to request 13H transaction reports for the
calendar days immediately preceding or following the calendar day on
which a significant market event occurred.
\5\6See Proposing Release, 56 FR 42556, at n. 68.
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In addition, the reproposed rule would recognize that broker-
dealers may prefer to report or ``dump'' all transactions in a given
security.57 In this regard, new paragraph (e)(2)(ii) of the
reproposed rule would be added to permit broker-dealers to report
transactions that are less than 2,000 shares or fair market value of
$100,000. Finally, paragraph (e)(2)(iii) of the reproposed rule
clarifies the proposed reporting provision for program trades and
states that each transaction that is part of a program trade shall be
reported regardless of share quantity or fair market value. The
Commission believes that the reproposed reporting activity level would
reduce the burden of the transaction reporting requirements.
---------------------------------------------------------------------------
\5\7See Proposing Release, 56 FR 42556, at n. 74.
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3. Multiple Large Trader Identification Numbers
The broker-dealer and bank commenters indicated that significant
costs would be incurred for enlarging systems and manually loading
multiple LTIDs into their automated name and address records.58
This concern was a direct result of the proposed definition of a large
trader and broad requirements for disclosure, recordkeeping, and
reporting of LTIDs of persons who own and control a given account. This
concern was compounded with respect to the proposed treatment of
omnibus accounts.59 The commenters generally suggested that tax
identification numbers or ID System numbers be used to alleviate this
burden.
---------------------------------------------------------------------------
\5\8See Memoranda to SEC File No. S7-24-91 from the Division of
Market Regulation dated March 20, 1992, which outline this issue as
discussed at meetings with the SIA and the American Bankers
Association.
\5\9See Proposing Release, 56 FR 42557, at text accompanying n.
79.
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The Commission has sought to reduce the burden of multiple LTIDs.
The Commission has chosen to accomplish this objective through a
narrowed definition of a large trader, reduced Form 13H information,
limited disclosure of LTIDs, the use of ID System numbers, and trade
reporting requirements that incorporate these changes.
The SIA generally expressed its concurrence with this solution to
the concerns with the multiple LTID reporting requirements.60 The
Commission, however, specifically solicits comments on the transaction
reporting aspects of the reproposed use of ID System numbers and any
other information, systems, or procedures that would more effectively
accomplish the objectives of the Market Reform Act.
---------------------------------------------------------------------------
\6\0See Memoranda to SEC File No. S7-24-91 from the Division of
Market Regulation dated June 8, 1992 and June 11, 1992 outlining
discussions with the American Bankers Association and the SIA,
respectively. See also supra n. 52, however, describing the Standing
Instructions Database features of the proposed Interactive ID System
and the potential elimination of the need for broker-dealers to
maintain such information.
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4. Execution Times
Due to the anticipated burden of automating execution times, the
Commission proposed and solicited comments on a two year plan to phase-
in the automation of execution time reporting requirements. The
Commission received substantial comments from broker-dealers regarding
the proposed execution time reporting requirements. One commenter
acknowledged that automated execution times were essential for reliable
time-sequenced trading reconstructions and expressed support for the
proposed two year phase-in plan. However, the majority of the
commenters asserted that the development and implementation of
automated systems for maintaining and reporting execution times would
be costly.
The commenters generally explained that in order to comply with the
proposed rule, broker-dealers would be required to develop and
implement so-called ``automated order match systems.'' These order
match systems would automatically link or match the execution time
recorded on customer order tickets with the execution time recorded on
the corresponding trade tickets prepared on the floor of an exchange.
Without these systems broker-dealers would be required to manually
research and identify the execution time for each customer trade.
Five broker-dealers and the SIA, on behalf of its members, supplied
cost estimates. These cost estimates ranged from a high of $8.5 million
to a low of $17,000.61 These cost estimates included many
different items, some of which were not intended by the proposed rule.
For example, many of these estimates included the cost of developing
sophisticated systems that would fulfill the obligation of broker-
dealers to supervise compliance with the proposed rule. These systems
presumably would identify related accounts that may be required to be
aggregated, through computer systems that employ forms of ``artificial
intelligence.''
---------------------------------------------------------------------------
\61\At the request of the Division of Market Regulation, 16
broker-dealers subsequently submitted cost estimates ranging from
$8.6 million to $100,000.
---------------------------------------------------------------------------
During the review of these cost estimates, it appeared to the
Commission that the magnitude of the cost may be dependent upon the
type of business conducted by a broker-dealer. The SIA acknowledged
that broker-dealers with large retail client bases, branch networks, or
widely marketed clearing services would be more likely to have
implemented an order match system as a necessary cost of doing such
business. Conversely, broker-dealers that primarily have institutional
clients and few branches would be less likely to have automated order
match systems and the ability to enhance their automated systems in a
cost-effective manner.
The commenters also indicated that ``average price'' trades and
accounts compound their execution time concerns exponentially.62
In addition, the commenters noted that a Commission request for
transaction reports would likely come at times of severe market stress,
which typically stretch broker-dealer trade processing capabilities to
their limits. Finally, as a result of the proposed next business day
reporting time frame, the commenters indicated that automation would be
the only feasible means to assure compliance.
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\6\2Average price trades usually entail the execution of one
large order, for one or more customers, through many small trades at
varying prices throughout a given day. Customers who employ a
broker-dealer, bank, or trust company as their centralized custodian
and agent for settlement typically request that trades be confirmed
and submitted for settlement as one trade at an average price in
order to minimize the ``ticket charges or fees'' levied by the
custodian. For example, a 150,000 share order may be filled through
the execution of 100 trades of 1,500 shares each, at 50 different
prices, and beginning at 9:30 a.m. and ending at 4:00 p.m. This
average price trade may be posted to the customer account, and
settled, as one ``ticket'' for 150,000 shares at an average price,
without any indication of the many smaller lots, different prices,
or actual execution times.
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A few commenters suggested alternatives for reducing this burden
that included requesting execution times on a need-to-know basis,
lengthening the reporting time frame, and postponing the effectiveness
of the requirements to see how frequently the data would be required.
From the outset, the Commission has sought alternative solutions that
would minimize this burden while achieving the fundamental purpose of
the large trader reporting provisions of the Market Reform Act. The
Commission staff, SIA, and SIAC have not identified existing industry
systems that would gather execution times for investor trading activity
in a simple and accurate manner.
Three alternatives that would require the development of new
systems, however, were proposed. First, it was suggested that ``branch
or DOT'' sequence numbers could be used in conjunction with SRO audit
trail data. While this suggestion appeared to be workable with respect
to ``system orders,''63 the SIA and SIAC agreed that this proposal
would still require some form of automated order match system and may
be considered by some broker-dealers to be equally as burdensome with
respect to ``manual orders.''64
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\6\3``System orders'' are those orders that are routed and
reported through SRO order routing systems and are automatically
posted to back-office accounting systems by the system. These
orders, generally, may be characterized as orders for small
individual investors or program trades.
\6\4``Manual orders'' are those orders that are routed and
reported manually over the telephone or telegraph and are manually
posted to back-office accounting systems by broker-dealer personnel.
These orders, generally, may be characterized as large block trades
for institutional investors.
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Second, after acknowledging that system order execution times did
not pose a significant problem, the SIA proposed the development of
computer algorithms that would match ``order entry times'' with SRO
audit trail data to determine the execution time of manual orders.
Third, the Division of Market Regulation proposed a hybrid of these
alternatives that bifurcates the execution time reporting requirements
along the lines of system and manual orders.65
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\6\5See Memoranda to SEC File No. S7-24-91 from the Division of
Market Regulation dated April 16, 1992, May 7, 1992, and June 11,
1992 outlining meetings where these proposals were discussed.
---------------------------------------------------------------------------
After carefully weighing costs and benefits, the Commission has
decided to repropose the Division's alternative for reducing the
burdens of the execution time reporting requirements. The reproposed
reporting requirements are found in new paragraphs (e) (3) and (4).
Paragraph (e)(3) of the reproposed rule would provide that with
respect to system orders, all transaction information required to be
maintained under the reproposed rule, including execution time, would
be required to be reported to the Commission or an SRO designated by
the Commission before the close of business on the day specified in a
request for such information. As indicated in the Proposing Release,
the Commission would not require reports to be submitted prior to trade
comparison and would consider pertinent market conditions as well as
the capabilities of the industry's trade processing facilities.66
Moreover, under the reproposed rule, the Commission may require the
transmission of transaction reports after final settlement because of
the inclusion of cancellations and corrections within the definition of
a transaction.67
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\6\6See Proposing Release, 56 FR 42557, at n. 84 and
accompanying text.
\6\7See supra Section III.A.1.e., for a discussion of the
definition of a transaction.
---------------------------------------------------------------------------
Paragraph (e)(4)(i) of the reproposed rule would provide that with
respect to manual orders, all transaction information required to be
maintained, except execution time, would be required to be reported
before the close of business on the day specified in a request for such
information. Lastly, new paragraph (e)(4)(ii) of the reproposed rule
would provide that the execution times of manual order transactions,
which were initially reported without execution times, would be
required to be reported within 15 calendar days after a subsequent
request for such information. It should be noted that the Commission
may request that broker-dealers provide such information for entire
transaction report submissions, individual transactions, or a group of
related transactions. Further, these manual order execution times would
be required to be transmitted electronically, in machine-readable form,
with all of the previously reported information regarding each of the
manual order transactions for which execution times were requested.
The Commission would carefully use these new reporting requirements
to minimize the extent of extraneous information gathered through the
system. The combination of the reporting requirements for execution
times and sequence numbers would enable the Commission to generate
accurate reconstructions of all large trader activity. Although these
new provisions may slow down the completion of trading reconstructions,
the Commission believes that the resulting analyses of trading
reconstructions will be superior to any previous efforts in terms of
accuracy, completeness, and timeliness. The SIA expressed its
concurrence with this solution to the execution time reporting
requirement concerns.68
---------------------------------------------------------------------------
\6\8See Memorandum to SEC File No. S7-24-91 from the Division of
Market Regulation dated June 11, 1992 indicating the SIA's
concurrence.
---------------------------------------------------------------------------
The Commission believes that the reporting requirements contained
in the reproposed rule incorporate all existing information or systems
and would minimize associated burdens. Further, the Commission believes
that these requirements would strike a fair and reasonable balance
between the costs of such reporting and the Commission's need to obtain
execution times. Finally, the Commission believes that the reproposed
reporting requirements would establish an efficient means for analyzing
multi-layered accounts.
E. Supervisory Safe Harbor
Section 13(h)(2) of the Exchange Act provides a mechanism for
supervision of the large trader reporting system by authorizing the
Commission to establish rules for recordkeeping and reporting of
transactions effected by persons a broker-dealer ``knows or has reason
to know'' is a large trader, based on transactions effected directly or
indirectly by or through such broker-dealer.69 As proposed, the
duty to supervise would apply to compliance with the identification
requirements and would be imposed on all broker-dealers and other large
traders that effect transactions through, or maintain omnibus accounts
with, broker-dealers.70
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\6\915 U.S.C. 78m(h)(2) (1990).
\7\0See Proposing Release 56 FR 42554, at text accompanying nn.
44-46, 53-54, and 108.
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A number of comments on this aspect of the proposed rule were
received from broker-dealers and banks. These comments revolved around
the scope of this duty and sought clarification concerning the steps to
be taken to avoid liability for their customers' intentional or
unintentional failure to comply with the identification requirements of
the proposed rule.71 Many of the commenters focused on the lack of
automated systems for cross-referencing or aggregating accounts that
may be commonly owned or controlled. The commenters extrapolated from
this premise that the development of automated systems for this purpose
would be extremely expensive and unduly burdensome. The commenters also
suggested that the principal compliance burden should be placed on
large traders and that an objective standard or ``safe harbor'' should
be created.
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\7\1See Proposing Release, 56 FR 42554, at n. 46, for the
administrative remedies that the Commission may impose for a failure
to supervise. The Commission also notes that it may institute
proceedings and impose any other remedies that it may deem
appropriate.
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The Commission emphasizes that the reproposed rule places the
principal burden of compliance with the identification requirements on
large traders. The Commission, however, also believes that some form of
supervisory requirements and systems, which are consistent with the
self-regulatory framework of the Exchange Act, are necessary to assure
that the objectives of the Market Reform Act are fulfilled.
Paragraph (f) of the reproposed rule would clarify and minimize the
burden of the duty to supervise imposed by the ``reason to know''
provisions of Section 13(h)(2) of the Exchange Act. This duty to
supervise would apply to registered introducing or correspondent
broker-dealers that clear their transactions on an omnibus basis
through a self-clearing broker-dealer. Absent other indications, self-
clearing broker-dealers would not normally be expected to supervise
compliance by such broker-dealers or their customers for whom
transactions are effected through omnibus accounts.
The Commission acknowledges that this duty to supervise would
impose additional burdens on broker-dealers. Accordingly, paragraph (f)
of the reproposed rule would establish a ``safe harbor'' for the
supervisory duty. This new paragraph would initially provide that
registered broker-dealers would not be deemed to know or have reason to
know that a person is a large trader if it does not have actual
knowledge that a person is a large trader and has established policies
and procedures reasonably designed to assure compliance with the
identification requirements of the reproposed rule. Paragraphs (f) (1)
and (2) of the reproposed rule provide the specific elements that would
be required for the supervisory safe harbor.
Paragraph (f)(1) of the reproposed rule requires the establishment
of systems ``reasonably designed to detect and identify'' persons who
have not complied with the identification requirements. This paragraph
incorporates the ``reason to know'' standard and clarifies that, with
respect to groups of accounts that may be identified as large traders
(i.e., commonly owned or controlled accounts), policies and procedures
would be within the safe harbor if they are reasonably designed to
detect and identify such groups of accounts based on account name, tax
identification number, or other readily available information.
The Commission would deem ``other readily available information''
to include, for example, those instances where a single customer
effects the requisite transactions through a single registered
representative, trading desk, or branch office in his or her personal
accounts, accounts of family members, or accounts of others, pursuant
to written trading authorizations. Similarly, customer authorization to
transfer funds or securities among accounts in order to receive
approval for trading activities, meet margin requirements, or to settle
transactions, may be deemed other readily available information.
Paragraph (f)(2) of the reproposed rule also would require that
broker-dealer supervisory policies and procedures contain systems
reasonably designed to inform persons and large traders of their
obligations to file Form 13H and disclose their large trader status. In
this respect, questions and informative disclosures on new account
applications, as well as annual notices to identified and unidentified
large traders, among other things, would be deemed by the Commission to
fulfill this element of the safe harbor.
The Commission notes that the elements of the safe harbor do not
specifically require automated systems, employee training programs, or
any other systems or procedures. The adequacy of supervisory procedures
would depend on the nature and characteristics of a broker-dealer's
business. The Commission believes that many different systems or
procedures may be effective for accomplishing the objectives of the
supervisory duties and, therefore, would satisfy the requirements of
the safe harbor.
Paragraph (f) of the reproposed rule incorporates many of the
suggestions contained in the comments for reducing the burdens
attendant to supervision of the system. The Commission believes that
these new paragraphs add detail and objectivity to the reason to know
requirements of the Market Reform Act and, therefore, reduce the burden
of the supervisory scheme of the reproposed rule. The Commission also
believes that these provisions are consistent with the general
supervisory obligation imposed on broker-dealers by the Exchange
Act.72 The Commission, however, specifically solicits comments on
the reproposed supervisory scheme and whether other more effective
means exist, within the limitations provided by the Market Reform Act,
for assuring the accuracy or reliability of information collected
through the reproposed system and maintaining a level playing field
between broker-dealers and banks.
---------------------------------------------------------------------------
\7\2 See e.g., Sections 15(b)(4)(E) of the Exchange Act, 15
U.S.C. 78o(b)(4)(E) (1988).
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F. Exemptions
Section 13(h)(6) of the Exchange Act authorizes the Commission to
exempt any person or class of persons or any transaction or class of
transactions, either conditionally, upon specific terms and conditions,
or for stated periods. The Commission may provide for such exemptions
through rules or orders that are consistent with the purposes of the
Exchange Act.73
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\7\3 See 15 U.S.C. 78m(h)(6) (1990).
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The commenters did not express objections to the proposed
exemptions, which were based upon the capture of similar information by
SROs or involve activity generally deemed not to affect markets for
publicly traded securities. The commenters, however, suggested
additional classes of persons and transactions that should be exempt.
These suggested exemptions included: (1) Introducing broker-dealers;
(2) foreign and domestic market makers; (3) certain custodian banks;
(4) small investment managers; (5) unit investment trusts; (6) issuer
repurchases; and (7) after-hours foreign trading activity.
Paragraph (g)(1) of the reproposed rule would specifically provide
that certain broker-dealers are exempt from the identification,
recordkeeping, and reporting requirements of the Rule. The reproposed
rule would retain the exemptions proposed (i.e., specialists, option
market makers, and floor brokers) and add market makers registered by a
national securities association to the extent that they are acting in
their market making capacity.
Paragraph (g)(2) of the reproposed rule would exempt certain
transactions and introducing broker-dealers from the reporting
requirements. The specific transactions that would be exempt from the
reporting requirements only include those transactions effected by
specialists, option market makers, and other market makers in the
publicly traded securities for which they are registered. In addition,
paragraph (g)(2)(iii) has been added to definitively exempt introducing
broker-dealers that do not carry accounts for themselves or others from
the reporting requirements of the reproposed rule.
The Commission believes that the comprehensive exemptions for
entities that are subject to similar SRO recordkeeping and reporting
requirements would establish an equal competitive environment between
all forms of market professionals that are registered with an SRO. The
Commission also believes that these exemptions would assure that the
reproposed system collects the appropriate information from the
appropriate registered broker-dealers.
With respect to other suggested exemptions, the Commission believes
that some have been incorporated in portions of the reproposed rule.
For instance, the reproposed definition of a large trader, reduced
scope of Form 13H, and inactive filing status, would implicitly exempt
or significantly reduce the burden on custodian banks or trust
companies, foreign market makers, and unit investment trusts.74 On
the other hand, the Commission believes that some of the other
suggested exemptions would not be consistent with the purposes of the
large trader reporting provisions of the Exchange Act.75
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\7\4 Unit investment trusts, and similar ``closed-end mutual
funds,'' essentially are fixed portfolios of securities assembled by
a sponsor and held for the life of the trust. Typically, these
entities investments are static and, therefore, the identification
or reporting requirements of the reproposed rule may be triggered
only at their inception and termination. The new inactive status was
designed, in part, with these entities in mind and would effectively
eliminate the ongoing burdens of the reproposed rule on these
entities.
\7\5 These suggested exemptions would include: (1) ``small''
investment advisers that control ``large transactions'' (i.e.,
transactions that reach the identifying activity level); (2) issuer
repurchases; and (3) after-hours foreign trading activity.
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The exemptive provisions of the reproposed rule acknowledge the
existing systems for collecting similar information. The Commission
believes that these exemptions accomplish the purposes of the Market
Reform Act and minimize the number of persons affected by the various
aspects of the reproposed rule.
G. Application to Foreign Entities
In the Proposing Release, the Commission discussed the application
of the proposed rule to foreign entities.76 The Commission was,
and continues to be, concerned that excluding foreign entities and
persons would leave domestic markets and exchanges at a competitive
disadvantage relative to foreign markets and exchanges. Moreover, the
Commission is concerned that the exclusion of foreign intermediaries
(i.e., broker-dealers and banks) that maintain omnibus accounts with
domestic broker-dealers would competitively disadvantage domestic
intermediaries that perform omnibus trade execution or custodial
functions for large traders. The Commission believes that the
preservation of a fair competitive environment is fundamental to the
accomplishment of the purposes of the Market Reform Act.
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\7\6 See Proposing Release, 56 FR 42558, at text accompanying
nn. 105-109.
---------------------------------------------------------------------------
The Commission solicited comments from foreign and domestic market
participants and foreign regulatory agencies regarding the application
of the proposed rule and, specifically, alternative means for filing
Form 13H, maintaining Form 13H information, and assigning LTIDs. The
Commission received 15 comments from foreign entities.77 These
commenters questioned the extent to which the proposed rule would apply
and asserted that compliance with the proposed rule may cause breaches
of certain local confidentiality requirements.
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\7\7 Of these 15 comments, 12 were submitted by regulatory
organizations or industry associations, including; the Ambassador of
France, London Stock Exchange, British Department of Trade and
Industry, German Ministry of Finance, Association of German Banks,
British Merchant Banking and Securities House Association,
Delegation of the Commission of the European Communities,
Institutional Fund Managers Association, Institute of International
Bankers, Swiss Bankers Association, Hong Kong Association of Banks,
and Thesaurier-Generaal of the Netherlands.
---------------------------------------------------------------------------
Many of these commenters generally asserted, without explanation,
that the application of the proposed rule was unacceptable. A few of
the commenters acknowledged the existence of memoranda of understanding
(``MOUs''), however, none offered specific ideas or sought further
discussions regarding alternatives or the development of ``MOU-type''
understandings. It should be noted that, in an enforcement context, the
Commission would continue to obtain information from foreign regulatory
authorities pursuant to existing MOU protocols.
As discussed above, the application and scope of the reproposed
rule would be established by the definition of a large trader, which
closely tracks Section 13(h)(8)(A) of the Exchange Act.78 The
Commission also notes that foreign broker-dealers would not be subject
to recordkeeping or transaction reporting requirements of the
reproposed rule. Accordingly, only foreign entities that are large
traders would be subject to the reproposed rule. The duties and burdens
imposed on all large traders include: (1) Filing Form 13H; (2)
disclosing large trader status; (3) providing other information about
accounts and reported transactions; and (4) if the foreign large trader
maintains or controls transactions in an omnibus account carried by a
registered broker-dealer, and the duty to assure compliance with the
identification and disaggregation requirements of the reproposed rule.
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\7\8 15 U.S.C. 78m(h)(8)(A) (1990).
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A foreign entity or person would be a large trader, thus subject to
the reproposed rule, only if the following four elements are present:
(1) A person owns or controls an account or aggregated accounts; (2)
such person effects aggregate transactions in publicly traded
securities that reach the identifying activity level; (3) such
transactions are effected directly or indirectly by or through accounts
maintained by a registered broker-dealer; and (4) such transactions are
effected by use of any means or instrumentality of interstate commerce
or the mails or any facility of a national securities exchange.
The various combinations of these elements are too numerous to
discuss at length. However, the bounds of the application of the
reproposed rule may be explored through the analysis of two typical
examples of securities activity that may be referred to as ``foreign
activity.'' First, assume that a foreign bank maintains an omnibus
account with a domestic registered broker-dealer. Through this omnibus
account, the foreign bank effects trades in publicly traded securities
on a national securities exchange for its foreign customers (i.e.,
citizens of, or persons domiciled in, a foreign country) that reach the
identifying activity level. In this case, the foreign bank would be a
custodian or nominee large trader and would be required to: (1) File
Form 13H and Schedules 7b and/or 8; (2) disclose its LTID and all such
accounts to the registered broker-dealers carrying such accounts; (3)
assure compliance with the disaggregation and identification
requirements as well as the accuracy of Schedules 7b or 8; and (4) if
requested, disaggregate accounts or transactions.
As noted above, the foreign bank large trader would not be required
to disclose on its Form 13H the non-large trader foreign customers
whose trades are effected through its omnibus accounts. However, the
reproposed rules would require the foreign bank large trader to assure
that the information contained on Schedules 7b and 8 is accurate and
complete. Accordingly, the foreign bank large trader would be required
to disclose to the Commission the LTID or IID System numbers of its
identified large trader customers.
In addition, if the foreign bank large trader effects transactions
through such omnibus accounts for one of its customers and such
transactions reach the identifying activity level, then in order to
assure compliance with the disaggregation and identification
requirements of the reproposed rule, the foreign bank large trader
would have a duty to advise such foreign customer of its duty to file
Form 13H and disclose its status in accordance with the reproposed
rule. This duty would apply to the foreign bank large trader whether
the customer's transactions were effected on a discretionary or non-
discretionary basis.
For a second example, assume that a registered broker-dealer
carries the account of a domestic or foreign customer, and it effects a
program trade in publicly traded securities in a foreign over-the-
counter market or exchange. In order to effect the trade, the
registered broker-dealer transmits the order information by facsimile
to a foreign broker-dealer affiliate. Further, assume that the
affiliated foreign broker-dealer effects the transaction for an omnibus
account which it carries in the name of the domestic broker-dealer.
This activity would cause the foreign or domestic customer to be a
large trader because it owned accounts, had effected the requisite
trades indirectly through an account maintained by a registered broker-
dealer, and through the means or instrumentality of interstate
commerce.
Alternatively, if the foreign broker-dealer exercised control over
the transaction then it also would be a large trader because it would
have controlled accounts and effected the requisite trades by or
through an account carried by a registered broker-dealer. Conversely,
neither the customer or foreign broker-dealer would be large traders if
the trade was effected exclusively by or for an account owned or
controlled by the foreign or domestic customer and carried by the
foreign broker-dealer, because the transaction would not be effected
directly or indirectly by or for an account carried by a registered
broker-dealer.
As discussed above, the identification requirements would
significantly clarify and narrow the scope of the reproposed rule and,
thereby, reduce the associated burdens on all large traders.
Accordingly, the Commission believes that the burdens imposed on
foreign large traders are necessary and appropriate, not unduly
burdensome, and are imposed uniformly on domestic and foreign markets,
exchanges, intermediaries, and investors.
H. Proposed Implementation
The Commission proposes that the transaction reporting requirements
contained in paragraph (e) of the reproposed rule become effective 18
months after adoption of the final rule. The Commission believes that
this time frame would provide sufficient time for the securities
information processors and broker-dealers to plan, design, and
implement all of the various enhancements to existing transaction
reporting systems required by the reproposed rule. During this
implementation period, the Commission would conduct periodic tests of
the trade reporting system and work closely with broker-dealers, SIAC,
and the ISG to develop all of the technical data processing software
required by the reproposed rule.
The Commission believes that this implementation objective would
facilitate the cost-effective development of the transaction reporting
systems required by the reproposed rule. The Commission specifically
solicits comments on whether the proposed 18 month period would be
feasible.
I. Statutory Authority
Section 13(h)(5) of the Exchange Act requires the Commission, when
exercising its rulemaking authority for large trader reporting, to
consider: (1) Existing reporting systems; (2) the costs associated with
keeping and reporting large trader information; and (3) the
relationship between United States and international securities
markets. The Commission considered these requirements when formulating
the proposed rule and firmly believed that, notwithstanding certain
elements of the proposed rule that may cause market participants to
incur additional costs, the proposed system minimized costs in
virtually every respect. The additional costs acknowledged by the
Commission, included: (1) Preparation, filing, and updating Form 13H;
(2) maintenance and reporting of large trader transaction information;
(3) maintenance and reporting of LTIDs and execution times; and (4)
development and implementation of supervisory systems and procedures.
The reproposed rule reflects the Commission's commitment to work
with market participants to incorporate all existing industry systems
that would minimize the costs associated with the reproposed system.
The reproposed rule also reflects the Commission's conscious decision
to shift substantial portions of the burdens imposed by the proposed
rule from market participants to the Commission. Further, the foreign
application of the reproposed rule has been carefully considered in
light of its impact on the relationship between foreign and domestic
securities markets, intermediaries, and investors.
The Commission believes that the comments on the proposed rule
highlight the complexity of designing a simple and efficient large
trader system that accommodates many different types of large traders
as well as business practices and procedures. Faced with these
conflicting needs and practices, the Commission is reproposing rules
that it believes would minimize the costs and burdens imposed on the
greatest number of affected market participants.
The Commission believes that the reproposed rule narrows and
clarifies the definition of a large trader, and thus reduces the costs
and burdens of the system. The revisions to the identification
requirements, through the various definitions and rules for
aggregation, have significantly reduced the number of persons who would
be subject to the identification requirements of the reproposed rule.
The inactive filing status, and the other filing or disclosure
requirements, have been revised to incorporate other existing
information and eliminate unnecessary information.
The Commission believes that the information captured and disclosed
under the reproposed identification requirements would be the minimum
necessary for creating an effective large trader reconstruction tool.
Moreover, the Commission believes that such information would be
collected or disclosed in a fashion that approximates existing systems,
practices, and procedures commonly used by all forms of large
traders.79
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\7\9The Commission reiterates its belief that the reproposed
rule is consistent with the intent of the Market Reform Act and only
requires identification or disclosure of large traders whose
transactions are effected through omnibus accounts, and not ``small
beneficial owners'' whose trades are effected through such accounts.
See Proposing Release, 56 FR 42553, at n. 41 (citing the Senate
Report); and House Report, supra n. 4, at 25.
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The modifications and additions to the recordkeeping and reporting
requirements of the reproposed rule would significantly clarify their
application and reduce technical burdens. The Commission believes that
the reproposed rule's additional elements of transaction information,
combined with the new reporting requirements for multiple LTIDs and
system or manual order execution times, incorporate existing
recordkeeping and reporting practices, procedures, and systems for
customer trade information. As a result, the Commission believes that
the reproposed recordkeeping and reporting requirements would provide
the least burdensome method of collecting large trader transaction
information.
The supervisory provisions of the reproposed rule would clarify the
duty to supervise. The supervisory obligations also would assure the
credibility of the reproposed system and a level playing field between
broker-dealers and other omnibus large traders to the greatest extent
permitted by the Market Reform Act. The Commission believes that the
new safe harbor provision provides meaningful detail and objectivity
that would considerably reduce the burden of the supervisory duties.
The Commission also believes that the reduced burdens of the
identification requirements may foster greater compliance with the
reproposed rule and indirectly reduce the supervisory burden of broker-
dealers and omnibus large traders.
The Commission believes that the reproposed rule's application to
foreign entities and persons would accomplish the objectives of the
Market Reform Act by maintaining uniformity between domestic and
foreign markets, exchanges, intermediaries, and investors. Finally, the
Commission believes that the proposed plan for implementing the
transaction reporting system would facilitate its cost-effective
development.
IV. Conclusion
The Commission is reproposing Rule 13h-1 and Form 13H, which would
establish an activity-based identification, recordkeeping, and
reporting system for large trader accounts and transactions. This
system would enable the Commission to gather large trader information
in a timely manner and in the form necessary to reconstruct trading
activity in periods of market stress and for surveillance, enforcement,
and other regulatory purposes. The Commission believes that the
reproposed rule achieves the objectives of the Market Reform Act and
would establish an effective market reconstruction tool that minimizes
costs.
V. Effects on Competition and Regulatory Flexibility Analysis
Section 23(a) of the Exchange Act80 requires that the
Commission, when proposing rules under the Exchange Act, consider the
effects on competition of such rules, if any, and balance any anti-
competitive impact against the regulatory benefits gained in terms of
furthering the purposes of the Exchange Act. The Commission is of the
view that the Rule will not result in any burden on competition that is
not necessary or appropriate in furtherance of the purposes of the
Exchange Act.
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\8\015 U.S.C. 78w(a) (1988).
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Pursuant to the requirements of the Regulatory Flexibility
Act,81 the Commission previously prepared an Initial Regulatory
Flexibility Analysis (``IRFA''), concerning the proposed rule. The IRFA
indicated that the proposed rule may impose some additional costs on
small broker-dealers, small investment advisers, and small investors.
The Commission has prepared a revised IRFA that details the changes to
the proposed rule found in the reproposed rule. The Commission believes
that the reproposed rule has been structured in a manner that further
minimizes the costs of the reproposed system and fulfills the
requirements of the Market Reform Act and section 13(h) of the Exchange
Act. A copy of the revised IRFA may be obtained from Cameron D. Smith,
Staff Attorney, Division of Market Regulation, Securities and Exchange
Commission, 450 Fifth Street NW., Washington, DC 20549, (202) 272-5418.
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\8\15 U.S.C. 604 (1988).
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VI. List of Subjects in 17 CFR Parts 240 and 249
Reporting and recordkeeping requirements, Securities.
In accordance with the foregoing, title 17, chapter II of the Code
of Federal Regulations is proposed to be amended as follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
1. The authority citation for part 240 continues to read in part as
follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77eee, 77ggg,
77nnn, 77sss, 77ttt, 78c, 78d, 78i, 78j, 78l, 78m, 78n, 78o, 78p,
78s, 78w, 78x, 78ll(d), 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37,
80b-3, 80b-4 and 80b-11, unless otherwise noted.
* * * * *
2. By adding Sec. 240.13h-1 to read as follows:
Sec. 240.13h-1 Large trader reporting system.
(a) Definitions. For purposes of this section--
(1) The term large trader means every person who, for an account
that he owns or controls, effects transactions for the purchase or sale
of any publicly traded security or securities by use of any means or
instrumentality of interstate commerce or of the mails, or of any
facility of a national securities exchange, directly or indirectly by
or through a registered broker or dealer in an aggregate amount equal
to or in excess of the identifying activity level.
(2) The term person shall mean those persons and entities specified
in Section 3(a)(9) of the Securities Exchange Act of 1934, two or more
persons acting as a partnership, limited partnership, syndicate, or
other group, but does not include a foreign central bank, and also
includes such persons, entities, partnerships, or groups acting as a
trustee.
(3) The term account or accounts means each proprietary and
customer account maintained or carried by a registered broker or
dealer, which is disclosed or undisclosed to such broker or dealer as
to ownership, and for which books and records are required to be made
and kept in accordance with the provisions of Sec. 240.17a-3.
(4) Ownership. An account of a person shall be deemed to be owned
or under common ownership of the person in whose name an account is
maintained, or a custodian or nominee that maintains an omnibus account
or accounts otherwise undisclosed as to ownership, and any other person
who has more than a 10 percent financial interest in the equity in the
account or accounts of such person.
(5) Control. An account of a person shall be deemed to be
controlled or under the common control of the owner of such account,
and any other person that has received or been assigned full or limited
investment discretion from the owner of such account. For purposes of
this section:
(i) The term full discretionary investment authority means the
discretion to enter orders for an account owned by another person, for
the purchase or sale of any publicly traded security or securities, of
any size, and at any time or price, without prior instruction or
approval of the owner of such account; and
(ii) The term limited discretionary investment authority means the
discretion to enter orders for an account owned by another person, for
the purchase or sale of any publicly traded security or securities,
limited only to the price or time of execution, upon the express prior
instruction or approval of the owner of such account.
(6) The term publicly traded security means any equity security,
option on an equity security, or an option on a group or index of
equity securities (or based on the value thereof) listed, or admitted
to unlisted trading privileges, on a national securities exchange and
all other national market system securities as defined in
Sec. 240.11Aa2-1.
(7) The term transaction or transactions means all transactions in
publicly traded securities, including cancellations, corrections, and
exercises or assignments of option contracts, except for the following
transactions:
(i) Any journal or bookkeeping entry made to an account in order to
record or memorialize the receipt or delivery of funds or securities
pursuant to the settlement of a transaction;
(ii) Any transaction that is part of an offering of securities by
or on behalf of an issuer, or by an underwriter on behalf of an issuer,
or an agent for an issuer, whether or not such offering is subject to
registration under the Securities Act of 1933, provided, however, That
this exemption shall not include an offering of securities effected
through the facilities of a national securities exchange;
(iii) Any transaction effected in reliance on Sec. 230.144A of this
chapter;
(iv) Any transaction that constitutes a gift;
(v) Any transaction effected by a court appointed executor,
administrator, or fiduciary pursuant to the distribution of a
decedent's estate;
(vi) Any transaction effected pursuant to a court order or judgment
for distribution of property in settlement of a marital proceeding;
(vii) Any transaction effected pursuant to a rollover of qualified
plan or trust assets subject to section 402(a)(5) of the Internal
Revenue Code (26 U.S.C. 402(a)(5)); or
(viii) Any transaction between an employer and its employee(s)
effected pursuant to the award, allocation, sale, grant or exercise of
a publicly traded security, option or other right to acquire securities
at a pre-established price pursuant to a plan which is primarily for
the purpose of an issuer benefit plan or compensatory arrangement.
(8) The term identifying activity level means:
(i) Aggregate transactions in publicly traded securities, effected
during a calendar day where the account is located, that are equal to
or greater than the lesser of 200,000 shares and fair market value of
$2,000,000, or fair market value of $10,000,000; or
(ii) Any transaction or transactions that constitute program
trading.
(9) The term program trading means either index arbitrage or any
trading strategy involving the related purchase or sale of a group or
basket of 15 or more publicly traded securities that have a total fair
market value of $1,000,000 or more.
(10) The term index arbitrage means a trading strategy involving
the purchase or sale of a group or basket of publicly traded securities
in conjunction with the purchase or sale, or intended purchase or sale,
of one or more cash-settled option or futures contracts on a group or
index of equity securities (or based on the value thereof), or options
on such futures contracts (collectively, derivative index products) in
an attempt to profit from a difference between the price of a group or
basket of equity securities and the price of a derivative index product
through transactions that need not be executed contemporaneously.
(b) Identification requirements for large traders.--(1) Form 13H.
Each large trader shall file Form 13H (17 CFR 249.327) with the
Commission, in accordance with the instructions contained therein:
(i) Within 10 business days after first effecting aggregate
transactions, or after effecting aggregate transactions subsequent to
becoming inactive pursuant to paragraph (b)(3) of this section, which
equal or exceed the identifying activity level; and
(ii) Within 60 calendar days after the end of each full calendar
year thereafter.
(2) Disclosure of large trader status. Each large trader that:
(i) Controls an account, or acts as a custodian or nominee for an
omnibus account, shall disclose its large trader identification number
and all of its owned or controlled accounts to any registered broker or
dealer that carries such accounts;
(ii) Controls an omnibus account, shall disclose its large trader
identification number or Depository Trust Company Institutional
Delivery System number to the custodian or nominee of such omnibus
account; or
(iii) Owns an account for which it has assigned control to another
person, shall disclose its large trader identification number or
Depository Trust Company Institutional Delivery System number to such
other person.
(3) Inactive Status. A large trader that has not effected aggregate
transactions during the previous full calendar year that equal or
exceed the identifying activity level and an aggregate calendar year
total of 2,000,000 shares or fair market value of $30,000,000, shall
become inactive upon filing and shall not be required to file Form 13H
or disclose its large trader status thereafter.
(4) Other Information. Large traders shall provide the Commission
with such other descriptive or clarifying information it may request
from time to time regarding accounts, or transactions effected through
accounts, identified on Form 13H.
(c) Aggregation of accounts and transactions.--(1) Accounts. For
the purpose of determining whether a person is a large trader, the
following shall apply:
(i) All accounts through which transactions are effected directly
or indirectly by a person that are owned or controlled by, or under
common ownership or control with such person, which independently would
be a large trader, may be aggregated;
(ii) All accounts through which transactions are effected directly
or indirectly by a person owned or controlled by, or under common
ownership or control with such person, which independently would not be
a large trader, shall be aggregated; and
(iii) Under no circumstances shall a person or group of persons
acting in concert toward a common investment objective, be permitted to
disaggregate accounts owned or controlled by or under the common
ownership or control of such person or group of persons, in order to
avoid the identification requirements of this section.
(2) Transactions. For the purpose of determining whether a person
is a large trader, the following shall apply:
(i) The gross volume or fair market value of transactions in equity
securities and the gross exercise volume or exercise value of the
equity securities underlying transactions in options on equity
securities, purchased and sold, shall be aggregated;
(ii) The gross exercise value of transactions in options on a group
or index of equity securities (or based on the value thereof),
purchased and sold, shall be aggregated; and
(iii) Under no circumstances shall a person or group of persons be
permitted to subtract, offset, or net purchase and sale transactions,
in equity securities or option contracts, and among or within accounts,
when aggregating the volume or fair market value of transactions
effected under this section.
(3) Disaggregation.--(i) Generally. The Commission may require a
large trader to disaggregate accounts or transactions in any manner,
and provide additional transaction or other information relating to
transactions previously reported by a registered broker or dealer, in
such cases and upon reasonable terms and conditions considering the
operational capabilities of such large trader, when it determines such
to be necessary or appropriate in the public interest, for the
protection of investors, or otherwise in the furtherance of the
purposes of this section.
(ii) Omnibus accounts. Large traders that effect transactions
through or maintain omnibus accounts with a registered broker or dealer
shall establish and maintain policies and procedures reasonably
designed to assure compliance with the disaggregation and
identification requirements of this section and, in particular, assure
the accuracy and completeness of Schedules 7b or 8 to Form 13H.
Policies and procedures that are substantially comparable to those
described in paragraph (f) of this section shall be deemed to be in
compliance with this section.
(d) Recordkeeping requirements for brokers and dealers.--(1)
Generally. Every registered broker or dealer that carries accounts for
large traders and persons such broker or dealer knows or has reason to
know are large traders, based on transactions effected by or through
such broker or dealer, shall maintain records of all elements of
information for all transactions effected directly or indirectly by or
through an account carried by such broker or dealer for all large
traders and persons that such broker or dealer knows or has reason to
know are large traders.
(2) Specific information. The elements of information required to
be maintained for all transactions, shall include:
(i) Date on which the transaction was executed;
(ii) Account number;
(iii) Identifying symbol assigned to the security;
(iv) Transaction price;
(v) The number of shares or option contracts traded and whether
such transaction was a purchase, sale, or short sale, and if an option
transaction, whether such was a call or put option, an opening purchase
or sale, a closing purchase or sale, or an exercise or assignment;
(vi) The clearing house number of such broker or dealer and the
clearing house numbers of the brokers or dealers on the opposite side
of the transaction;
(vii) A designation of whether the transaction was effected or
caused to be effected for the account of a customer of such broker or
dealer, or was a proprietary transaction effected or caused to be
effected for the account of such broker or dealer;
(viii) Market center where the transaction was executed;
(ix) The time that the transaction was executed, as required to be
reported under paragraph (e) of this section;
(x) The large trader identification number, of the person that
controls the account or the custodian or nominee of an omnibus account,
for which the transaction was effected;
(xi) The Depository Trust Company Institutional Delivery System
numbers of agents, broker-dealers, institutions, and other interested
parties otherwise maintained by such broker or dealer for the account
for which a transaction is effected;
(xii) The code, identification, or sequence number assigned to a
transaction that was routed or effected through an automated order
routing system maintained by a self-regulatory organization; and
(xiii) Any other codes, designations, or identifiers that the
Commission may deem necessary or appropriate for compliance with the
recordkeeping or reporting requirements of this section.
(3) Retention. The records and information required to be made and
kept pursuant to the provisions of this section shall be kept for such
periods of time as provided in Sec. 240.17a-4(b).
(e) Reporting requirements for brokers and dealers.--(1) Generally.
Upon the request of the Commission, or a self-regulatory organization
designated by the Commission, every registered broker or dealer that
carries accounts for large traders and other persons for whom records
must be maintained, shall electronically report in machine-readable
form and in accordance with instructions issued by the Commission, all
elements of information for all transactions effected directly or
indirectly by or through accounts carried by such broker or dealer for
large traders and other persons for whom records must be maintained,
which equal or exceed the reporting activity level.
(2) The term reporting activity level means:
(i) Each transaction in publicly traded securities, effected during
a calendar day where the account is located, that is equal to or
greater than the lesser of 2,000 shares or fair market value of
$100,000;
(ii) Any other transaction in publicly traded securities of lesser
amount, that a registered broker or dealer may deem appropriate;
(iii) Each transaction, regardless of share quantity or fair market
value, that is part of a group of transactions that constitute program
trading; or
(iv) Such other amount that may be established by order of the
Commission from time to time.
(3) System orders. With respect to transactions routed or effected
through an automated order routing system maintained by a self-
regulatory organization, registered brokers or dealers shall report,
all elements of information for all transactions required to be
maintained, including the time that the transaction was executed,
before the close of business on the day specified in the request for
such transaction information.
(4) Manual orders. With respect to transactions that are not routed
or effected through an automated order routing system maintained by a
self-regulatory organization, registered brokers or dealers shall
report:
(i) All elements of information for all transactions required to be
maintained, except the time that the transaction was executed, before
the close of business on the day specified in a request for such
transaction information; and
(ii) The time that each of such transactions were executed, within
15 calendar days after receipt of a specific request for such
information.
(5) Unidentified large traders. With respect to transactions
effected directly or indirectly by or through the account of a person
that a registered broker or dealer knows or has reason to know is a
large trader, all elements of information for all transactions required
to be maintained and such person's name, address, date that the account
was opened, and tax identification number(s) shall be reported.
(f) Supervisory safe harbor. For the purposes of this section, a
registered broker or dealer shall not be deemed to know or have reason
to know that a person is a large trader if it establishes policies and
procedures reasonably designed to assure compliance with the
identification requirements of this section and does not have actual
knowledge that a person is a large trader. Policies and procedures
shall be deemed to satisfy this section, if they include:
(1) Systems reasonably designed to detect and identify persons that
have not complied with the identification requirements of this section,
which such broker-dealer knows or has reason to know is a large trader,
based upon transactions effected through an account or a group of
accounts, that may be identified as a large trader, based on account
name, tax identification number, or other information readily available
to such broker-dealer; and
(2) Systems reasonably designed to inform large traders of their
obligations to file Form 13H and disclose large trader status under
this section.
(g) Exemptions.--(1) Comprehensive. The identification,
recordkeeping, and reporting requirements of this section shall not
apply to any registered broker or dealer that does not carry accounts
for itself or others, and:
(i) Is registered as a specialist or option market maker by a
national securities exchange;
(ii) Is a member or allied member of a national securities exchange
that exclusively executes transactions on the floor of such national
securities exchange; or
(iii) Is registered as a market maker by a national securities
association to the extent that it effects transactions in its capacity
as a registered market maker.
(2) Reporting requirements. The reporting requirements of this
section shall not apply to:
(i) Transactions for the account of a specialist or option market
maker registered by a national securities exchange, effected in its
capacity as a registered specialist or option market maker;
(ii) Transactions for the account of a market maker registered by a
national securities association, effected in its capacity as a
registered market maker; or
(iii) Any broker or dealer that does not carry accounts for itself
or others.
(3) Written requests. The Commission may, upon written application,
exempt from the provisions of this section, either unconditionally or
on specified terms and conditions, any person, large trader, broker or
dealer, or class of transactions for which the Commission determines
that application of this section is not necessary or appropriate in the
public interest, for the protection of investors, or otherwise in
furtherance of the purposes of this section.
PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934
3. The authority citation for part 249 continues to read in part as
follows:
Authority: 15 U.S.C. 78a, et seq., unless otherwise noted;
* * * * *
4. By adding Sec. 249.327 to read as follows:
Sec. 249.327 Form 13H, information required of large traders pursuant
to section 13(h) of the Securities Exchange Act of 1934 and rules
thereunder.
This form shall be used by persons that are large traders required
to furnish identifying information to the Commission pursuant to
section 13(h)(1) of the Securities Exchange Act of 1934 (15 U.S.C.
78m(h)(1)) and Rule 13h-1(b)) thereunder (Sec. 240.13h-1(b) of this
chapter).
Dated: February 9, 1994.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
Note: Appendix A will not appear in the Code of Federal
Regulations.
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