[Federal Register Volume 59, Number 158 (Wednesday, August 17, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-20121]


[[Page Unknown]]

[Federal Register: August 17, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 3434512; File No. SR-MBSCC-94-3]

 

Self-Regulatory Organizations; MBS Clearing Corporation; Notice 
of Amendments and Order Granting Accelerated Approval of Proposed Rule 
Change Relating to Corporate Governance Changes

August 10, 1994.
    On June 21, 1994, MBS Clearing Corporation (``MBSCC'') filed with 
the Securities and Exchange Commission (``Commission'') a proposed rule 
change pursuant to Section 19(b)(1) of the Securities Exchange Act of 
1934 (``Act'').\1\ The Commission published notice of the proposed rule 
change in the Federal Register on July 18, 1994.\2\ On July 15, July 
22, August 4, and August 9, 1994, MBSCC filed amendments to the 
proposed rule change.\3\ No comments have been received on the filing. 
As discussed below, the Commission is approving the proposed rule 
change, including the amendemnts, on an accelerated basis.
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    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\Securities Exchange Act Release No. 34337 (July 8, 1994), 59 
FR 36457.
    \3\ Amendment No. 1 corrected a typographical error in the 
filing. Letter from David T. Rusoff, Foley & Lardner, to Jerry 
Carpenter, Division of Market Regulation (``Division''), Commission 
(July 14, 1994). Amendment No. 2 clarified certain provisions of the 
Shareholders Agreement. Letter from Daniel B. Silver, Cleary, 
Gottlieb, Steen & Hamilton to Jerry Carpenter, Division, Commission 
(July 21, 1994). Amendment No. 3 clarified the procedure for 
shareholders to terminate the Shareholders Agreement. Letter from 
David T. Rusoff, Foley & Lardner, to Jerry Carpenter, Division, 
Commission (August 3, 1994). Amendment No. 4 provided for a 
limitation on the voting entitlements of bank holding companies. 
Letter from David T. Rusoff, Foley & Lardner, to Jerry Carpenter, 
Division, Commission (August 9, 1994).
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I. Description

    MBSCC is currently a wholly owned subsidiary of the Chicago Stock 
Exchange, Incorporated (``CHX''). CHX has agreed to sell all of CHX's 
ownership interest in MBSCC to MBSCC participants and the National 
Securities Clearing Corporation (``NSCC'').\4\ After the transaction is 
completed, participants of MBSCC will own 100% of Class A common shares 
of MBSCC, and NSCC will own 100% of Class B common shares of MBSCC.\5\
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    \4\CHX will sell all of its shares to a corporation formed for 
the sole purpose of acquiring MBSCC stock (``MBSCC Acquisition 
Corporation''). MBSCC participants will own 90% of MBSCC Acquisition 
Corporation, and NSCC will own 10% of MBSCC Acquisition Corporation. 
After the sale of MBSCC stock to MBSCC Acquisition Corporation, 
MBSCC Acquisition Corporation will be merged into MBSCC with MBSCC 
being the surviving corporation.
    \5\All MBSCC participants will have the opportunity to purchase 
shares in MBSCC in proposition to their usage of MBSCC. After the 
initial sale to participants, participants who are not shareholders 
will be entitled to purchase one share of Class A common stock. All 
shareholders will be required to sign the Shareholders Agreement 
described below.
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    The proposed rule change adopts corporate governance changes for 
MBSCC consistent with the transaction described above. The proposed 
rule change amends Article FOURTH of MBSCC's Certificate of 
Incorporation, amends various provisions of MBSCC's By-Laws and Rules, 
and authorizes MBSCC to enter into a Shareholders Agreement.
    Article FOURTH of MBSCC's Certificate of Incorporation is amended 
to increase the number of shares of stock that MBSCC is authorized to 
issue and to divide the common stock into Class A and Class B shares. 
The increased number of authorized shares permits MBSCC participants to 
hold MBSCC shares in proportion to their usage of MBSCC without 
creating fractional shares. The division of the common stock into Class 
A and Class B shares provides a mechanism whereby NSCC, which will 
purchase 100% of Class B shares, is assured one seat on the board of 
directors of MBSCC.
    The amendments to the By-Laws and the Shareholders Agreement set 
forth, among other things, the number of directors, their eligibility, 
and the manner in which directors will be elected. Specifically, the 
amendment to Article 3, Section 3.1 of the By-Laws increases the size 
of the MBSCC board to thirteen from its present size of eleven 
directors.\6\ In addition, Article 3, Section 3.1 of the By-Laws and 
Section 2 of the Shareholders Agreement require that each director, 
other than the NSCC director and one director that represents the 
management of MBSCC, must be an officer or general partner of or hold a 
similar management position with a participant of MBSCC (``Participant 
Director'') and that no more than one officer, partner, director, or 
employee of a participant may serve as director at any given time.
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    \6\Pursuant to Article 3, Section 3.2 of the By-Laws and 
pursuant to the proposed Shareholders Agreement, one of the newly 
created slots on the MBSCC board is for NSCC's delegate to the 
board, and one slot is for an additional representative of 
participants. NSCC will elect one director of the Class III 
directors for so long as NSCC owns Class B shares. Section 3.1 of 
the By-Laws provides for a staggered board of directors with each of 
the three classes elected once every three years.
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    The proposed rule change also amends provisions of the By-Laws to 
lower the number of votes required to call a special meeting from 75% 
to 25% of the outstanding voting power (Article 2, Section 2.3), to 
provide for waiver of notice of a stockholders' meeting (Article 2, 
Section 2.4), and to authorize the board of directors to establish the 
salaries of MBSCC's officers (Article 5, Section 5.2).
    Section 2 of the Shareholders Agreement specifies how Participant 
Directors and members of the nominating committee\7\ are elected. As is 
currently the practice, the nominating committee will nominate 
candidates for Participant Directors and members of the following 
year's nominating committee.\8\ Participants are given the opportunity 
to petition for additional candidates.\9\ If no petitions are filed, 
the participant shareholders must elect the candidates nominated by the 
nominating committee.
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    \7\Under Section 2(A)(ii) of the Shareholders Agreement, no 
person who is a current member of the board or who was a member of 
the board or nominating committee for the prior year may be elected 
to the nominating committee. Members of the nominating committee 
must be officers or general partners of or hold similar management 
positions with MBSCC participants.
    \8\The nominating committee must submit its list of nominees to 
the Secretary of MBSCC no later than sixty days before the annual 
meeting.
    \9\The petition must be signed by a least five participants and 
filed with the Secretary of MBSCC at least thirty days prior to the 
annual meeting.
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    If there are competing candidates due to a petition or petitions 
being filed, ballots will be mailed to all participants. Pursuant to 
Section 2(A)(iii) of the Shareholders Agreement, each participant of 
MBSCC is entitled to the number of votes determined by multiplying the 
number of persons to be elected Participant Directors at the annual 
meeting by one vote for each $1,000 of average monthly volume-related 
fees (rounded down to the nearest one thousand dollars) payable or paid 
by the participant to MBSCC during the preceding year (``Voting 
Entitlement'').\10\ Every participant shall have at least one vote. 
Each participant may cast all of its votes for a single nominee or 
distribute its votes among several nominees. Participants Owners of 
Class A stock must vote their shares as determined by the vote of all 
of the participants whether or not the voting participants are 
shareholders. In the event of a tie vote, the nominating committee 
selects the person who is to be elected director.
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    \10\The Shareholders Agreement contains special provisions for 
participants that are bank holding companies (``BHC'') (as such term 
is defined under the Bank Holding Company Act of 1956) and their 
affiliates. The voting entitlement of a BHC participant and its 
affiliates is limited to 4.9% of the total voting entitlements. The 
voting entitlement of all BHC participants and their affiliates is 
limited to 24.9% of the total voting entitlements. Should the sum of 
the voting entitlements of all BHC participants exceed 24.9%, each 
BHC participant's voting entitlement will be reduced pro rata to 
comply with the 24.9% limitation. The 4.9% limitation will not apply 
to a BHC participant if that BHC participant provides confirmation 
from the appropriate bank regulatory agency that the limitation is 
not applicable to that BHC participant. The 24.9% limitation will 
not apply to BHC participants if any BHC participant provides 
confirmation from the appropriate bank regulatory agency that the 
total voting entitlements of all BHC participants can exceed 24.9% 
of the total voting entitlements.
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    The Shareholders Agreement also contains provisions relating to 
shareholder votes for other than the election of directors.\11\ In 
addition, the Shareholders Agreement contains provisions relating to 
required transfers of MBSCC's stock\12\ and permitted transfers of 
MBSCC's Class A and Class B stock.\13\ The Shareholders Agreement also 
provides that the provisions governing the voting of shares shall 
continue in force for ten years and shall be automatically renewed for 
a subsequent ten year period.\14\ Finally, MBSCC is amending Article V, 
Rule 6, Section 3 of its Rules to delete references to the CHX.
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    \11\Participant shareholders may not remove a director of MBSCC, 
with or without cause but must remove a director for cause if 
directed to do so by a majority of the directors. A \2/3\ 
affirmative vote of the MBSCC shares is required to amend the 
Certificate of Incorporation or the By-Laws of MBSCC, for MBSCC to 
repurchase or issue any of its securities, or for MBSCC to purchase 
securities not incident to MBSCC's normal business. In addition, the 
shareholders must vote as directed by the board of directors for 
amendments to the Certificate of Incorporation relating to (1) 
Greater than majority requirements of quorum and voting at board 
meetings; (2) cumulative voting for the election of directors; (3) 
classification of directors; (4) shareholder rights to fix 
consideration for shares, to determine the stated capital and 
surplus upon issuance, and to authorize a reduction in capital in 
respect of such shares; (5) shareholder rights to fix compensation 
of directors; and (6) shareholder rights to elect and remove 
directors. In addition, the board also has the authority to direct 
shareholder voting for the amendment of any By-Laws except any By-
Law which the board is prohibited from amending by the provisions of 
the By-Laws.
    \12\Upon the insolvency of a participant shareholder, all MBSCC 
shares held by it will be transferred automatically to all other 
participant shareholders pro rata.
    \13\A participant may sell its Class A shares only to another 
participant but only after giving notice to MBSCC of the proposed 
sale. NSCC, the sole owner of Class B stock, may sell its Class B 
shares only to another participant (which shares will immediately 
convert into Class A shares) or to a registered clearing agency but 
only after giving notice to MBSCC of the proposed sale. MBSCC has 
the option to purchase the Class A or Class B shares for the lower 
of $100 per share or the offering price.
    \14\The provisions in the Shareholders Agreement governing 
voting include: (1) The obligation of the shareholders to elect 
directors selected by all participants; (2) the prohibition against 
shareholders removing directors with or without cause; (3) \2/3\ 
majority voting requirements; and (4) requirements that the 
shareholders vote as directed by the board for certain matters (see 
supra footnote 10). All other provisions of the Shareholders 
Agreement remain in effect unless the agreement is terminated or 
amended by the consent of all of the parties to the agreement. If at 
the end of any calendar year there is no agreement governing the 
voting of the shares in effect, the shares of MBSCC will be 
redistributed in proportion to each participant's usage of MBSCC.
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II. Discussion

    The Commission believes the proposed rule change is consistent with 
Section 17A of the Act and, therefore, is approving the proposal. 
Specifically, the Commission believes the proposal is consistent with 
Section 17A(b)(3)(C)\15\ of the Act in that it assures the fair 
representation of its shareholders and participants in the selection of 
its directors and administration of its affairs.
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    \15\15 U.S.C. 78q-1(b)(3)(C) (1988).
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    The Act does not define fair representation or set up particular 
standards of representation. Instead it provides that the Commission 
must determine whether the rules of the clearing agency assure adequate 
representation of participants and shareholders in the selection of the 
board of directors and the administration of the clearing agency's 
affairs. In its release setting forth the standards for registration of 
clearing agencies (``Standards Release''), the Commission stated that 
rather than prescribing a single method for providing fair 
representation, the Commission would evaluate each clearing agency's 
procedures on a case-by-case basis.\16\ With respect to providing 
participants with a meaningful opportunity to be represented in the 
selection of the board of directors and the administration of the 
clearing agency's affairs, the Standards Release suggests a number of 
methods can be used to comply with the fair representation standard. 
Among others, these include the allocation of voting stock to all 
participants based on their usage of the clearing agency or the 
selection by participants of a slate of nominees for which the 
stockholders of the clearing agency will be required to vote their 
shares.\17\
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    \16\Securities Exchange Act Release No. 16900 (July 1, 1980), 45 
FR 41920.
    \17\The other suggestions in the Standards Release are: (1) 
Solicitation of board of director nominations from all participants; 
(2) selection of candidates for election to the board of directors 
by a nominating committee which would be composed of and selected by 
the participants or representatives chosen by participants; or (3) a 
number of directors chosen by and from the participants.
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    MBSCC's proposal initially allows all participants to purchase 
voting stock based on their usage of MBSCC. Rather than reallocating 
the voting shares each year in proportion to participants' usage of 
MBSCC, the Shareholders Agreement requires the participant shareholders 
to elect directors selected by all participants. If the voting 
provisions of the Shareholders Agreement expire, the participants' 
voting stock will be reallocated each year in accordance with each 
participant's usage of MBSCC. Both methods of electing directors appear 
to be consistent with the methods outlined in the Standards Release.
    The Shareholders Agreement should ensure that the candidates for 
the board and the nominating committee represent the entire MBSCC 
participant base. The nominating committee is directed to select 
candidates with a view toward providing fair representation for the 
interests of a cross section of the participants. Other candidates may 
be nominated if the nominating committee is petitioned by participants.
    Other aspects to the proposed rule change serve to enhance the 
ability of small participants to have a voice in the administration of 
MBSCC's affairs. By limiting each participant's representation on the 
board to only one director, MBSCC's board should represent a cross-
section of MBSCC's participant base and should not be dominated by one 
or two large participants. To counter the potential for a few large 
participants to determine the outcome of a shareholder vote, certain 
provisions of the Shareholders Agreement limit the shareholders' 
authority in favor of board power. For example, the shareholders must 
vote as directed by the board regarding removal of directors and the 
amendment of certain provisions of the Certificate of Incorporation. In 
addition, by requiring a \2/3\ vote to amend the Certificate of 
Incorporation or the By-Laws, a greater consensus among shareholders 
must be obtained before making substantial changes to MBSCC's 
administration. The Commission believes that the provisions enhancing 
the authority of the board of directors, who represent all the 
participants, are consistent with a clearing agency's obligations of 
fair representation.
    The Commission also believes that the limitation on the voting 
entitlement of BHC participants is permissible under the fair 
representation requirements. During 1993, the BHCs' usage of MBSCC was 
less than 20% of the total usage of MBSCC, and therefore, no reduction 
in the BHCs' voting entitlement would have been required. MBSCC has 
agreed to notify the Commission if the BHCs' usage of MBSCC exceeds 
24%. However, the Commission believes that even if a reduction of the 
BHCs' voting entitlement occurs, the fair representation requirements 
are not violated because the provision was adopted at the request of 
the BHCs, whose voting entitlements are being reduced, because of the 
Bank Holding Company Act of 1956.
    MBSCC has requested that the Commission find good cause for 
approving the proposed rule change prior to the thirtieth day after the 
date of publication of the notice of filing. The parties to the merger 
have agreed to close the transaction during the first two weeks of 
August 1994. To permit an efficient transfer of ownership from the CHX 
to MBSCC participants, it is necessary that the appropriate governance 
changes are in place. Therefore, the Commission finds sufficient cause 
to accelerate approval of this proposal.
    Interested persons are invited to submit written data, views, and 
arguments concerning the amendments to the proposed rule change. 
Persons making written submissions should file six copies thereof with 
the Secretary, Securities and Exchange Commission, 450 Fifth Street, 
NW., Washington, DC 20549. Copies of the submission, all subsequent 
amendments, all written statements with respect to the proposed rule 
change that are filed with the Commission, and all written 
communications relating to these amendments between the Commission and 
any person, other than those that may be withheld from the public in 
accordance with the provisions of 5 U.S.C. 552, will be available for 
inspection and copying in the Commission's Public Reference Section, 
450 Fifth Street, NW., Washington, DC, 20549. Copies of such filing 
also will be available for inspection and copying at the principal 
office of the above-mentioned self-regulatory organization. All 
submissions should refer to File No. SR-MBSCC-CC-94-3 and should be 
submitted by September 7, 1994.

III. Conclusion

    For the reasons stated above, the Commission finds that the 
proposed rule change is consistent with Section 17A of the Act.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-MBSCC-94-03) be, and hereby 
is, approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-20121 Filed 8-16-94; 8:45 am]
BILLING CODE 8010-01-M