[Federal Register Volume 59, Number 205 (Tuesday, October 25, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-26357]


[[Page Unknown]]

[Federal Register: October 25, 1994]


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FEDERAL RESERVE SYSTEM

12 CFR Part 220

[Regulation T; Docket No. 0840]

 

Credit by Brokers and Dealers

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Final rule.

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SUMMARY: The Board is adopting amendments to Regulation T. The 
amendments are part of the Board's review of Regulation T and respond 
to rulemaking by the Securities and Exchange Commission (SEC) 
concerning settlement of securities transactions and Congressional 
action concerning government securities. The proposed amendments were 
published for public comment in the Federal Register on July 1, 1994. 
The amendments address two general areas: payment periods for 
securities purchases and transactions in government securities. The 
amendments concerning payment periods will reduce by two days the 
amount of time customers have to meet initial margin calls or make full 
cash payment for securities at the same time the SEC reduces the 
standard settlement period by two days, require broker-dealers seeking 
an extension of this time period to obtain the extension from their 
designated examining authority if the balance due is $1000 or more, and 
revise regulatory language in the cash account so that the time periods 
within which extensions must be obtained and when the ``90-day freeze'' 
may be lifted are consistent for certain transactions in which 
settlement exceeds the standard settlement period. The amendments 
concerning transactions in government securities will exempt from 
Regulation T those broker-dealers registered with the SEC solely as 
government securities brokers or dealers and create a new account for 
customers of general broker-dealers that permits transactions in 
government securities to be effected without regard to other provisions 
of the regulation.

EFFECTIVE DATE: November 25, 1994.

FOR FURTHER INFORMATION CONTACT: Scott Holz, Senior Attorney or Angela 
Desmond, Senior Attorney, Division of Banking Supervision and 
Regulation (202) 452-2781; for the hearing impaired only, 
Telecommunications Device for the Deaf (TDD), Dorothea Thompson (202) 
452-3544.

SUPPLEMENTARY INFORMATION: The proposed amendments are part of the 
Board's general review of Regulation T (Docket R-0772) and were 
published for public comment on July 1, 1994 (59 FR 33923). Twenty-two 
comments have been received. The comments on the proposed amendments 
concerning transactions in government securities were supported by all 
commenters, although some asked for additional amendments. The comments 
concerning the proposed reduction in payment periods were mixed, with 
some commenters in favor, some opposed, and some requesting a delay in 
the amendments' effectiveness. The related payment period issues were 
generally supported by the commenters, with the exception of the 
requirement that extensions be obtained solely from the broker-dealer's 
examining authority and the use of language that will automatically 
reduce the payment periods if the standard settlement cycle is reduced. 
Comments on these issues were also mixed.
    The Board is adopting the proposed amendments substantially as 
proposed. Technical changes have been made in the regulatory language 
and structure to respond to comments and clarify the intent of the 
amendments. The two general areas are discussed below.

I. Payment Periods

A. T+3 and Shortening of Payment Periods

    1. Introduction. On October 6, 1993, the SEC adopted Rule 15c6-
1,1 which establishes a standard three business day settlement 
cycle for most securities transactions in the United States, effective 
June 1, 1995. Regular settlement is presently effected in five business 
days. This new standard is often referred to as ``T+3,'' meaning 
regular settlement will occur three business days after trade date. 
Regulation T contains a seven day time period within which brokers must 
obtain cash or margin deposits from their customers. The seven day 
payment period in Regulation T is based on the current five day 
settlement period.
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    \1\17 CFR 240.15c6-1; 58 FR 52891 (October 13, 1993).
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    The Board proposed shortening the payment period in Regulation T by 
the same amount of time that SEC Rule 15c6-1 shortens the standard 
settlement cycle. Instead of changing the phrase ``seven business 
days'' to ``five business days,'' the proposal defined a new term, 
``payment period,'' to represent the number of days in the standard 
settlement cycle plus two business days. This formulation allows the 
regulation to be amended immediately without changing the current 
payment period. Once SEC Rule 15c6-1 becomes effective next June, the 
regulation will automatically require payment within five business 
days. Although the definition of payment period refers to settlement 
date, Regulation T remains a trade date based regulation. The use of 
the phrase ``payment period'' is meant to be an alternate way of 
requiring payment within seven business days until June 1995 and five 
business days thereafter, unless the SEC acts to further change the 
standard settlement cycle. Future changes by the SEC would be 
automatically incorporated in the Board's rule without the necessity of 
further amendment.
    2. Issues raised by commenters. Comments on the proposal to shorten 
the payment periods in conjunction with the SEC's shortening of the 
standard settlement cycle were focused on three issues: whether the 
payment periods should be shortened, whether the proposed language 
clearly accomplishes this goal, and whether future reductions in the 
standard settlement period should be automatically accommodated or 
reviewed by the Board.
    a. Shortening the payment period by two days. The Board is adopting 
the proposed amendments, subject to the clarification discussed in 
section b below. Many of the commenters who oppose shortening the 
payment periods had written to the SEC last year to oppose its T+3 
proposal. The Board and the SEC both have responsibilities in the area 
of settlement and clearance. Shortening the Regulation T payment 
periods is consistent with (if not required by) the SEC's adoption of a 
three day settlement cycle. A failure to adjust the payment periods 
would lessen the overall benefits to be realized from the transition to 
T+3 and increase risk to the broker-dealer community since they will 
have to settle trades amongst themselves in the shortened time frame 
while allowing their customers' behavior and payment patterns to remain 
unchanged. Increased risk to broker-dealers also affects customers with 
cash and securities at those firms. Adoption of the proposed amendments 
by the Board does not reduce the two-day period currently provided to 
resolve payment problems, but merely clarifies that two days beyond the 
usual settlement date should be sufficient to resolve any mistakes in 
the payment process.
    Some of the commenters opposed to shortening the payment periods in 
conjunction with the shortening of the standard settlement cycle 
believe that the mail system does not permit funds to be delivered 
within this time frame. However, the increased use of fax machines and 
money market mutual funds provide alternate ways for customers to make 
prompt payment for their securities purchases. Although the Board 
shares the concerns expressed about investors who rely on the mail to 
pay for securities, it believes that most investors will be able to 
adjust to the shortened periods. Indeed, the Bachmann Task Force on 
Clearance and Settlement Reform in U.S. Securities Markets, which 
recommended to the SEC that the standard settlement cycle be reduced to 
T+3, stated that it ``believes that current customer behavior practices 
should not be an obstacle to shortened settlement provided there is 
strong leadership from within the industry and educational efforts to 
address customer and account executive concerns.''\2\ Many of the 
commenters stressed the fact that the brokerage industry is already 
educating customers about the approach of T+3 settlement and the 
changes this will entail. The Board is of the view that the successful 
implementation of T+3 includes a reduction in the Regulation T payment 
periods. It is expected that broker-dealers will be working with 
customers who may have difficulty making prompt payment. A delay in the 
effectiveness of shortening the payment periods would not necessarily 
improve the educational process, which is already well underway at most 
firms, and might serve as an excuse for others to delay their 
educational efforts.
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    \2\57 FR 27819 (June 22, 1992).
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    b. Uniform payment period. The proposed term ``payment period'' was 
defined as the two business days beyond ``the standard securities 
settlement cycle in the United States.'' This phrase was meant to refer 
to the current five day settlement cycle for most securities 
transactions until SEC Rule 15c6-1 becomes effective next June, at 
which time the Board's regulation would be referring to the three day 
period established in the SEC rule. Additional language has been added 
to the definition of payment period to clarify this point. Some 
commenters believed the reference to a ``standard settlement cycle'' 
depends on the type of security being purchased, so that trades 
involving standardized options or government securities, both of which 
settle the day after trade date, would have to be paid for by the third 
business day after trade date. Although broker-dealers can require 
payment for transactions by settlement date of the particular trade, 
Regulation T establishes a standard period within which customers must 
make payment even though certain securities settle in less than the 
current five day period. It was not the intent of the Board to change 
this general policy.
    c. Impact of further reductions in settlement periods. As noted in 
the request for public comment, one of the reasons for using the phrase 
``payment period'' instead of a fixed number of days was to ensure that 
future reductions in the settlement cycle would be automatically 
reflected in Regulation T, without the need for further amendments. 
Commenters were evenly split on whether the Board should be forced to 
review the Regulation T payment periods whenever the standard 
settlement cycle is altered. The proposed language has been retained. 
In light of the fact that investors are expected to pay for securities 
on settlement date, tying the payment period to the standard settlement 
cycle merely codifies the Board's current position that two business 
days should be sufficient to insure that a failure to receive the 
customer's payment is not due to an error or other exceptional 
circumstance.

B. Granting of Extensions of Time by a Broker-dealer's Examining 
Authority

    If a customer has not made full cash payment or met an initial 
margin call within the payment period, the broker-dealer must liquidate 
the customer's position. However, if exceptional circumstances exist, 
the broker-dealer can obtain an extension for its customer. Regulation 
T currently permits any self-regulatory organization (SRO) to grant 
these extensions. A New York Stock Exchange (NYSE) rule recently 
approved by the SEC requires broker-dealers for whom the NYSE is the 
designated examining authority (DEA) to obtain these extensions only 
from the NYSE.\3\ Although the Board could leave Regulation T unchanged 
and most broker-dealers would still be required to go to their DEA 
instead of any SRO, the Board proposed amending Regulation T to require 
that extensions be granted only by a broker-dealer's DEA. This decision 
was based on analysis of the comments received by the Board in response 
to its advance notice of proposed rulemaking concerning the current 
review of Regulation T and the SEC's consideration of the NYSE rule 
filing. No new information was presented in this area. The Board is 
therefore adopting the requirement that extensions be granted by a 
broker-dealer's DEA.
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    \3\NYSE Rule 434; SEC approval: 59 FR 26826 (May 24, 1994); 
Securities Exchange Act Release 34073 (May 17, 1994).
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C. Technical Amendments Concerning Foreign Securities

    The Board proposed technical amendments to the cash account to 
clear up confusion resulting from its 1990 amendment allowing payment 
for foreign securities to be tied to the appropriate foreign settlement 
period. The amendments would clarify that this longer period is also 
used to determine when extensions of time must be obtained and when the 
``90-day freeze'' may be lifted for foreign securities. Two securities 
trade associations point out that the cash account establishes three 
other situations in which settlement regularly exceeds the standard 
settlement cycle: unissued securities, ``when-issued'' securities, and 
refunded securities.\4\ These commenters suggest the proposed language 
be revised to consistently refer to the various time periods in 
determining when extensions are required and when the ``90-day freeze'' 
may be lifted. These amendments have been redrafted to accommodate this 
suggestion.
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    \4\See Sec. 220.8(b)(1)(i)(B)-(D) of Regulation T.
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D. De Minimis Amount

    The required liquidation of customer purchases for which payment 
has not been received within the required time currently does not apply 
to amounts of $500 or less. The Board proposed doubling this amount to 
$1000 in light of the ten years that had passed since the amount was 
last increased. This increase was supported by a wide variety of 
commenters. The increase to $1000 will still reduce the regulatory 
burden on broker-dealers and their examining authorities by reducing 
the number of extensions that must be requested and processed.

II. Government Securities

    Two amendments were proposed to exempt most transactions in * * * 
government securities from Regulation T. The first exempts those 
brokers and dealers who effect customer transactions only in government 
securities (Section 15C Brokers). The second amendment effectively 
exempts transactions involving government securities for customers of 
general securities broker-dealers by allowing the transactions to be 
effected in a new government securities account. All of the commenters 
supported these two proposed amendments.

A. Exemption from Regulation T for Brokers and Dealers Whose Activities 
are Limited to Government Securities

    The scope of Regulation T, as stated in section 220.1(b)(1), is 
``all financial relations between a customer and a creditor.'' In order 
to exempt Section 15C brokers from Regulation T, the Board proposed 
excluding them from the definition of creditor in section 220.2(b) of 
the regulation. The Public Securities Association (PSA) and the 
Securities Industry Association (SIA) suggest that the exclusion be 
moved to the scope section, so that Section 15C brokers would still be 
defined as ``creditors'' when they are not dealing with ``customers.'' 
For example, the commenters point out that the term ``creditor'' is 
used in the broker-dealer credit account to describe permissible 
transactions between broker-dealers. In light of these comments, the 
exclusion has been moved to the scope section of Regulation T.

B. Government Securities Account

    The second amendment proposed in the area of government securities 
was the creation of a new government securities account. This account 
would allow general broker-dealers to effect customer transactions that 
could be effected by Section 15C Brokers without regard to other 
restrictions in Regulation T.
    In addition to general support of the proposal, commenters focused 
on two areas: the regulatory language used to describe the account and 
whether additional securities and other financial instruments should be 
included in its scope.
    1. Description. The government securities account was proposed for 
``transactions involving government securities, provided the 
transaction would be permissible for a broker or dealer registered 
under section 15C of the act.'' The PSA and the SIA both suggest 
deletion of the reference to Section 15C Brokers because they believe 
it is confusing and unnecessary. They argue that section 15C does not 
establish permissible and impermissible classes of transactions in 
government securities. However, section 15C(b)(7) of the Act prohibits 
government securities brokers and dealers from effecting ``any 
transaction * * * in any government security in contravention of any 
rule under this section.'' The regulatory language for the government 
securities account has been redrafted to clarify that it is available 
for transactions involving government securities as long as the 
transaction is not prohibited under section 15C or any of the rules 
thereunder.
    2. Scope. The PSA, SIA, SIA-Credit Division and one broker-dealer 
suggest that all exempted securities, including municipal securities, 
be included in the new account. A second broker-dealer would include 
foreign sovereign debt that meets the margin requirements of Regulation 
T. In addition, three of these commenters believe that all 
nonconvertible debt securities that meet the margin requirements of 
Regulation T should be eligible for the account and one of these 
commenters would like ``money market instruments'' such as certificates 
of deposit, bankers acceptances and commercial paper to be covered by 
the new account. All of these suggestions will be considered in the 
course of Board's review of Regulation T, with an opportunity for 
public comment. As explained in the request for public comment on the 
proposed government securities account, the rationale for the new 
account stems from the unique regulatory scheme established for U.S. 
government securities and brokers and dealers in that market.

Regulatory Flexibility Act

    The Board certifies that this final rule will not have a 
significant economic impact on a substantial number of small entities.

Paperwork Reduction Act

    This regulation imposes no additional reporting requirements or 
modification to existing reporting requirements.

List of Subjects in 12 CFR Part 220

    Banks, Banking, Bonds, Brokers, Commodity futures, Credit, Federal 
Reserve System, Investment companies, Investments, Margin, Margin 
requirements, National Market System (NMS Security), Reporting and 
recordkeeping requirements, Securities.

    For the reasons set out in the preamble, 12 CFR part 220 is amended 
as follows:

PART 220--CREDIT BY BROKERS AND DEALERS (REGULATION T)

    1. The authority citation for Part 220 is revised to read as 
follows:

    Authority: 15 U.S.C. 78c, 78g, 78h, 78q, and 78w.

    2. Section 220.1 is amended as follows:
    a. The word ``seven'' in the first sentence of paragraph (b)(1) is 
revised to read ``eight''.
    b. A new paragraph (b)(3) is added to read as follows:


Sec. 220.1  Authority, purpose, and scope.

* * * * *
    (b) * * *
    (3) This part does not apply to transactions between a customer and 
a broker or dealer registered only under section 15C of the Act.

    3. Section 220.2 is amended as follows:
    a. Paragraph (h) is revised.
    b. Paragraphs (w) through (aa) are redesignated as paragraphs (x) 
through (bb) and new paragraph (w) is added.
    The revisions and additions read as follows:


Sec. 220.2  Definitions.

* * * * *
    (h) Examining authority means:
    (1) The national securities exchange or national securities 
association of which a creditor is a member; or
    (2) If a member of more than one self-regulatory organization, the 
organization designated by the SEC as the examining authority for the 
creditor.
* * * * *
    (w) Payment period means the number of business days in the 
standard securities settlement cycle in the United States, as defined 
in SEC Rule 15c6-1 (17 CFR 240.15c6-1) under the Act, plus two business 
days. Until June 1, 1995, payment period means seven business days.
* * * * *
    4. In Sec. 220.4, the figure ``$500'' in paragraph (d) is revised 
to read ``$1000'' and paragraph (c)(3) is revised to read as follows:


Sec. 220.4  Margin account.

* * * * *
    (c) * * *
    (3) Time limits. (i) A margin call shall be satisfied within one 
payment period after the margin deficiency was created or increased.
    (ii) The payment period may be extended for one or more limited 
periods upon application by the creditor to its examining authority 
unless the examining authority believes that the creditor is not acting 
in good faith or that the creditor has not sufficiently determined that 
exceptional circumstances warrant such action. Applications shall be 
filed and acted upon prior to the end of the payment period or the 
expiration of any subsequent extension.
* * * * *
    5. In Sec. 220.8, the figure ``$500'' in paragraph (b)(4) is 
revised to read ``$1000'' and paragraphs (b)(1)(i) introductory text, 
(b)(1)(ii), (b)(3), (c)(2)(i), and (d) are revised to read as follows:


Sec. 220.8  Cash account.

* * * * *
    (b) * * *
    (1) * * *
    (i) Within one payment period of the date:
* * * * *
    (ii) In the case of the purchase of a foreign security, within one 
payment period of the trade date or the date on which settlement is 
required to occur by the rules of the foreign securities market, 
provided this period does not exceed the maximum time permitted by this 
part for delivery against payment transactions.
* * * * *
    (3) Shipment of securities, extension. If any shipment of 
securities is incidental to consummation of a transaction, a creditor 
may extend the payment period by the number of days required for 
shipment, but by not more than one additional payment period.
* * * * *
    (c) * * *
    (2) * * *
    (i) Within the period specified in paragraph (b)(1) of this 
section, full payment is received or any check or draft in payment has 
cleared and the proceeds from the sale are not withdrawn prior to such 
payment or check clearance; or
* * * * *
    (d) Extension of time periods; transfers. (1) Unless the creditor's 
examining authority believes that the creditor is not acting in good 
faith or that the creditor has not sufficiently determined that 
exceptional circumstances warrant such action, it may upon application 
by the creditor:
    (i) Extend any period specified in paragraph (b) of this section;
    (ii) Authorize transfer to another account of any transaction 
involving the purchase of a margin or exempted security; or
    (iii) Grant a waiver from the 90 day freeze.
    (2) Applications shall be filed and acted upon prior to the end of 
the payment period, or in the case of the purchase of a foreign 
security within the period specified in paragraph (b)(1)(ii) of this 
section, or the expiration of any subsequent extension.


Sec. 220.18  [Redesignated as Sec. 220.19]

    6. Section 220.18 is redesignated as Sec. 220.19 and new 
Sec. 220.18 is added to read as follows:


Sec. 220.18  Government securities account.

    In a government securities account, a creditor may effect and 
finance transactions involving government securities, provided the 
transaction is not prohibited by section 15C of the Act or any rule 
thereunder.

    By order of the Board of Governors of the Federal Reserve 
System, October 18, 1994.
Jennifer J. Johnson,
Deputy Secretary of the Board.
[FR Doc. 94-26357 Filed 10-24-94; 8:45 am]
BILLING CODE 6210-01-P