[Federal Register Volume 60, Number 190 (Monday, October 2, 1995)]
[Notices]
[Pages 51510-51511]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-24481]



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SECURITIES AND EXCHANGE COMMISSION
[Rel. No. IC-21377; International Series Release No. 859; 812-9728]


The Canadian Depository for Securities Limited and the Investment 
Dealers Association of Canada; Notice of Application

September 26, 1995.
AGENCY: Securities and Exchange Commission (``SEC'').

ACTION: Notice of Application for Exemption under the Investment 
Company Act of 1940 (the ``Act'').

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APPLICANTS: The Canadian Depository for Securities Limited (``CDS'') 
and the Investment Dealers Association of Canada (``IDA'').

RELEVANT ACT SECTIONS: Order requested under section 6(c) of the Act 
that would exempt certain custodial arrangements from all provisions of 
the Act.

SUMMARY OF APPLICATION: Applicants request an order under section 6(c) 
to exempt the custodial arrangements for stripping certain Canadian 
debt securities from all provisions of the Act.

FILING DATES: The application was filed on August 22, 1995, and amended 
on September 20, 1995.

HEARING OR NOTIFICATION OF HEARING: An order granting the application 
will be issued unless the SEC orders a hearing. Interested persons may 
request a hearing by writing to the SEC's Secretary and serving 
applicants with a copy of the request, personally or by mail. Hearing 
requests should be received by the SEC by 5:30 p.m. on October 23, 1995 
and should be accompanied by proof of service on the applicants, in the 
form of an affidavit or, for lawyers, a certificate of service. Hearing 
requests should state the nature of the writer's interest, the reason 
for the request, and the issues contested. Persons may request 
notification of a hearing by writing to the SEC's Secretary.

ADDRESSES: Secretary, SEC, 450 5th Street, NW., Washington, DC 20549. 
Applicants, CDS, 85 Richmond Street West, Toronto, Ontario, M5H 2C9 
Canada; IDA, 121 King Street West, Suite 1600, Toronto, Ontario, M5H 
3T9 Canada.

FOR FURTHER INFORMATION CONTACT:
Sarah A. Buescher, Staff Attorney, at (202) 942-0573, or C. David 
Messman, Branch Chief, at (202) 942-0564 (Division of Investment 
Management, Office of Investment Company Regulation).

SUPPLEMENTARY INFORMATION: The following is a summary of the 
application. The complete application may be obtained for a fee from 
the SEC's Public Reference Branch.

Applicants' Representations

    1. CDS is the major securities depository and clearing corporation 
in Canada. CDS is regulated by the Ontario Securities Commission and by 
the Commission des valeurs mobilieres du Quebec pursuant to provincial 
securities acts. CDS also has entered into an oversight agreement with 
the Bank of Canada, and CDS cooperates with the Office of the 
Superintendent of Financial Institutions. CDS is qualified to serve in 
Canada as an eligible foreign custodian for registered United States 
investment companies under rule 17f-5 of the Act.\1\

    \1\ See The Canadian Depository for Securities Limited (pub. 
avail. Aug. 4, 1994).
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    2. IDA is the national self-regulatory organization for the 
Canadian securities industry, and is the primary regulator of the 
Canadian fixed income market, including Canadian treasury bills and 
government and corporate bonds and debentures.
    3. A group of CDS participants, including major IDA member firms 
and certain Canadian chartered banks and trust companies, have created 
payment strips (``Canadian Strips'') by stripping Canadian securities 
into component parts for sale to investors. The most common form of 
Canadian Strips involves separating bonds of Canadian federal or 
provincial government issuers into individual interest and principal 
payment components. Each individual Canadian Strip is then separately 
held by the CDS participant or traded.
    4. CDS participants sell Canadian Strips directly to investors and 
maintain a secondary market for the Strips. Canadian Strips are 
typically held by CDS participants as nominees for investors. The 
investors have accounts with CDS participants and are the beneficial 
owners of the Strips. CDS participants generally follow the 
instructions of beneficial owners with respect to matters relating to 
securities held by them as nominees, including matters relating to 
defaults.
    5. Originally, CDS participants created Canadian Strips by 
physically separating individual coupons from bearer bond certificates 
(``Physical Strips''). Certificates underlying Physical Strips are in 
bearer form, held for CDS by Canadian banks or trust companies. In 
1987, CDS participants began depositing Physical Strips into CDS and 
also began stripping Canadian debt securities electronically on a book-
entry only basis under CDS procedures. The electronic ledger system at 
CDS separates the underlying securities held in participants' accounts 
into the corresponding book-entry only strip payment components 
(``Book-Entry Strips''). The certificates underlying Book-Entry Strips 
are registered on the books of the issuer in the name of CDS or its 
custodian. Canadian Strips include Physical Strips deposited with CDS 
and Book-Entry Strips which are recorded on CDS ledgers.
    6. The total face value of Canadian Strips on deposit as of April 
30, 1995 was Cdn $130 billion, of which more than 95% relate to bonds 
issued or guaranteed either by Canada or a Canadian province, 
approximately 3.5% relate to Canadian corporate issuers, and the 
remainder relate to municipal and other Canadian issuers, such as 
colleges and hospitals, that are typically supported by provincial 
government credit. More than 85% of the face value of the Canadian 
Strips as of April 30, 1995 were Book-Entry Strips.
    7. The CDS custody arrangements are governed by the CDS rules and 
operating procedures (``CDS Rules''), which allow participants to 
create 

[[Page 51511]]
Canadian Strips and thereafter trade them separately, combine them to 
create strip payment packages, or reconstitute them into underlying 
bonds.
    8. Upon default or certain other events, such as a change in tax 
laws, CDS would typically have certain rights as registered owner, 
including the right in some instances to declare the principal of all 
the underlying bonds then held by it to be immediately due and payable. 
Under the terms of the underlying bonds, such as those issued by the 
Government of Canada and Canadian provinces, the rights of a bondholder 
to act upon a default can be exercised typically only by a person 
recognized as a bondholder on the records of the bond issuer. 
Beneficial owners of the underlying bonds do not appear to have the 
legal right under applicable Canadian law to be recognized by the bond 
issuer. Accordingly, since bonds underlying Canadian Strips are 
commonly held in the name of CDS as bondholder, neither investors that 
beneficially own strips nor CDS participants acting as nominees for 
investors would be able to enforce their rights directly against the 
issuer of such underlying bonds upon a default.
    9. Under CDS Rules, CDS exercises its rights as registered owner in 
accordance with instructions given by CDS participants. CDS 
participants that hold Strips as nominees for investors will instruct 
CDS generally in accordance with instructions received from such 
investors. In the event of an underlying bond default, CDS will 
endeavor to follow instructions from CDS participants to the extent 
practicable, and take such action as it, in good faith and in light of 
any legal advice it may receive, deems reasonable. Consequently, 
investors in Canadian Strips are affected in their right to enforce the 
terms of the underlying bond directly against the issuer because they 
may proceed against the issuer only by giving directions to CDS through 
their CDS participants. When the underlying bonds are in default or 
accelerated, the entitlement of each holder of Canadian Strips will be 
transformed into an undivided interest in the proceeds thereafter 
received on the underlying bonds, allocated among the holders based on 
the ``proportionate economic interest'' of their respective Canadian 
strips determined in accordance with a specified procedure.
    10. CDS acts as receiving and disbursing agent and depository/
recordkeeper for the Canadian Strips and, if directed to do so by the 
holders in accordance with the CDS Rules, to exercise any rights of a 
registered holder of the underlying bonds, including any right to 
accelerate payment of principal thereunder. CDS has no authority to 
exercise any investment discretion at any time with respect either to 
any payments received or to any underlying bonds generally.
    11. Any offers and sales of Canadian Strips to United States 
investors will be made in full compliance with applicable United States 
securities laws, including those relating to registration, disclosure, 
and investor suitability requirements.

Applicants' Legal Analysis

    1. Section 3(a)(3) of the Act defines an investment company as any 
issuer which is engaged or proposes to engage in the business of 
investing, reinvesting, owning, holding, or trading in securities, and 
owns or proposes to acquire investment securities having a value 
exceeding 40 per centum of the value of such issuer's total assets 
(exclusive of Government securities and cash items) on an 
unconsolidated basis.
    2. Applicants recognize that the CDS custody arrangements may be 
viewed as creating an investment company within the meaning of section 
3(a)(3) of the Act by virtue of the procedures governing the exercise 
of remedies and the allocation of any payments subsequently received. 
The CDS custody arrangements may be viewed as constituting a separate 
issuer that both (a) issues the Strips as securities with enforcement 
and payment rights that differ from the enforcement and payment rights 
of the underlying bonds and (b) holds the underlying bonds as separate 
securities in the CDS arrangement. An issuer that issues securities 
such as the Strips and holds other securities such as the underlying 
bonds may be an investment company within the meaning of section 
3(a)(3).
    3. Applicants request an order under section 6(c) of the Act 
exempting the CDS custody arrangements from all provisions of the Act. 
Section 6(c) provides that the SEC may exempt any person or transaction 
from any provision of the Act or any rule thereunder to the extent that 
such exemption is necessary in the public interest and consistent with 
the protection of investors and the purposes fairly intended by the 
policy and provisions of the Act.
    4. Applicants represent that the nature of the Canadian Strips and 
the limited activities of the applicants are not of a character 
intended to be regulated by the Act and do not give rise to the abuses 
against which the Act was directed. CDS is not involved in a general 
program of investing, trading or dealing in securities. CDS does not 
exercise any investment discretion, and performs administrative 
functions.
    5. The investor in Canadian Strips is aware of the issuer of the 
bonds underlying the Canadian Strips at the time of purchase. 
Applicants represent that, since the Canadian Strips are sold 
exclusively on the basis of the credit of the bond issuer, purchasers 
look ultimately to the issuer for their assurance of repayment, rather 
than to CDS.
    6. Applicants represent that, given the remoteness of any claims of 
CDS creditors, the CDS custody arrangements do not appear to present 
any significant credit risk in addition to that presented by the 
investment in the underlying bonds themselves.

    For the Commission, by the Division of Investment Management, 
pursuant to delegated authority.
Margaret M. McFarland,
Deputy Secretary.
[FR Doc. 95-24481 Filed 9-29-95; 8:45 am]
BILLING CODE 8010-01-M