[Federal Register Volume 61, Number 28 (Friday, February 9, 1996)]
[Notices]
[Pages 5050-5052]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-2872]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36806; File No. SR-DTC-95-26]


Self-Regulatory Organizations; the Depository Trust Company; 
Notice of Filing and Immediate Effectiveness of Proposed Rule Change 
Relating to Securities Payment Order Instructions to Modify Substitute 
Income Payments on Stock Loans

February 2, 1996.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on December 5, 1995, The 
Depository Trust Company (``DTC'') filed with the Securities and 
Exchange Commission (``Commission'') the proposed rule change (File No. 
SR-DTC-95-26) as described in Items I, II, and III below, which items 
have been prepared primarily by DTC. The Commission is 

[[Page 5051]]
publishing this notice to solicit comments on the proposed rule change 
from interested persons.

    \1\ 15 U.S.C. 78s(b)(1) (1988).
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The proposed rule change facilitates participant recordkeeping by 
enabling a participant to specify that a Securities Payment Order 
(``SPO'') \2\ is for the specific purpose of increasing or decreasing 
the amount of a substitute payment \3\ made in connection with 
distributions on borrowed securities.

    \2\ SPOs allow DTC participants to make money payments through 
DTC when these payments are in connection with, but are not the 
direct result of, securities transactions in DTC (e.g., stock 
loans). For a complete description of SPOs refer to Securities 
Exchange Act Release No. 15193 (October 10, 1978), 43 FR 46615 [File 
No. SR-DTC-78-10] (order approving a proposed rule change relating 
to the implementation of securities payment orders).
    \3\ A substitute payment is a payment made by a borrower of 
securities to the lender in lieu of dividends, interest, or other 
distributions on the securities.
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II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, DTC included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments that it received on the proposed rule change. 
The text of these statements may be examined at the places specified in 
Item IV below. DTC has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of such 
statements.\4\

    \4\ The Commission has modified the text of the summaries 
prepared by DTC.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    The purpose of the proposed rule change is to enable participants 
to account for SPOs given to increase or decrease the amount of a 
substitute payment in connection with a securities loan. The amount of 
a substitute payment may be affected by laws requiring the withholding 
of taxes or by a contract between the parties. The proposed rule change 
will allow participants to use existing procedures to specify the 
purpose of the withholding.\5\

    \5\ If this rule change were not implemented, participants could 
accomplish the same purpose using existing procedures, but their 
records would not be specific with regard to the reason for the SPO.
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    The following is an example of how the proposed rule change would 
be used by participants. A typical stock loan occurs to cover a short 
sale or a fail. Suppose the borrower, B, sells 100 shares sort to a 
third party, X. B arranges to borrow stock from a lender, L, to settle 
with X. L delivers the 100 shares to B through DTC with a deliver order 
(``DO'') coded as a stock loan. B then delivers the 100 shares to X 
with an ordinary DO used to settle the transaction. While the loan is 
outstanding, the record date for an upcoming distribution occurs. X 
does not know that B was a short seller or that the stock now in X's 
position at DTC was borrowed from L. DTC's books on the record date 
show L with 0, B with 0, and X with 100 shares. DTC will pay the 
distribution only to X.
    The typical stock loan contract provides that the borrower will 
compensate the lender in lieu of any distribution made on the borrowed 
securities during the period of the loan that the lender would have 
received absent the loan. The compensating payment is referred to in 
the United States as a substitute payment. Because X and not L receives 
the distribution on payment date, B owes L a substitute payment. 
Consequently, there are two payments. The payment to X is a dividend, 
and the payment from B to L is a substitute payment.
    Under DTC's existing Stock Loan Income Tracking (``SLT'') 
system,\6\ does not need to take any action to cause the payment of the 
substitute payment to L. The SLT system notes the stock loan DO and 
creates a memo account to be utilized on future distributions. Under 
the SLT procedures, B's account will be debited and L's account 
credited the cash amount of the substitute payment. For U.S. 
securities, the loan contract between a U.S. lender and a U.S. borrower 
provides that the substitute payment will be computed as 100% of the 
dividend amount.

    \6\ For a complete description of SLT, refer to Securities 
Exchange Act Release No. 34665 (September 13, 1994), 59 FR 48345 
[File No. SR-DTC-94-07] (order approving proposed rule change 
establishing the Stock Loan Income Tracking System).
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    However, some payments by B to L require tax withholding. For 
example, if B and L are both U.S. tax residents and the stock loan is a 
U.S. security, B is required to obtain L's Tax Identification Number 
(``TIN'') before paying the substitute payment. The Internal Revenue 
Code requires B to report the amount of the substitute payment and L's 
TIN to the Internal Revenue Service (``IRS'') with a copy of L. If the 
IRS determines that L's TIN is invalid, B may be required to withhold 
31% of each future substitute payment to L and remit it to the IRS. 
This requirement is known as ``backup withholding.''
    It should be noted that the possibility of L supplying B with an 
invalid TIN causing B to have to make back up withholdings is extremely 
remote. Nevertheless, if this happens when, for example, a dividend 
paralleling a substitute payment is $1.00, B needs a way to cause DTC 
to make a substitute payment of 69 cents instead of $1.00. Under DTC's 
existing rules, B would use DTC's SPO procedure to instruct DTC to 
debit L and credit B for 31 cents. L, having been credited $1.00 by DTC 
and debited 31 cents, would receive a net payment of 69 cents. B would 
receive a net debit of 69 cents and also would be required to remit 
31 cents to the IRS for a net payment of $1.00. This is exactly the 
amount of the substitute payment required under B's and L's stock loan 
contract.
    B could issue an SPO for 31 cents under DTC's existing rules and 
its settlement statement would show the 31 cents, but the settlement 
statement would not state that the 31 cents constituted a decrease in a 
substitute payment. Therefore, DTC is enhancing the SPO and stock loan 
process to give a borrowing participant a method of indicating for its 
records that a certain SPO was for the specific purpose of increasing 
or decreasing the amount of a substitute payment made in connection 
with the distribution on borrowed securities.
    The proposed rule change is consistent with the requirements of the 
Act and specifically with Sections 17A(b)(3)(A) and (F) \7\ because the 
proposed rule change promotes the prompt and accurate clearance and 
settlement of securities transactions by enabling substitute payments 
to be correctly identified.

    \7\ 15 U.S.C. 78q-1(b)(3)(A) and (F) (1988).
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(B) Self-Regulatory Organization's Statement on Burden on Competition

    DTC does not believe that the proposed rule change will have an 
impact on or impose a burden on competition.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants, or Others

    During the design phase of SLT, DTC received suggestions and 
comments indicating that the preferred method of increasing or 
decreasing substitute payments in the SLT would be through DTC's 
existing SPO function. DTC participants suggested that with 
modifications the SPO could allow lenders or borrowers to specify that 
a particular SPO increased or decreased 

[[Page 5052]]
the borrower's substitute payment to the lender. With modifications, 
participants also could enter the SLT-related SPO in advance of the 
payment date so that DTC could execute the SLT-related SPO payment on 
the payment date for the distribution on the borrowed shares. This 
proposed rule change is to implement these modifications and also is to 
assist participants in recordkeeping for cross-border stock loans of 
U.S. securities.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    The foregoing rule change has become effective pursuant to Section 
19(b)(3)(A)(iii) \8\ of the Act and pursuant to Rule 19b-4(e)(4) \9\ 
promulgated thereunder because the proposal constitutes a change in an 
existing service of a registered clearing agency that does not 
adversely affect the safeguarding of securities or funds in the custody 
or control of the clearing agency or for which it is responsible and 
does not significantly affect the respective rights or obligations of 
the clearing agency or persons using the service. At any time within 
sixty days of the filing of such rule change, the Commission may 
summarily abrogate such rule change if it appears to the Commission 
that such action is necessary or appropriate in the public interest, 
for the protection of investors, or otherwise in furtherance of the 
purposes of the Act.

    \8\ 15 U.S.C. 78s(b)(3)(A)(iii) (1988).
    \9\ 17 CFR 240.19b-4(e)(4) (1994).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 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 the proposed 
rule change 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 Room, 450 Fifth Street, N.W., Washington, 
D.C. 20549. Copies of such filing also will be available for inspection 
and copying at the principal office of DTC. All submissions should 
refer to the file number SR-DTC-95-26 and should be submitted by March 
1, 1996.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\10\

    \10\ 17CFR 200.30-3(a)(12) (1995).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-2872 Filed 2-8-96; 8:45 am]
BILLING CODE 8010-01-M