[Federal Register Volume 61, Number 98 (Monday, May 20, 1996)]
[Notices]
[Pages 25253-25257]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-12540]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37208; File No. SR-DTC-95-27]
Self-Regulatory Organizations; The Depository Trust Company;
Order Approving a Proposed Rule Change Implementing the Initial Public
Offering Tracking System
May 13, 1996.
On January 2, 1996, The Depository Trust Company (``DTC'') filed
with the Securities and Exchange Commission (``Commission'') a proposed
rule change (File No. SR-DTC-95-27) under Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'') \1\ seeking to implement the
Initial Public Offering (``IPO'') Tracking System. On January 31, 1996,
DTC amended the proposed rule change.\2\ Notice of the proposal was
published in the Federal Register on March 6, 1996.\3\ On march 7,
1996, DTC filed a second amendment to the proposed rule change.\4\ The
Commission received one comment letter in response to the filing.\5\
For the reasons discussed below, the Commission is approving the
proposed rule change.
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\1\ 15 U.S.C. 78(b)(1) (1988).
\2\ Memo from Richard B. Nesson, Executive Vice President and
General Counsel, DTC, to Christine Sibille, Commission (January 31,
1996).
\3\ Securities Exchange Act Release No. 36897 (February 27,
1996), 61 FR 8992.
\4\ Letter from Richard B. Nesson, Executive Vice President and
General Counsel, DTC, to Christine Sibille, Senior Counsel, Division
of Market Regulation, Commission (March 4, 1996). The amendment
provides that DTC will provide thirty days notice prior to
implementing the IPO Tracking System. Because the amendment did not
change the substance of the filing, the Commission did not republish
the proposed rule change for comment.
\5\ Letter from Carl H. Hewitt, Managing Director and General
Counsel, Spear, Leeds & Kellogg, to Commission (May 3, 1996).
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I. Description
DTC is implementing its IPO Tracking System to allow lead managers
(also referred to as managing underwriters) and syndicate members\6\ of
equity underwritings to monitor ``flipping'' \7\ of new issues.
Currently, many IPOs are distributed entirely in physical, certificated
form outside the depositories so that tracking may be accomplished by
using certificate numbers to monitor the movements of the securities.
DTC's IPO Tracking System provides a means for lead managers to track
IPOs in a book-entry environment and thus eliminates the need to
distribute newly underwritten equity securities through the use of
physical certificates.
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\6\ Syndicate members are a group of broker-dealers that agree
to purchase a new issue of securities from an issuer under an
underwriting agreement. The selling group is a group of broker-
dealers that market the new issue to the public. Selling group
broker-dealers may purchase from a syndicate member or may be a
syndicate member.
\7\ Flipping occurs when a syndicate's lead manager is
supporting the IPO with a stabilization bid (i.e., the lead manager
is purchasing shares in the secondary market in order to keep the
price of the issue from dropping below its initial offering price),
and securities of the IPO that had been distributed to investors are
sold by those investors in the secondary market and are purchased by
a syndicate member. The lead manager may wish to identify flipped
transactions so that underwriting concessions (i.e., the discount
from the offering price received by syndicate members) can be
recovered from the appropriate syndicate members.
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Currently, securities to be listed on an exchange or quoted through
the Nasdaq Stock Market (``Nasdaq'') must be made depository
eligible.\8\ Furthermore, the
[[Page 25254]]
NASD and most exchanges have rules which require transactions in
depository eligible securities between financial intermediaries and
between a financial intermediary and a customer with delivery versus
payment privileges to be settled by book entry.\9\ Due to the need to
distribute new issues in physical form (i.e., without using book entry
movements) for tracking purposes, these rules provide that prior to the
availability of a flipping tracking system a managing underwriter can
delay the date a security is deemed depository eligible for up to three
months after trading has commended in the security. Once a flipping
tracking system becomes available, managing underwriters will no longer
have the option to delay an issue's depository eligible date and will
be unable to distribute Nasdaq quoted or exchange listed new issues in
physical certificate form outside the depositories. DTC will provide
notice of the IPO Tracking system's availability date at least thirty
calendar days prior to its availability.\10\
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\8\ Under the rules of most national securities exchanges and
the National Association of Securities Dealers (``NASD''), in order
to be listed for trading on a national securities exchange or to be
eligible for inclusion in the Nasdaq and issuer must represent that
the CUSIP number identifying the security to be listed of such
exchange or to be eligible for inclusion in Nasdaq is included in
the file of eligible issues maintained by a securities depository
registered as a clearing agency under Section 17A of the Act. E.q.,
New York Stock Exchange (``NYSE'') Rule 227 and NASD Uniform
Practice Code Section 11. Securities Exchange Act Release No. 35798
(June 1, 1995), 60 FR 30909.
\9\ Securities Exchange Act Release No. 32455 (June 11, 1993),
58 FR 33679. E.g., NYSE Rule 226, NASD By-laws, Schedule D, Part II,
Section 1(c)(23) and Uniform Practice Code Section 11.
\10\ Supra note 3.
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Under DTC's proposed rule change, the lead manager will be required
to notify DTC of its decision to use the IPO Tracking System to track
an issue by 4:00 p.m. two days prior to the date of the initial
distribution of securities (``closing date''). On the closing date,
DTC's underwriting department will place the IPO shares in the IPO
control account of the lead manager.\11\ Allocation of these shares by
the lead manager depends upon the nature of the ultimate buyer (i.e.,
retail or institutional).
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\11\ IPO control accounts are restricted accounts established
for DTC participant broker-dealers in which their IPO shares are
kept separate from other shares held by the participants and from
which limited account movements may be made without a ``flip'' being
reported. These unreported movements include: (i) the movement of
shares from the lead manager (or comanager when there are shares to
be distributed to foreign brokers) to a DTC participant and (ii) the
movement of shares from a DTC participant to a custodian for an
institution.
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Retail Trade
For a retail distribution, the lead manager moves the securities
from its IPO control account directly to the IPO control account of the
selling group broker-dealer for the retail customer.\12\ While broker-
dealers are not required to provide customer level detail, selling
group broker-dealers may populate the IPO database with information for
retail accounts (e.g., internal customer identification numbers) either
directly into the IPO Tracking System by using the ``Add Customer-Level
Detail'' function or into the IPO Tracking System through submissions
of daily formatted trade files. Broker-dealers also may change such
information using the IPO Customer Level Adjustment function.
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\12\ Share movements out of the selling group broker-dealer's
IPO control account will be reported as a flip.
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Upon the subsequent sale of a position that was established in the
initial distribution, the selling group broker-dealer releases the
shares from its IPO control account to its free account by using the
IPO release capability through DTC's participant terminal system
(``PTS''), computer-to-computer facilities (``CCF''), or main frame
dual host (``MDH''). The release instructions must include number of
shares, trade date, and price. If the broker-dealer has previously
assigned a customer internal account number to the IPO shares, the
release instructions must include such number which must match a
previously established IPO database entry or the transaction will be
rejected. Upon DTC's acceptance of the release instructions, the shares
are moved from the broker-dealer's IPO control account to its free
account. It is this movement that marks the activity as a flip. All
deliveries and Continuous Net Settlement (``CNS'') short positions are
satisfied from the participant's free account.
Institutional Trade
For an institutional customer, the lead manager moves the shares
from its IPO control account directly into the selling group broker-
dealer's IPO account at DTC by using an initial distribution deliver
order (``DO''). The selling group broker-dealer then distributes the
institutional portion of the initial distribution to the institution's
custodian, which is either an agent bank or prime broker,\13\ through
DTC's Institutional Delivery (``ID'') system or by submitting a DO with
an ID agent bank identifier.\14\ The DO or ID confirm will contain the
Agent Internal Account (``AIA'') number and the Broker Internal Account
(``BIA'') number,\15\ which will be stored in the IPO database.
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\13\ A prime broker is a broker-dealer that acts as custodian
for institutional customers and uses DTC's ID system (i.e., the
prime broker acts as an agent bank).
\14\ Alternatively, the lead manager may deliver directly to the
custodian of the selling group member's institutional client. This
process is referred to as directed concessions.
\15\ The AIA number is the internal number used by the custodian
to identify the institutional client. The BIA number is the internal
account number that the selling group broker-dealer uses to identify
the institutional client.
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Agents banks do not have IPO control accounts; therefore, all
activity into and out of the agent banks' free accounts is monitored to
keep track of customer purchases and sales. When an ID confirm is
generated for a sale in a tracked issue, DTC matches the AIA number on
the confirm against the AIA number in the IPO database. A warning
message is produced on the confirmation and on the affirmed
confirmation when an AIA number does not match any AIA number contained
in the IPO database. Similarly, settlement authorization or DO
processing is prohibited if a match to an AIA number in the IPO
database is not found.\16\ In order to settle the transaction, the
agent bank must either change the AIA number in the IPO database using
the IPO Customer-Level Adjustment function or submit a DO with an AIA
number that matches the IPO database.
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\16\ As a result, the transaction is marked as a fail.
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Unlike agent banks, prime brokers will have IPO control accounts at
DTC. Shares from an initial distribution are moved into the prime
broker's IPO control account, and the IPO database is updated with AIA
and BIA numbers from the ID trade confirmation. The IPO Tracking System
automatically releases IPO positions to the prime broker's free account
for affirmed ID trades of secondary market transactions when the AIA
number on the confirmation matches an AIA number contained in the IPO
database. It is the release of the IPO position that results in a
report of a flip.
When an institutional customer has positions in the same security
purchased both in an IPO and in the secondary market, the system uses
the secondary market position to complete a delivery before using
shares received during the initial distribution. Also, when a customer
has received shares from multiple broker-dealers and subsequently sells
such shares, the system assigns the ``flipped'' shares on a prorated
basis among the selling group members servicing that customer.
Correspondent Relationships
When an introducing broker (ie., not a DTC participant) is acting
as a selling group member, its shares are held by its designated
clearing agent, which may be a broker-dealer or agent bank. When
[[Page 25255]]
distribution these shares, the lead manager identifies the transaction
as a correspondent delivery by entering the Correspondent Account
(``CA'') number on the DO.\17\ The IPO Tracking System captures the CA
number from the delivery to the clearing agent. The CA number is stored
in the IPO database with the clearing agent's participant number to
fully identify a correspondent (i.e., the introducing broker) as a
selling group member.\18\ Subsequent share movements for
correspondents, either sales or account transfers, require use of the
CA number and are subject to the same release rules that apply to
direct DTC participants.
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\17\ The CA number is the clearing firm's internal number for
the introducing broker.
\18\ When the ultimate purchaser is a retail customer, clearing
agents may enter customer-level details into the IPO database on
behalf of correspondents. When the ultimate purchaser is an
institution, clearing agents are able to use the ID system or a
properly identified DO to deliver shares as part of the initial
distribution to a custodian.
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Physical Certificates
DTC does not accept deposits of physical certificates in tracked
issues. Participants may request a physical certificate through a
withdrawal-by-transfer (``WT'') request, which will be processed
beginning on the first settlement day of the issue.\19\ For shares held
by agent banks, the bank must input into the automated WT system the
AIA, CA, and ID agent bank numbers. If the numbers entered do not match
those in the IPO database, the WT request will be rejected. If a WT
request exceeds the position in the agent bank's account, the request
will be rejected, and an error message will be generated. The IPO
Tracking System will process WT requests first using shares which were
not part of the initial distribution and then using shares which were
part of the initial distribution provided there is sufficient position.
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\19\ A WT is used when participants need to withdraw physical
stock or registered bond certificates from DTC registered in a name
other than DTC's nominee name, Cede & Co. DTC permits participants
to withdraw securities in round lots, odd lots, or mixed lots
registered in a name designated by the participant.
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For shares held by broker-dealers, the WT request must include the
customer identification number. DTC will process WT requests using
shares in the IPO control account with a matching customer number. When
there is a customer number match in the IPO database, DTC generates a
release from the IPO account and reports it on the lead manager's and
selling group member's reports as a WT even if the WT is not processed.
The released IPO shares are combined with free account shares, and the
WT is processed from the free account. If the broker-dealer's IPO
control account does not contain shares with a matching customer
number, the WT is processed using shares from the free account provided
there is sufficient position.
Stock Loan
Participants may process stock loan DOs using stock loan reason
codes. Participants do not have to enter individual account numbers
(e.g., AIA numbers) to match the IPO database. For brokers, IPO tracked
shares do not have to be released by participants to execute stock
loans because the IPO system automatically releases these shares. Stock
loans will be reported to the lead manager as separate items from
flipped shares.
Customer Account Transfer
When a customer account includes shares in a tracked issue, the
transfer of such shares cannot occur through the National Securities
Clearing Corporation's (``NSCC'') normal Automated Customer Account
Transfer (``ACAT'') system processing. While the initial processing at
NSCC will remain the same, at the end of the settlement process NSCC
will issue a trade-for-trade ticket for shares in a tracked issue, and
the shares will not be delivered through NSCC's Continuous Net
Settlement System.\20\ Instead, customer shares in a tracked issue must
be processed by DTC's new IPO customer account transfer function. The
function allows the deliverer (i.e., the broker-dealer or agent bank)
to enter the customer internal account number associated with the
shares to be delivered, its participant number, and customer internal
account number of the broker-dealer to which the shares are to be
delivered. The shares are then moved from the IPO control account of
the delivering broker-dealer to the IPO control account of the
receiving broker-dealer.
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\20\ For a complete description of customer account transfers of
IPOs in the ACAT system, refer to Securities Exchange Act Release
No. 36931 (March 6, 1996), 61 FR 10050 [File No. SR-NSCC-96-05]
(notice of filing of proposed rule change modifying the ACAT service
to facilitate the transfer of shares being tracked in the IPO
Tracking System).
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Reclamation
Initial distribution deliveries (i.e., deliveries from the lead
manager to a selling group member) that are reclaimed and matched will
return to the account from which they originated (i.e., the lead
manager's IPO control account). Reclamations done for shares which were
released from a selling group broker-dealer's IPO control account or a
prime broker's IPO control account to a free account to satisfy an
obligation on the secondary market will be returned to the delivering
participant's free account, and such shares will still be registered as
flipped. When a reclamation occurs for an agent bank, the reclaimed DO
will be matched to the original delivery, and the information in the
IPO database will be reversed (i.e., no flip will be registered).
Oversubscription
Generally, when an issue is oversubscribed the lead manager will
purchase securities in the secondary market. These shares will reside
in the lead manager's free account. The lead manager will have the
option of delivering oversubscribed shares from its free account to
selling group members' IPO control accounts or to its IPO control
account for its own customers' shares.
Memo Segregation
Participants may enter memo segregation instructions with share
quantities that represent the combined total of their free and IPO
shares.\21\ As DTC processes DOs, the share quantity of the memo
segregation instruction will be subtracted from the combined share
total of the free account and the IPO account and then compared against
the quantity on the DO to determine if the delivery can take place. The
shares to be delivered will be removed from the participant's free
account.
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\21\ The memo segregation function creates a memo position
within the participant's account enabling participants to protect
customer securities.
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Termination of Tracking
During the tracking period, the lead manager and selling group
members are able to obtain information on the flipping of shares
through hard copy or machine readable daily reports or through a new
PTS inquiry function.\22\ DTC discontinues tracking an IPO on the
earlier of the business day following DTC's receipt of a termination
request from the managing underwriting or 120 calendar days from the
date trading commenced. Once IPO tracking is discontinued, any shares
remaining in a broker-dealer's IPO control account are moved to its
free account.\23\
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\22\ The lead manager's report combined with market conditions
will assist the lead manager in determining when to instruct DTC to
discontinue IPO tracking.
\23\ DTC will automatically release the shares from the IPO
control account to the participant's memo segregation account at the
close of the tracking period when requested in writing as a standing
instruction by individual participants that use the memo segregation
service. Without this standing instruction, DTC will release shares
residing in the IPO control account directly into the participant's
free account at the end of the tracking period.
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[[Page 25256]]
At the close of the tracking period the lead manager receives a
final report detailing the selling group members (including the
clearing agents) whose customers have flipped. The report includes sale
price, trade date, and number of shares as well as the clearing agent's
participant number and the CA number. The report also shows: (1)
Outstanding CNS short positions for selling group members long in the
IPO control account, (2) a total aggregate of all open CNS commitments,
(3) WT transfers, and (4) outstanding stock loans by agent banks or
broker-dealers. The lead manager's report does not include customer
level detail information (i.e., BIA numbers, AIA numbers, or customers
internal account numbers).
Selling group members and lead managers, as part of the syndicate,
receive a report of their institutional or retail customers' sale
transactions.\24\ Such report includes the original BIA number, the
identity of any prime brokers or agent banks, and the AIA numbers or
the customer internal account numbers. This provides sufficient
information for selling group members to identify the clients that have
potentially flipped shares during the tracking period.
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\24\ Syndicate members will not see information regarding
customers of their selling group broker-dealers.
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II. Comment Letter
The Commission received one comment letter in response to the
proposed rule change.\25\ The commenter believes that the proposal is
too broad because the IPO Tracking System will allow tracking of all
new issues regardless of whether the issues are subject to a
stabilization bid. The commenter is concerned that DTC's IPO Tracking
System will encourage syndicates to monitor secondary market sales of
all IPOs. The commenter believes such use of the IPO Tracking System
will place a burden on the marketplace by restricting trading in the
secondary market and will infringe upon the anonymous nature of
trading.
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\25\ Supra note 5.
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III. Discussion
The Commission believes that DTC's proposal is consistent with
Section 17A of the Act \26\ and specifically with Sections 17A(b)(3)
(A) and (F) thereunder.\27\ Sections 17A(b)(3) (A) and (F) require that
a clearing agency be organized and its rules be designed to facilitate
and to promote the prompt and accurate clearance and settlement of
securities transactions and to assure the safeguarding of securities
and funds which are in the custody or control of DTC or for which it is
responsible. By facilitating a lead manger's ability to track flipping
of IPOs in a book-entry environment, DTC's IPO Tracking System should
further efficiencies and safety in the clearance and settlement of
securities transactions by reducing the number of transactions that are
settled outside the national clearance and settlement system.
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\26\ 15 U.S.C. 78q-1 (1988).
\27\ 15 U.S.C. 78q-1(b)(3) (A) and (F) (1988).
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Book-entry settlement of securities transactions has been a goal
since Congress enacted the Securities Acts Amendments of 1975.\28\ In
Section 17A(e),\29\ Congress directed the Commission to use its
authority to end the physical movement of securities certificates in
connection with the settlement among brokers and dealers of
transactions in securities. Since 1975, substantial progress has been
made in reducing the flow of physical certificates for settlement of
interdealer and institutional securities transactions.\30\ Approval of
the present rule change should further aid in the efficiencies of the
clearance and settlement system because the IPO Tracking System should
reduce costs, risks, and delays associated with the physical delivery
of certificates.
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\28\ Pub. L. No. 94-29, 89 Stat. 97 (1975) (codified at 15
U.S.C. 77-80h [1988]).
\29\ 15 U.S.C. 78q-1(e) (1988).
\30\ E.g., Securities Exchange Act Release Nos. 22021 (September
23, 1983), 48 FR 45167 (order granting full registration to nine
clearing agencies); 19698 (April 15, 1983), 48 FR 17604 (order
implementing DTC;'s Fast Automated Securities Transfer program);
30283 (January 23, 1992), 57 FR 3658 (order implementing DTC's
Deposit/Withdrawal at Custodian program); 30505 (March 20, 1992), 57
FR 10683 (order eliminating DTC's Certificate on Demand service for
most corporate issues); 31645 (December 23, 1992), 57 FR 62407
(order approving rule change requiring that most interdealer
transactions in municipal securities be settled by book-entry
through a depository); 32455 (June 11, 1993), 58 FR 33679 (order
approving uniform book-entry settlement rules); and 35798 (June 1,
1995), 60 FR 30909 (order approving depository eligibility
requirements).
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The one commenter has suggested that the IPO Tracking System is
overly broad. It is true that the IPO Tracking System may facilitate
the tracking of more issues than the method currently used. However,
the increase in the amount of information available to the lead manager
does not, in itself, create the problems cited by the commenter. Any
use of the IPO Tracking System would need to be consistent with federal
securities laws in effect at that time, including, if adopted, recent
proposals designed to address concerns about post-offering activities
by underwriters.\31\ Therefore, the Commission does not believe that
the gathering of information by the IPO Tracking System will be
detrimental to public policy.
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\31\ Securities Exchange Act Release No. 37094 (April 11, 1996),
61 FR 17108.
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The commenter also stated that the IPO Tracking System prevents
anonymity in the securities market. The Commission believes that the
IPO Tracking System generally does not provide any more information
than is obtained through the current method of tracking with physical
certificates. In a retail trade, the selling group broker-dealer is not
required to populate the IPO datebase with retail customer information.
In instances where customer information is provided either in a retail
or institutional trade, only the selling group broker-dealer, and not
the lead manager, will receive reports identifying the customer. This
process mirrors the flow of information in physicial tracking where a
lead manager can identify the selling group broker-dealer by the
certificate number, and the selling group broker-dealer can identify
its customer by the certificate number. Further, the Commission
disagrees that the proposal will restrict secondary market sales. The
system may in practice actually make it easier for retail customers to
resell through any broker-dealer because an investor can immediately
request issuance of physical certificates in her name or request a
transfer to another broker-dealer through the ACAT service, which
generally provides a more expedient method to transfer an account
because the transfer is conducted through book entry movements.
Finally, the Commission believes the efficiencies of the IPO Tracking
System outweigh the potential for misuse of the system and finds the
system to be an effective alternative to the present method of tracking
IPO shares in certificate form.
Furthermore, the IPO Tracking System will not impede an investor's
ability to obtain physical certificates through a WT transaction. The
modifications to the automated WT system allow participants to withdraw
physical certificates of tracked issues without causing the withdrawals
to show as flipped transactions.\32\ Similarly, investors will be able
to loan or to pledge stock or to transfer their accounts between
broker-dealers during the tracking period.
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\32\ The system will report the withdrawal of a certificate to
the lead manager which may request further clarification from the
selling group broker-dealer as to the nature of the transaction.
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However, the Commission notes that while a delivery reclaimed by an
agent bank on behalf of an institution will be matched to the original
delivery and the reclamation will not be recorded as a flip, a
reclamation done for shares delivered from a selling group broker-
dealer's IPO control account will be registered as flipped. This
distinction could possibly result in discrimination between retail
customers, who typically hold through broker-dealers, and institutional
customers. The Commission understands that this distinction is a result
of systems limitations.\33\ The Commission urges DTC to monitor this
situation once the system is operational to determine whether the
limitation has a discriminatory effect. If so, DTC should consider
systems modifications to address this concern.
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\33\ Because all movements out of an agent bank's account are
monitored, DTC is able to determine exactly which shares are
reclaimed. In contrast, shares are removed from a broker-dealer's
free account without regard to their origin.
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IV. Conclusion
The Commission finds that DTC's proposal is consistent with the
requirements of the Act and particularly with Section 17A and the rules
and regulations thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-DTC-95-27) be and hereby is
approved. As stated, DTC has agreed to notify self-regulatory
organizations and managing underwriters at least thirty calendar days
prior to the general availability of the IPO Tracking System.\34\
\34\ Supra note 3.
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For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\35\
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\35\ 17 CFR 200.30-3(a)(12) (1995).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-12540 Filed 5-17-96; 8:45 am]
BILLING CODE 8010-01-M