[Federal Register Volume 64, Number 23 (Thursday, February 4, 1999)]
[Notices]
[Pages 5691-5693]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-2661]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41003; File No. 600-31]


Self-Regulatory Organizations; Thomson Financial Technology 
Services, Inc.; Notice of Filing of Application for Exemption From 
Registration as a Clearing Agency

January 29, 1999.

I. Introduction

    On January 11, 1999, Thomson Financial Technology Services, Inc. 
(TFTS) \1\ filed with the Securities and Exchange Commission 
(Commission) an application on Form CA-1 for exemption from 
registration as a clearing agency pursuant to Section 17A of the 
Securities Exchange Act of 1934 (Exchange Act) \2\ and Rule 17Ab2-1 
thereunder.\3\ TFTS is requesting an exemption from clearing agency 
registration in connection with its proposal to offer two services: an 
electronic trade confirmation (ETC) service and a central matching 
service. The Commission is publishing this notice to solicit comments 
on the exemption request.\4\
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    \1\ TFTS is a wholly owned subsidiary of Thomson Information 
Services, Inc., which is indirectly owned by the Thomson 
Corporation. The Thomson Corporation is a public company 
incorporated under the laws of Ontario, Canada.
    \2\ 15 U.S.C. 78q-1.
    \3\ 17 CFR 240.17Ab2-1.
    \4\ Copies of TFTS's Form CA-1 are available for inspection and 
copying at the Commission's Public Reference Room in File No. 600-
31. TFTS also submitted a document entitled ``Application for 
Exemptive Order'' which we do not consider part of the Form CA-1.
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II. Background

A. Confirmation and Affirmation of Institutional Securities 
Transactions

    The confirmation/affirmation process is used to communicate the 
terms and acknowledgment of trades among institutional customers, 
broker-dealers, and custodian banks. Securities trades for 
institutional customers generally involve greater sums of money, 
greater amounts of securities, and more participants than trades for 
retail customers. As a result, there are more steps between order entry 
and final settlement in an institutional transaction than in a retail 
transaction.
    Typically, in an institutional trade, the institution's investment 
manager places an order with a broker-dealer. After the broker-dealer 
executes the trade, it advises the institution of the execution 
details. The institution then informs the broker-dealer how the trade 
should be allocated among its accounts. The broker-dealer then sends 
confirmations of the allocated trades back to the institution. The 
institution reviews the confirmations, and if they are accurate, the 
institution affirms the trade with the broker-dealer by sending an 
affirmed confirmation. Generally, the parties involved in an 
institutional trade use an ETC service to transmit the messages 
necessary to confirm and affirm the trade,\5\ The trade is then ready

[[Page 5692]]

for the settlement process (i.e., the transfer of securities and money 
for completion of the trade).
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    \5\ Currently, the rules of certain self-regulatory 
organizations (SROs) require their broker-dealer members to use the 
facilities of a registered clearing agency for the electronic 
confirmation and affirmation of transactions where the broker-dealer 
provides delivery-versus-payment (DVP) or receive-versus-payment 
(RVP) privileges to its customer. See, e.g., Municipal Securities 
Rulemaking Board (MSRB) Rule G-15(d)(ii); National Association of 
Securities Dealers (NASD) Rule 11860(a)(5); and New York Stock 
Exchange (NYSE) Rule 387(a)(5). Broker-dealers generally extend DVP 
and RVP privileges only to their institutional customers. As a 
practical matter, the SROs' confirmation rules require broker-
dealers to use The Depository Trust Company's (DTC) Institutional 
Delivery (ID) system because it is the only ETC service offered by a 
registered clearing agency.
    The Commission has published notice of proposed rule changes by 
the MSRB, NASD, and NYSE under which broker-dealers would be able to 
use ETC services provided by an entity that has received an 
exemption from clearing agency registration to provide confirmation 
and affirmation services. See Securities Exchange Act Release Nos. 
39830 (April 6, 1998), 63 FR 18060 [File No. SR-NYSE-98-07]; 39831 
(April 6, 1998), 63 FR 18057 [File No. SR-NASD-98-20]; and 39833 
(April 6, 1998), 63 FR 18055 [File No. SR-MSRB-98-06] The Commission 
expects to act on the proposed rule changes in the near future.
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B. The Commission's Interpretive Release on Matching

    The development of ``matching services'' has been a recent step in 
the evolution of the confirmation/affirmation process. The term 
matching in this context describes a process in which an intermediary 
compares the broker-dealer's trade data submission with the 
institution's allocation instructions to determine whether the two 
descriptions agree. If the trade data and allocation instructions 
match, the intermediary produces an affirmed confirmation. Matching 
services eliminate the separate steps of producing a confirmation from 
the trade data, review of the confirmation by the institution, and 
issuance of an affirmed confirmation by the institution.\6\
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    \6\ The Commission has approved a proposed rule change filed by 
DTC that allows DTC to provide matching services. Securities 
Exchange Act Release No. 39832 (April 6, 1998), 63 FR 18062 [File 
No. SR-DTC-95-23]. Currently, only DTC offers a matching service 
where it acts as an intermediary between broker-dealers and 
institutional customers for U.S. trades.
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    On April 6, 1998, we issued an interpretive release regarding 
matching services (Matching Release).\7\ In the Matching Release, we 
concluded that an entity that provides matching services as an 
intermediary between broker-dealers and institutional customers is a 
clearing agency within the meaning of Section 3(a)(23) of the Exchange 
Act \8\ and is subject to the registration requirements of Section 17A 
of the Exchange Act.\9\
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    \7\ Securities Exchange Act Release No. 39829 (April 6, 1998), 
63 FR 17943 [File No. S7-10-98]. The Matching Release contains a 
detailed description of the confirmation/affirmation process as it 
currently operates through DTC's ID system.
    \8\ 15 U.S.C. 78c(a)(23). Section 3(a)(23) defines the term 
clearing agency as, among other things. [A] person who acts as an 
intermediary in making payments or deliveries or both in connection 
with transactions in securities or who provides facilities for 
comparison of data respecting the terms of settlement of securities 
transactions, to reduce the number of settlements of securities 
transactions, or for the allocation of securities settlement 
responsibilities.
    \9\ Specifically, the Commission concluded that matching 
constitutes ``comparison of data respecting the terms of settlement 
of securities transactions.'' Exhibit S to TFTS's Form CA-1 contains 
a statement that it disagrees with the Matching Release's 
conclusion. In addition, on June 4, 1998, Thomson Information 
Services, Inc. (TIS), an affiliate of TFTS, filed a petition with 
the United States Court of Appeals for the District of Columbia 
Circuit (D.C. Circuit) to review and set aside the part of the 
Matching Release that concludes that broker-to-customer matching is 
a clearing agency function under the Exchange Act.
    In a settlement agreement with the Commission dated December 22, 
1998, TIS stated that it would withdraw its petition before the D.C. 
Circuit if the Commission approved TFTS's application for exemption 
from clearing agency registration within 120 days of the filing of 
its application. Our consideration of TFTS's application is 
consistent with the statement in the Matching Release that matching 
is a clearing agency function and that we would consider granting 
matching services conditional exemptions from clearing agency 
registration. Our consideration of TFTS's application is independent 
of and will not be influenced by TIS's petition to the D.C. Circuit.
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III. TFTS's Request for Exemption

A. TFTS's Proposed Service

    TFTS would offer two types of services under an exemption from 
clearing agency registration. First, TFTS would offer an ETC service 
that would transmit messages among broker-dealers, customers, and 
custodian banks regarding the terms of a trade executed for the 
customer. As noted above, ETC services are usually used to confirm and 
affirm securities trades for institutional investors. Second, TFTS 
would offer a central matching service under which it would act as an 
intermediary in the confirmation/affirmation process to compare a 
broker-dealer's trade data with a customer's allocation instructions to 
produce an affirmed confirmation.
    All electronic messages that are sent through TFTS's systems will 
originate at the sender's (i.e., the broker-dealer or the customer) 
computer terminal and will be routed through TFTS's data center. TFTS's 
data center will copy and store the data that passes through it. In its 
Form CA-1, TFTS represents that it will not perform other functions of 
a clearing agency such as net settlement, maintaining a balance of open 
positions between buyers and sellers, or marking securities to the 
market.\10\
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    \10\ Exhibit J to TFTS's Form CA-1.
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    TFTS has agreed to certain undertakings as a condition of obtaining 
an exemption from clearing agency registration:

    (1) To make available to the Commission prior to the commercial 
operation of its central matching service an audit report that 
addresses all the areas discussed in the Commission's Automation 
Review Policies (ARPs);\11\
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    \11\ Securities Exchange Act Release Nos. 27445 (November 16, 
1989), 54 FR 48703; and 29185 (May 9, 1991), 56 FR 22490.
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    (2) To make available to the Commission on an annual basis 
(beginning in the central matching service's second year of 
operation) reports prepared by competent, independent audit 
personnel that are generated in accordance with the annual risk 
assessment of the areas set forth in the ARPs, and field work 
associated therewith;
    (3) To provide the Commission with twenty business days' advance 
notice of any material changes that TFTS makes to its matching 
service, provided that such changes shall not be subject to 
regulatory approval;
    (4) To provide the Commission with prompt notification of 
significant systems outages, to be defined as outages lasting more 
than thirty minutes;
    (5) To respond to the Commission's requests for additional 
information relating to TFTS's matching service and to provide 
access to the Commission to conduct on-site inspections of all 
facilities (including automated systems and systems environment), 
records, and personnel related to the matching service, provided 
that such requests for information shall be made and such 
inspections shall be conducted solely for the purpose of reviewing 
the matching service's operations and compliance with the federal 
securities laws and the terms and conditions of TFTS's exemptive 
order;
    (6) To supply the Commission or its designee with periodic 
reports regarding the affirmation rates for depository-eligible 
transactions that settle in the United States effected by 
institutional investors that utilize TFTS's matching service;
    (7) To preserve a copy or record of all trade details, 
allocation instructions, central trade matching results, reports and 
notices sent to customers, reports regarding affirmation rates that 
are sent to the Commission or its designee, and any complaint 
received from a customer, all of which pertain to the operation of 
the matching service, for a period of not less than five years, the 
first two years in an easily accessible place; and
    (8) To develop fair and reasonable linkages between the matching 
service and the Depository Trust Company and other central matching 
services regulated by the Commission.

B. Statutory Standards

    Section 17A(b)(1) of the Exchange Act requires all clearing 
agencies to register with us before performing any of the functions of 
a clearing agency.\12\ However, Section 17A(b)(1) also states that, 
upon our own motion or upon a clearing agency's application, we may 
conditionally or unconditionally exempt the clearing agency from any 
provisions of Section 17A or the rules or regulations thereunder if we 
find that such exemption is consistent with the public interest, the 
protection of investors, and the purposes of Section 17A. TFTS believes 
that the undertakings it has proposed as a condition of obtaining an 
exemption from clearing agency registration will allow it to protect 
the public interest and strike the appropriate balance between safety 
and soundness and the need to foster efficiency, competition, and 
capital formation.
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    \12\ 15 U.S.C. 78q-1(b)(1).
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    We have exercised our authority to conditionally exempt an 
applicant from

[[Page 5693]]

clearing agency registration on three prior occasions.\13\ In those 
cases, the applicants requesting exemption from clearing agency 
registration were required to meet standards substantially similar to 
those required of registrants under Section 17A in order to assure that 
the fundamental goals of that section were furthered (i.e., safety and 
soundness of the national clearance and settlement system).
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    \13\ Securities Exchange Act Release Nos. 36573 (December 12, 
1995 60 FR 65076 (order approving application for exemption from 
clearing agency registration for the Clearing Corporation for 
Options and Securities); 38328 (February 24, 1997), 62 FR 9225 
(order approving application for exemption from clearing agency 
registration for Cedel Bank); and 39643 (February 11, 1998), 63 FR 
8232 (order approving application for exemption from clearing agency 
registration by Morgan Guaranty Trust Company of New York, Brussels 
Office, as operator of the Euroclear System).
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    In the Matching Release, we stated that an entity that limited its 
clearing agency functions to providing matching services might not have 
to be subject to the full range of clearing agency regulation. In 
addition, we stated that an entity seeking an exemption from clearing 
agency registration for matching would be required to: (1) provide us 
with information on its matching services and notice of material 
changes to its matching services; (2) establish an electronic link to a 
registered clearing agency that provides for the settlement of its 
matched trades; (3) allow us to inspect its facilities and records; and 
(4) make periodic disclosures to us regarding its operations.
    TFTS's matching service would be the only clearing agency function 
that it would perform under an exemptive order. While we believe that 
TFTS's matching services could have a significant impact on the 
national clearance and settlement system, we do not believe that TFTS's 
matching services raise all of the concerns raised by an entity that 
performs a wider range of clearing agency functions. TFTS represents in 
its Form CA-1 that as a condition of its exemption it will comply with 
the conditions suggested by the Commission in the Matching Release. 
Therefore, we believe that it may not be necessary to require TFTS to 
satisfy all of the standards required of registrants under Section 
17A.\14\
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    \14\ For example, TFTS's Form CA-1 (1) represents that TFTS will 
not handle funds or securities and (2) states that TFTS will not 
impose prohibitions or limit access to its service by potential 
customers but that it might terminate a subscription for failure to 
pay fees. In addition, TFTS will provide us with a current balance 
sheet and income statement before beginning operations which will 
enable us to assess TFTS's financial capability.
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    We anticipate that in addition to considering the public interest 
and the protection of investors, the primary factor in our 
consideration of TFTS's Application will be whether TFTS is so 
organized and has the capacity to be able to facilitate prompt and 
accurate matching services subject to the specific conditions that it 
has proposed.\15\ In particular, TFTS has represented that, among other 
things, it will provide us with (1) an independent audit report that 
addresses all the areas discussed in the Commission's ARPs prior to 
beginning commercial operations and annually thereafter, (2) on-site 
inspection rights, and (3) a current balance sheet and income statement 
prior to beginning operations.\16\
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    \15\ See Section 17A(b)(3)(A) of the Exchange Act, 15 U.S.C. 
78q-1(b)(3)(A).
    \16\ See Section III.A, supra.
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    We expect that any exemption from clearing agency registration for 
TFTS would contain all of the conditions that TFTS has proposed in its 
Form CA-1. We request comment on whether these conditions are 
sufficient to promote the purposes of Section 17A and to allow us to 
adequately monitor the effects of TFTS's proposed activities on the 
national system for the clearance and settlement of securities 
transactions. In addition, we invite commenters to address whether 
granting TFTS an exemption from clearing agency registration would 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the Exchange Act.

IV. Solicitation of Comments

    Comments are due by March 8, 1999. These comments will be 
considered in deciding whether to grant TFTS's application for 
exemption from registration as a clearing agency. Six copies of the 
comments should be filed with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. Comments 
also may be submitted electronically at the following E-mail address: 
[email protected]. All comment letters should refer to File No. 
600-31; this file number should be used on the subject line if E-mail 
is used. Copies of the application and all written comments will be 
available for inspection and copying at the Commission's Public 
Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a0(16).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-2661 Filed 2-3-99; 8:45 am]
BILLING CODE 8010-01-M