[Federal Register Volume 65, Number 228 (Monday, November 27, 2000)]
[Notices]
[Pages 70745-70748]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-30137]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43586; File No. SR-DTC-00-09]


Self-Regulatory Organizations; The Depository Trust Company; 
Order Granting Approval of a Proposed Rule Change Relating to the 
Profile Surety Program in the Direct Registration System

November 17, 2000.
    On June 29, 2000, The Depository Trust Company (``DTC'') filed with 
the Securities and Exchange Commission (``Commission''), pursuant to 
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act''),\1\ a 
proposed rule change. Notice of the proposal was published in the 
Federal Register on August 11, 2000.\2\ The Commission received six 
comment letters in response to the proposed rule change.\3\

[[Page 70746]]

 The Commission is publishing this order to grant approval of the 
proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 43125 (August 7, 2000), 
65 FR 49278.
    \3\ Letters from Robert J. Duke, Director of Underwriting, The 
Surety Association of America (August 28, 2000); Jerome J. Clair, 
Chairman, Securities Industry Association Operations Committee 
(August 30, 2000); Dan W. Schneider, Baker and McKenzie (on behalf 
of EquiServe L.P.) (August 31, 2000); and William A. Harris, Vice 
President and Assistant General Counsel, ChaseMellon Shareholder 
Services (September 1, 2000); Joseph M. Velli, Senior Executive Vice 
President, The Bank of New York (September 6, 2000); and Larry E. 
Thompson, Managing Director and Deputy General Counsel, The 
Depository Trust and Clearing Corporation (September 19, 2000).
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I. Description

    On April 19, 2000, the Commission granted approval of a DTC rule 
filing concerning changes to the Profile Modification System 
(``Profile''), a feature of the Direct Registration System 
(``DRS'').\4\ Pursuant to that rule filing, a screen-based 
indemnification was incorporated into DRS.\5\ Because companies issuing 
securities in DRS after September 15, 1999, are required to use Profile 
and because Profile was deemed inoperable without an indemnification 
agreement, DTC adopted a screen-based indemnification as an 
accommodation to those issuers and their transfer agents wanting to 
issue securities in DRS on or after September 15, 1999.\6\ The screen-
based indemnification adopted by DTC was substantially in the form of 
an indemnification approved by the DRS Committee in 1999 \7\ and will 
be used in DRS until such time as the DRS Committee agreed to an 
alternative indemnification.\8\
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    \4\ For a description of DRS and Profile, refer to Securities 
Exchange Act Release Nos. 35038 (December 1, 1994), 59 FR 63652 
(concept release relating to DRS); 41862 (September 10, 1999), 64 FR 
51162 (September 21, 1999) (order approving implementation of the 
Profile Modification feature of DRS); 42366 (January 28, 2000), 65 
FR 5714 (February 4, 2000) (order approving an interpretation of an 
existing rule pertaining to DRS); 42704 (April 19, 2000), 65 FR 
24242 (April 25, 2000) (order approving modification of Profile to 
incorporate use of an electronic screen-based indemnification).
    \5\ Profile contains two indemnities. The first is applicable 
when a DTC participant (i.e., generally a broker-dealer) requests 
that a customer's registered book-entry position be transferred from 
the books of the issuer to the participant's account at DTC, to be 
held in street name for the benefit of the customer. The second 
indemnity is applicable when a DRS limited participant (i.e., a 
transfer agent) requests a shareholder's position at a broker-dealer 
be transferred from the broker-dealer's account at DTC to the books 
of the issuer and registered in the name of the shareholder. Except 
for language reflecting whether the broker-dealer or the transfer 
agent is the requestor or the guarantor, the language of these two 
indemnities is identical. Securities Exchange Act Release No. 42704 
(April 19, 2000), 65 FR 25242 (April 25, 2000).
    \6\ Securities Exchange Act Release No. 41862 (September 10, 
1999), 64 FR 51162 (September 21, 1999).
    \7\ DRS Committee meeting minutes of January 12, 1999. Minutes 
of the DRS Committee meetings are available from DTC. The DRS 
Committee is an industry committee responsible for designing DRS. 
Its members include the Securities Transfer Association, the 
Corporate Transfer Association, the Securities Industry Association, 
the American Society of Corporate Secretaries, and DTC.
    \8\ Subsequent to the DRS Committee's approval of the screen-
based indemnification, a number of transfer agents raised concerns 
regarding the perceived lack of protections in the indemnification 
for issuers and transfer agents. The DRS Committee agreed to reopen 
discussions in an attempt to develop an alternative indemnification 
that would address the transfer agents' concerns. After a year of 
discussions, an impasse developed and discussions ceased. Since 
Profile was effectively inoperable due to a lack of any 
indemnification, DTC determined to adopt the screen-based 
indemnification approved by the DRS Committee in 1999. Any changes 
to the language of the screen-based indemnities will be subject to a 
rule filing pursuant to Section 19(b) of the Exchange Act.
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    At the time DTC filed the rule change modifying Profile to 
incorporate the use of a screen-based indemnification into DRS, 
industry representatives on the DRS Committee contemplated the 
organization currently administering one of the three signature 
guarantee programs in connection with transfers of physical 
certificates \9\ would develop a similar surety program to accommodate 
some version of a screen-based indemnification to be used in Profile. 
The program envisioned by the DRS Committee would have required 
guarantors (i.e., the initiator of the instruction in Profile to move 
an investor's position) to subscribe to surety bond coverage that would 
have specifically covered a claim that a DRS transfer was unauthorized 
in the event that a guarantor refused or failed to satisfy the claim. 
However, the DRS Committee was unable to reach a consensus on a 
program, thereby making it impossible for any of the signature 
guarantee program administrators to extend its program or develop a 
similar program to accommodate the Profile indemnification.
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    \9\ Today, physical certificates must be signature guaranteed by 
a guarantor participating in a signature guarantee program. The 
Medallion Signature Program, the Securities Transfer Association 
Medallion Program, and the Securities Exchange Medallion Program are 
the three operating signature guarantee programs.
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    On April 20, 1999, representatives of the DRS Committee met in an 
effort to find an alternative solution. At that meeting, those in 
attendance concluded because of its role as administrator of DRS, DTC 
would be a logical party to administer an electronic indemnification 
program. As a result, DTC proposed to implement and administer the DRS 
Profile Surety Program (``PSP'') and filed the present rule change.
    PSP is designed to provide for a surety bond to back the 
representation a guarantor makes under the screen-based indemnity. 
Since PSP is modeled in large part after the NYSE's Medallion Signature 
Program, many of the two programs' details are similar.
    All broker-dealers and transfer agents participating in DRS will be 
required to procure a surety bond in order to send electronic 
instructions through Profile. (Profile will be programmed to not accept 
an instruction until the guarantor enters a valid PSP membership 
number.) The surety company issuing the surety bond for PSP will either 
be a company selected by DTC as the administrator of PSP or a surety 
company selected by the DRS user. If a DRS user elects to use a surety 
company other than one DTC has selected, the surety company selected 
will be required to issue its surety bond in a form consistent with the 
bond issued by the surety company selected by DTC. For example, the 
surety bond must have a coverage limit of $2 million per occurrence and 
an aggregate limit of $6 million. DTC will also require that all 
companies issuing surety bonds must be highly rated by an approved 
rating service.

II. Comment Letters

    The Commission received six comment letters.\10\ In stating its 
support for PSP, the Securities Industry Association stated it believed 
that the PSP had been formulated by the DRS Committee to address the 
concerns of certain interested parties and should finally make DRS the 
electronic alternative to certificate ownership for many investors.
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    \10\ Supra note 3.
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    The Surety Association of America (``SAA'') expressed qualified 
support for the implementation of PSP. The SAA stated that institutions 
that were able to qualify under the paper-based medallion programs 
might not be able to qualify under PSP because PSP is requiring higher 
bond limits than the current paper-based medallion programs, which in 
turn requires guarantors to have greater financial strength, stronger 
internal controls, and stronger risk management. Furthermore the SAA 
requested that the Commission refrain from approving the filing until 
their membership has had an opportunity to review the proposed bond 
form and requirements of the PSP.\11\
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    \11\ DTC has informed the Commission that its has had 
conversations with the SAA and will make the bond form publicly 
available. Telephone conversation between Larry E. Thompson, 
Managing Director and Deputy General Counsel, The Depository Trust 
and Clearing Corporation, and Jerry W. Carpenter, Assistant 
Director, Commission (November 16, 2000).
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    The Bank of New York (``BONY'') also qualified its support of PSP. 
BONY expressed its belief that the screen-based indemnification 
agreement was inadequate and stated that implementation of the PSP 
should be

[[Page 70747]]

conditioned on revisions to the screen-based indemnity.
    ChaseMellon Shareholder Services (``CMSS'') expressed no position 
on whether it supported DTC's proposal. Rather it expressed its belief 
that the screen-based indemnification language is vague and does not 
provide transfer agents with sufficient assurances that requested 
transfers are authorized. CMSS suggested several modifications to the 
indemnification language to better address perceived potential for 
transfer agent liability.
    Baker & McKenzie (on behalf of EquiServe L.P.) contends that DTC's 
rule filing is vague, specifically with regards to the surety bond 
processing arrangements, the claims procedures, and the standards used 
by DTC to select a designated surety. Baker & McKenzie also states that 
there should be no aggregate limit on the surety bond under PSP. This 
commenter also elaborated on what it believes to be the deficiencies of 
DRS and Profile.
    In its letter, DTC responded specifically to the issues raised by 
Baker & McKenzie's comment letter and generally to the issues raised by 
CMSS and BONY. DTC states that while the Baker & McKenzie letter was 
submitted as a comment letter to this proposed rule filing on PSP, the 
bulk of the letter raises issues relating to the screen-based indemnity 
language, which was the subject of another DTC rule filing approved by 
the Commission on April 19, 2000.\12\ DTC states it is ``mystified'' by 
the Baker & McKenzie letter in light of the contributions made by 
EquiServe to the indemnity language, which language Baker & McKenzie 
criticize in its comment letter. DTC states that the language of the 
screen-based indemnity is based closely on language approved in 1998 by 
the DRS Committee, on which EquiServe has always been represented, and 
reflects comments received from EquiServe when the language of the 
screen-based indemnity was being finalized. DTC states that many of the 
issues that Baker & McKenzie raise either have already been resolved 
over the last several years or are issues that key industry officials, 
including representatives from EquiServe, have decided to move beyond 
in order to advance DRS.
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    \12\ Securities Exchange Act Release No. 42704 (April 19, 2000), 
65 FR 24242 (April 25, 2000).
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III. Discussion

    Section 17A(b)(3)(F) of the Act \13\ requires that the rules of a 
clearing agency be designed to promote the prompt and accurate 
clearance and settlement of securities transactions and to foster 
cooperation and coordination with persons engaged in the clearance and 
settlement of securities transactions.\14\ As set forth below, the 
Commission believes that DTC's proposed rule change is consistent with 
its obligations under Section 17A(b)(3)(F).\15\
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    \13\ 15 U.S.C. 78q-1(b)(3)(F).
    \14\ The prompt and accurate clearance and settlement of 
securities transactions includes the transfer of record ownership of 
securities. 15 U.S.C. 78q-1(a)(1)(A).
    \15\ The Commission also notes that when enacting Section 17A, 
Congress set forth its findings that the prompt and accurate 
clearance and settlement of securities transactions, including the 
transfer of record ownership, is necessary for the protection of 
investors; inefficient procedures for clearance and settlement 
impose unnecessary costs on investors; and that new data processing 
and communication techniques create the opportunity for more 
efficient, effective, and safe procedures for clearance and 
settlement. 15 U.S.C. 78q-1(a)(1)(A), (B), and (C). DRS, including 
Profile supported by PSP, advance these objectives.
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    As the Commission has stated in previous orders dealing with the 
DRS, the primary purpose of Profile is to provide a more prompt and 
accurate mechanism for the transfer of an investor's book-entry 
position between the investor's broker-dealer and the transfer agent 
for the issue than the multistep, paper based processing otherwise used 
by the industry. Without Profile, investors holding securities 
positions in DRS, a majority of whom were issued securities in DRS 
through corporate actions, would continue to be disadvantaged by their 
inability to transfer their shares to their broker-dealer (or back to 
the transfer agent) without significant delays.
    The adoption of PSP by DTC does not affect DRS's operations or its 
mechanisms to facilitate a more efficient manner of transfer ownership 
of investors' book-entry positions. The purpose of PSP is to provide an 
additional layer of protection for transfer agents and broker-dealers 
using DRS. DTC developed PSP in an effort to foster cooperation and 
coordination between transfer agents, issuers, and broker-dealers by 
addressing concerns of risk resulting from unauthorized instructions to 
transfer investors' book-entry positions.
    We have considered the views of commenters. Three commenters (BONY, 
CMSS, and Baker & McKenzie) raised a number of issues regarding Profile 
and the screen-based indemnifications that were not the subject of this 
filing. BONY also predicated its support of PSP on the condition that 
the condition that the screen-based indemnifications be revised. Baker 
& McKenzie indicated its belief that the specifics of PSP were not 
sufficiently described in DTC's filing.
    The adoption of PSP does not affect the ability of the DRS 
Committee to continue to negotiate alternative indemnification 
language. DTC has stated it will use the screen-based indemnification 
only until such time as an alternative indemnification agreement is 
reached by the DRS Committee. If and when that happens, DTC will modify 
PSP accordingly.
    In addition, DTC structured PSP, including the increased aggregate 
limit amount of surety coverage, in the manner specified by the DRS 
Committee. The limit was increased to accommodate transfer agents' 
concerns that the current signature guarantee programs' aggregate 
limits were too low for transfer activity in an electronic environment. 
The DRS Committee is always free to revisit the issue of surety 
coverage amounts and to adjust PSP as necessary. The assertion made by 
Baker & McKenzie that the surety coverage should contain no aggregate 
limit is not feasible because no surety company is likely to provide 
coverage where its exposure is unlimited.
    Finally, PSP's application and subscription agreement, which 
describes the coverage and claims process to be applied under PSP, are 
available from DTC upon request. DRS users that deem PSP's coverage 
insufficient may independently purchase additional insurance to cover 
outstanding liabilities.
    The Commission urges the DRS Committee to continue to meet to 
address on-going concerns regarding liability and to continue to 
discuss improvements in the design of DRS. These efforts will 
contribute to the industry's objective of promoting the immobilization 
of physical certificates.
    As set forth above, the Commission finds that DTC's establishment 
of PSP is consistent with Section 17A(b)(3)(F) of the Act \16\ because 
it will facilitate the use of a more efficient mechanism by which to 
transfer investors' book-entry positions and thereby promotes the 
prompt and accurate settlement of securities transactions. Furthermore, 
since PSP will provide additional protection to DRS users for 
liabilities that may arise in certain DRS transactions, PSP should 
foster cooperation between person engaged in the clearance and 
settlement of securities transactions.
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    \16\ 15 U.S.C. 78q-1(b)(3)(F).
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V. Conclusion

    On the basis of the foregoing, the Commission finds that DTC's 
proposal to modify Profile to include an electronic screen-based 
indemnification

[[Page 70748]]

is consistent with the requirements of the Act and in particular with 
the requirements of Section 17A of the Act 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 N. SR-DTC-00-09) be and hereby is 
approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 00-30137 Filed 11-24-00; 8:45 am]
BILLING CODE 8010-01-M