[Federal Register Volume 68, Number 143 (Friday, July 25, 2003)]
[Notices]
[Pages 44128-44130]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-18990]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48201; File No. SR-GSCC-2002-10]


Self-Regulatory Organizations; Government Securities Clearing 
Corporation; Order Approving Proposed Rule Change To Establish a 
Comprehensive Standard of Care and Limitation of Liability to its 
Members

July 21, 2003.

I. Introduction

    On October 10, 2002, the Government Securities Clearing Corporation 
(``GSCC'') \1\ filed with the Securities and Exchange Commission 
(``Commission'') proposed rule change SR-GSCC-2002-10 pursuant to 
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'').\2\ 
Notice of the proposal was published in the Federal Register on January 
14, 2003.\3\ The Commission received two comment letters in response to 
the proposed rule change.\4\ For the reasons discussed below, the 
Commission is approving the proposed rule change.
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    \1\ On January 1, 2003, MBS Clearing Corporation (``MBSCC'') was 
merged into the Government Securities Clearing Corporation 
(``GSCC'') under New York law, and GSCC was renamed the Fixed Income 
Clearing Corporation (``FICC''). The functions previously performed 
by GSCC are now performed by the Government Securities Division 
(``GSD'') of FICC, and the functions previously performed by MBSCC 
are now performed by the Mortgage-Backed Securities Division 
(``MBSD'') of FICC. The GSD succeeded to the GSCC proposed rule 
change upon the merger of MBSCC and GSCC. To avoid confusion and 
maintain consistency with the Notice, in this Order, we will 
continue to refer to GSCC instead of the GSD of FICC. Securities 
Exchange Act Release No. 47015 (December 17, 2002), 67 FR 78531 
[File Nos. SR-GSCC-2002-09 and SR-MBSCC-2002-01].
    \2\ 15 U.S.C. 78s(b)(1).
    \3\ Securities Exchange Act Release No. 47135 (January 7, 2003), 
68 FR 1876.
    \4\ Letters from Dan W. Schneider, Counsel to the Association of 
Global Custodians (``AGC'') (March 24, 2003) and Jeffrey F. Ingber, 
Managing Director, General Counsel, and Secretary, Fixed Income 
Clearing Corporation (June 12, 2003).
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II. Description

    The purpose of GSCC's rule change is to establish a comprehensive 
standard of care and limitation of liability with respect to its 
members. Historically, the Commission has left to user-governed 
clearing agencies the question of how to

[[Page 44129]]

allocate losses associated with, among other things, clearing agency 
functions.\5\ In determining the appropriate standard of care, the 
Commission has reviewed clearing agency services on a case-by-case 
basis in order to balance the need for a high degree of care at 
clearing agencies with the effects that liabilities may have on 
clearing agency operations, costs, and safekeeping of securities and 
funds.\6\ Because standards of care represent an allocation of rights 
and liabilities between a clearing agency and its members or 
participants, which are sophisticated financial entities, the 
Commission has refrained from establishing a unique federal standard of 
care and has allowed clearing agencies and other self-regulatory 
organizations and their participants to establish their own standards 
of care.\7\
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    \5\ Securities Exchange Act Release Nos. 20221 (September 23, 
1983), 48 FR 45167 and 22940 (February 24, 1986), 51 FR 7169.
    \6\ Id.
    \7\ Id.
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    GSCC believes that adopting a rule \8\ limiting GSCC's liability to 
its members to direct losses caused by GSCC's gross negligence, willful 
misconduct, or violation of Federal securities laws for which there is 
a private right of action: (1) Memorializes an appropriate commercial 
standard of care that will protect GSCC from undue liability; (2) 
permits the resources of GSCC to be appropriately utilized for 
promoting the prompt and accurate clearance and settlement of 
securities; and (3) is consistent with similar rules adopted by other 
self-regulatory organizations and approved by the Commission.\9\
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    \8\ The language of new Section 3 to Rule 39 is as follows: 
Section 3--Limitation on Liability of the Corporation 
Notwithstanding any other provision in the Rules:
    (a) The Corporation will not be liable for any action taken, or 
any delay or failure to take any action, hereunder or otherwise to 
fulfill the Corporation's obligations to its Members, other than for 
losses caused directly by the Corporation's gross negligence, 
willful misconduct, or violation of Federal securities laws for 
which there is a private right of action. Under no circumstances 
will the Corporation be liable for the acts, delays, omissions, 
bankruptcy, or insolvency, of any third party, including, without 
limitation, any depository, custodian, sub-custodian, clearing or 
settlement system, transfer agent, registrar, data communication 
service or delivery service (``Third Party''), unless the 
Corporation was grossly negligent, engaged in willful misconduct, or 
in violation of Federal securities laws for which there is a private 
right of action in selecting such Third Party; and
    (b) Under no circumstances will the Corporation be liable for 
any indirect, consequential, incidental, special, punitive or 
exemplary loss or damage (including, but not limited to, loss of 
business, loss of profits, trading losses, loss of opportunity and 
loss of use) howsoever suffered or incurred, regardless of whether 
the Corporation has been advised of the possibility of such damages 
or whether such damages otherwise could have been foreseen or 
prevented.
    \9\ See, e.g., Securities Exchange Act Release Nos. 37421 (July 
11, 1996), 61 FR 37513 [SR-CBOE-96-02] and 37563 (August 14, 1996), 
61 FR 43285 [SR-PSE-96-21].
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III. Comment Letters

    The Commission received a comment letter from Dan W. Schneider, 
Counsel to AGC, and a response comment letter from GSCC. The AGC letter 
asserted that registered clearing agencies should be subject to a 
negligence standard of care in safeguarding funds and securities and in 
performing processing obligations relating to custody functions. In 
addition, registered clearing agencies like GSCC that provide the 
securities markets and the securities processing community with 
centralized essential utility services and that become focal points for 
concentrated risk should meet at least the same standard of care that 
is required of commercial custodians under Commission rules designed to 
protect investors. Finally, AGC opined that permitting registered 
clearing agencies that are central facilities in the national clearance 
and settlement system to conform their conduct to gross negligence 
while requiring bank custodians to adhere to a higher standard of care 
creates a liability differential for which no appropriate statutory or 
policy basis exists.
    GSCC responded that the proposed rule change would not affect 
GSCC's standard of performance because registered clearing agencies 
such as GSCC are subject to rigorous regulatory standards for their 
operations under Section 17A of the Act. The proposed rule change only 
relates to GSCC's standard of liability and not to the Commission's 
regulatory operational standards for GSCC. Also, GSCC has operated for 
15 years with a gross negligence standard of liability under SEC 
temporary registration orders without any financial loss to its members 
or third parties arising from a failure of performance by GSCC. Neither 
the Act nor prior Commission orders require that a particular level of 
liability for private rights of action be assumed by registered 
clearing agencies, as distinguished from the high regulatory standards 
imposed by the Commission for clearing agency operations under Section 
17A. In addition, GSCC members are sophisticated parties who can best 
determine the allocation of GSCC risk for unintentional loss. GSCC 
pointed out that adoption of a universal simple negligence standard of 
liability for GSCC would likely result in a gap between the liability 
limitation of GSCC and the gross negligence liability limitation of 
clearing banks and other service providers to which GSCC is dependent 
for certain key operational services.

IV. Discussion

    Section 19(b) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
such proposed rule change is consistent with the requirements of the 
Act and the rules and regulations thereunder applicable to such 
organization. Section 17A(b)(3)(F) of the Act requires that the rules 
of a clearing agency be designed to promote the prompt and accurate 
clearance and settlement of securities transactions.\10\ The Commission 
believes that approval of GSCC's rule change is consistent with this 
Section because it will permit the resources of GSCC to be 
appropriately utilized for promoting the prompt and accurate clearance 
and settlement of securities.
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    \10\ 15 U.S.C. 78q-1(b)(3)(F).
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    Although the Act does not specify the standard of care that must be 
exercised by registered clearing agencies, the Commission has 
determined that a gross-negligence standard of care is acceptable for 
non-custodial functions where the parties contractually agree to limit 
liability.\11\ GSCC's functions are

[[Page 44130]]

non-custodial in that it does not hold its members funds or securities. 
GSCC relies on clearing banks to perform custodial services for 
Government securities, which are uncertificated, and for funds. It is 
reasonable for GSCC, which is member-owned and governed, and its 
members to agree among themselves through board approval of the 
proposed rule change and through the proposed rule change notice and 
approval process to agree and to contract with one another in a 
cooperative arrangement as to how to allocate GSCC's liability among 
GSCC and themselves.
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    \11\ In the release setting forth standards to be used by the 
Division of Market Regulation in evaluating clearing agency 
registration applications, the Division of Market Regulation urged 
clearing agencies to embrace a strict standard of care in 
safeguarding participants' funds and securities. Securities Exchange 
Act Release No. 16900 (June 17, 1980), 45 FR 4192. In the release 
granting permanent registration to The Depository Trust Company, the 
National Securities Clearing Corporation, and several other clearing 
agencies, however, the Commission indicated that it did not believe 
that sufficient justification existed at that time to require a 
unique federal standard of care for registered clearing agencies. 
Securities Exchange Act Release No. 20221 (October 3, 1983), 48 FR 
45167. In a subsequent release, the Commission stated that the 
clearing agency standard of care and the allocation of rights and 
liabilities between a clearing agency and its participants 
applicable to clearing agency services generally may be set by the 
clearing agency and its participants. In the same release, the 
Commission stated that it should review clearing agency proposed 
rule changes in this area on a case-by-case basis and balance the 
need for a high degree of clearing agency care with the effect 
resulting liabilities may have on clearing agency operations, costs, 
and safeguarding of securities and funds. Securities Exchange Act 
Release No. 22940 (February 24, 1986), 51 FR 7169. Subsequently, in 
a release granting temporary registration as a clearing agency to 
The Intermarket Clearing Corporation, the Commission stated that a 
gross negligence standard of care may be appropriate for certain 
noncustodial functions that, consistent with minimizing risk 
mutualization, a clearing agency, its board of directors, and its 
members determine to allocate to individual service users. 
Securities Exchange Act release No. 26154 (October 3, 1988), 53 FR 
39556. Finally, in a release granting the approval of temporary 
registration as a clearing agency to the International Securities 
Clearing Corporation, the Commission indicated that historically it 
has left to user-governed clearing agencies the question of how to 
allocate losses associated with noncustodial, data processing, 
clearing agency functions and has approved clearing agency services 
embodying a gross-negligence standard of care. Securities Exchange 
Act Release No. 26812 (May 12, 1989), 54 FR 21691.
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    In its order granting temporary registration as a clearing agency, 
the Commission expressed concerned that GSCC's failure to perform 
accurately and timely the comparison service could adversely affect the 
ability of GSCC members to deliver securities and effect trade 
settlements. Considering the size of the Government securities market 
and the next-day time frame for trade settlements, the Commission 
deemed it appropriate that GSCC amend its standard of care to an 
ordinary negligence standard of care in performing all functions 
affecting member settlements of Government securities. \12\ The 
Commission, recognizing that GSCC's members are best suited to allocate 
GSCC's rights and liabilities, has determined and finds that, given the 
non-custodial nature of GSCC's services, the extensive and rigorous 
financial and operational regulatory oversight to which GSCC is 
subject,\13\ and GSCC's exemplary level of performance,\14\ a gross 
negligence standard of care is appropriate for GSCC.
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    \12\ Securities Exchange Act Release No. 25740 (May 24, 1988), 
53 FR 19639.
    \13\ GSCC must have its rule changes approved by the Commission 
and is the subject of frequent Commission examinations for 
compliance with its rules and those of the Commission. As directed 
by Congress, the Commission cannot approve GSCC's proposed rule 
changes if they are inconsistent with Section 17A of the Act, 
including being inimical to the public interest or the protection of 
investors.
    \14\ Over the past 15 years, GSCC has demonstrated a high level 
of responsibility in performing its non-custodial functions and has 
had appropriate standards in place to ensure adequate performance. 
As a result, GSCC has operated without financial loss to its members 
or third parties arising from its failure to perform.
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    The Commission has given thoughtful and careful consideration to 
the comment letter of AGC and finds that AGC's concerns about the 
performance level of GSCC operating under a gross negligence standard 
of care and limitation of liability are addressed by the extensive 
regulatory oversight to which GSCC is subject as a registered clearing 
agency and the fact GSCC is not changing its financial and operational 
standards with the adoption of a gross negligence standard of care and 
limitation of liability.\15\
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    \15\ The Commission notes that the rule change does not 
alleviate GSCC from liability for violation of the Federal 
securities laws where there exists a private right of action and 
therefore is not designed to adversely affect GSCC's compliance with 
the Federal securities laws and private rights of action that exist 
for violations of the Federal securities laws.
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V. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
in particular 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 No. SR-GSCC-2002-10) be and hereby 
is approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-30(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 03-18990 Filed 7-24-03; 8:45 am]
BILLING CODE 8010-01-P