[Federal Register Volume 69, Number 49 (Friday, March 12, 2004)]
[Notices]
[Pages 11921-11922]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-5653]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49373; File No. SR-FICC-2003-09]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Approving Proposed Rule Change to Establish a Comprehensive 
Standard of Care and Limit the Mortgage-Backed Securities Division's 
Liability to its Participants

March 8, 2004.

I. Introduction

    On August 19, 2003, the Fixed Income Clearing Corporation 
(``FICC'')\1\ filed with the Securities and Exchange Commission 
(``Commission'') proposed rule change SR-FICC-2003-09 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 
15, 2004.\3\ No comment letters were received. 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''), 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. 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. 49048 (January 9, 2004), 
69 FR 2375.
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II. Description

    FICC is establishing a comprehensive standard of care and 
limitation of liability for the participants of MBSD that is identical 
to that of FICC's Government Securities Division (``GSD'').\4\ 
Historically, the Commission has left to user-governed clearing 
agencies the question of how to allocate losses associated with, among 
other things, clearing agency functions.\5\ In past considerations, the 
Commission has reviewed clearing agency services on a case-by-case 
basis and in determining the appropriate standard of care has balanced 
the need for a high degree of clearing agency care with the effect the 
resulting liabilities may have on a clearing agency's operations, 
costs, and ability to safekeep securities and funds.\6\ Because 
standards of care limitations of liability represent an allocation of 
rights and liabilities between a clearing agency and its participants, 
which are generally 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 standard of care.\7\
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    \4\ The Commission has approved identical rule language for GSD 
establishing a comprehensive standard of care and limitation of 
liability to its members. Securities Exchange Act Release No. 48201 
(July 21, 2003), 68 FR 44128 [File No. SR-GSCC-2002-10].
    \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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    MBSD rules already provide for a standard of care similar to that 
now provided for in the GSD rules. The proposed rule changes make the 
MBSD standard of care provision in its rules identical to the provision 
in GSD's rules. Thus, in addition to being responsible to participants 
for gross negligence and willful misconduct, MBSD will be liable for 
direct losses caused by its violation of Federal securities laws for 
which there is a private right of action. MBSD will not be liable for 
the acts or omissions of third parties unless MBSD 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. Moreover, MBSD will be relieved of any 
liability for consequential and other indirect damages. By making these 
changes to MBSD rules, both GSD and MBSD rules will be identical, 
lending consistency to FICC's approach to these issues.
    FICC believes that adopting a uniform rule \8\ limiting MBSD's 
liability to its participants to direct losses caused by MBSD's gross 
negligence, willful misconduct, or violation of Federal securities laws 
for which there is a private right of action: (a) Memorializes an 
appropriate commercial standard of care that will protect MBSD from 
undue liability; (b) permits the resources of MBSD to be appropriately 
utilized for promoting the accurate clearance and settlement of 
securities; and (c) is consistent with similar rules adopted by other 
self-regulatory organizations and approved by the Commission.\9\
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    \8\ MBSD Clearing Rules Article V, Rule 6, Sections 1(a) and (b) 
and MBSD EPN Rulebook Article X, Rule 6, Sections 1(a) and (b) now 
read as follows:
    (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 Participants [EPN users 
and Participants], 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. 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 FICC's rule change is consistent with this 
Section because it will permit the resources of MBSD 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 
noncustodial functions where a

[[Page 11922]]

clearing agency and its participants contractually agree to limit the 
liability of the clearing agency.\11\ MBSD's functions are noncustodial 
in that it does not hold its participants' funds or securities. It is 
reasonable for MBSD, which is participant-owned and governed, and its 
participants to agree through board approval of the proposed rule 
change and to contract with one another in a cooperative arrangement as 
to how to allocate MBSD's liability among MBSD and its participants. 
Therefore, the Commission has determined that given the noncustodial 
nature of MBSD's services, a gross negligence standard of care and 
limitation of liability is allowable for MBSD.\12\
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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.
    \12\ The Commission notes that the rule change does not 
alleviate MBSD 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 MBSD's compliance with 
the Federal securities laws and private rights of action that exist 
for violations of the Federal securities laws.
    The Commission's approval of FICC's proposed rule change 
establishing a comprehensive standard of care and limiting MBSD's 
liability to its participants does not limit the standard of care 
required of MBSD by Rule 17f-4 of the Investment Company Act of 1940 
and the Division of Investment Management's no-action letter to FICC 
deeming MBSD to be an eligible fund custodian under Rule 17f-4. Rule 
17f-4 and the Division of Investment Management's no-action letter 
require MBSD to exercise, at a minimum, due care in accordance with 
reasonable commercial standards in discharging its duties as a 
securities intermediary. Fixed Income Clearing Corporation (March 
13, 2003).
    A negligence standard of care continues to be required for 
custodial clearing agency functions.
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IV. 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-FICC-2003-09) be and hereby 
is approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 04-5653 Filed 3-11-04; 8:45 am]
BILLING CODE 8010-01-P