[Federal Register Volume 69, Number 112 (Thursday, June 10, 2004)]
[Proposed Rules]
[Pages 32784-32793]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-13084]



[[Page 32783]]

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Part V





Securities and Exchange Commission





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17 CFR Part 240



Issuer Restrictions or Prohibitions on Ownership by Securities 
Intermediaries; Proposed Rule

  Federal Register / Vol. 69, No. 112 / Thursday, June 10, 2004 / 
Proposed Rules  

[[Page 32784]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-49809, File No. S7-24-04]
RIN 3235-AJ26


Issuer Restrictions or Prohibitions on Ownership by Securities 
Intermediaries

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
proposing a new rule under the Securities Exchange Act of 1934 
(``Exchange Act'') that would prohibit registered transfer agents from 
effecting any transfer of any equity security registered under section 
12 or any equity security that subjects an issuer to reporting under 
15(d) of the Exchange Act if such security is subject to any 
restriction or prohibition on transfer to or from a securities 
intermediary, such as clearing agencies, banks, or broker-dealers, is 
restricted or prohibited. The primary purpose of the proposed rule is 
to promote the integrity and efficiency of the U.S. clearance and 
settlement system.

DATES: Comments should be received on or before July 12, 2004.

ADDRESSES: Comments may be submitted by any of the following methods:
    Electronic comments:
     Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number S7-24-04 on the subject line; or
     Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.
    Paper comments:
     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609. All submissions should refer to File Number 
S7-24-04. This file number should be included on the subject line if e-
mail is used. To help us process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments are also available for public 
inspection and copying in the Commission's Public Reference Room, 450 
Fifth Street, NW., Washington, DC 20549. All comments received will be 
posted without change; we do not edit personal identifying information 
from submissions. You should submit only information that you wish to 
make available publicly.

FOR FURTHER INFORMATION CONTACT: Jerry Carpenter, Assistant Director, 
or Susan M. Petersen, Special Counsel, Office of Risk Management, 202/
942-4187, Division of Market Regulation, Securities and Exchange 
Commission, 450 Fifth Street, NW., Washington, DC 20549-1001.

SUPPLEMENTARY INFORMATION: Recently, a number of issuers of equity 
securities trading in the public markets have imposed restrictions on 
their securities to limit or to prohibit ownership of the securities by 
securities intermediaries such as depositories, broker-dealers, and 
banks. Such restrictions require these securities to be certificated 
and transactions in these securities to be manually cleared, settled, 
and transferred on a transaction-by-transaction basis.
    To facilitate the clearance and settlement of securities 
transactions, securities held by a securities intermediary on behalf of 
its customers or another securities intermediary are commonly 
registered in the name of the securities intermediary or in its nominee 
name, which makes the securities intermediary the registered owner.\1\ 
This is often referred to as holding a security in ``street name.'' \2\ 
Holding securities in street name at a securities depository 
facilitates the transfer of negotiable certificates and obviates the 
need for investor signatures and delivery of certificates. Registered 
clearing agencies acting as securities depositories help to centralize 
and automate the settlement of securities, in part by reducing the 
physical movement of securities traded in the U.S. markets through the 
use of book-entry movements. On occasion, other securities 
intermediaries, such as broker-dealers or banks, may perform similar 
functions for securities by holding a certificate registered in the 
name of securities intermediary but held on behalf of its customers and 
internally adjust its books to reflect customers' purchases and sales 
of that security.
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    \1\ The registered owner is the name of the individual 
shareholder recorded on the official records of the issuer 
(sometimes referred to as the record owner or legal owner of the 
securities).
    \2\ In the case of securities held in street name, generally the 
securities are held by a securities depository (e.g., The Depository 
Trust Company) who as the registered owner holds the securities on 
behalf of another securities intermediary (e.g., a broker-dealer or 
bank) who in turn holds the securities for its customers, the 
beneficial owners. All the rights and obligations of the securities 
are passed through the registered holder to the beneficial owners. 
For more information on the relationship between securities 
intermediaries and beneficial owners, see infra note 23.
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    The use of securities depositories in order to minimize the 
physical movement in connection with the settlement for securities 
traded in the public market is essential to the prompt and accurate 
clearance and settlement of securities transactions.\3\ The effort by 
some issuers to restrict ownership of publicly traded securities by 
securities intermediaries can result in many of the inefficiencies and 
risks Congress sought to avoid when promulgating Section 17A of the 
Exchange Act.\4\ Restrictions on intermediary ownership deny investors 
the ability to use a securities intermediary to hold their securities 
and to efficiently and safely clear and settle their securities 
transactions by book-entry movements.
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    \3\ Section 17A of the Exchange Act directs the Commission to 
use its authority to end the physical movement of securities 
certificates in connection with the settlement among brokers and 
dealers of transaction in securities. 15 U.S.C. 78q-1(e).
    \4\ 15 U.S.C. 78q-1 et seq.
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    The Commission is proposing Rule 17Ad-20 that would prohibit 
registered transfer agents \5\ from effecting any transfer of any 
equity security registered under section 12 or any equity security that 
subjects an issuer to reporting under 15(d) of the Exchange Act \6\ if 
such security is subject to any restriction or prohibition on transfer 
to or from a securities intermediary.\7\ Under the proposed rule, the 
term

[[Page 32785]]

``securities intermediary'' would be defined as a clearing agency 
registered under Section 17A of the Exchange Act or a person, including 
a bank, broker, or dealer, that in the ordinary course of its business 
maintains securities accounts for others. The Commission is proposing 
to exclude from proposed Rule 17Ad-20 any equity security issued by a 
partnership, as defined in Item 901 of Regulation S-K.\8\ For tax or 
other reasons,\9\ partnerships may have an appropriate need to restrict 
ownership and issue a securities certificate. The Commission invites 
comment on the proposed rule, the proposed timetable for 
implementation, and the costs and benefits of such a rule.
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    \5\ The Exchange Act defines transfer agent as any person who 
engages on behalf of an issuer of securities or on behalf of itself 
as an issuer of securities in (A) countersigning such securities 
upon issuance; (B) monitoring the issuance of such securities with a 
view to preventing unauthorized issuance; (C) registering the 
transfer of such securities; (D) exchanging or converting such 
securities; or (E) transferring record ownership of securities by 
book-entry without the physical issuance of securities certificates. 
15 U.S.C. 78c(a)(25). Accordingly, issuers acting as their own 
transfer agent would be subject to the rule.
    \6\ Pursuant to section 12(g) of the Exchange Act and the rules 
thereunder, a company must generally register a class of equity 
securities if on the last day of its fiscal year it has total assets 
of more than $10 million and the class is held of record by more 
than 500 persons. 15 U.S.C. 78l(g). Under section 12 (b), all 
securities registered on a securities exchange must also be 
registered with the Commission. 15 U.S.C. 78l(b). Section 15(d) of 
the Exchange Act generally requires a company with an effective 
Securities Act registration statement to file the same periodic 
reports as a company that has a section 12 registered class of 
securities. 15 U.S.C. 78o(d).
    \7\ Section 17A(c)(1) makes it unlawful for any transfer agent, 
unless registered with the Commission, to directly or indirectly 
perform the function of a transfer agent with respect to any 
security registered under Section 12 of the Act or which would be 
required to be registered except for the exemption from registration 
proved by section 12(g)(2)(B) (investment companies) or section 
12(g)(2)(G) (certain securities issued by insurance companies). 15 
U.S.C. 78q-1(c)(1).
    \8\ Item 901(b)(1) defines the term partnership to mean any: (i) 
finite-life limited partnership or (ii) other finite-life entity. 17 
CFR 229.901(b)(1). The Commission has the authority under section 36 
of the Exchange Act to conditionally or unconditionally exempt any 
security or class of securities from the provisions of the Exchange 
Act to the extent that such exemption is necessary or appropriate in 
the public interest, and is consistent with the protection of 
investors. 15 U.S.C. 78mm(a)(1).
    \9\ A ``publicly traded partnership'' as defined in Section 7704 
of the Internal Revenue Code is subject to treatment as a 
corporation rather than a partnership for tax purposes. 26 CFR 
1.7704-1.
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I. Background

A. Legislative History of the National System for Clearance and 
Settlement of Securities Transactions

    In the late 1960s and early 1970s, the securities industry 
experienced a ``paperwork crisis'' that nearly brought the industry to 
a standstill and that directly or indirectly caused the failure of a 
large number of broker-dealers.\10\ This crisis primarily resulted from 
drastically increasing trade volume coupled with inefficient, 
duplicative, and extensively manual clearance and settlement systems; 
the extensive use of securities certificates; poor records; and 
insufficient controls over funds and securities.\11\ To address the 
concerns raised by the paperwork crisis, Congress amended the Exchange 
Act to add, among other things, section 17A.\12\
    In section 17A(a), Congress made findings that (1) the prompt and 
accurate clearance and settlement of securities transactions, including 
the transfer of registered ownership and safeguarding of securities and 
funds related to clearance and settlement activities, are necessary for 
the protection of investors and those acting on behalf of 
investors,\13\ and (2) inefficient clearance and settlement procedures 
impose unnecessary costs on investors and those acting on their 
behalf.\14\ To address these concerns, Congress gave the Commission the 
authority and responsibility to regulate, coordinate, and direct the 
processing of securities transactions in order to establish a national 
system for the prompt and accurate clearance and settlement of 
transactions in securities.\15\ The basic purpose of Section 17A is to 
promote the development of a modern, nationwide system for the safe and 
efficient processing of securities transactions that serves the 
interests of the financial community and the investing public.\16\ 
Congress expressly provided the Commission with jurisdiction over 
clearing agencies and transfer agents, as well as other participants in 
the national system for clearance and settlement.\17\ Furthermore, 
specifically recognizing that the use of securities certificates to 
transfer registered ownership decreases efficiency and safety in the 
capital markets, Congress also directed the Commission to end the 
physical movement of securities certificates in connection with the 
settlement among brokers and dealers.\18\
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    \10\ Securities and Exchange Commission, Study of Unsafe and 
Unsound Practices of Brokers and Dealers, H.R. Doc. No. 231, 92nd 
Cong., 1st Sess. 13 (1971). Congress held hearings to investigate 
the problems and ultimately enacted the Securities Acts Amendments 
of 1975. Securities Acts Amendments of 1975: Hearings on S. 3412, S. 
3297, S. 2551 Before the Subcomm. on Securities of the Senate Comm. 
on Banking, Housing and Urban Affairs, 92nd Cong., 2nd Sess. (1972).
    \11\ S. Rep. No. 75, 94th Cong., 1st Sess. at 4 (1975).
    \12\ 15 U.S.C. 78q-1 et seq.
    \13\ 15 U.S.C. 78q-1(a)(1)(A).
    \14\ 15 U.S.C. 78q-1(a)(1)(B).
    \15\ 15 U.S.C. 78q-1(a)(2)(A)(i). Congress expressly envisioned 
the Commission's authority to extend to every facet of the 
securities handling process involving securities transactions within 
the United States, including activities by clearing agencies, 
depositories, corporate issuers, and transfer agents. See S. Rep. 
No. 75, 94th Cong., 1st Sess. at 55 (1975).
    \16\ See S. Rep. No. 75, 94th Cong., 1st Sess. at 122 (1975).
    \17\ See e.g., section 17A(c)(1) of the Exchange Act, which 
makes it unlawful for any transfer agent, unless registered with the 
Commission, to directly or indirectly perform the function of a 
transfer agent with respect to any security registered under section 
12 of the Act or which would be required to be registered except for 
the exemption from registration proved by section 12(g)(2)(B) 
(investment companies) or section 12(g)(2)(G) (certain securities 
issued by insurance companies). 15 U.S.C. 78q-1(c)(1) and 15 U.S.C. 
78l(a) respectively. Exchange Act Section 17A(d)(1) prohibits any 
registered clearing agency or registered transfer agent from 
engaging in any activity as a clearing agency or transfer agent in 
contravention of rules and regulations as the Commission may 
prescribe as necessary or appropriate in the public interest, for 
the protection of investors or otherwise in furtherance of the 
purposes of the Act. 15 U.S.C. 78q-1(d)(1).
    \18\ Section 17A(e) directs the Commission to use its authority 
``to end the physical movement of the securities certificates in 
connection with the settlement among brokers and dealers of 
transactions in securities consummated by means of the mails or 
other means or instrumentalities of interstate commerce.'' 15 U.S.C. 
78q-1(e).
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B. The Role of Securities Intermediaries

    The process for delivering and transferring certificated securities 
is almost entirely manual and as such, is labor-intensive, expensive, 
and time-consuming.\19\ The use of securities certificates can result 
in significant delays and expense in processing securities 
transactions. Moreover, as negotiable instruments, certificates also 
can be lost, stolen, or forged.\20\ All this adversely affects the 
national system for clearance and settlement. The concern associated 
with lost certificates was dramatically demonstrated after September 
11, 2001, when thousands of certificates at broker-dealers or banks 
(either being held in custody in vaults or being processed for 
transfer) either were destroyed or were unavailable for transfer. 
Certificates have also been identified by the financial services 
industry as an obstacle to achieving streamlined processing (i.e., 
straight-through-processing) and shorter settlement cycles.\21\
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    \19\ For more information on the costs and risks associated with 
processing certificates, see Exchange Act Release No. 49405 (March 
11, 2004), 69 FR 12922 (March 18, 2004), [File No. S7-13-04] 
(concept release regarding securities transaction settlement 
concept).
    \20\ In an effort to identify lost, counterfeit, and stolen 
securities, Exchange Act Rule 17f-1 requires, among other entities, 
every exchange, the securities association, broker, dealer, transfer 
agent, registered clearing agency, and many banks to report to the 
Securities Information Center (``SIC'') missing, lost, counterfeit, 
or stolen securities certificates. See 17 CFR 240.17f-1. SIC 
operates a centralized database that records lost and stolen 
securities. When a broker-dealer receives a security certificate to 
sell, the broker-dealer will submit information about the 
certificate to SIC so that SIC may search its database to see if the 
certification has been reported as missing, lost, stolen, or 
counterfeited. (For more information about SIC, see www.secic.com.) 
If a broker-dealer is unable to have the security reregistered into 
the name of the buyer or the buyer's securities intermediary after 
trade date, the rejection of the transfer after trade date exposes 
the customer to the costs and risks that she may have to buy in the 
security and exposes the broker-dealer to the costs and risks 
associated with buy-ins. Investors bear direct costs as well. 
Transfer agents require investors to obtain a surety bond before the 
transfer agent will issue a replacement certificate for lost and 
stolen certificates. We understand that generally most transfer 
agents charge investors between 2%-4% of the current market value of 
the securities to obtain a surety bond.
    \21\ See Exchange Act Release No. 49405 (March 11, 2004), 69 FR 
12922 (March 18, 2004), [File No. S7-13-04].
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    Securities intermediaries hold securities on behalf of others in 
order to facilitate more efficient clearance and settlement of 
securities transactions by reducing the need to transfer certificates. 
Investors' securities generally are held in the name of a securities 
intermediary, such as a securities depository, broker-dealer, or

[[Page 32786]]

bank, or its nominee, for the benefit of the security intermediary's 
customers. The securities intermediary or its nominee is generally the 
registered owner of the securities while the securities intermediary's 
customer typically is the beneficial owner.\22\ Securities registered 
in the name of the securities intermediary or its nominee allows the 
securities to be immobilized \23\ and held in fungible bulk \24\ 
thereby significantly reducing the number of certificates that need to 
be delivered and transferred. This in turn reduces the risk and cost 
associated with transferring the securities. Transfers in ownership of 
securities held in the name of a securities intermediary are 
accomplished by making book-entry adjustments to the accounts on the 
securities intermediary's records.
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    \22\ The relationship between various levels of securities 
intermediaries and beneficial owners is complex. There may be many 
layers of beneficial owners (some of which may also be securities 
intermediaries) with all ultimately holding securities on behalf of 
a single beneficial owner, who is sometimes referred to as the 
ultimate beneficial owner. For example, an introducing broker-dealer 
may hold its customer's securities in its account at a clearing 
broker-dealer, that in turn holds the introducing broker-dealer's 
securities in an account at The Depository Trust Company (DTC). In 
this context, DTC or its nominee is the registered owner and DTC's 
participants (i.e., broker-dealers and banks) are beneficial owners, 
as are the participants' customers. However, DTC, the clearing 
broker-dealer (the DTC participant), and the introducing broker-
dealer are all securities intermediaries. These distinctions may be 
important under both federal and state law when determining the 
rights and obligations of the parties holding securities on behalf 
of others.
    \23\ Immobilization of securities occurs where a securities 
depository holds the underlying certificate and transfers of 
ownership are recorded through book-entry movements between the 
depository's participants' accounts. An issue is partially 
immobilized (as is the case with most equity securities traded on an 
exchange or at the NASD) when the street name positions are 
immobilized (i.e., those held through broker-dealers that are 
participants of a depository), but certificates are still available 
to individual shareholders upon request. For more information about 
immobilization and dematerialization, see Exchange Act Release No. 
49405 (March 11, 2004), 69 FR 12922 (March 18, 2004), [File No. S7-
13-04].
    \24\ Fungible bulk means that no participant or customer of a 
participant has any claim or ownership rights to any particular 
certificate held by DTC. Rather, participants have a securities 
entitlement to obtain a certificate representing securities held in 
their DTC accounts.
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    Consistent with Congress' directive to establish a national system 
for clearance and settlement and to decrease the inefficiencies and 
risks associated with processing securities certificates, the 
Commission has long encouraged the use of alternatives to holding 
securities in certificated form. The Commission's approval of the 
registration of securities depositories as clearing agencies in 1983 
constituted an important step in achieving the mandates established by 
Congress by immobilizing securities in a registered clearing agency and 
settling transactions by book-entry movements.\25\ The Commission also 
has approved the rule filings of self-regulatory organizations that 
require their members to use the facilities of a securities depository 
for the book-entry settlement of all transactions in depository-
eligible securities \26\ and that require securities to be made 
depository eligible if possible before they can be listed for 
trading.\27\
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    \25\ Exchange Act Release No. 20221 (September 23, 1983), 48 FR 
45167 (October 3, 1983), [File Nos. SR-600-5 and 600-19] (order 
approving the clearing agency registration of four depositories and 
four clearing corporations).
    \26\ Exchange Act Release No. 32455 (June 11, 1993), 58 FR 33679 
(June 18, 1993), [File Nos. SR-Amex-93-07; SR-BSE-93-08; SR-MSE-93-
03; SR-NASD-93-11; SR-NYSE-93-13; SR-PSE-93-04; and SR-Phix-93-09)] 
(order approving rules requiring members, member organizations, and 
affiliated members of the New York Stock Exchange, National 
Association of Securities Dealers, American Stock Exchange, Midwest 
Stock Exchange, Boston Stock Exchange, Pacific Stock Exchange, and 
Philadelphia Stock Exchange to use the facilities of a securities 
depository for the book-entry settlement of all transactions in 
depository-eligible securities with another financial intermediary). 
In rare circumstances, DTC will be unable to accept a deposit of a 
security because it is unable to process it. In those cases, the 
rules of the self-regulatory organizations do not require the 
security to be depository eligible.
    \27\ Exchange Act Release No. 35798 (June 1, 1995), 60 FR 30909 
(June 12, 1995), [File Nos. SR-Amex-95-17; SR-BSE-95-09; SR-CHX-95-
12; SR-NASD-95-24; SR-NYSE-95-19; SR-PSE-95-14; SR-PHLX-95-34] 
(order approving rules setting forth depository eligibility 
requirements for issuers seeking to have their shares listed on the 
American Stock Exchange, Boston Stock Exchange, Chicago Stock 
Exchange, National Association of Securities Dealers, New York Stock 
Exchange, Pacific Stock Exchange, and the Philadelphia Stock 
Exchange).
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    Registered clearing agencies acting as securities depositories 
immobilize securities and centralize and automate securities 
settlements.\28\ Holding securities positions in book-entry form at 
securities depositories reduces the physical movement of publicly 
traded securities in the U.S. markets and significantly improves 
efficiencies and safeguards in processing securities certificates, 
which in turn reduces the costs of those transactions to investors and 
market professionals alike.
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    \28\ Securities depositories work in conjunction with securities 
clearing corporations. Both types of entities must be registered as 
clearing agencies under section 17A of the Exchange Act. Clearing 
corporations, such as the National Securities Clearing Corporation, 
serve to compare trades submitted to it by its participants and net 
those trades to a single position at the end of the day. The trade 
position data is then submitted to the depository in order to 
effectuate settlement by debiting or crediting the participants' 
book-entry securities position at DTC and facilitating the payments 
to or from the participants.
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    DTC, the largest securities depository in the world, provides 
custody and book-entry transfer services for the vast majority of 
securities transactions in the U.S. market involving equities, 
corporate and municipal debt, money market instruments, American 
depositary receipts, and exchange-traded funds.\29\ In accordance with 
its rules, DTC accepts deposits of securities from its participants 
(i.e., broker-dealers and banks),\30\ credits those securities to the 
depositing participants' accounts, and effects book-entry movements of 
those securities.\31\ The securities deposited with DTC are registered 
in DTC's nominee name \32\ and are held in fungible bulk for the 
benefit of its participants and their customers.\33\ Each participant 
having an interest in securities of a given issue credited to its 
account has a pro rata interest in the securities of that issue held by 
DTC.\34\
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    \29\ Of the four depositories registered as clearing agencies in 
1983, DTC is the only one still operating. DTC estimates that as of 
December 31, 2002, approximately 84% of the shares issued by 
domestic companies listed on the NYSE and 88% of the domestic 
companies listed on the Nasdaq are deposited at DTC. (These 
statistics do not include ADRs.) E-mail from Joseph Trezza, Senior 
Product Manager, DTCC, to the Commission staff (November 14, 2003).
    \30\ In the case of ``book-entry-only'' securities (e.g., no 
securities certificates are available), the issuer will authorize 
DTC to credit the account or accounts of participants with all of 
the issuer's outstanding shares.
    \31\ See, e.g., Rules 5 and 6 of DTC's Rules.
    \32\ DTC registers securities in the name of its nominee, Cede & 
Co., which makes it the registered owner of the securities.
    \33\ Securities deposited at DTC by its participants or the 
issuers in the case of book-entry-only securities are legally or 
beneficially owned by the participants or their customers at the 
time of the deposit and are subsequently transferred into DTC's 
nominee name.
    \34\ While DTC is the registered owner, the participants and 
their customers are the beneficial owners. At no time does an issuer 
have an ownership interest in the securities deposited at DTC. See 
supra note 22.
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    Some securities trading in the public market are not deposited at a 
securities depository because either the securities are not eligible 
for deposit \35\ or the securities intermediary chooses not to deposit 
the securities.\36\ To clear and settle securities transactions without 
the use of a securities depository, broker-dealers must make 
independent arrangements to provide for delivery of securities (in 
certificated form) and payment on a trade-by-trade basis. In

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cases where an issuer has prohibited ownership of their securities by 
certain securities intermediaries, such as DTC, some broker-dealers 
register their customers' positions in the name of the broker-dealer so 
that certificates do not need to be issued for each customer and 
transferred on each trade. However, securities transactions between 
broker-dealers would still have to be manually processed. Thus, 
clearing and settling securities transactions outside of a depository 
raises greater risks and inefficiencies, including credit risk issues 
and risk of defaults, than transfers within a depository. Furthermore, 
the payment of dividends and proceeds from corporate actions for 
securities held outside a depository typically are slower and more 
costly because issuers must send a check to each shareholder rather 
than make a single deposit of the funds at DTC.\37\
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    \35\ A securities depository determines whether a security is 
eligible for deposit. Certain securities may not be eligible for a 
variety of reasons such as the security cannot conform to the 
depository's processing systems or ownership of the security is 
restricted in such a manner that it cannot be freely transferred.
    \36\ For example, DTC participants may choose to not deposit the 
securities in the depository if the security is not widely traded 
and instead hold certificated securities registered in the name of 
either the participant's nominee or its customer.
    \37\ Payments from issuers submitted to DTC are immediately 
distributed to DTC participants (generally the same day) who then 
pay the dividends to their investor clients.
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    In addition to encouraging the use of securities depositories, the 
Commission has also long supported industry efforts to develop other 
alternatives to securities certificates, particularly for those 
investors who want to retain the registration of the securities in 
their own names.\38\ The Commission issued a concept release in 1994 
seeking public comment on the policy implications and the regulatory 
issues raised by use of a system that would allow individual investors 
to register securities in their own names but hold their positions in 
book-entry form on the books of the issuers or its transfer agent. Such 
a system, known as the Direct Registration System (``DRS'') began 
operating in mid 1990s. DRS provides investors with the ability to 
register their securities in their own names directly on the issuer's 
records in book-entry form and to electronically transfer by book-entry 
movements the securities positions between the issuer or its transfer 
agent and the investors' broker-dealers.\39\ In place of a certificate, 
issuers send a periodic statement to reflect the number of shares 
registered in the name of and held in DRS by the shareholder. Today 
over 750 issuers have made their securities eligible for DRS and nearly 
40 million investors hold their shares in DRS.\40\
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    \38\ See ``Progress and Prospects: Depository Immobilization of 
Securities and the Use of Book-Entry Systems,'' Staff Report, 
Division of Market Regulation, U.S. Securities and Exchange 
Commission (June 14, 1985). In 1990, the Commission held a 
Roundtable on Clearance and Settlement to discuss the implementation 
of the Group of Thirty's U.S. Working Committee regarding clearance 
and settlement. ``Clearance and Settlement in the World's Securities 
Markets,'' Group of Thirty (March 1989). The Committee noted in its 
report that the pressure to have securities available for settlement 
in shorter settlement timeframes would increase the need for 
immobilizing securities certificates and the use of book-entry 
transfer at the retail level. The roundtable participants envisioned 
a transfer agent operated book-entry registration system that would 
allow investors to be ``directly registered'' in electronic form on 
the books of the issuer and receive a periodic statement reflecting 
their ownership interest. ``Providing Alternatives to Certificates 
For the Retail Investor,'' Group of Thirty, U.S. Working Committee, 
Clearance and Settlement Project (August 1991).
    \39\ Prior to full implementation of DRS's electronic transfer 
capability (the ``Profile Modification System''), shareholders 
wanting to sell shares held in DRS had to certificate and physically 
deliver the securities to the broker-dealer. With DTC's Profile 
Modification System, DRS shares can be electronically transferred 
between DTC participants and transfer agents. Exchange Act Release 
Nos: 37931 (November 7, 1996), 61 FR 58600 (November 15, 1996), 
[File No. SR-DTC-96-15] (order granting approval to establish DRS); 
41862 (September 10, 1999), 64 FR 51162 (September 21, 1999), [File 
No. SR-DTC-99-16] (order approving implementation of the Profile 
Modification System); 42704 (April 19, 2000), 65 FR 24242 (April 25, 
2000), [File No. SR-00-04] (order approving changes to the Profile 
Modification System); 43586 (November 17, 2000), 65 FR 70745 
(November 27, 2000), [File No. SR-00-09] (order approving the 
Profile Surety Program in DRS); 44696 (August 14, 2001), 66 FR 43939 
(August 21, 2001), [File No. SR-DTC-2001-07] (order approving 
movement of DRS issues into the Profile Modification System and the 
establishment of the ``S'' position as the default in DRS). DRS also 
can be used as a means for issuers to dematerialize their securities 
(i.e., so that certificates are no longer issued to evidence 
security ownership).
    \40\ DRS statistics are as of April 5, 2004. E-mail to industry 
participants from Joseph Trezza, DTC, May 5, 2004.
---------------------------------------------------------------------------

II. Need for the Proposed Rule

    A small but growing number of issuers whose securities are 
registered under section 12 or are reporting under section 15(d) of the 
Exchange Act \41\ recently have restricted, or indicated their 
intention to restrict, ownership of their securities by prohibiting 
their transfer agents from acknowledging ownership of shares registered 
in the name of DTC or by prohibiting transfer of their securities to 
DTC or in some cases to any securities intermediary.\42\ Most, if not 
all, of the issuers restricting ownership of their securities have also 
required that the shares be represented in certificated form.\43\ In 
several cases, the issuer has required the broker-dealer to disclose 
the name of the ultimate beneficial owner before reregistering any 
securities held by the broker-dealer either in the name of the broker-
dealer or in the name of DTC.\44\ Some brokers refused because they 
believed disclosure of the customer's name would violate federal 
securities laws \45\ or contractual obligations to the customer. Other 
broker-dealers could not disclose the name of the ultimate beneficial 
owner because they knew only the identity of their customer and not 
necessarily for whom their customer was holding the securities.
---------------------------------------------------------------------------

    \41\ See supra note 6.
    \42\ See e.g., www.jagnotes.com or www.nutk.com. Also see 
``Intergold Corporation Announces Custody Only CommonShare Transfer 
System,'' PRNewswire-First Call (January 30, 2003).
    \43\ Id. The certification requirement does not in and of itself 
preclude securities from being deposited at DTC. In fact, DTC's 
nominee owns most securities deposited at DTC in certificated form, 
generally by a global or balance certificate.
    \44\ See supra note 42. Registration of a transfer is necessary 
to change registered ownership of a security.
    \45\ For example, some broker-dealers have expressed concern 
that such disclosure may cause them to violate Exchange Act Rule 
14b-1 that requires a broker to provide a requesting issuer only 
with the identities of beneficial owners who have not objected to 
disclosures of this information to issuers. 17 CFR 240.14b-1.
---------------------------------------------------------------------------

    Issuers imposing these restrictions, sometimes referred to as 
``custody-only trading,'' frequently state that they are imposing 
ownership or transfer restrictions on their securities to protect their 
shareholders and their share price from ``naked'' short selling.\46\ 
These issuers believe that requiring all securities to be in 
certificated form and precluding ownership by certain securities 
intermediaries forces broker-dealers to deliver certificates on each 
transaction, thereby eliminating the ability of naked short sellers to 
maintain a naked short sale position.\47\
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    \46\ See Exchange Act Release No. 47978 (June 4, 2003), 68 FR 
35037 (June 11, 2003). A short sale is a sale of a security that the 
seller does not own or is effectuated by the delivery of borrowed 
securities. Although a ``naked short sale'' is not a defined term 
under federal securities laws, it generally refers to situations 
where a seller sells a security without owning or borrowing the 
security and does not deliver when delivery is due.
    \47\ Id.
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    A number of issuers imposing ownership or transfer restrictions 
sought to withdraw from DTC all securities issued by them and indicated 
that they would not allow their securities to be reregistered in the 
name of DTC.\48\ In June 2003, the Commission approved a DTC rule 
change clarifying that DTC's rules and procedures provide only for 
participants (i.e., broker-dealers and banks) to submit withdrawal 
instructions for securities deposited at DTC and do not require DTC to 
comply with withdrawal requests from issuers.\49\
---------------------------------------------------------------------------

    \48\ Id.
    \49\ Exchange Act Release Nos. 47365 (February 13, 2003), 68 FR 
8535 (February 21, 2003), [File No. SR-DTC-2003-02] (notice of 
proposed rule change); 47978 (June 4, 2003), 68 FR 35037 (June 11, 
2003), [File No. SR-DTC-2003-02] (order approving proposed rule 
change concerning requests for withdrawal of certificates by 
issuers). DTC noted in a response letter to commenters on File No. 
SR-DTC-2003-02 that DTC, on behalf of its participants or their 
customers, owned these securities without restrictions at the time 
of the deposit into the depository. DTC also stated that in the 
situations where the issuers attempted to restrict transferability 
of its shares, none of their securities bore any legend, conspicuous 
or otherwise, noting the restrictions.

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[[Page 32788]]

    In response, a number of issuers indicated that they had adopted or 
would adopt restrictions, assertedly pursuant to state corporation 
laws, to prohibit ownership of their securities by a depository, 
securities intermediaries, or both.\50\ Issuers' actions to implement 
the restrictions caused numerous clearance and settlement problems. 
Some of these issuers refused to recognize positions that had been 
registered in the name of DTC's nominee or in the name of broker-
dealers before the adoption of the restriction and refused to transfer 
(or allow their transfer agent to transfer) stock to the name of any 
entity or person that the issuer believed was not the ultimate 
beneficial owner.\51\ Where issuers refused to recognize ownership 
positions registered in the name of securities intermediaries, the 
broker-dealers and banks were forced individually to negotiate a 
solution directly with the issuer.
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    \50\ See e.g., www.jagnotes.com or www.nutk.com. Also see 
``Intergold Corporation Announces Custody Only CommonShare Transfer 
System,'' PRNewswire-First Call (January 30, 2003).
    \51\ Telephone conversation between Susan Geigel, Director, 
Legal and Regulatory Compliance, The Depository Trust Clearing 
Corporation and Staff, Division of Market Regulation, Commission 
(August 4, 2003).
---------------------------------------------------------------------------

    In order to compel securities intermediaries to register stock only 
in the names of the ultimate beneficial owners, some issuers initiated 
corporate actions or ``reorganizations.'' These corporate actions or 
reorganizations, such as stock dividends, exchanges, reverse splits, or 
name changes, were intended to force the intermediaries to either 
comply with the issuers' instructions to deliver securities to the 
issuer or its agent for exchange and reregistration into the name of 
the ultimate beneficial owner or exclude their customers from 
participating in a corporate action or dividend.\52\ In situations 
where broker-dealers refused to comply with the issuer demands to 
disclose the name of customers so that new restricted shares may be 
issued, the new securities remain unissued.
---------------------------------------------------------------------------

    \52\ In the case of a stock dividend, some issuers would require 
broker-dealers to remit their shares registered in the name of 
either DTC's nominee or the broker-dealer and to disclose the names 
of their customers so that the current shares and the stock dividend 
could be reregistered in the name of the broker-dealer's customers 
(i.e., the beneficial owners). In the case of a merger, a new entity 
would be formed for the sole purpose of requiring that outstanding 
securities in the old company to be remitted to the issuer and 
reregistered in the name of the beneficial owner.
---------------------------------------------------------------------------

    Where securities intermediaries are precluded from having 
securities registered in their names, the securities intermediaries' 
ability to hold and move securities is severely limited. As a result, 
trading and clearance and settlement efficiency suffers, and costs and 
risks increase. This consequence of issuer restrictions is not 
compatible with the congressional objective that trades in the 
securities of publicly traded companies should be settled through the 
national system for clearance and settlement and benefit from its 
efficiencies and risk reductions and is a significant step backwards in 
our progress to develop the national system. Furthermore, forced 
certification of securities is inconsistent with the industry's goals 
of streamlining processing of securities transactions.\53\
---------------------------------------------------------------------------

    \53\ See Exchange Act Release No. 49405 (March 11, 2004), 69 FR 
12922 (March 18, 2004), [File No. S7-13-04] (securities transaction 
settlement concept release). See also ``SIA T+1 Business Case Final 
Report,'' at 18-21 (August 2000) (``SIA Business Case Report''). The 
report is available online at http://www.sia.com/t_plus_one_issue/pdf/BusinessCaseFinal.pdf.
---------------------------------------------------------------------------

    These types of restrictions have also caused investors increased 
costs and delays. By forcing securities intermediaries to submit 
securities as part of an issuer's recapitalization, the transfer agent 
must transfer the securities by canceling the certificate registered in 
the name of the securities intermediary and re-register a new 
certificate in the name of the beneficial owner. Transfer agent 
registration fees, which may range from $10.00 to $75.00 per transfer, 
and costs for secure delivery of securities certificates, can be more 
than the market value of the securities being processed.\54\ In some 
cases, the broker-dealers assume these costs but in many cases the cost 
is passed along to investors. Broker-dealers that did reregister 
securities received numerous complaints from investors about the fees, 
particularly where the investors had not issued instructions to 
reregister the securities. In addition, broker-dealers had to deliver 
the securities certificates to an issuer's transfer agent and the 
transfer agent similarly had to deliver the newly registered 
certificates. As a result, there were significant costs and delays in 
obtaining certificates, which could ultimately impede the customers' 
ability to sell or otherwise negotiate the security in the marketplace.
---------------------------------------------------------------------------

    \54\ Securities trading in the non-Nasdaq over-the-counter 
market are not subject to listing requirements and as such, have no 
rules governing fees charged for transfers of the issuers' 
securities.
---------------------------------------------------------------------------

    The Commission understands that some issuers view this mechanism as 
a means of deterring manipulative naked short selling.\55\ These 
issuers believe that by requiring securities be processed through the 
national system for clearance and settlement, the securities are 
subject to manipulative naked short selling, which, they argue, can 
result in issuers and investors suffering losses due to the diminution 
in the market value or adverse effects on ownership (e.g., dilution, 
decrease in market value, or loss of voting rights).\56\ The Commission 
has recently published for comment proposed rules directly relating to 
issues raised by short selling.\57\ The Commission does not believe 
that naked short selling concerns should or can be addressed by issuers 
attempting to control the ownership or transferability of their 
securities that trade in the public market. Restrictions on securities 
can often make the stock less liquid, causing reduction in the value of 
the securities, and interfere with efficient processing. Accordingly, 
we are proposing a rule that would prohibit registered transfer agents 
from transferring any equity security registered under section 12 or 
any equity security that subjects an issuer to reporting under section 
15(d), other than equity securities issued by partnerships, if such 
security is subject to any restriction or prohibition on transfer to or 
from a securities intermediary. The objective of the proposed rule is 
to prohibit registered transfer agents from effecting transfers in 
securities of public companies that have restricted their stock in a 
manner that prevents trades in these securities from being processed 
through the national clearance and settlement system.
---------------------------------------------------------------------------

    \55\ See Exchange Act Release No. 47978 (June 4, 2003), 68 FR 
35037 (June 11, 2003), [File No. SR-DTC-2003-02].
    \56\ Id.
    \57\ Exchange Act Release No. 48709 (October 28, 2003), 68 FR 
62972 (November 6, 2003), [File No. S7-23-03] (Regulation SHO 
proposing changes to Commission rules relating to short sales).
---------------------------------------------------------------------------

III. Description of Proposed Rule 17Ad-20

A. Rule Text

    Proposed Rule 17Ad-20 would provide that a registered transfer 
agent \58\ is prohibited from effecting any transfer of any equity 
security registered under section 12 or any equity security that 
subjects an issuer to reporting

[[Page 32789]]

under section 15(d) of the Exchange Act \59\ if such security is 
subject to any restriction or prohibition on transfer to or from a 
securities intermediary.\60\ The term ``securities intermediary'' would 
be defined as a clearing agency registered under section 17A of the 
Exchange Act \61\ or a person, including a bank, broker, or dealer, 
that in the ordinary course of its business maintains securities 
accounts for others.\62\ Any equity security issued by a partnership, 
as defined in Item 901(b) of Regulation S-K,\63\ is excluded from the 
proposed rule.\64\
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    \58\ See supra notes 5 and 7. Transfer agents will not be able 
to evade compliance with this proposed rule or any other transfer 
agent rule by failing to register as transfer agents when the 
Exchange Act requires such registration.
    \59\ 15 U.S.C. 78l and 15 U.S.C. 78o(d) respectively.
    \60\ The term ``transfer'' means (1) delivery of the security 
(i.e., the certificate, or in the case of book-entry, an 
instruction); (2) a volitional act by the transferor which manifests 
an intent to change ownership or convey a security interest; and (3) 
reregistration of ownership. See Egon Guttman, Modern Securities 
Transfers Sec.  6:2, at 6-4 (3d ed. 2002).
    \61\ 15 U.S.C. 78q-1 et seq.
    \62\ The term ``securities intermediary'' as used for purposes 
of the proposed rule differs from the definition of securities 
intermediary as adopted in the Uniform Commercial Code (``UCC'') in 
that the clearing corporation or person that in the ordinary course 
of its business maintains securities accounts for others does not 
need to be acting in that capacity in order for prohibition to 
apply.
    \63\ See supra notes 8 and 9.
    \64\ The Commission has the authority under Section 36 of the 
Exchange Act to conditionally or unconditionally exempt any security 
or class of securities from the provisions of the Exchange Act to 
the extent that such exemption is necessary or appropriate in the 
public interest, and is consistent with the protection of investors. 
15 U.S.C. 78mm(a)(1).
---------------------------------------------------------------------------

    The proposed rule will apply only to transfer agents who are 
registered or should be registered with the Commission pursuant to 
section 17A of the Exchange Act. Since the Exchange Act only requires 
registration of entities acting as transfer agents for securities 
registered under section 12, the proposed rule will not extend to 
unregistered transfer agents acting solely for securities not 
registered under section 12. In other words, if an unregistered 
transfer agent is acting as agent for only section 15(d) securities, 
the transfer agent would be able to transfer securities that have 
restrictions on intermediary ownership. But if a transfer agent is 
required to register, the agent would be required to comply with 
proposed Rule 17Ad-20 for any equity security registered under section 
12 or any equity security that subjects an issuer to reporting under 
section 15(d) of the Exchange Act.
    As agent of the issuer responsible for processing transfers, a 
transfer agent is in the optimal position to know if the issuer has 
restricted the stock in a manner covered by the rule. Under the 
proposed rule, registered transfer agents would be required to make a 
determination prior to effecting a transfer in an equity security 
registered under section 12 or an equity security that subjects an 
issuer to reporting under section 15(d) of the Exchange Act that the 
securities do not have a restriction or prohibition on transfer to or 
ownership by a securities intermediary. We understand that many 
transfer agents already have procedures in place to ascertain whether 
securities have other restrictions on trading or transfer. In addition, 
many transfer agents obtain representations from each issuer prior to 
becoming its transfer agent that the issuer's securities are properly 
registered under federal securities laws or exempt from registration.
    The vast majority of securities trading on exchanges or Nasdaq are 
already subject to market rules requiring depository eligibility of 
securities and mandating members' use of depositories.\65\ Most 
securities whose issuers restrict ownership of their securities by 
securities intermediaries are trading in the non-Nasdaq over-the-
counter market. Accordingly, the proposed rule effectively would 
supplement the market rules to expand the scope of securities covered 
to include most public company securities (i.e., registered under 
section 12 or securities of issuers subject to reporting under section 
15(d)) that trade in the non-Nasdaq over-the-counter market.
---------------------------------------------------------------------------

    \65\ See supra notes 26 and 27. As a result, most securities 
trading on exchanges or Nasdaq cannot be restricted in a manner that 
precludes ownership by or transfer to securities intermediaries.
---------------------------------------------------------------------------

B. Scope and Compliance Date

    In order to achieve the goals of the national system for clearance 
and settlement, it is imperative that as many publicly traded 
securities as practicable be eligible to clear and settle through the 
national system for clearance and settlement and that investors and 
securities intermediaries retain the choice as to how to hold their 
securities in order to avail themselves of the benefits of the national 
system for clearance and settlement. Therefore the Commission proposes 
to apply the proposed rule to all covered equity securities that are 
either currently registered under section 12 or any equity security 
that subjects an issuer to reporting under section 15(d), not just 
those that are registered or become reporting companies after the 
rule's effective date. In order to provide sufficient notice and 
opportunity for issuers to remove restrictions from securities and for 
transfer agents to comply with the rule, if it were adopted, the 
Commission is proposing to require compliance with the rule on and 
after the ninetieth day after the date the Commission adopts the rule.

IV. Solicitation of Comment

    The Commission invites commenters to address the merits of the 
proposed rule and specifically invites comment on specific costs and 
benefits of the proposed rule. The Commission seeks comment on the 
effects of the proposed rule on the national system for clearance and 
settlement and the national market system, as well as whether the 
approach and scope of the proposed rule is necessary or appropriate. 
Interested persons are also invited to comment on whether alternative 
approaches would address the concerns raised by issuer restrictions on 
publicly traded securities.
    The Commission invites comment on the effect of the proposed rule 
on registered transfer agents, the entities primarily responsible for 
compliance with the proposed rule, and whether the transfer agent is 
the appropriate entity to be responsible for compliance or whether the 
compliance obligations should be placed on or extended to other market 
participant. Interested persons may comment on how registered transfer 
agents will ensure compliance, on the costs to comply, and on any 
risks, risk reduction, benefits, or savings that may result from the 
proposed rule. The Commission also seeks comment on what if any 
difficulties registered transfer agents may have in monitoring whether 
securities are registered under section 12 or any equity security that 
subjects an issuer to reporting under section 15(d). Interested persons 
are invited to comment on how registered transfer agents will address 
the situations where issuers refuse to remove the restrictions and 
whether the rule should address this concern.
    The Commission invites comment on the effects of the proposed rule 
on issuers, and in particular, the costs and benefits of prohibiting 
the issuers' agents from transferring equity securities that are 
restricted in a manner prohibited by the proposed rule. Given that most 
of the companies that will be effected by the proposed rule are those 
currently not trading on a national exchange or Nasdaq, the Commission 
also seeks comment on the impact of the proposed rule on issuers, 
particularly small issuers, and its effect on ownership and capital 
formation.
    The Commission invites comment on whether the scope of the proposed 
rule is appropriate and whether the

[[Page 32790]]

application of the rule to any particular securities would create 
difficulties or costs for investors, issuers, transfer agents, or other 
market participant. The Commission invites comment on whether the 
exclusion of equity securities issued by partnerships as defined in 
Item 901 of Regulation S-K is appropriate. The Commission also requests 
comment on whether there should be other exclusions included in the 
proposed rule.
    As proposed, the rule would apply to equity securities currently 
registered under section 12 or to equity securities that currently 
subjects an issuer to reporting under section 15(d) as well as those 
securities that will be section 12-registered securities or securities 
of issuers that will be subject to Section reporting in the future. The 
Commission seeks comment on whether the application of the proposed 
rule should not extend to those securities already registered or those 
securities of issuers already subject to reporting and whether by doing 
so, particular hardships or costs will ensue. Interested persons are 
invited to comment on whether 90 days is sufficient time for issuers to 
remove the restrictions and for transfer agents to operationally adjust 
their procedures.

V. Paperwork Reduction Act

    The proposed Rule 17Ad-20 does not contain new ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (``PRA'').\66\ Accordingly, the PRA is not 
applicable to the proposed amendments because they do not impose any 
new collection of information requirements that would require approval 
of the Office of Management and Budget (``OMB'').
---------------------------------------------------------------------------

    \66\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

VI. Costs and Benefits of Proposed Rule

    The Commission is considering the costs and the benefits of 
proposed Rule 17Ad-20, which would prohibit registered transfer agents 
from effecting transfers of equity securities (other than those issued 
by certain partnerships) registered under section 12 or any equity 
security that subject an issuer to reporting under section 15(d) if 
such security is subject to any restriction or prohibition on transfer 
to or from a securities intermediary. The Commission is sensitive to 
the costs and benefits associated with proposed rule, and encourages 
commenters to discuss the costs and benefits addressed below, as well 
any additional costs or benefits that we may have not considered. In 
particular, the Commission requests comment on the potential costs for 
any modification to computer systems, operations, or procedures the 
proposed rule may require, as well as any potential benefits resulting 
from the proposal for investors, securities intermediaries (including, 
but not limited to, broker-dealers, depositories, and banks), transfer 
agents, other securities industry professionals, and others. To assist 
us in evaluating the costs and benefits that may result from the 
proposed rule, we encourage commenters to provide analysis and data to 
support their view.

A. Benefits

    By prohibiting registered transfer agents from effecting a transfer 
in any equity security registered under section 12 or in any equity 
security that subjects an issuer to reporting under section 15(d) that 
restricts or prohibits transfers to or from securities intermediaries, 
proposed Rule 17Ad-20 would allow investors to clear and settle their 
securities transactions through the national system for clearance and 
settlement and thereby take advantage of benefits of that system. We 
believe that the use of the national system, which can only be accessed 
through securities intermediaries, provides significant benefits to 
U.S. investors, brokers, dealers, other securities intermediaries, and 
issuers, by increasing efficiencies and reducing risks associated with 
processing, transferring, and settling securities certificates. While 
some of these benefits may not be readily quantifiable in terms of 
dollar value, particularly those related to risk reduction, we 
nonetheless believe that investors and broker-dealers who choose to use 
a securities intermediary will lower their transactions costs and 
realize a reduction in certain risks related to settlement of 
securities transactions and transfer of securities to registered 
ownership.
    Issuers restricting transfers of their securities to or from 
securities intermediaries are causing investors to have to certificate 
their positions, which must be reregistered after every purchase or 
sale transaction. The Securities Industry Association (``SIA'') 
recently noted that the annual direct and indirect cost of processing 
and transferring certificates in the U.S. market, including those 
related to shipping, signature guarantees,\67\ transfer fees, custody, 
and manual processing, exceeds $234,000,000.\68\ Costs and risks 
associated with missing, lost, counterfeit, or stolen certificates are 
also significant. Between 1996 and 2000, the SIA estimated that an 
average of 1.7 million certificates were reported lost or stolen.\69\ 
In 2001, that figure increased to 2.5 million certificates.\70\ 
Reporting missing, lost, stolen, or counterfeit securities certificates 
to SIC, determining negotiability of these certificates, and paying for 
surety bonds for lost certificates costs the financial industry and 
investors millions of dollars each year.\71\ In recent years, the 
fraudulent resale and fraudulent collateralization of cancelled 
certificates (certificates with no resale value) alone have cost 
investors and financial institutions millions of dollars.\72\
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    \67\ Every endorsement of a securities certificate requires a 
signature guarantee by an acceptable guarantor. Securities Transfer 
Association Rule Book, Section 1.02 (1998). The Uniform Commercial 
Code that states that a signature guarantee is a warranty by the 
signature guarantor that, among other things, the endorser is an 
appropriate person to endorse and thus the transfer the security. 
UCC 8-312.
    \68\ Letter to Robert L.D. Colby, Deputy Director, Division of 
Market Regulation, Commission, from Donald Kittell, Executive Vice 
President, SIA (August 20, 2003); letter to Annette Nazareth, 
Director, Division of Market Regulation, Commission, from Donald 
Kittell, Executive Vice President, SIA (March 24, 2003) (``Nazareth 
Letter''). These letters advocate the need to dematerialize the U.S. 
market.
    \69\ Id. The SIA's statistics on securities reported lost and 
stolen were obtained by the SIA directly from SIC.
    \70\ Id.
    \71\ Nazareth Letter. Investors who have either lost their 
certificates or had the certificates stolen generally must obtain a 
surety bond before the transfer agent will register a transfer of 
ownership in order to protect the transfer agent from the risk of 
wrongful transfers in the event that the lost or stolen certificates 
reappear at a later date. We understand that generally most transfer 
agent charge investors 2%-4% of the current market value of the 
securities for such a bond.
    \72\ See Exchange Act Release No. 48931 (December 16, 2003), 68 
FR 74390 (December 23, 2003), [File No. S7-18-00] (order adopting 
rule relating to certificate destruction).
---------------------------------------------------------------------------

    Furthermore, the process of manually transferring securities 
transactions on an individual trade basis through the transfer agent 
causes significant delays in settling securities transactions and 
registering ownership. These delays may prevent investors from 
effecting timed transactions in the market. All of these costs and 
risks are ultimately borne by investors. The Commission believes the 
costs and risks are substantially reduced or even eliminated through 
the use of book-entry transfers and automated settlement at a 
securities depository.
    The Commission seeks comments, analysis, and empirical data on the 
extent to which the proposed rule will benefit investors by reducing 
costs associated with issuer-imposed restrictions on transferring 
securities to or from securities intermediaries. In particular, the 
Commission seeks

[[Page 32791]]

comment and data on the benefits to investors of the proposed rule to 
the extent it precludes decreased liquidity, increased risk, and 
increased transaction costs that may be associated with such issuer-
imposed restrictions on securities. We also solicit comments and data 
on the potential benefits that may accrue due to a reduction in 
production, transfers, and processing of certificates, and the 
increased use of a depository.
    Moreover, the proposed rule may benefit issuers by reducing the 
number of transfers recorded and the number of certificates produced. 
Many issuers pay their transfer agent a fee to produce a certificate 
and transfer securities. Accordingly, the Commission requests data on 
how many issuers, particularly those affected by the proposed rule, 
permit their transfer agent to charge a fee for transfers, and if so, 
whether that fee is paid by the issuer or the investor.
    A number of broker-dealers have informed the Commission that they 
have had to undertake special communications with investors and 
institute manual processing in order to exit securities positions from 
DTC (or any other intermediary position) and to accommodate issuers' 
requests to certificate positions in the name of the ultimate 
beneficial owner. The Commission seeks comment as to any cost savings 
that may be realized, as well as any other potential benefits, 
resulting from not having to undertake these expenses should the 
proposed rule be adopted.
    The Commission does not have data to quantify the value of the 
benefits described above. We are therefore seeking comment on how we 
may quantify these benefits and any other benefits not already 
identified that may result from the adoption of the proposed 
amendments.

B. Costs

    The Commission seeks comment on what costs, if any, could be 
incurred if a registered transfer agent acted for an issuer that 
restricted or prohibited transfers, as the rule proposes to prohibit. 
For example, will there be handling, shipping, or insurance costs 
associated with the repackaging and returning non-transferable 
certificates? If so, what are these costs and are these costs incurred 
on a one-time or ongoing basis?
    The proposed Rule 17Ad-20 would require registered transfer agents 
to determine whether or not securities subject to the proposed rule 
could be eligible for transfer prior to effecting a transfer and 
whether the person or class of persons restricted from ownership by the 
issuer are securities intermediaries. The Commission requests comment 
and data on what, if any, operational or procedural changes would need 
to be made to comply with the proposed rule and how much these changes 
would cost.
    Issuers and registered transfer agents might obtain certain 
representations or indemnifications from each other to remove any 
current restrictions that would be prohibited by the proposed rule and 
to assist registered transfer agents in complying with the proposed 
rule, which might require one-time expenses related to contract 
revisions or legal fees. Accordingly, we request comment on the 
potential costs to issuers and registered transfer agents for any 
removal of restrictions, and developments of or modifications to 
systems, procedures, or records that might be necessary to determine 
whether a security is subject to the proposed rule.
    The Commission understands that, if it were to adopt the proposed 
rule, some issuers might believe that the rule removes a mechanism by 
which they believe they can counter the negative effects of naked short 
selling in general, and manipulative naked short selling in 
particular.\73\ As has been previously contended in comment letters to 
the Commission, by requiring these securities to participate in the 
national system for clearance and settlement, it has been alleged that 
both issuers and investors will suffer losses due to the diminution in 
the market value of these securities caused by naked short selling or 
by adverse effects on ownership (e.g., market value and voting rights) 
stemming from such short sale transactions.\74\ The Commission believes 
that these issues should be addressed through regulation rather than 
issuers attempting to control the ownership or transfer of securities 
that trade in the public market. As stated earlier in this release, we 
believe issuer-imposed restrictions on securities often make the stock 
less liquid, causing reduction in the trading volume of the securities. 
To the extent that there is any diminution of issuers' abilities to 
counter the perceived negative effects of naked short selling by 
restricting or prohibiting ownership or transfer by securities 
intermediaries, we do not believe this cost is significant and is 
likely justified by the benefits of the national system for clearance 
and settlement.\75\ We request comment on whether this cost exists and 
the extent of these costs. We also request comment on whether the 
proposal will result in any other costs for issuers or their transfer 
agents to facilitate transfers of securities should the securities be 
held by a securities intermediary.
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    \73\ See Exchange Act Release No. 47978 (June 4, 2003), 68 FR 
35037 (June 11, 2003), [File No. SR-DTC-2003-02].
    \74\ Id.
    \75\ As noted above, most securities trading on an exchange or 
Nasdaq are already subject to SRO rules that require depository 
eligibility. See supra notes 26 and 27.
---------------------------------------------------------------------------

    The Commission also seeks comments, analysis, and empirical data on 
any costs to investors or other market participants associated with any 
impact the proposed rule may have on the issuers or their transfer 
agent. Among other things, the Commission seeks comments and data on 
the extent to which, if any, investors may incur costs associated with 
any decrease in the capacity or propensity of the issuer to deter 
manipulative naked short selling as a result of the proposed rule.

VII. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996,\76\ a rule is ``major'' if it has resulted or is likely to 
result in: an annual effect on the economy of $100 million or more;
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    \76\ 5 U.S.C. 801 et. seq.
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     A major increase in costs or prices for consumers or 
individual industries; or
     Significant adverse effects on competition, investment, or 
innovation.

We request comment regarding the potential impact of the proposed rule 
amendments on the economy on an annual basis. We also request that 
commenters provide empirical data and other factual support for their 
views.

VIII. Consideration of Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation

    Section 3(f) the of the Exchange Act,\77\ as amended by the 
National Securities Markets Improvement Act of 1996,\78\ provides that 
whenever the Commission is engaged in rulemaking and is required to 
consider or to determine whether an action is necessary or appropriate 
in the public interest, it must also consider whether the action will 
promote efficiency, competition, and capital formation. Section 
23(a)(2) of the Exchange Act requires the Commission, in adopting rules 
under the Exchange Act, to consider the anti-competitive effects of any 
rule it adopts. Exchange Act section 23(a)(2) prohibits

[[Page 32792]]

the Commission from adopting any rule that would impose a burden on 
competition not necessary or appropriate in furtherance of the purposes 
of the Exchange Act.
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    \77\ 15 U.S.C. 78c.
    \78\ Pub. L. 104-290, 110 Stat. 3416 (1996).
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    The Commission's preliminary view is that the proposed rule would 
promote the objectives of the national system for clearance and 
settlement as established in section 17A of the Exchange Act by 
allowing securities intermediaries and their customers effecting 
securities transactions in the public market to benefit from the 
increased efficiencies and risk reduction afforded by the national 
system for clearance and settlement. By permitting transfers to and 
from securities depositories and other intermediaries, the proposed 
rule should promote efficiency by reducing some of the costs and delays 
associated with the clearance and settlement of securities transactions 
and promote capital formation by making it easier for the securities to 
be traded in the marketplace. We solicit comment on whether the 
proposal would promote both efficiency and capital formation.
    The proposed rule could enhance competition. While most companies 
listed on a national exchange or Nasdaq are already subject to rules 
that in essence prohibit restrictions on transfers to or from 
securities intermediaries,\79\ those issues trading in the non-national 
market and not subject to any listing requirements have not been 
subject to this restriction, such as those securities trading in the 
Pink Sheets. Proposed Rule 17Ad-20 would help to level the playing 
field by extending these obligations to all companies issuing equity 
securities that are registered under section 12 or that subject issuers 
to reporting under section 15(d) of the Exchange Act and transferred by 
a registered transfer agent.\80\ In doing so, the proposal would also 
promote liquidity in these securities by removing barriers to ownership 
of securities and decreasing transaction costs, thereby facilitating 
increased efficiency and capital formation. We request comment on the 
other effects on competition of the proposed rule to both issuers and 
transfer agents. We also request comment on any effects on efficiency 
or capital formation that may result under the proposed rules.
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    \79\ See supra notes 26 and 27.
    \80\ As noted above, the proposed rule would not apply to equity 
securities of issuers subject to section 15(d) that are transferred 
by transfer agents that are not required to be registered under 
Section 17A of the Exchange Act.
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IX. Summary of Initial Regulatory Flexibility Analysis

    The Commission has prepared an Initial Regulatory Flexibility 
Analysis (``IRFA'') in accordance with the provisions of the Regulatory 
Flexibility Act \81\ regarding proposed Rule 17Ad-20 under the Exchange 
Act. The IRFA states the purpose of the proposal is to prohibit 
registered transfer agents from effecting transfers of certain equity 
securities where the issuer restricts or prohibits the transfer of an 
equity security to or from a securities intermediary.
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    \81\ 5 U.S.C. 603.
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    The IRFA sets forth the statutory authority for the proposal. The 
IRFA also discusses the effect of the proposal on registered transfer 
agents that are small entities pursuant to Rule 0-10 under the Exchange 
Act.\82\ A transfer agent is a small entity if it: (1) Received fewer 
than 500 items for transfer and fewer than 500 items for processing 
during the preceding six months (or in the time that it has been in 
business, if shorter); (2) transferred items only of issuers that would 
be deemed a ``small business'' or ``small organizations'' as defined in 
Rule 0-10 under the Exchange Act; (3) maintained master shareholder 
files that in the aggregate contained less than 1,000 shareholder 
accounts or was the named transfer agent for less than 1,000 
shareholder accounts at all times during the preceding fiscal year (or 
in the time that it has been in business if shorter); and (4) is not 
affiliated with any person other than a natural person that is not a 
small business or small organization under Rule 0-10. The IRFA states 
that we estimate that 470 transfer agents of approximately 900 
registered transfer agents qualify as ``small entities'' for purposes 
of RFA and would be subject to the requirements of the proposed Rule 
17Ad-20.
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    \82\ 17 CFR 240.0-10.
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    The IRFA also discusses the effect of the proposal on issuers that 
are small entities pursuant to Rule 0-10 under the Exchange Act.\83\ An 
issuer is a small entity if it had on the last day of its most recent 
fiscal year total assets of $5 million or less. The IRFA states that we 
estimate that 2500 issuers qualify as ``small entities'' for purposes 
of RFA and could be affected by the requirements of the proposed Rule 
17Ad-20.
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    \83\ Id.
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    Proposed Rule 17Ad-20 would prohibit all registered transfer agents 
from transferring certain equity securities registered under section 12 
or any equity security that subjects an issuer to reporting under 
section 15(d) that restrict or prohibit transfers to or from a 
securities intermediary. While there are no reporting or recordkeeping 
obligations associated with the rule, compliance by registered transfer 
agents will be subject to examination by the transfer agent's 
appropriate regulatory agency.\84\
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    \84\ Registered transfer agents are currently subject to 
numerous rules under section 17A of Exchange Act and subject to 
examination by the transfer agents' appropriate regulatory 
authority. 15 U.S.C. 78q-1(d).
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    The IRFA states that the Commission considered whether viable 
alternatives to the proposed rulemaking exist that accomplish the 
stated objectives of applicable statutes that minimize any significant 
economic impact of the proposed rules on small entities. As explained 
more fully in the IRFA, the Commission has considered alternatives to 
the proposed rules that would adequately address the problem posed by 
issuers imposing restrictions or prohibitions on ownership, and 
therefore restrictions or prohibitions on the transfer, of securities 
in the public market. The Commission believes that the establishment of 
different requirements for small entities is neither necessary nor 
practical because the proposal is designed to provide general standards 
that would protect the public and members of the financial community 
from increased inefficiencies, costs, and risks associated with 
trading, clearing, and settling securities without the protections 
afforded by the national system for clearance and settlement. Finally 
the IRFA addresses each of the other requirements set forth under 5 
U.S.C. 603.
    The Commission encourages the submission of written comments with 
respect to any aspect of the IRFA. These comments should specify costs 
of compliance with the proposed rule, and suggest alternatives that 
would accomplish the objective of proposed Rule 17Ad-20. A copy of the 
IRFA may be obtained by contacting Jerry W. Carpenter or Susan M. 
Petersen, Division of Market Regulation, Securities and Exchange 
Commission, 450 5th Street, NW., Washington, DC 20549-1001.

X. Statutory Authority

    The Commission is proposing to add Sec.  240.17Ad-20 of chapter II 
pursuant to sections 3(b), 17A(a)(1), 17A(a)(2), 17A(d), 17A(e), 23(a), 
and 36 of the Exchange Act \85\ in the manner set forth below.
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    \85\ 15 U.S.C. 78q-1(a)(1), 78q-1(a)(2), 78q-1(d), and 78w(a).

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[[Page 32793]]

List of Subjects in 17 CFR Part 240

    Securities, Securities intermediaries, Transfer agents.

Text of Proposed Rule

    In accordance with the foregoing, title 17, chapter II of the Code 
of Federal Regulations is proposed to be amended as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    1. The general authority citation for part 240 is revised to read 
as follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78q-1, 78s, 
78u-5, 78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-
37, 80b-3, 80b-4, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350, 
unless otherwise noted.
* * * * *
    2. Section 240.17Ad-20 is added to read as follows:


Sec.  240.17Ad-20  Issuer Restrictions or Prohibitions on Ownership by 
Securities Intermediaries.

    (a) Except as provided in paragraph (c) of this section, no 
registered transfer agent shall transfer any equity security registered 
pursuant to section 12 or any equity security that subjects an issuer 
to reporting under section 15(d) of the Act (15 U.S.C. 78l or 15 U.S.C. 
78o(d)) if such security is subject to any restriction or prohibition 
on transfer to or from a securities intermediary.
    (b) The term securities intermediary means a clearing agency 
registered under section 17A of the Act (15 U.S.C. 78q-1) or a person, 
including a bank, broker, or dealer, that in the ordinary course of its 
business maintains securities accounts for others.
    (c) The provisions of this section shall not apply to any equity 
security issued by a partnership as defined in Sec.  229.901(b) of 
Regulation S-K.

    Dated: June 4, 2004.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-13084 Filed 6-9-04; 8:45 am]
BILLING CODE 8010-01-P