[Federal Register Volume 69, Number 229 (Tuesday, November 30, 2004)]
[Notices]
[Pages 69653-69655]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-3384]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50718; File No. SR-FICC-2004-09]


Self-Regulatory Organizations; Notice of a Proposed Rule Change 
by the Fixed Income Clearing Corporation Relating to Changes to 
Membership Requirements

November 22, 2004.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on April 14, 2004, the Fixed 
Income Clearing Corporation (``FICC'') filed with the Securities and 
Exchange Commission (``Commission'') and on November 16, 2004, amended 
the proposed rule change as described in items I, II, and III below, 
which items have been prepared primarily by FICC. The Commission is 
publishing this notice to solicit comments on the proposed rule change 
from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The proposed rule change would amend FICC's Government Securities 
Division (``GSD'') and Mortgage Backed Securities Division (``MBSD'') 
rules to require applicants and members to submit two years of audited 
annual financial statements or less for newly formed entities, to 
permit applicants and members to submit audited consolidated statements 
in situations where audited financial statements are not prepared at 
the applicant or member level, to eliminate the rule that requires 
comparison-only members to be in compliance with the capital 
requirements of their examining authority, and to require non-US banks 
that wish to become an approved letter of credit issuer to have 
language in their opinion of counsel indicating that the head office is 
``ultimately responsible'' for the credit obligation of the branch.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FICC included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
item IV below. FICC has prepared summaries, set forth in sections A, B, 
and C below, of the most significant aspects of such statements.\2\
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    \2\ The Commission has modified the text of the summaries 
prepared by FICC.
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A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    The proposed rule change would affect GSD's and MBSD's rules in the 
following areas:
1. Annual Audited Financial Statements
    Currently, GSD's rules require U.S. applicants for membership to 
submit annual audited financial statements for the preceding year and 
non-U.S. applicants to submit annual audited financial statements for 
the preceding three years. MBSD's rules currently require U.S. and non-
U.S. membership applicants to submit annual audited financial 
statements for the preceding year.
    FICC proposes to amend both divisions' rules to require GSD netting 
applicants and MBSD clearing applicants to submit two years of annual 
audited financial statements. However, if an applicant or member has 
not been in business for two years (i.e., a newly-formed applicant or 
member \3\), FICC would permit it to submit annual audited financial 
statements for a lesser period and/or annual audited financial 
statements of a predecessor firm in the case of an applicant or member 
formed by a corporate transaction. If audited financial statements 
cannot be obtained, newly-formed applicants will be permitted to submit 
unaudited pro forma financial statements.
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    \3\ A newly formed applicant may include a company with no 
business history or a company formed as a result of a corporate 
transaction such as a merger.
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    Firms that submit less than two years of financial statements would 
also have to submit: (1) Annual audited financial statements of a 
predecessor firm, if applicable; (2) pro forma financial statements 
signed by a senior officer of the firm; (3) regulatory reports for the

[[Page 69654]]

period since inception; \4\ and (4) evidence from a third party 
verifying the applicant's capital at the time of application.
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    \4\ A regulated entity, such as a U.S. broker-dealer or domestic 
bank, will file regulatory reports (FOCUS reports for a broker-
dealer and CALL reports for a bank) with its regulators in the 
required time period following its regulatory approval. Such firms' 
regulators would require them to include as much information in 
these reports as is normally required of all other entities except 
where certain information would be unavailable. For example, if a 
broker-dealer has not yet begun trading, it would not report any 
trading revenue.
    Unregulated and non-U.S. entities would be required to produce 
specific information that FICC would need in order to develop a risk 
profile to evaluate creditworthiness. This information would be 
requested in a form provided to the firms by FICC and signed by a 
senior officer of the firm. (This form, which is the subject of a 
pending rule filing, SR-FICC-2004-14, would replace the current 
requirement for the submission of regulatory reports for non-U.S. 
entities only and that U.S.-regulated entities will still be 
required to submit regulatory reports). If necessary, and regardless 
of whether regulatory reports are available, FICC may seek evidence 
from a third party to prove that an applicant or newly approved 
member meets minimum standards. For example, FICC may request a bank 
statement to verify that cash has been deposited, thereby verifying 
that the applicant meets FICC's minimum capital requirement.
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    FICC believes the proposed rule change permitting less than two 
years of annual audited financial statements or unaudited pro forma 
financial statements is necessary and appropriate in order to 
accommodate entities that are newly-formed and those that are created 
as a result of a merger of existing entities or other similar corporate 
transaction. First, firms that are newly-formed do not have audited 
financials and in some instances can only provide pro forma financial 
statements. Second, the GSD's rules already contemplate the admission 
of entities with little or no business history, which often are of 
equal or even greater credit quality than more established entities. 
For example, GSD's rules provide that a netting applicant must have an 
established, profitable business history of a minimum of six months or 
personnel with sufficient operational background and experience to 
ensure in the judgment of FICC's Membership and Risk Management 
Committee the ability of the firm to conduct its business.\5\ Third, 
FICC believes that the foregoing information will provide sufficient 
evidence that the applicant meets FICC's membership standards. Upon 
approval for membership, such a firm will be required to submit interim 
financial data to FICC, which will be used to monitor adherence to 
FICC's established financial parameters. As of its fiscal year-end, the 
firm will be required to provide its annual audited financial 
statement. At that time, the applicable interim statement will be 
compared to the audited financial statement. If there are 
discrepancies, the firm will be required to supply FICC with an 
acceptable explanation.
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    \5\ FICC Rule 2, Sec.  4 and Rule 3, Sec.  2(c).
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2. Financial Statements Prepared at the Applicant or Member Level
    The rules of both FICC divisions currently specify that all 
required audited financial statements be prepared at the applicant or 
member level. However, some entities do not prepare their own audited 
financial statements. Their financial status is included in audited 
consolidated financial statements of a parent company.\6\ Accordingly, 
FICC proposes to amend both divisions' rules to permit the submission 
of audited consolidated financial statements in situations where 
audited financial statements are not prepared at the applicant or 
member level.
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    \6\ References to a ``parent'' company can mean a direct parent, 
intermediate parent, or ultimate parent company.
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    FICC believes that it is not appropriate for it to mandate that 
members prepare their own audited financial statements if it is not 
their practice to do so. First, many members are not required to 
prepare their own audited financial statements by their regulators and 
doing so would be very expensive. Second, FICC is comfortable in 
accepting audited consolidated financial statements because FICC is 
able to obtain information regarding an applicant's or member's 
financial status through interim financial data on the applicant or 
member itself. This interim data is on the applicant or member firm 
level and is obtained from regulatory reports filed by the applicant or 
member itself or unaudited financial reports prepared internally by the 
applicant or member. FICC staff compares data from the applicable 
interim statement to the audited financial statement or applicable 
audited consolidated financial statement, and if there are 
discrepancies, the firm would be required to supply FICC with an 
acceptable explanation. In addition, in instances where the member or 
applicant is unregulated and regulatory reports are thus not available, 
FICC may request consolidating financial statements from the member 
firm, which will show the financials of the entities that were included 
in the audited consolidated financial statement.
    In addition to this change, FICC is proposing to make a technical 
change to the term ``financial statements'' in GSD Rule 2, Section 7, 
to update the current reference to ``shareholder's equity'' to 
``owner's equity'' to encompass those entities that do not have 
shareholders.
3. Compliance With Certain Capital Requirements
    The GSD's rules currently state that a comparison-only applicant 
must be in compliance with the capital requirements imposed by its 
designated examining authority, appropriate regulatory agency, or other 
examining authority or regulator, and any other self-regulatory 
organizations to which it is subject by statute, regulation, or 
agreement.
    FICC proposes to eliminate this requirement because comparison-only 
membership does not present FICC with any credit or financial risk 
since FICC does not guarantee that service.
4. Letters of Credit
    GSD's rules currently provide that if an approved letter of credit 
issuer is a non-US bank acting through a branch or agency in the US, it 
must provide FICC with a ``guarantee of performance'' of such branch or 
agency deemed sufficient by FICC. FICC believes that the current 
language needs to be clarified because it was never meant to require a 
financial guarantee. FICC believes that it is not appropriate to 
require the head office of an approved letter of credit issuer to 
provide a financial guarantee for its branch or agency, given that the 
latter is simply an ``arm'' of the head office itself and not a 
separate legal entity.
    Accordingly, FICC proposes to change the current language to 
specify that non-US banks wishing to become approved letter of credit 
issuers must have language in their opinion of counsel indicating that 
the head office is ``ultimately responsible'' for the credit obligation 
of the branch or agency. This language is already contained in the pro 
forma legal opinions that are part of the FICC letter of credit issuer 
application.
    FICC believes that the proposed rule change is consistent with the 
requirements of section 17A of the Act \7\ and the rule thereunder 
because it will enhance FICC's risk management procedures thereby 
further safeguarding the funds and securities under FICC's control.
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    \7\ 15 U.S.C. 78q-1.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    FICC does not believe that the proposed rule change will have any 
impact or impose any burden on competition.

[[Page 69655]]

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments relating to the proposed rule change have not yet 
been solicited or received. FICC will notify the Commission of any 
written comments it receives.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to ninety days of such date if it finds such longer period 
to be appropriate and publishes its reasons for so finding or (ii) as 
to which the self-regulatory organization consents, the Commission 
will:
    (A) By order approve such proposed rule change or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-FICC-2004-09 on the subject line.

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 SR-FICC-2004-09. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission 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/sro.shtml). Copies of the submission, all subsequent amendments, 
all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for inspection 
and copying in the Commission's Public Reference Section, 450 Fifth 
Street, NW, Washington, DC 20549. Copies of such filing also will be 
available for inspection and copying at the principal office of FICC 
and on FICC's Web site at http://ficc.com/gov/gov.docs.jsp?NS-query=. 
All comments received will be posted without change; the Commission 
does not edit personal identifying information from submissions. You 
should submit only information that you wish to make available 
publicly. All submissions should refer to File Number SR-FICC-2004-09 
and should be submitted on or before December 21, 2004.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\8\
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    \8\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E4-3384 Filed 11-29-04; 8:45 am]
BILLING CODE 8010-01-P