[Federal Register Volume 70, Number 92 (Friday, May 13, 2005)]
[Notices]
[Pages 25634-25636]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-2374]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51669; File No. SR-NSCC-2004-09]


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

May 9, 2005.

I. Introduction

    On December 8, 2004, the National Securities Clearing Corporation 
(``NSCC'') filed with the Securities and Exchange Commission 
(``Commission'') proposed rule change SR-NSCC-2004-09 pursuant to 
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'').\1\ 
Notice of the proposal was

[[Page 25635]]

published in the Federal Register on April 6, 2005.\2\ No comment 
letters were received. For the reasons discussed below, the Commission 
is approving the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 51458 (March 31, 2005), 
70 FR 17494.
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II. Description

    NSCC is establishing a comprehensive standard of care and 
limitation of liability with respect to its members. Historically, the 
Commission has left to user-governed clearing agencies the question of 
how to allocate losses associated with, among other things, clearing 
agency functions.\3\ The Commission has reviewed clearing agency 
services on a case-by-case basis and in determining the appropriate 
standard of care has balanced the need for a high degree of clearing 
agency care with the effect the resulting liabilities may have on 
clearing agency operations, costs, and safekeeping of securities and 
funds.\4\ Because standards of care represent an allocation of rights 
and liabilities between a clearing agency and its members, which are 
generally sophisticated financial entities, the Commission has 
refrained from establishing a unique federal standard of care and 
generally has allowed clearing agencies and other self-regulatory 
organizations and their members to establish their own standards of 
care.\5\ In addition, the Commission has recognized that a gross 
negligence standard of care is appropriate for certain noncustodial 
functions where a clearing agency, its board of directors, and its 
members determine to allocate risk to individual service users.\6\
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    \3\ Securities Exchange Act Release Nos. 20221 (September 23, 
1983), 48 FR 45167 and 22940 (February 24, 1986), 51 FR 7169.
    \4\ Id.
    \5\ Id.
    \6\ Securities Exchange Act Release No. 26154 (October 3, 1988), 
53 FR 39556. NSCC's services provided to members are noncustodial in 
that, other than clearing fund deposits, it does not hold its 
members funds or securities.
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    NSCC believes that adopting a uniform rule \7\ limiting NSCC's 
liability to its members to direct losses caused by NSCC's gross 
negligence, willful misconduct, or violation of Federal securities laws 
for which there is a private right of action will: (1) Memorialize an 
appropriate commercial standard of care that will protect NSCC from 
undue liability; \8\ (2) permit the resources of NSCC to be 
appropriately utilized for promoting the accurate clearance and 
settlement of securities; and (3) will be consistent with similar rules 
adopted by other self-regulatory organizations and approved by the 
Commission.\9\
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    \7\ New Section 2 of Rule 58 states:
    SEC. 2. Notwithstanding any other provision in the Rules:
    (a) The Corporation will not be liable for any action taken, or 
any delay or failure to take any action, hereunder or otherwise to 
fulfill the Corporation's obligations to its Members including 
Settling Members, Settling Bank Only Members, Municipal Comparison 
Only Members, Insurance Carrier Members, TPA Members, Mutual Fund/
Insurance Services Members, Non-Clearing Members, Fund Members and 
Data Services Only Members, other than for losses caused directly by 
the Corporation's gross negligence, willful misconduct, or violation 
of Federal securities laws for which there is a private right of 
action. Under no circumstances will the Corporation be liable for 
the acts, delays, omissions, bankruptcy, or insolvency, of any third 
party, including, without limitation, any depository, custodian, 
sub-custodian, clearing or settlement system, transfer agent, 
registrar, data communication service or delivery service (``Third 
Party''), unless the Corporation was grossly negligent, engaged in 
willful misconduct, or in violation of Federal securities laws for 
which there is a private right of action in selecting such Third 
Party.
    (b) Under no circumstances will the Corporation be liable for 
any indirect, consequential, incidental, special, punitive or 
exemplary loss or damage (including, but not limited to, loss of 
business, loss of profits, trading losses, loss of opportunity and 
loss of use) howsoever suffered or incurred, regardless of whether 
the Corporation has been advised of the possibility of such damages 
or whether such damages otherwise could have been foreseen or 
prevented.
    (c) With respect to instructions given to the Corporation by a 
Special Representative/Index Recipient Agent, the Corporation shall 
have no responsibility or liability for any errors which may occur 
in the course of transmissions or recording of any transmissions or 
which may exist in any magnetic tape, document or other media so 
delivered to the Corporation.
    (d) With respect to the Corporation's distribution facilities, 
the Corporation assumes no responsibility whatever for the form or 
content of any tickets, checks, papers, documents or other material 
(other than items prepared by it) placed in the boxes in its 
distribution facilities assigned to each Settling Member, Municipal 
Comparison Only Member, Insurance Carrier Member, TPA Member, Fund 
Member and Data Services Only Member, or otherwise handled by the 
Corporation; nor does the Corporation assume any responsibility for 
any improper or unauthorized removal from such boxes or from the 
Corporation's facilities of any such tickets, checks, papers, 
documents or other material, including items prepared by the 
Corporation.
    (e) With respect to Fund/Serv transactions, the Corporation will 
not be responsible for the completeness or accuracy of any 
transaction or instruction received from or transmitted to a 
Settling Member, Data Services Only Member, TPA Member, TPA Settling 
Entity, Mutual Fund Processor or Fund Member through Fund/Serv, nor 
for any errors, omissions or delays which may occur in the 
transmission of a transaction or instruction to or from a Settling 
Member, Data Services Only Member, TPA Member, TPA Settling Entity, 
Mutual Fund Processor or Fund Member.
    (f) The Corporation will not be responsible for the completeness 
or accuracy of any IPS Data and Repository Data received from or 
transmitted to an Insurance Carrier Member, Member or Data Services 
Only Member through IPS nor for any errors, omissions or delays 
which may occur in the transmission of such IPS Data and Repository 
Data to or from an Insurance Carrier Member, or Data Services Only 
Member.
    \8\ NSCC has always operated under a gross negligence standard 
of care and both internal and external counsel have consistently 
advised members that this is the case. NSCC is seeking to eliminate 
any confusion due to the absence of a clear standard set forth in 
its rules and to memorialize its historical practice. In addition, 
NSCC has in effect a service agreement with the Fixed Income 
Clearing Corporation (``FICC'') pursuant to which FICC provides 
services for NSCC's fixed income products. This service agreement 
provides for a gross negligence standard of care. In the absence of 
this new rule, NSCC could be in the position of having to pay for 
losses caused by FICC that are not recoverable under the agreement.
    \9\ See, e.g., Securities Exchange Act Release Nos. 37421 (July 
11, 1996), 61 FR 37513 [File No. SR-CBOE-96-02]; 37563 (August 14, 
1996), 61 FR 43285 [File No. SR-PSE-96-21]; 48201 (July 21, 2003), 
68 FR 44128 [File No. SR-GSCC-2002-10]; and 49373 (March 8, 2004), 
69 FR 11921 [File No. SR-FICC-2003-09].
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III. Discussion

    Section 19(b) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
such proposed rule change is consistent with the requirements of the 
Act and the rules and regulations thereunder applicable to such 
organization. Section 17A(b)(3)(F) of the Act requires that the rules 
of a clearing agency be designed to assure the safeguarding of 
securities and funds which are in its custody or control.\10\ The 
Commission believes that NSCC's rule change is consistent with this 
Section because it will permit the resources of NSCC to be 
appropriately utilized to protect funds and assets.
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    \10\ 15 U.S.C. 78q-1(b)(3)(F).
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    Although the Act does not specify the standard of care that must be 
exercised by registered clearing agencies, the Commission has 
determined that a gross negligence standard of care is acceptable for 
noncustodial functions where a clearing agency and its participants 
contractually agree to limit the liability of the clearing agency.\11\ 
NSCC's

[[Page 25636]]

functions are noncustodial in that it does not hold its members' funds 
or securities. It is reasonable for NSCC, which is member-owned and 
governed, and its members to agree through board approval of the 
proposed rule change and to contract with one another in a cooperative 
arrangement as to how to allocate NSCC's liability among NSCC and its 
members. Therefore, the Commission has determined that given the 
noncustodial nature of NSCC's services, a gross negligence standard of 
care and limitation of liability is allowable for NSCC.\12\
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    \11\ In the release setting forth standards that would be used 
by the Division of Market Regulation in evaluating clearing agency 
registration applications, the Division of Market Regulation urged 
clearing agencies to embrace a strict standard of care in 
safeguarding participants' funds and securities. Securities Exchange 
Act Release No. 16900 (June 17, 1980), 45 FR 4192. In the release 
granting permanent registration to The Depository Trust Company, the 
National Securities Clearing Corporation, and several other clearing 
agencies, however, the Commission indicated that it did not believe 
that sufficient justification existed at that time to require a 
unique Federal standard of care for registered clearing agencies. 
Securities Exchange Act Release No. 20221 (October 3, 1983), 48 FR 
45167. In a subsequent release, the Commission stated that the 
clearing agency standard of care and the allocation of rights and 
liabilities between a clearing agency and its participants 
applicable to clearing agency services generally may be set by the 
clearing agency and its participants. In the same release, the 
Commission stated that it should review clearing agency proposed 
rule changes in this area on a case-by-case basis and balance the 
need for a high degree of clearing agency care with the effect 
resulting liabilities may have on clearing agency operations, costs, 
and safeguarding of securities and funds. Securities Exchange Act 
Release No. 22940 (February 24, 1986), 51 FR 7169. Subsequently, in 
a release granting temporary registration as a clearing agency to 
The Intermarket Clearing Corporation, the Commission stated that a 
gross negligence standard of care may be appropriate for certain 
noncustodial functions that, consistent with minimizing risk 
mutualization, a clearing agency, its board of directors, and its 
members determine to allocate to individual service users. 
Securities Exchange Act Release No. 26154 (October 3, 1988), 53 FR 
39556. Finally, in a release granting the approval of temporary 
registration as a clearing agency to the International Securities 
Clearing Corporation, the Commission indicated that historically it 
has left to user-governed clearing agencies the question of how to 
allocate losses associated with noncustodial, data processing, 
clearing agency functions and has approved clearing agency services 
embodying a gross-negligence standard of care. Securities Exchange 
Act Release No. 26812 (May 12, 1989), 54 FR 21691.
    \12\ The Commission notes that the rule change does not 
alleviate NSCC from liability for violation of the Federal 
securities laws where there exists a private right of action and 
therefore is not designed to adversely affect NSCC's compliance with 
the Federal securities laws and private rights of action that exist 
for violations of the Federal securities laws.
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IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
in particular Section 17A of the Act and the rules and regulations 
thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-NSCC-2004-09) be and hereby 
is approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Jill Peterson,
Assistant Secretary.
[FR Doc. E5-2374 Filed 5-12-05; 8:45 am]
BILLING CODE 8010-01-P