[Federal Register Volume 73, Number 52 (Monday, March 17, 2008)]
[Notices]
[Pages 14294-14297]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-5279]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57461; File No. SR-NSCC-2007-12]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of Filing of a Proposed Rule Change To Provide a 
New Alternative Investments Products Service

March 10, 2008.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on July 17, 2007, National 
Securities Clearing Corporation (``NSCC'') filed with the Securities 
and Exchange Commission (``Commission'') and on February 19, 2008, 
amended the proposed rule change described in Items I, II, and III 
below, which items have been prepared primarily by NSCC. The Commission 
is publishing this notice to solicit comments 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

    NSCC is proposing to establish a new Alternative Investment 
Products service (``AIP Service''), which would be a processing 
platform for alternative investment products such as hedge funds, funds 
of hedge funds, commodities pools, managed futures, and real estate 
investment trusts (``REITs'').

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

    In its filing with the Commission, NSCC 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. NSCC has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of these 
statements.\2\
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    \2\ The Commission has modified the text of the summaries 
prepared by NSCC.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    The purpose of this rule filing is to amend NSCC's Rules in order 
that NSCC may provide its proposed AIP Service, which would be a 
processing platform for alternative investment products such as hedge 
funds, funds of hedge funds, commodities pools, managed futures, and 
REITs. Such products are more fully described below in the section 
titled ``Alternative Investment Products.''
(1) Summary of AIP Service
    The AIP Service would provide for processing of information 
relating to transactions in alternative investment products and for 
settlement of related payments (``AIP Payments''). It would facilitate, 
among other things, processing activities such as subscriptions and 
redemptions, distributions, position reporting, and account 
maintenance. Activities that would be supported by the AIP Service are 
more fully described below in the section titled ``Scope of AIP 
Service.''
    Settlement of AIP Payments through NSCC would be done on a 
prefunded basis. NSCC would simply pass-through AIP Payments from AIP 
members to their respective contraside AIP members without netting or 
without guarantying payment in the event of contraside default. NSCC 
would not be liable to make payment to an AIP member in the event of a 
default in payment by the contraside AIP member. Settlement of AIP 
Payments (``AIP Settlement'') would be segregated from all other money 
settlements at NSCC. NSCC would have no exposure to credit risk as a 
result of the operation of the AIP Settlement. AIP Settlement is more 
fully described below in the section titled ``AIP Settlement.''
    Participation in the AIP Service would be governed by NSCC's Rules 
and procedures applicable to the AIP Service. Each user of the AIP 
Service (``AIP Member'') would be required to enter into an AIP 
membership agreement with NSCC that would govern its use of the AIP 
Service. Entities eligible for membership would include entities 
subject to regulation under U.S. federal or state laws such as 
registered broker-dealers, investment advisers, banks, and insurance 
companies. Because of the unique processing and distribution features 
of alternative investment products and because NSCC would have no 
exposure to the credit risk of AIP Members and would have no liability 
to make payments in the event of an AIP Member's AIP Settlement 
default, entities that are not required to register under applicable 
U.S. federal or state law and entities organized under applicable law 
outside of the U.S. may also be eligible to become AIP Members. 
Membership in the AIP Service is more fully described below in the 
section titled ``AIP Members.''
    NSCC developed the concept and functionality for the AIP Service at 
the request of and in consultation with industry participants, many of 
which were NSCC members in different capacities using other NSCC 
services. Some of these interested parties committed to become pilot 
subscribers to the proposed AIP Service and committed to assist NSCC in 
funding the launch of the AIP Service. These parties are more fully 
described below in the section titled ``AIP Pilot Group.''
(2) Alternative Investment Products
    Alternative investment products are typically illiquid, pooled 
investment products that are exempt from registration under the 
Security Act of 1933 and the Investment Company Act of 1940 and that 
are offered through private placements to high net worth individuals 
and institutional investors such as pension funds.
    Alternative investment products may be placed and held by an end 
investor through a direct relationship with the issuer or manufacturer 
of an alternative investment product or through an entity acting on 
behalf of an issuer or manufacturer (called the ``AIP Manufacturer'' 
for purposes of NSCC Rules). They may also be placed and held through a 
distribution channel such as a registered broker-dealer that 
facilitates transactions as a processing contraparty to the AIP 
Manufacturer (called the ``AIP Distributor'' for

[[Page 14295]]

purposes of NSCC Rules). Alternative investment products are not 
generally traded in the secondary market. In this respect, the 
distribution for alternative investment products is similar to the 
distribution of mutual funds on NSCC's Fund/SERV system. Alternative 
investment products have processing characteristics and risk profiles 
that differ from those of mutual funds, and those differences would be 
taken into account and reflected in the functionality of the AIP 
Service and in NSCC Rules and procedures.
    Increasingly, investors and their advisers are including 
alternative investment products as part of their balanced portfolios. 
The alternative investment products market represents over $1 trillion 
in assets and continues to grow. Despite the large asset base, 
processing remains extremely manual using methods such as delivery of 
hard copy documents, transmission of information by fax, email 
messages, telephone calls, and emailed spreadsheets. The lack of 
automation and standardized, centralized processing is inefficient, 
prolongs transaction processing time, introduces high costs per 
transaction, and increases the likelihood of errors--factors that 
increase in importance as the volume of transactions increases as it 
has in recent years.
(3) AIP Pilot Group
    Accordingly, several industry participants (many of which were 
members of NSCC) approached NSCC to explore whether NSCC services could 
bring automation and standardization to the alternative investment 
product industry analogous to that which NSCC's Mutual Fund Services 
has provided to the mutual fund industry. Mutual funds and alternative 
investment products frequently share similar distribution channels and 
are frequently both included in an investor's portfolio for which a 
financial intermediary consolidates asset reporting and servicing.
    NSCC solicited its members to assess industry interest. A pilot 
group of interested broker-dealers, alternative product manufacturers, 
and fund administrators was formed to determine the feasibility of NSCC 
providing such a service and to assist in the development of the 
business requirements and functional specifications for such a service. 
Some members of the pilot group committed to assist in the costs of 
development of the service through payment of a fixed amount that would 
be applied to their respective usage fees when the service was in 
production. Consistent with this commitment to support the costs of 
launching the service, NSCC agreed to consult with the members of the 
pilot group in refining and enhancing the necessary functionality for 
the service. The functionality for the initial scope of the AIP Service 
has been developed and is described below in the section titled ``Scope 
of AIP Service.''
(4) Eligible AIP Products
    Alternative investment products processed through NSCC's AIP 
Service (``Eligible AIP Products'') would initially include the types 
of products referenced above (i.e., hedge funds, funds of hedge funds, 
commodities pools, managed futures, and REITs). Additional products 
could be added in the initial phase or from time to time as requested 
by industry participants and as approved by NSCC.\3\ Eligible AIP 
Products would include those registered with the Commission or those 
not required to be registered. An AIP Manufacturer that submits an 
alternative investment product for processing through the AIP Service 
would represent and warrant to NSCC that the offer and sale of the 
investment product complies with applicable law.
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    \3\ Due to the nature of alternative investment products, NSCC 
retains the right to refuse to process a specific product or type of 
product through the AIP Service or to require that it no longer be 
processed through the AIP service if NSCC deems it to be in the 
interests of NSCC or its members to do so.
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(5) AIP Members
    The following type of entities would be eligible to become AIP 
Manufacturers or AIP Distributors:
    (i) A broker-dealer registered under the Exchange Act or subject to 
regulation by the appropriate financial services regulator in its home 
jurisdiction;
    (ii) A bank or trust company under supervision of federal or state 
banking authorities or a non-U.S. bank subject to regulation in its 
home jurisdiction;
    (iii) An investment company registered under the Investment Company 
Act or an issuer (structured as a fund or pooled investment vehicle) 
that is not required to register thereunder;
    (iv) An investment adviser as defined under the Investment Advisers 
Act of 1940 regardless of whether it is registered under the Investment 
Advisors Act or is exempt from registration;
    (v) A commodity pool operator or commodity trading advisor as 
defined under the Commodity Exchange Act regardless of whether the 
commodity pool operator or commodity trading advisor is registered 
pursuant to the Commodity Exchange Act or is exempt from registration 
thereunder;
    (vi) An insurance company regulated under state insurance law or a 
non-U.S. insurance company subject to regulation by the appropriate 
insurance regulator in its home jurisdiction;
    (vii) With respect to an AIP Manufacturer, an entity engaged under 
contract to provide administrative services to one or more Eligible AIP 
Products; or
    (viii) An entity that does not qualify as one of the above entities 
but that has demonstrated to the Board of Directors of NSCC that its 
business and capabilities are such that it could reasonably expect 
material benefit from direct access to the AIP Service.
    Because AIP Settlement would be prefunded and because NSCC would be 
insulated from exposure to the credit risk of AIP Members and would 
have no liability to make payments in the event of an AIP Member's AIP 
Settlement default, there are no financial requirements for 
participation in the AIP Service. Members would be required to meet 
NSCC's operational requirements and general standards applicable to 
competency for membership and to meet such other requirements as NSCC 
may establish from time to time.\4\
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    \4\ NSCC's general standards applicable to competency are 
designed to screen for any action or condition of an applicant or 
member that could, in the reasonable judgment of NSCC, present undue 
risk to NSCC or its members.
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(6) Scope of AIP Services
    The AIP Service would support communication of information and 
settlement of AIP Payments between the AIP Manufacturer and the AIP 
Distributor in order to facilitate the processing of subscriptions and 
purchases, tenders and redemptions, dividends and distributions, 
commissions and fees, position reporting, product information, account 
maintenance, automated transmission of imaged documents, and such other 
actions as NSCC may determine from time to time. The AIP Service would 
provide AIP Members with the ability to transmit data in connection 
with transactions whether the payments are made outside of NSCC or 
through the AIP Service.
    As with all NSCC Services, NSCC would not be responsible for the 
completeness or accuracy of data transmitted through the AIP Services 
or for any errors, omissions, or delays which may occur in the absence 
of gross negligence on the part of NSCC.

[[Page 14296]]

    Fees for the use of the AIP Service have not yet been established 
and would be the subject of a subsequent proposed rule change filed 
under Section 19(b)(3)(A) of the Act if this proposed rule filing is 
approved.
(7) AIP Settlement
    AIP Settlement would be in same day funds over fedwire and would be 
segregated from all other settlement payments at NSCC. Unless otherwise 
approved by NSCC, AIP Members would be required to appoint a settling 
bank (``AIP Settling Bank'') for purposes of settlement similar to NSCC 
settlement procedures for its other money settlements.
    NSCC would maintain credit balances and debit balances for each AIP 
Member to which NSCC would post gross credits and gross debits for 
settlement on the date designated by the AIP Member (``Settlement 
Date''). AIP Settlement would be on a gross basis meaning that the 
credit balance of an AIP Member would not be netted against its debit 
balance. If NSCC does not receive funds from an AIP Member in the 
amount of the debit balance by the requisite time on the Settlement 
Date, NSCC would reduce the corresponding settlement credit balances of 
the AIP Members that are the contrasides to the AIP Member that did not 
pay its gross debit balance. Nonpayment of a debit balance would not be 
deemed a payment default under NSCC Rules, but NSCC may establish fees 
for late payment or nonpayment and may establish a threshold number of 
instances of late payment or nonpayment which would cause other 
sanctions, including NSCC's ceasing to act for such an AIP Member.
    After receipt of an AIP Member's debit balance from the AIP 
Member's AIP Settling Bank on Settlement Date, NSCC would transfer to 
the AIP Settling Bank(s) of the contraside AIP Member(s) the settlement 
credit balance(s). NSCC's payment would include gross credit balances 
which may have been reduced to reflect the reversal of any credits with 
respect to debit balance amounts that were not paid by a contraside AIP 
Member.
    Use of NSCC's AIP Service would provide the alternative investment 
product industry with the ability to process transactions and to settle 
funds on a centralized, fully redundant platform that would provide 
more robust business continuity in the event of interruption to 
processing on a primary system, better audit trails on transactions, 
lower costs, and fewer errors and delays than are currently the case 
through manual processing.
    Settlement on the basis of gross debits and gross credits without 
offsets insulates NSCC from any financial risks associated with 
Eligible AIP Products and AIP Members. Because NSCC's obligation to pay 
a credit balance would be conditioned upon receipt of the funds by NSCC 
from the contraside AIP Member, NSCC would not bear the risk that an 
AIP Member may default at settlement.
(8) AIP Document Transmission
    The AIP Service would automate the transmission of imaged hard-copy 
documents (``paper workflow'') between AIP Manufacturers and AIP 
Distributors. The alternative investment industry has a number of 
investment instruments that are private or are traded outside of the 
normal processes and that require the exchange of documentation. 
Typically, the parties may exchange up to forty pages of hard-copy 
documents. Subaccount documentation is typically sent for both initial 
and subsequent subscriptions, depending on the requirements of the 
alternative investment product, and for tender offers. The paper 
workflow component of the AIP Service would allow parties to scan and 
convert documents to a file format such as portable document format 
(``PDF'') file for transmission with or without a pending transaction 
message.
(9) Proposed Changes to NSCC Rules
    Under the proposed rule change, a new Rule 53, ``Alternative 
Investment Product Services and Members,'' would be added to NSCC's 
Rules, and additional confirming changes would be made elsewhere 
throughout NSCC's Rules as needed to provide consistency with the new 
Rule 53.
    NSCC believes that the proposed rule change is consistent with the 
requirements of Section 17A of the Act \5\ and the rules and 
regulations thereunder because by facilitating the transmission of 
standardized information for alternative investment products on a 
centralized communications platform and by automating money settlements 
through a centralized location in the same day funds, the proposed AIP 
Service would provide increased efficiencies and reduced risks that are 
typically associated with manual processing. As such, the proposed 
changes would help remove impediments to and perfect the mechanism of a 
national system for the prompt and accurate clearance and settlement of 
securities transactions.
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    \5\ 15 U.S.C. 78q-1.
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(B) Self-Regulatory Organization's Statement on Burden on Competition

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

(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.

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

    Within thirty-five 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-NSCC-2007-12 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

    All submissions should refer to File Number SR-NSCC-2007-12. 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

[[Page 14297]]

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 Room, 100 F Street, NE., Washington, DC 20549, on official 
business days between the hours of 10 a.m. and 3 p.m. Copies of such 
filing also will be available for inspection and copying at the 
principal office of NSCC and on NSCC's Web site at http://www.dtcc.com/downloads/legal/rule_filings/2007/nscc/2007-12.pdf. 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-NSCC-2007-12 and should be 
submitted on or before April 7, 2008.

    For the Commission by the Division of Trading and Markets, 
pursuant to delegated authority.\6\
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    \6\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E8-5279 Filed 3-14-08; 8:45 am]
BILLING CODE 8011-01-P