SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 240 [Release No. 34-35040; File No. S7-35-94 RIN 3235-AG24 Proposed Amendments to the Transfer Agent Rules AGENCY: Securities and Exchange Commission ACTION: Notice of Proposed Rulemaking and Request for Comments SUMMARY: The Securities and Exchange Commission is proposing amendments to certain transfer agent rules regarding turnaround time, recordkeeping, and safekeeping of funds. The Commission is proposing these rules in light of the changes in the clearance and settlement of corporate securities from five days after the trade ("T+5") to three days after the trade ("T+3") and the proposal to establish a transfer agent operated book-entry registration system (hereinafter referred to as the "direct registration system" or "DRS"). The proposed amendments to the transfer agent rules are designed to minimize disruptions, delays, and financial losses in the securities markets, particularly in the national clearance and settlement system for securities, that may be caused by poor turnaround performance, substandard or inaccurate recordkeeping practices, and inadequate safekeeping procedures. The Commission also is soliciting comment on whether additional rules are needed in light of T+3 and DRS, including net worth and insurance requirements. DATES: Comments should be submitted on or before [insert date 60 days after publication date]. ADDRESSES: Interested persons should submit three copies of their written data, views, and opinions to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington D.C. 20549. Comment letters should refer to File No. S7-35-94 and will be available for public inspection and copying at the Commission's public reference room, 450 Fifth St., N.W., Washington D.C. 20549. FOR FURTHER INFORMATION CONTACT Ester Saverson, Jr., Special Counsel, or Michele J. Bianco, Attorney, at 202/942-4187, Office of Market Supervision, Mail Stop 5-1, Division of Market Regulation, Securities and Exchange Commission, Washington, D.C. 20549. SUPPLEMENTARY INFORMATION: I. Background and Summary Transfer agents are an integral component of the clearance and settlement process. There are approximately 1,576 registered transfer agents that maintain the official registers of stockholders or bondholders on behalf of the issuers of securities. Transfer agents issue negotiable certificates evidencing security ownership, communicate on behalf of issuers with securityholders, and record changes in securities ownership as a result of securities transactions. A certificate issued in the name of the securityholder is one method of evidencing ownership of a security. The certificate is a negotiable instrument, and the proper indorsement of the securities has been the traditional method of transferring ownership. Because of the desire to immobilize certificates to facilitate the clearance and settlement of the increasingly large number of transactions that occur every day, transfer agents began to maintain custody of securities for which they act as transfer agent. Some transfer agents maintain custody of certificates on behalf of securities depositories, -[1]- exchange information with the relevant depositories about -[1]- Securities depositories are registered as clearing agencies under Section 17A of the Securities Exchange Act of 1934. Depositories serve as clearinghouses for the settlement of trades in corporate and municipal (continued...) -------------------- BEGINNING OF PAGE #2 ------------------- position balances each day, and issue and transmit certificates pursuant to the depositories' instructions. -[2]- Transfer agents also may function as custodian for individual securityholders through dividend reinvestment and stock purchase programs ("DRSPPs"), employee stock purchase programs, and similar transfer agent book-entry custody programs. The functions performed by transfer agents are critical to the safe and efficient processing of securities transactions. Substandard performance by transfer agents can affect the accuracy of an issuer's securityholder records, interrupt the channels of communication between issuers and securityholders, frustrate investor expectations, and cause financial loss to investors and intermediaries such as broker-dealers, banks, and clearing agencies. -[3]- Congress authorized federal regulation of transfer agent activities in 1975 as one component of a regulatory scheme designed to foster a National Clearance and Settlement System ("National System") among broker-dealers, issuers, exchanges, and clearing agencies. -[4]- The Securities and Exchange Commission ("Commission") has adopted certain rules governing the performance of transfer agent functions by registered transfer agents to protect investors and to facilitate the prompt, accurate, and safe transfer, clearance, and settlement of securities transactions. -[5]- For example, Rules 17Ad-1 through 17Ad-7 ("turnaround rules") under the Securities Exchange Act of 1934 ("Act") establish minimum performance standards for registered transfer agents in connection with the timely cancellation and issuance of securities certificates. -[6]- In addition, Rules 17Ad-9 through 17Ad-13 establish standards for registered transfer agents governing recordkeeping practices and -[1]-(...continued) securities and perform securities safekeeping services for their participating banks and broker-dealers. -[2]- Securities Exchange Act Release No. 13342 (March 8, 1977), 42 FR 14792. -[3]- See SEC, Study of Unsafe and Unsound Practices of Brokers and Dealers, H.R. Doc. No. 231, 92nd Cong., 1st Sess., 37-39 (1971); Clearance and Settlement of Securities Transactions, Hearings on S.3412, S.3297 and S.2551 Before the Subcomm. on Securities of the Senate Comm. on Banking, Housing and Urban Affairs, 92nd Cong., 2d Sess., 94-96, 105-106 (1972); Securities Processing Act Hearings on H.R. 14567, H.R. 14826 and S.3876 Before the Subcomm. on Commerce and Finance of the House Comm. on Interstate and Foreign Commerce, 92nd Cong. 2d Sess., 100 (1972). -[4]- S. Report 94-249. -[5]- A transfer agent is required to register with its appropriate regulatory agency. Bank transfer agents register with one of the banking agencies (i.e., the Comptroller of the Currency, the Board of Governors of the Federal Reserve System and the Federal Depository Insurance Corporation) and non-bank transfer agents register with the Commission. -[6]- 17 CFR 240.17Ad-1 through 240.17Ad-7 (1994). See Securities Exchange Act Release No. 13636 (June 16, 1977), 42 FR 32404. -------------------- BEGINNING OF PAGE #3 ------------------- the safeguarding of securities and funds. -[7]- These rules were intended to promote, among other things, accurate securityholder records. -[8]- The Commission believes it is appropriate to solicit comment on the proposed amendments to the transfer agent rules. The Commission also solicits comment on whether other changes are needed to the transfer agent regulations in light of impending changes in the National System. Effective in June 1995, Rule 15c6-1 will shorten the standard time frame for settling securities transactions from T+5 to T+3. As discussed more fully in a companion release issued today, -[9]- industry efforts are underway to develop expanded direct registration systems that rely on account statements instead of negotiable certificates, automated recordkeeping systems, and automated links between securities depositories, broker-dealers and banks. In light of these developments, the performance and operational efficiency of transfer agents increasingly will be important to the smooth functioning of the National System. Substandard or inefficient performance by transfer agents could have a significant adverse impact on the functioning of the National System. -[10]- II. Discussion A. Turnaround of Requests for Transfer The current turnaround rule -[11]- requires a transfer agent to process ("turnaround") within three-business days of receipt at least 90% of all routine items -[12]- received for transfer -[7]- Securities Exchange Act Release No. 19860 (June 10, 1983), 48 FR 28231. -[8]- 17 CFR 240.17Ad-9 through 240.17Ad-13 (1994). The Commission last amended these rules in 1986. Securities Exchange Act Release No. 22882 (February 10, 1986), 51 FR 5703. -[9]- Securities Exchange Act Release No. 35038 (December 1, 1994) (hereinafter referred to as "companion release"). -[10]- This discussion is limited to transfer agent regulation and does not address the application of the broker- dealer registration provisions of the Exchange Act to DRS or DRSPPs. Some of the activities in connection with DRS or DRSPPs may raise broker-dealer registration issues under Section 15 of the Exchange Act. Refer to companion release at n. 21. -[11]- 17 CFR 240.17Ad-2 (1994). -[12]- 17 CFR 240.17Ad-1(i) (1994) defines a routine item as follows: A item is routine if it does not: (1) require requisitioning certificates of an issue for which the transfer agent, under the terms of its agency, does not maintain a supply of certificates; (2) include a certificate as to which the transfer agent has received notice of a stop order, adverse claim, or any other restriction on transfer; (3) require any additional certificates, documentation, instructions, assignments, guarantees, endorsements, explanations or opinions of counsel before transfer may be effected; (4) require review of supporting documentation other (continued...) -------------------- BEGINNING OF PAGE #4 ------------------- during that month. -[13]- In addition, most transfer agents that transfer New York Stock Exchange ("NYSE") listed securities meet the more stringent NYSE requirement that requires transfer agents to transfer NYSE-listed securities within 48-hours of receipt. -[14]- In light of the shortening of the settlement cycle to T+3, the Commission is proposing to amend Rule 17Ad-2 to reduce the turnaround requirement from three business days to two business days for transfer agents that do not qualify for the exemption under Rule 17Ad-4(b). Although there are several ways to transfer ownership of securities in settlement of secondary market trades, -[15]- changing ownership on the books maintained by the transfer agent can still be a critical step in that process. The Commission also is proposing to amend Rule 17Ad- 2(e) to require "exempt" transfer agents that transfer depository-eligible securities to turnaround ninety percent of all routine items received during a month within three business days of receipt. -[16]- Currently, those transfers must be completed within five business days. The Commission invites commenters to address whether a shorter turnaround standard should be established for all -[12]-(...continued) than assignments, endorsements or stock powers, certified corporate resolutions, signature or other common and ordinary guarantees or appropriate tax or tax waivers; (5) involve a transfer in connection with a reorganization, tender offer, exchange, redemption or liquidation; (6) include a warrant, right or convertible security presented for transfer of record ownership within five business days before any day upon which exercise or conversion privileges lapse or change; (7) include a warrant, right, or convertible security presented for exercise or conversion; or (8) include a security of an issue which within the previous 15 business days was offered to the public, pursuant to a registration statement effective under the Securities Act of 1933, in an offering of a continuing nature. -[13]- An exempt transfer agent i.e., a transfer agent that during any six consecutive months has received fewer than 500 items for transfer and fewer than 500 items for processing does not have to meet the three day turnaround requirement. 17 CFR 240.17Ad-4 (1994). An exempt transfer agent that handles any depository- eligible securities must turnaround 90% of all routine items received during a month within five business days of receipt. 17 CFR 240.17Ad-2(e)(2) (1994). All other exempt transfer agents must turnaround all items promptly. 17 CFR 240.17Ad-2(e)(1) (1994). -[14]- NYSE Rule 496, NYSE Guide (CCH) 2496 at 4225. -[15]- See, e.g., N.Y. U.C.C. LAW 8-313(1) (McKinney 1994). The most common method today is by book-entry notation on the records of a securities depository, bank, or broker-dealer. See 1993 SEC Annual Report at 125. -[16]- The Commission invites commenters to address whether other time frames, such as one or two business days, would be more appropriate. -------------------- BEGINNING OF PAGE #5 ------------------- transfer agents. -[17]- Currently, Rule 17Ad-2 establishes different turnaround standards for "low-volume" transfer agents because these transfer agents are generally small businesses and the cost associated with requiring faster turnaround might be significant to these entities. The Commission invites commenters to address whether the distinction among transfer agents based on volume should be maintained. Commenters addressing this issue are requested to provide data in support of their views. B. Accurate Securityholder Records Rule 17Ad-10 requires all recordkeeping transfer agents "promptly" -[18]- and accurately to update the securityholders file. Issuer transfer agents -[19]- and transfer agents that employ batch posting systems must post certificate detail -[20]- to the master securityholder file within 10 business days. Transfer agents that qualify for the exemption under Rule 17Ad- 4(b) must post certificate detail to the master securityholder files within 30 calendar days. All other recordkeeping transfer agents must post certificate detail to the master securityholder files within five business days. The Commission is proposing to amend Rule 17Ad-10(a)(2) to require "exempt" registered transfer agents to update the master securityholder file within ten business days of an issuance, purchase, transfer, or redemption of a security instead of the 30 calendar days currently required. Although recordkeeping transfer agents would continue to have as much as two weeks from the transfer of ownership to update the master securityholder file, their subsidiary file system must contain records that reflect all transfers and that are readily accessible. The Commission understands that many transfer agents maintain systems that provide for same-day or immediate updates to the master securityholder files, while other transfer agents update the file periodically and direct their staff to review transfer ledgers between updates. The Commission invites commenters to address whether more stringent time frames should be mandated, such as -[17]- The Securities Transfer Association ("STA") questioned the validity of other distinctions of exempt transfer agents. STA's Petition for Commission Rulemaking to Rule IVa of the Securities and Exchange Commission's Rules of Practice to Eliminate Differential Regulatory Standards for Transfer Agents Under Section 17A of the Securities Exchange Act of 1934 (November 23, 1988). Those distinctions include different exemptions for independent audit requirements, and recordkeeping requirements. A copy of the petition will be placed in the public file and will be available for inspection. The Commission invites commenters to address the continued validity of these exceptions. -[18]- Promptly is defined as five business days, ten business days, or 30 calendar days depending on the category of the transfer agent. 17 CFR 240.17Ad-10(a)(2)(ii) (1994). -[19]- Issuer transfer agents are those transfer agents which perform transfer agent functions exclusively with respect to their own securities or those issued by an affiliate. See 17 CFR 240.17Ad-10(2) (1994). -[20]- "Certificate detail" is defined in 17 CFR 240.17Ad- 9(a) (1994) and generally means those data elements that identify the owner and the certificate or positions held by that owner. -------------------- BEGINNING OF PAGE #6 ------------------- same-day, next-day, or five business days, and whether the rule should continue to reflect differences in the automation and size of registered transfer agents. One of the major functions of a transfer agent is to transfer the security from the seller to the buyer after a transaction. Typically this is evidenced by cancelling the old certificate and issuing a new certificate. With the growth of uncertificated recordkeeping functions by transfer agents, an increasing number of transfers are effected by book-entry only. Without the certificate, the integrity of the records of the transfer agent is crucial. As discussed in the Companion Release, under the DRS Concept and other uncertificated recordkeeping functions, the request for transfer in many instances may no longer be submitted in writing but will be submitted electronically. In addition, the DRS Concept could allow an investor to direct the sale of securities or to request a certificate by telephone. Accordingly, the Commission invites commenters to address whether additional recordkeeping requirements are necessary in light of the trend toward statement-based securities ownership accounting (i.e., recording ownership without issuing a negotiable certificate evidencing those securities). For example, are there additional records transfer agents should maintain concerning transfer instructions transmitted electronically or by telephone? The Commission also invites commenters to address the following questions. Should the Commission require transfer agents to issue confirmation statements every time there is a transaction that changes an investor's DRSPP or DRS account similar to those required to be sent by broker-dealers in Rule 10b-10. -[21]- If there is no activity in an account, how often should a transfer agent send an account statement? What, if anything, should the Commission require to be disclosed on such account statements? C. Investors' Funds and Securities Currently Rule 17Ad-12 requires transfer agents that have custody or possession of funds or securities related to their transfer agent activities to assure that: (1) All such securities are held in safekeeping and are handled, in light of all facts and circumstances, in a manner reasonably free from risk of destruction, theft or other loss; and (2) all such funds are protected, in light of all facts and circumstances, against misuse. In evaluating which particular safeguards and procedures must be employed, the cost of the various safeguards and procedures as well as the nature and degree of potential financial exposure are two relevant factors. -[22]- The Commission believes a transfer agent should not commingle investor funds with other funds of the transfer agent. With the growth of DRSPPs, it is not unusual for transfer agents to hold considerable sums of investor funds. Although the Commission is not aware of any losses to investors from existing practices, the Commission believes it is appropriate to take steps to reduce the potential for such losses. Accordingly, the Commission is proposing to amend Rule 17Ad-12 to require every registered transfer agent to maintain with a bank or banks at all times a "Bank Account for the Exclusive Benefit of -[21]- 17 CFR 240.10b-10 (1994). -[22]- 17 CFR 240.17Ad-12 (1994). -------------------- BEGINNING OF PAGE #7 ------------------- Securityholders" (hereinafter referred to as the "Securityholders' Bank Account") which shall remain separate from any other bank account of the transfer agent. The proposed amendment to Rule 17Ad-12 also would require every registered transfer agent to maintain at all times in such Securityholders' Bank Account all securityholders' funds in the transfer agent's custody and possession that are related to its transfer agent activities. The proposed rule is intended to restrict transfer agents from using or investing securityholders' funds for any purpose and to protect those funds from the transfer agent's general creditors. As proposed, transfer agents must deposit cash in a bank, as that term is defined in Section 3(a)(6) of the Act. The Commission invites comments on whether other financial institutions or account structures might be used or mandated to preserve the liquidity and safety of funds. D. Minimum Net Worth and Insurance Requirements During its 1983 rulemaking process, the Commission sought comment on whether it should impose minimum net worth and insurance requirements on transfer agents registered under Section 17A of the Exchange Act, other than federally regulated banks or transfer agents that perform transfer agent functions exclusively for their own securities. -[23]- The Commission also requested comment on whether a minimum net worth requirement would be necessary if an appropriate insurance requirement were imposed. Most commenters favored a minimum insurance requirement and many favored both minimum insurance and net worth requirements. Commenters, however, suggested widely varying ranges of minimum insurance and net worth levels. In June 1983, when the Commission adopted recordkeeping rules and safeguarding procedures for registered transfer agents, the Commission considered, but decided to defer, promulgating rules regarding transfer agent net worth and insurance requirements. -[24]- Thereafter, the Securities Transfer Association, Inc. ("STA") petitioned the Commission for changes to rules concerning transfer agents which included, among other things, minimum insurance and net worth requirements. -[25]- As discussed below, the Commission believes it is appropriate to reconsider the merits and costs of minimum net worth and insurance requirements for transfer agents. 1. Net Worth Requirements The STA advocated net worth requirements for several reasons. First, transfer agents may require a minimum amount of net worth to permit efficient and safe transfer operations. -[26]- Second, transfer agents may require a minimum amount of -[23]- See Securities Exchange Act Release No. 19860 (June 10, 1983), 48 FR 28231. -[24]- Id. -[25]- The STA's Petition for Commission Rulemaking Filed Pursuant to Rule IVa of the Securities and Exchange Commission's Rules of Practice to Establish Minimum Capital and Adequate Insurance Requirements for Transfer Agents Under Section 17A of the Securities Exchange Act of 1934 (November 23, 1988). -[26]- Of course, the amount of net worth necessary to sustain efficient operations and service levels will depend, among other things, on the number of securities issues, the number of securityholder accounts to be serviced, (continued...) -------------------- BEGINNING OF PAGE #8 ------------------- net worth to meet potential liabilities in connection with those functions. Although the Uniform Commerical Code ("UCC") imposes liability on issuers for damages to securityholders and bona fide purchasers as a result, among other things, of a refusal to register transfers, -[27]- that liability is often borne by the transfer agent (if the issuer does not perform its own transfer agent functions) under the terms of the contract governing the transfer agent's appointment. -[28]- If, for example, inadequate procedures, internal controls, employee errors, or defalcations result in inaccurate records, transfer agents must have sufficient net worth to enable them to reestablish accurate records. -[29]- In addition, if errors, omissions, or employee defalcations result in an overissuance of securities, transfer agents may be required to purchase securities for delivery to securityholders or bona fide purchasers who have suffered consequential damages. Because the market value of securities can fluctuate significantly and considerable time can elapse between the event giving rise to liability and the discovery of that liability, an insignificant error today can result in significant expense when it is finally discovered. -[30]- Although many transfer agents can purchase insurance against some of these risks, many of those policies contain deductibles, exclusions or conditions that result in the transfer agent bearing a significant percentage of the ultimate cost. The Commission is not aware of any formal studies assessing transfer agent losses or liabilities. Nevertheless, based on its oversight of transfer agents since 1975 and episodic recordkeeping and transfer difficulties, the Commission believes that financial exposure associated with erroneous, unsafe or inaccurate transfer agent functions can range from several thousand dollars to several hundred thousand dollars. -[31]- -[26]-(...continued) and the volume of transfers in those securities issues. -[27]- UCC 8-401 and 8-404 (Official Text, 1978). -[28]- See UCC 8-406 (Official Text, 1978) and E. Guttman, Modern Securities Transfer (revised ed. 1987) at 3-34. -[29]- Record reconstruction can be very expensive, depending on the number of accounts affected, since research and reconciliation procedures are time-consuming and labor- intensive. -[30]- For example, a transfer agent might incorrectly account for a conversion of debentures into common stock because a conversion tender was lost in processing at the transfer agent. Upon discovery of the error, the transfer agent likely will be liable not only for delivery of the number of shares pursuant to the conversion, but also for any intervening dividends, distributions and stock splits the securityholder would have realized if the securityholder's instructions had not been lost. -[31]- For example, an operational crisis in the transfer agent industry, (such as the collapse of First Independent Stock Transfer Agent, Inc. ("FISTA") in 1981, that makes it necessary for issuers to find an alternative means to ensure the performance of transfer (continued...) -------------------- BEGINNING OF PAGE #9 ------------------- The Commission requests comment as to whether minimum net worth requirements for transfer agents are necessary or appropriate. -[32]- Would the financial risks to shareholders and financial intermediaries be reduced significantly if a minimum net worth requirement for transfer agents were imposed? Would the existence of a minimum net worth requirement cause transfer agents to make a greater commitment to their transfer agent business? If the Commission were to establish minimum net worth requirements, should it consider whether a transfer agent issues negotiable certificates evidencing ownership? Should the Commission limit any minimum net worth requirements to transfer agents that provide the DRS services or engage in other unregistered recordkeeping functions? Would investors have sufficient confidence in the integrity of the proposed DRS, in the absence of either minimum net worth or minimum insurance requirements? Does the present lack of minimum net worth requirements for transfer agents performing transfer functions exclusively for non-NYSE and non-Amex issues create undue risk to investors? -[33]- The Commission also invites comment on whether net worth requirements would impose undue expense on transfer agents and whether alternatives to net worth requirements might achieve the goals of prompt, accurate, and safe transfer, clearance, and settlement of securities transactions. Such alternatives might include reliance on existing market forces, such as the incentive -[31]-(...continued) functions could significantly delay the transfer of certificates, causing brokers, financial institutions, securities depositories and investors to sustain financial losses. See In the Matter of First Independent Stock Transfer Agent, Inc., Securities Exchange Act Release No. 19608 (March 17, 1983). See also cases cited in Securities Exchange Act Release No. 19142 (October 15, 1982), 47 FR 47269 and SEC v. Dynapac, Inc., et al., Civ. No. C-86-20694-RPA, NDCA (Final Judgement of Permanent Injunction and Other Equitable Relief entered November 7, 1986) where the Commission filed a complaint against 23 defendants alleging fraudulent distribution of unregistered stock and numerous other violations of the securities laws. -[32]- The STA proposed that every registered transfer agent maintain a level of net worth related to the number of issues handled by the transfer agent. The proposed level of required net worth for registered transfer agents is: (i) $150,000 for five or fewer issues; (ii) $200,000 for six to 24 issues; (iii) $300,000 for 25 to 99 issues; (iv) $500,000 for 100 to 499 issues; (v) $650,000 for 500 to 999 issues; and (vi) $1,000,000 for 1,000 issues or more. While the STA's proposal is a starting point, the Commission believes that transfer agents that engage in uncertificated recordkeeping functions may need more net worth than transfer agents that do not perform such functions to adequately perform their duties. The NYSE and the American Stock Exchange ("Amex") impose a $10,000,000 and a $3,000,000 minimum capital requirement, respectively, for non- issuer transfer agents that perform transfer functions for NYSE-listed and Amex-listed issues, respectively. See NYSE Rule 496 and Amex Rule 891. -[33]- See note 32. -------------------- BEGINNING OF PAGE #10 ------------------- for issuers to avoid liability by policing transfer agent performance. Persons addressing these issues are invited to submit data in support of their views. 2. Insurance Requirement Unlike funds and securities held by broker-dealers, funds and securities held by transfer agents are not covered under the Securities Investors Protection Act of 1970 ("SIPA"). -[34]- SIPA established the Securities Investors Protection Corporation ("SIPC") fund, which insures each customer of a broker-dealer against the loss of funds and securities at the broker-dealer in the event of the broker-dealer's insolvency for cash and securities up to a maximum of $500,000, with a limit of $100,000 on claims for cash. Nothing analogous exists with respect to transfer agents, although non-issuer transfer agents that transfer securities listed on the Amex or the NYSE are required to obtain insurance. -[35]- SIPC was established for broker- dealers because they regularly handle customers' funds and securities, and, without such protection, investors face the potential loss of funds and securities if they fail. To cover liabilities that might arise in connection with the transfer process, many transfer agents have purchased insurance similar to insurance coverage obtained by broker-dealers and banks. Insurance currently available to transfer agents is designed to protect the transfer agent against financial loss resulting from liabilities for substandard transfer agent performance, including, but not limited to premises loss, in transit loss, breach of duty of fidelity, and fraudulent transfers. -[36]- In addition, many transfer agents already are subject to self- regulatory organization insurance requirements. The Commission requests comment on whether an insurance requirement is necessary or appropriate for the protection of -[34]- 15 U.S.C. 78aaa-lll (1993). -[35]- Amex Rule 891 requires a minimum of $10,000,000 of insurance coverage and NYSE Rule 496 requires $25,000,000 of insurance coverage for non-issuer transfer agents that transfer Amex-listed and NYSE- listed securities, respectively. See note 32. -[36]- On Premises Loss insurance covers loss of funds or securities through criminal acts of other than employees and through unexplained causes while on the insured's premises. In Transit Loss insurance covers all methods of shipping securities and to any destination or addressee (e.g., mail, overnight delivery service, messenger, or armored carrier). Fidelity insurance covers losses through any dishonest, fraudulent, or criminal act of any employee of the insured. Fraudulent Transfers insurance covers losses when a security is registered to a person because of a wrongful transfer. This usually occurs because the signature of the person authorizing the transfer is fraudulent or the person signing the transfer request does not have the authority to make such transfer. Such insurance is generally available to transfer agents under a blanket bond coverage. See E. Guttman, Modern Securities Transfer (revised ed. 1987). -------------------- BEGINNING OF PAGE #11 ------------------- investors or to further other statutory goals. -[37]- For example, requiring transfer agents to maintain an adequate amount of insurance or bonding might reduce the risks posed by transfer agents to investors and other participants in the clearance and settlement system. The Commission invites commenters to address whether an insurance requirement for registered transfer agents would be necessary if a net worth requirement is adopted. Should an insurance requirement be imposed as an alternative to a net worth requirement? Assuming a net worth requirement is not adopted, are there safeguards other than an insurance requirement that might be appropriate? The Commission invites commenters to address the type and amount of insurance they believe should be required. Commenters addressing these issues also might consider the following questions. What criteria should be considered in determining the appropriate amount of insurance (e.g., volume of business, types of securities)? Should there be some minimum amount of insurance coverage coupled with subsequent increases reflecting the transfer agent's potential financial liability based on the dollar value of securities for which the transfer agent performs transfer functions? Is an insurance requirement necessary in light of NYSE and Amex rules? Should the Commission rely on the insurance requirements in the NYSE and Amex listing standards? III. Request for Comment The Commission is interested in receiving comment on all aspects of transfer agent regulations in light of the upcoming change in settlement time frames. The Commission also invites comment on whether new transfer agent recordkeeping systems, as discussed in the Companion Release, justify new or different regulations to promote prompt, accurate, and safe transfer of securities. The Commission also invites commenters to address the costs associated with the proposed amendments, whether the proposed amendments would impose a burden on competition, and whether such a burden, if any, is necessary or appropriate to achieve the purposes of the Act. -[38]- IV. Initial Regulatory Flexibility Analysis The Commission has prepared an Initial Regulatory Flexibility Analysis ("Analysis"), in accordance with 5 U.S.C. -[37]- The STA proposed that every registered transfer agent maintain a level of insurance that will reasonably protect the transfer agent in the event it incurs liabilities in performing its transfer activities. The STA recommended that the Commission expand the Annual Study and Evaluation of Internal Accountant Control ("Internal Control Report"), under Commission Rule 17Ad-13, to require the auditor to determine the appropriate level of insurance to cover those liabilities. Specifically, the STA recommended that the Internal Control Report cover insurance or bonding protection including whether such coverage is adequate in light of its operational capability, level of net worth, nature and degree of financial exposure from its transfer activities, and cost of various insurance and bonding alternatives. The STA also recommended requiring bank and issuer transfer agents to comply with Rule 17Ad-13 and to the proposed insurance requirements. -[38]- See 15 U.S.C. 78w(a) (1993). -------------------- BEGINNING OF PAGE #12 ------------------- 603, as amended by the Regulatory Flexibility Act ("RFA") regarding the proposed amendments to Rules 17Ad-2, 17Ad-10, and 17Ad-12. The Analysis notes that the proposed rule changes would affect approximately 393 low volume transfer agents that qualify as "exempt transfer agents" within the meaning of Rule 17Ad- 4(b). Furthermore, the Analysis notes that the proposed rule changes would affect 174 transfer agents that perform transfer functions for depository eligible securities. The proposals would affect all transfer agents, including issuer, bank and small mutual fund transfer agents, that handle book-entry securities. The Analysis notes the Commission's belief that the majority of the 174 transfer agents performing transfer functions for depository eligible securities affected by the proposed rule change to Rule 17Ad-2 will not incur significant additional compliance costs because many of these registered transfer agents currently comply with the proposed rule changes. Moreover, many transfer agents performing transfer functions for issues listed on the NYSE are presently required to transfer securities within 48 hours of receipt. The Analysis, therefore, notes the Commission's belief that the new transfer turnaround time frames will have a practical effect only on those transfer agents that are currently not subject to the NYSE requirement. The Analysis states that the proposed amendment to Rule 17Ad-10, to require that exempt transfer agents update the master securityholder files every 10 days of transfer instead of 30 days, will not impose significant cost on exempt transfer agents because these exempt transfer agents are low volume transfer agents (i.e., transfer agents that process fewer than 500 items in a six month period). The Commission believes that 10 days is sufficient time to allow such small transfer agents to update their master securityholder files. The 10 day updating requirement is the same requirement for transfer agents that employ batch posting systems and thus should not significantly effect small transfer agents that employ such systems. In addition, the Commission believes that the benefits to investors outweigh any additional cost to comply with the 10 day updating requirement. The Analysis also notes the Commission's belief that the additional requirements to have a Securityholders' Bank Account in Rule 17Ad-12 will not impose significant cost on registered transfer agents, including exempt transfer agents, because most registered transfer agents that currently handle dividends, interest, or funds involving DRSPPs currently maintain accounts at banks similar to the Securityholders' Bank Account. For those registered transfer agents that do not have such accounts, the Commission stated that it believes that establishment and maintenance of such an account will not impose significant cost on registered transfer agents. The Commission has considered alternatives to the proposed rule changes consistent with the requirements of the RFA. The alternatives have been fully considered as to their economic impact and compliance with the statutory objectives. The Commission has not found an acceptable alternative to the proposed rule changes. Accordingly, the Commission does not believe that the proposal would impose undue costs on small transfer agents, and that any costs incurred by transfer agents who do not currently comply with these proposed rules would be outweighed by the benefits that would accrue to the securities industry. A copy of the Analysis may be obtained by contacting Michele Bianco, Attorney, Division of Market Regulation, U.S. Securities -------------------- BEGINNING OF PAGE #13 ------------------- and Exchange Commission, 450 5th Street, N.W., Washington, D.C., 20549, at 202/942-4187. V. Text of the Amendments List of Subjects in 17 CFR Part 240 Transfer agents; Reporting and recordkeeping requirements; Securities For the reasons set out in the preamble, the Commission proposes to amend Part 240 of Chapter II of Title 17 of the Code of Federal Regulations to read as follows: PART 240 -- GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934 1. The authority citation for Part 240 continues to read in part as follows: Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78i, 78j, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78w, 78x, 78ll(d), 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4 and 80b-11, unless otherwise noted. * * * * * 2. By amending 240.17Ad-2(a) by removing the phrase "three business days" and adding in its place "two business days". 3. By amending 240.17Ad-2(c) by removing the phrase "four business days" and adding in its place "three business days". 4. By amending 240.17Ad-2(e)(1) by removing the phrase " three business days" and adding in its place "two business days". 5. By amending 240.17Ad-2(e)(2) by removing the phrase "five business days" and adding in its place "three business days". 6. By amending 240.17Ad-10 by removing paragraph (a)(2)(i) and redesignating paragraphs (a)(2)(ii) and (a)(2)(iii) as paragraphs (a)(2)(i) and (a)(2)(ii). 7. By amending 240.17Ad-12 to add paragraph (b) to read as follows: 240.17Ad-12 Safeguarding of funds and securities. * * * * * (b) Reserve account for the exclusive benefit of securityholders. Every registered transfer agent shall maintain with a bank or banks at all times a "Bank Account for the Exclusive Benefit of Securityholders" (hereinafter referred to as -------------------- BEGINNING OF PAGE #14 ------------------- the "Securityholders' Bank Account"), and it shall be separate from any other bank account of the transfer agent. Every registered transfer agent at all times shall maintain in such Securityholders' Bank Account all securityholders' funds in its custody and possession that are related to its transfer agent activities. By the Commission. Jonathan G. Katz Secretary Dated: December 1, 1994