The Depository Trust & Clearing Corporation
55 Water Street
New York, NY 10041-0099

Jack R. Wiener
Managing Director &
Deputy General Counsel
Tel: 212 855 3280
Fax: 212 855 3215
jwiener@dtcc.com

February 22, 2002

Via Airborne and E-Mail (rule-comments@sec.gov)

Jonathan G. Katz; Secretary
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609

Re: Response to SEC Solicitation of Comments Concerning Proposed Revisions to Rule 17f-4 of the Investment Company Act of 1940; Custody of Investment Company Assets with a Securities Depository; File # S7-22-01; SEC Release # IC-25266.

Dear Mr. Katz:

This letter responds to the SEC's request for comments regarding the above-indicated release.1 The release relates to proposed amendments to Investment Company Act of 1940 Rule 17f-4. Since 1978 that rule has governed the conditions under which registered management investment companies ("Funds") may use central securities depositories ("CSDs") such as The Depository Trust Company ("DTC").2

Generally, we support the proposals set forth in the release. We appreciate the opportunity to provide you with our comments, in Sections I-IV below, on those few aspects of the proposal as to which we either have a different view or request clarification. In addition, while we would like to respond to your request for comments on certain changes that had been suggested by an association representing 9 U.S. banks (the "Banks"), we have respectfully requested in Section V that we be allowed time to seek to forge a common position with the Banks, which - if we are successful in this regard - we would then submit to the SEC.

In short, we suggest below that:

I. The SEC should not permit Non-RCA TAs to operate depositories under the proposed rule.

The proposal suggests that Rule 17f-4 be revised to apply not only to RCAs, such as DTC, but also to registered transfer agents ("TAs") that hold shares of open-ended mutual funds for Funds. While we are sympathetic to the SEC's desire to cover "fund of funds" and similar developments, for the reasons articulated below we believe that it would not be appropriate to include registered TAs in this particular rule.

The rationale presented in the release is that the TAs also register with the SEC, and may serve as the functional equivalent of a CSD.

We believe that such a revision would be inappropriate. Rule 17f-4 has specifically been limited to RCAs (and Federal Reserve banks) since 1978 for good reason.

Admittedly, the phrases "registered clearing agency" and "registered transfer agent" are confusingly similar. And it is true that registered TAs do "register" with the SEC, and comply with applicable SEC regulations (including the submission of standard annual reports). Their similarity to RCAs ends there, however. RCAs are subject to a rigorous regime of regulatory oversight that dwarfs any supervision to which registered TAs are subject.

Appendix A below discusses in some detail the extraordinarily high level of regulation to which RCAs are subject.

In contrast, in the case of a registered TA, generally speaking the SEC's active oversight ends largely upon the TA's filing with the SEC of a simple pro forma TA-1 registration form (other than routine inspections, considerably less penetrating than the Staff's RCA reviews and audits, which the Staff seeks to perform at least once every 3 years).

Rule 17f-4 is predicated on the assumption that the depository to which it applies is highly regulated. In DTC's case, for example, every foreign link to date has been reviewed and approved by the SEC Staff. All other significant DTC procedures are also implemented only after the Staff has published them for public comment, analyzed them, and approved them. Absent registered TAs registering as RCAs, meeting the registration standards and the ongoing obligations of an RCA, and becoming subject to the rigorous oversight of the SEC's Division of Market Regulation, it would seem inappropriate for registered TAs to rely on Rule 17f-4.

II. It is not necessary, in order to comport the rule to Revised Article 8 of the UCC, to require a CSD that deals directly with a Fund to contract to: "take all actions reasonably necessary or appropriate under applicable commercial and regulatory law to safeguard assets" held by the CSD or elsewhere for the Fund's benefit.

We support the SEC's interest in assuring that the rule comports with UCC Revised Article 8.

We would respectfully suggest, however, that the proposed requirement in Rule 17f-4(a)(2)(i) is unnecessary, in that the rule in its already-existing form comports with Revised Article 8 in this respect.

It is true that Article 8 does, in Section 8-504(c), discuss the duty of a securities intermediary maintaining a financial asset. However, Article 8 expressly carves out intermediaries such as RCAs from that provision.

Specifically, as to intermediaries such as RCAs, Section 8-509(a) provides that: "If the substance of a duty imposed upon a securities intermediary by sections 8-504 through 8-508 is the subject of other statute, regulation, or rule, compliance with that statute, regulation, or rule satisfies the duty." 3

Therefore, for SEC-registered clearing agencies such as DTC, there is no need under Article 8 for the imposition of any further contractual provisions of this type; nor for any revisions to Rule 17f-4 requiring same. To impose such a requirement here would be to part paths with Article 8 - precisely the opposite of the Commission's stated goal.4

Furthermore, it might be noted that while it is suggested that the proposed revision is intended to mirror Article 8, even the Article 8 standard for non-RCAs is in fact quite different than the one proposed here.5

In addition, to the extent that the rule applies only to RCAs, which are heavily regulated on a day-to-day basis by the SEC, the SEC Staff can be expected of course to require that the RCA take all actions that the Staff deems appropriate in this regard.6

In any event, we do not believe that the insertion of any standard would be appropriate here for the reasons outlined above.

III. The rule should clarify its proposal that each CSD provide available reports on the controls of any CSD or intermediary custodian it uses.

We are not certain that there is any need to require provision of RCA information here, since this is already dealt with in the SEC's regulation of RCAs. In addition, if RCAs were to be required by proposed Rule 17f-4(a)(2)(i) to make available "available reports" of their subcustodians, that might raise an issue - depending on the meaning of the phrase "available reports." We have found for example that at times subcustodians acting for DTC will make internal accounting controls reports available to DTC, but will not allow DTC to make such reports available in turn to DTC's participants. We would suggest that, if this provision remains, the rule clarify that "available reports" means those reports that the CSD is free to make available to its participants, rather than those reports that are available to the CSD itself.7

IV. The rule should clarify the limited application of Rule 17f-5.

Our understanding is that the rule's Note is meant to address the following fact pattern: Fund assets are custodied with a foreign custodian, which in turn custodies the assets with a U.S. CSD.

As we understand the proposal, Rule 17f-5 would apply in such a scenario to the first link in that chain (that between the "holder" and the foreign custodian), but not to the second link in the chain (that between the foreign custodian and the U.S. CSD).

If that is correct, we have no comment other than to request that the rule clarify this point.

V. Comments on effects on competition and efficiency.

In response to your request for comments as to whether the proposal, if adopted, and Rule 17f-4 itself promote or hinder competition and efficiency, we would respectfully request an opportunity to reserve comment until we have had an opportunity to conclude discussions that we have just now initiated with the Association of Global Custodians in an effort to find a common position in this regard.

Very truly yours,

/s/

Jack R. Wiener
Managing Director & Deputy General Counsel
The Depository Trust & Clearing Corporation

Attachment

cc: Securities and Exchange Commission
The Honorable Harvey L. Pitt; Chairman
The Honorable Cynthia Glassman; Commissioner
The Honorable Isaac C. Hunt, Jr.; Commissioner

Division of Investment Management
Paul F. Roye; Director
Robert E. Plaze; Associate Director
C. Hunter Jones; Assistant Director

Division of Market Regulation 
Annette L. Nazareth; Director
Larry E. Bergmann; Associate Director

Footnotes
1 As required, we are submitting this letter in triplicate. A copy is also being filed electronically.
2 DTC, a clearing agency registered with the SEC under Section 17A of the Securities Exchange Act of 1934 (15 U.S.C. 78q-1), is a wholly owned subsidiary of The Depository Trust & Clearing Corporation ("DTCC"). DTCC in turn is completely industry-owned. DTCC's shareholders are primarily banks, broker-dealers, and exchanges. DTCC's Board of Directors reflects this financial industry ownership.
3 The accompanying Official Comment states: "For many intermediaries, regulatory law specifies in great detail the intermediary's obligations on such matters as safekeeping of customer property ... and the like. To avoid any conflict between the general statement of duties in this Article and the specific statement of intermediaries' obligations in such regulatory schemes, subsection (a) provides that compliance with applicable regulation constitutes compliance with the duties specified in Sections 8-504 through 8-508."
4 Nor, in fact, do we understand this standard to exist in either Rule 17f-5 or 17f-7.
5 Section 8-504(c) deals with the duty of a securities intermediary to whom Section 8-509(a) does not apply (effectively, other than highly regulated intermediaries such as RCAs) that is maintaining a financial asset. It does not go nearly as far as the proposal's suggested language. Section 8-504(c) provides in pertinent part that: "A securities intermediary satisfies the duty [relating to maintaining a financial asset] ... if: (1) the securities intermediary acts with respect to the duty as agreed upon by the entitlement holder and the securities intermediary; or (2) in the absence of agreement, the securities intermediary exercises due care in accordance with reasonable commercial standards to obtain and maintain the financial asset." Rather than mirror the UCC - even as to the standard for non-RCAs - it would appear that the proposed language, by both combining and expanding upon the 2 alternative options above, inadvertently creates a much stiffer standard than that set forth in the UCC.
6 Moreover, as a practical matter this provision applies only if Funds become direct participants of CSDs in the future. Because RCAs are required by Section 17A of the Securities Exchange Act of 1934 to have rules that are not designed to permit unfair discrimination in the use of the RCA, however, the adoption here of such a standard might well compel RCAs to apply this standard to all of their Participants. Given that the SEC Staff in the Division of Market Regulation participates in the refinement of RCA standards through a process of rule filings and rulemaking, it would seem more appropriate to leave such far-reaching revisions to the existing regulatory process. For such a dramatic change to be made in back-door fashion via a revision to this '40 Act rule would be a case of a very small tail (since there are currently no Fund Participants of DTC) wagging a considerably larger dog.
7 We note that the SEC Staff has reviewed each foreign account opening by DTC under Rule 17f-4 to date. Thus, the Staff has the ability to review such information, even if it is not made available to participants.

Appendix A

DTC, RCA Regulation, and RCA Foreign Links

Given that the proposed rule primarily impacts DTC, it may be helpful to describe DTC and its high level of SEC regulation.

Regulation of RCAs. Rule 17f-4 differs from the Non-RCA Rules precisely because RCAs are supervised so much more closely by the SEC than are Non-RCAs such as registered TAs.1

To understand the rationale behind the long-standing practice of having different rules for RCAs and Non-RCAs, it is helpful to understand the practical implications of DTC's status as an RCA (registered with the SEC pursuant to Section 17A of the Securities Exchange Act of 1934) and as an SRO (under Section 3(a)(26) of the Exchange Act). As an RCA and a Self Regulatory Organization ("SRO"), DTC is heavily regulated by the SEC, subject to rigorous oversight standards that are designed to safeguard the interests of investors - including investment companies.

The SEC Staff meets with RCAs throughout the year to review their practices, and performs frequent periodic on-site inspections. A sense for the extraordinarily high level of standards to which RCAs are bound can be gleaned from the Commission's 1980 "standards release." The release articulates standards that apply to the registration and SEC oversight of RCAs. They also require RCAs to have the capacity to facilitate the prompt and accurate settlement of securities transactions, and to safeguard securities and assets. See 15 U.S.C. 78q-1(b)(3)(A) & (F). The standards require RCAs, among other things, to: (a) perform periodic operational risk assessments; (b) have a Board audit committee of non-management directors participate in selecting the RCA's independent public accountant, and review its work; (c) have a competent internal audit department review internal accounting controls; (d) furnish audited financial statements to participants annually, and furnish unaudited quarterly financial statements on request; (e) furnish to participants annually an independent public accountant's opinion report based on a study and evaluation of the RCA's system of internal accounting control; and (f) have detailed plans to assure the physical safeguarding of securities and funds, the integrity of data processing systems, and the recovery from loss or destruction of securities, funds, or data.2

In addition, the SEC generally does not allow the RCA to make any significant changes to the RCA's practices without: a) the RCA first filing a request for SEC approval; b) the RCA then awaiting publication of the proposal in the Federal Register; c) followed by a 35-day public comment period; d) before and after which a rigorous analysis is performed by the SEC Staff of the proposal and those public comments that have been received, typically including discussions between the Staff and the RCA; e) leading at times to modifications in, and a resubmission of, the proposal; f) followed at some point - if the RCA has satisfied the Staff - by the SEC's issuance of an Approval Order. Generally, until all those steps have been completed, the RCA cannot move forward with its proposal. As a practical matter, DTC finds itself making rule filings with the SEC once every 2 weeks or so. As a result of the rigorous level of analysis applied by the Staff, coupled with the Staff's obligation to often weigh competing interests and conflicting positions that may be expressed in public comment letters, approval orders generally follow months or (in the unusual case in which the conflicting interests that must be balanced are greatest) years later.3

RCA Foreign Links. The SEC Staff reviews each proposed RCA account abroad.4 Before DTC can establish a link with a foreign custodian or CSD, for example, DTC must follow the steps described above. RCAs must demonstrate to the Staff, to its satisfaction, that the arrangement with the custodian or CSD will adequately safeguard customer securities. No such account has been opened by an RCA until the RCA has made a filing which has been published in the Federal Register with regard to the opening of the account, the public has had a chance to comment, the Staff has had an opportunity to consider the comments, the Staff has asked all questions of the RCA that it deemed appropriate and received answers that it found to be satisfactory, and the SEC has determined that it would be appropriate to issue an Approval Order allowing the RCA to establish the link.

Footnotes
1 The level of DTC's regulation in particular, in both depth and breadth, is extraordinary. Not simply the SEC's oversight. But also that of the Federal Reserve Bank of NY, which is triggered by the fact that DTC is a member of the Federal Reserve System. As well as that of the NY State Banking Department; DTC is both a limited-purpose trust company organized under, and a "banking organization" within the meaning of, the NY Banking Law. To top it off, DTC is a "clearing corporation" within the meaning of the NY UCC, subject to corresponding UCC obligations.

Consequently, DTC engages in its day-to-day operations with up to 5 squads of separate auditors looking over its employees' shoulders at any one time. And sometimes more. In recent years, the NSA and 2 unrelated Presidential Commissions on Infrastructure have reviewed DTC as well.

2 See Securities Exchange Act Release # 16900 (June 17, 1980), 45 FR 41920 (June 23, 1980). Back-up facilities that can provide full services in under 60 minutes in the event of a failure at a primary site, and which are located in ever-more-distant locations as technology allows them to be moved further away, are the result not only of the fact that DTC is industry-owned, and that its management is primarily focused on these issues. They are also largely the result of the fact that (as an RCA) DTC is charged with an extraordinary obligation respecting safety and soundness - something that the SEC Staff, in its supervision of DTC's activities, is highly sensitive to as well.
3 DTC-90-6, relating to DTC-eligibility of Rule 144A securities, is an example. The filing prompted two dozen comment letters by members of the financial industry, and was approved (as revised) 3½ years after it was published for comment in the Federal Register.
4 Section 17A of the Exchange Act requires that RCA Rules: "promote the accurate clearance and settlement of securities transactions, ... assure the safeguarding of securities ... in the custody or control of the clearing agency or for which it is responsible, ... and ... protect investors and the public interest ...."