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8000 - Miscellaneous Statutes and Regulations
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DEPARTMENT OF THE TREASURY STAFF INTERPRETATIONS OF GOVERNMENT
SECURITIES REGULATIONS
Definition of "Associated Person" and "Fiduciary
Capacity" in the Temporary Securities Regulations
DT-1
October 23, 1987
Charles O. Sethness
Assistant Secretary (Domestic Finance)
This is in response to your letter of July 3, 1987, concerning the
definitions of the terms "associated person" and "fiduciary
capacity" in section 400.3 of the temporary regulations promulgated
by the Department of the Treasury implementing the Government
Securities Act of 1986 (52 FR 19642, May 26, 1987).
You have asked for confirmation of the informal advice provided by
Ellen Seidman, Special Assistant to the Under Secretary, that financial
institution personnel responsible for providing investment advisory
services not involving the exercise of sole or shared discretion would
be deemed to be functioning in a fiduciary capacity, provided that, in
the case of an institution that is a national bank, such persons are
subject to supervision under policies of the bank pursuant to 12 CFR
Part 9, and the customer accounts involved are subject to examination
by the Office of the Comptroller of the Currency for compliance with
fiduciary requirements. You have also asked whether the same criteria
would apply with respect to the definition of "fiduciary
capacity" set forth in section 450.2(d) of the temporary
regulations.
Section 15C of the Securities and Exchange Act of 1934 ("the
Act"), as amended by the Government Securities Act of 1986, Pub. L.
99--571, 100 Stat. 3208 (1986), requires a government securities broker
or dealer that is a financial institution to file notice with its
appropriate regulatory agency of its status as a government securities
broker or government securities dealer. The notice shall be in such
form and contain such information concerning any persons associated
with the financial institution as the Board of Governors of the Federal
Reserve System shall prescribe. Section 3(a) of the Act, as amended,
generally defines a "person associated" with a government
securities broker or dealer as (1) any partner, officer, director, or
branch manager of the government securities broker or dealer, (2) any
other employee of the government securities broker or dealer engaged in
the management, direction, supervision, or performance of government
securities activities, and (3) any person controlling, controlled by,
or under common control with the government securities broker or
dealer.
As you pointed out, section 400.3(c)(3) of the temporary regulations
provided, in part, that in the case of a financial institution, persons
who function solely in a fiduciary capacity shall not be considered
"associated persons." The term "fiduciary capacity" was
defined under section 400.3(i) to include "trustee, executor,
administrator, registrar, transfer agent, guardian, assignee, receiver,
managing agent, and any other similar capacity involving the sole or
shared exercise of discretion by a financial institution having
fiduciary powers that is supervised by a federal or state financial
institution regulatory agency."
It is our opinion that under the temporary regulations, persons
providing investment advisory services, who do not actually exercise
investment discretion, would not be considered "associated
persons" if all of their activities are subject to trust or
fiduciary supervision and the related customer accounts are subject to
fiduciary examination standards. In the case of national banks, the
accounts must be subject to 12 CFR Part 9, "Fiduciary Powers of
National Banks and Collective Investment Funds." We understand that
the Office of the Comptroller of the Currency has taken the position
that investment advisory accounts are subject to 12 CFR Part 9.
Under the final regulations, (52 FR 27910, July 24, 1987), the
definition of the term "associated person" in section 400.3(c)
has been clarified to provide, in part, that in the case of a financial
institution, the term does not include "persons whose
government
{{6-30-92 p.8280}}securities
functions (A) consist solely of carrying out the financial
institution's activities in a fiduciary capacity and (B) are subject to
examination by the appropriate regulatory agency for compliance with
requirements applicable to activities by the financial institution in a
fiduciary capacity." As noted in the explanation of this section in
the preamble to the regulations, the definition of the term
"fiduciary capacity" in section 400.3(i), which refers to the
activity of the financial institution, was confusing when applied in
the context of the definition of "associated person" in the
temporary regulations. The change in the final regulations makes it
clear that persons are excluded whose sole activities consist of
carrying out the financial institution's fiduciary activities and are
examined as such.
The rationale for exclusion of persons who perform fiduciary
activities from the definition of "associated persons" is similar
to the rationale for the exemption in section 450.3(a) from the
requirements of Part 450 for holdings of government securities by
depository institutions in a fiduciary capacity. In both cases,
additional regulation was considered unnecessary because the standards
and examination procedures applicable to the institution's fiduciary
activities were deemed adequate. However, the purpose of the definition
of "fiduciary capacity" in section 450.2(d), which is unchanged
in the final regulations, relates to the exemption of the depository
institution from the requirements of Part 450. Because Part 450 does
not address the role of associated persons in the institution, the
interpretation of the definition of "associated person" in
section 400.3 is not directly relevant to sections 450.2(d) and 450.3.
As provided in section 400.2(c)(7), your incoming letter and this
response will become available to the public thirty days from the date
of this letter.
Custodial Holdings of Government Securities by Depository
Institutions
DT-2
December 18, 1987
Charles O. Sethness
Assistant Secretary (Domestic Finance)
This is in response to your letter of September 15, 1987,
concerning the Department of the Treasury regulations applicable to
custodial holdings of government securities by depository institutions,
17 CFR Part 450 (52 FR 27957, July 24, 1987), which implement title II
of the Government Securities Act of 1986.
You note that section 450.4(a)(2)(i)(A) of the regulations requires
a depository institution maintaining customer securities at a custodian
institution to notify the custodian institution that such securities
are customer securities. You have asked whether similar notice is
required in the case of securities maintained at a Federal Reserve
bank.
Section 450.4(a)(1) of the regulations states that, except as
otherwise provided in that section, a depository institution shall
maintain possession or control of all government securities held for
the account of customers by segregating such securities from the assets
of the depository institution and keeping them free of any lien, charge
or claim of any third party granted or created by such depository
institution. In cases where customer securities are maintained by a
depository institution at another depository institution ("custodian
institution"), section 450.4(a)(2) also requires certain actions of
the depository institution and its custodian institution to meet the
requirements of section 450.4(a)(1). To ensure in such cases that
liens, charges or claims of the custodian institution or any party
claiming through it do not extend to securities held for customers of
the depository institution, the custodian institution is required,
based on notification and instructions from the depository institution,
to maintain such customer securities in an account designated
exclusively for customers of the depository institution.
Where a depository institution maintains customer securities at a
Federal Reserve bank, there is no requirement in the current
regulations that the depository institution notify the Federal Reserve
bank which securities are customer securities or request segregation
of such securities. (See the discussion in the temporary regulations
at 52 FR 19666, May 26, 1987.) Section 450.4(a)(3) provides that the
depository institution shall be in compliance
{{8-31-90 p.8280.01}}with paragraph
(a)(1) of that section if any lien, charge or other claim of such
Federal Reserve bank or other person claiming through it against
securities of the depository institution expressly excludes customer
securities. Thus, a depository institution should ensure that any
agreements that it enters into with a Federal Reserve bank that would
grant a lien, charge or claim against securities held in an account at
the Federal Reserve would exclude its customers' securities. Section
450.4(a)(3) does provide that a depository institution shall be deemed
in compliance with the section if, as a result of extraordinary
circumstances, a Federal Reserve bank retains a lien on securities
received during the day that are subsequently determined to be customer
securities under certain specified conditions set out in that section.
As discussed in the preamble to the final regulations (52 FR 27925),
such exception was provided to deal only with extraordinary
circumstances and is not meant to allow a depository institution to
enter into a standing agreement with a Federal Reserve bank that
collateralizes daylight overdrafts or extensions of discount window
credit with securities that are customer securities.
Your incoming letter and this response will become available to the
public thirty days from the date of this letter.
Confirmation of Government Securities Transactions
DT-3
February 26, 1988
Charles Q. Sethness
Assistant Secretary (Domestic Finance)
This is in response to your letter of December 9, 1987, concerning
the confirmation requirement of section 403.5(d) of the Treasury
Department's implementing regulations for the Government Securities Act
of 1986 (52 FR 27910; July 24, 1987).
You have asked whether the following practice by *** complies with
section 403.5(d) of the regulations. You state that in some cases
customers will instruct *** not to mail confirmation to them. You state
that it is your position that the bank will not violate the regulations
if it does not mail confirmations to these customers provided the bank
retains evidence of each customer's instructions.
Section 403.5(d)(1)(ii) of the regulations states that a financial
institution that retains custody of securities that are the subject of
a repurchase transaction, as described in this section, shall confirm
in writing the specific securities that are the subject of the
repurchase transaction. The confirmation must be issued at the end of
the day of initiation of the transaction and at the end of any other
day during which other securities are substituted. Section
403.5(d)(2)(i) of the regulations specifies the information that must
be included on the confirmation.
The regulations do not allow customers of financial institutions to
waive the right to receive a confirmation except as authorized in
section 403.5(d)(2)(ii). That section states that a non-United States
citizen residing outside the United States or a foreign corporation,
partnership, or trust may waive, but only in writing, the right to
receive the confirmation required by section 405.3(d)(1)(ii). As
discussed in the preamble to the implementing regulations (52 FR
27919), the confirmation required by section 403.5(d) may not be waived
by any other customer.
Consistent with section 403.5(d), the same restriction applies to
the confirmations that must be issued pursuant to section 403.4(e) by a
registered government securities broker or dealer that retains custody
of securities that are the subject of a repurchase agreement. In
addition, only a foreign customer is permitted to waive the
confirmation or safekeeping receipt that must be issued pursuant to
section 450.4(b)(1) by a depository institution that holds government
securities for the account of a customer.
Pursuant to 17 CFR 400.2(c)(7), your letter and this response will
become available to the public thirty days from the date of this
letter.
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Application of the Government Securities Act to the Operations of
a Trust Department
DT-4
June 6, 1988
Charles O. Sethness
Assistant Secretary (Domestic Finance)
This is in response to your letter of December 24, 1987, concerning
the application of the Government Securities Act of 1986 (GSA) to the
operations of a trust department. Specifically, you asked whether the
trust department of *** must ratify special policies and procedures in
order to comply with 17 CFR 450.3 of the regulations promulgated
pursuant to the GSA. (17 CFR Chap. IV) Information regarding these
matters was provided to you by a member of the Bureau of the Public
Debt's Government Securities Regulations Staff in a telephone
conversation on December 23, 1987.
Since all parts of your bank, including the trust department, that
conduct government securities activities are affected by the
regulations, it is important that the activities of all areas be
reviewed for compliance. It is for this reason that we are providing a
general overview of the regulations before responding to your specific
question concerning trust department operations.
Generally, the regulations implementing the GSA are divided into two
subchapters to regulate two types of activities. Subchapter A (17 CFR
Parts 400--405, 449) of the regulations applies to the activities of
government securities brokers and dealers, including financial
institutions that are government securities brokers or dealers. It sets
forth rules concerning the financial responsibility, protection of
investor securities and funds, recordkeeping, reporting, and audit of
brokers and dealers in government securities, Subchapter B (17 CFR Part
450) of the regulations deals with the custodial holdings of government
securities by depository institutions, including those that are
government securities brokers or dealers.
With respect to the regulations contained in subchapter A, it should
be noted that the statutory definition of "government securities
dealer" specifically excludes bank purchases and sales in a
fiduciary capacity. (15 U.S.C. 78(c)(1)(44)) That exclusion is
reiterated in the regulations at section 401.4, which exempts from
subchapter A regulation, except for section 403.5(d), financial
institutions whose dealer activities are limited to sales or purchases
in a fiduciary capacity and repurchase transactions. These institutions
would still be required to comply with Part 450 which concerns the
custodial holdings of government securities for customers and, to the
extent applicable, with the provisions of section 403.5(d) pertaining
to hold-in-custody repurchase transactions.
In addition, section 401.2 exempts from regulation as a government
securities broker depository institutions whose activities are limited
to submitting tenders on behalf of customers for purchase on original
issue of U.S. Treasury securities, and section 401.3 exempts financial
institutions that effect a limited number of brokerage transactions or
effect all such transactions on a fully disclosed basis pursuant to a
"networking" arrangement. As is the case for institutions that
are exempted from the regulations as government securities dealers,
these exempt institutions would still be required to comply with Part
450 relating to custodial holdings of government securities by
depository institutions.
In general, Part 450 (subchapter B) of the regulations applies to
depository institutions that hold government securities as a fiduciary,
custodian, or otherwise for customer accounts. Section 450.3 grants an
exemption from Part 450 for a depository institution which holds
government securities in a fiduciary capacity subject to examination by
the appropriate regulatory agency under the agency's fiduciary
standards.
Section 450.3 also exempts depository institutions that hold
government securities in a custodial capacity provided the institutions
have adopted policies and procedure that would apply to such custodial
holdings all the requirements imposed by its appropriate regulatory
agency on government securities held in a fiduciary capacity. As is the
case for government securities held in a fiduciary capacity, the
appropriate regulatory agency must,
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examination of the institution, examine the custodial holdings under
all of the agency's fiduciary standards in order for the institution to
qualify for the exemption.
All of the information contained in this letter is offered as
informal advice pursuant to 400.2(c)(6) of the regulations. If you
require any additional assistance, please do not hesitate to call the
Government Securities Regulations Staff at (202) 376-4632. If you would
like a binding interpretation of a specific provision of the
regulations, please submit a written request which includes all of the
information required under section 400.2(c)(3) of the regulations.
As provided in section 400.2(c)(7), your letter and this response
will become available to the public thirty days from the date of this
letter.
Financial Institutions Performing Clearing and Custodial Services
for Exempt Depository Institutions are Subject to "No Lien"
Provision of Section 450.4
DT-5
May 11, 1989
Richard L. Gregg
Commissioner
The Department has received inquiries concerning situations in
which a depository institution instructs another financial institution
("custodian institution") to receive securities for the account
of the depository institution's customers. The circumstances involve
depository institutions that, under the Government Securities Act
regulations, 17 C.F.R. chap. IV, are eligible for exemption from the
requirement to give notice of being a government securities broker or
dealer ("exempt institution"). Such exempt institutions remain
subject to 17 C.F.R. Part 450, including section 450.4(a)(2), which
requires that fully paid customer securities be maintained free of
lien. Section 450.4(a)(2) specifically requires an exempt institution,
which is maintaining fully paid customer securities through a custodian
institution, to instruct the custodian institution that the securities
are fully paid customer securities to be maintained in a separate
customer account free from lien, charge, or claim of the custodian
institution. In the context of that prohibition, questions have been
raised about the possibility of an exempt institution granting a lien
on securities to a custodian institution until such time that the
custodian institution receives payment for the securities from the
exempt institution, even though the customer has paid the exempt
institution for the securities.
It is our understanding that situations involving delays in receipt
of payments by the custodian institution arise infrequently, but may
occur, for example, if the exempt institution has misdirected the funds
for payment of the securities or has missed the cut-off time for wire
payments. As a result of these situations, the custodian institutions
have raised questions concerning our rules with respect to securities
for which they have not yet received payment, but which are fully paid
customer securities from the perspective of the exemption institution.
To obtain protection for an extension of credit in such situations,
some custodian institutions have informally been seeking an
interpretation of section 450.4(a)(2) that would permit the exempt
institution to grant a temporary lien on its customers' fully paid
securities until payment has been received by the custodian
institution.
Although a custodian institution may be concerned that it is bearing
the risk of exposure for clearing securities for other parties, the
custodial rules, specifically, the "no lien" provision contained
in section 450.4(a)(2) does not permit an exempt institution to grant a
lien, even on a temporary basis, to the custodian institution, nor does
it permit the custodian institution to take one. The Department views
this treatment of fully paid customer securities to be an essential
element of customer protection. It is the Department's view that the
custodian institution must look toward the exempt institution to
provide a remedy, and that alternative arrangements can be made, other
than a lien on customer securities.
While the subject of this letter specifically addresses questions
that are being raised about clearing for exempt institutions, it is
noted that the requirements of section 450.4(a)(2) are applicable to
all depository institutions, whether or not exempt. In discussions of
these
{{8-31-90 p.8280.04}}requirements,
the provision of section 450.4(a)(4)(ii) was referenced to support
arguments for permitting exempt institutions to grant liens on customer
securities. This provision addresses situations of banks that are
clearing for government securities broker-dealers, not exempt
institutions, and states that the clearing bank is not required to
segregate securities upon the instruction of the broker-dealer if the
clearing bank determines that the securities continue to be required as
collateral for the extension of clearing credit. The provision was
expressly intended to be limited to situations involving financial
institutions that are performing clearing functions for government
securities broker-dealers.
Those clearing operations are conducted differently than the custody
and clearing performed by the custodian institutions in the instant
case. In the situation described in section 450.4(a)(4)(ii), on any
given day, a clearing bank would be conducting a large number of
transactions for a broker-dealer and would retain an intra-day lien
until it could segregate customer securities at the end of the trading
day. This is a different operation than custodial functions performed
on behalf of exempt institutions. The exception was intended to be a
narrow one of infrequent occurrence and limited application and it
should not be interpreted as authorizing the broker-dealer to grant a
lien on customers' securities. When a clearing bank invokes this
provision, the broker-dealer is in violation of the possession or
control requirements for customer securities. Further, the clearing
bank is required to send notification of the violation to the
broker-dealer's appropriate regulatory agency.
Therefore, pursuant to 15 U.S.C. 78o-5(b), it is our interpretation
of 17 C.F.R. 450.4(a)(2) that financial institutions performing
clearing and custody functions for exempt depository institutions may
not take, nor may exempt depository institutions grant, a lien against
fully paid customer securities.
This interpretation will be immediately available to the public and
is being issued to each appropriate regulatory agency for depository
institutions.
Interpretation of the Temporary Lag Provision in Section 403.5;
Hold-in-Custody Repurchase Transactions
DT-6
July 24, 1989
Richard L. Gregg
Commissioner
The Department has received an inquiry from a noticed financial
institution requesting a clarification of section 403.5(b) of the
regulations promulgated by the Department of the Treasury under the
Government Securities Act of 1986 (the "GSA", Pub. L. 99--571,
100 Stat. 3208, 15 U.S.C. 78o-5). The issue raised by the financial
institution involves the temporary lag provision contained in section
403.5(b) as it relates to the hold-in-custody repurchase transaction
provisions of section 403.5(d). The specific issue to be addressed is
whether a security for which a financial institution has taken
contractual title from a third party, and has a rightful expectation to
hold at the end of a day, is an acceptable security for a
hold-in-custody repurchase transaction, provided that a financial
institution makes every good-faith effort to secure delivery from the
third party on the contracted receipt date and to remedy any failure to
receive within the required time.
It is suggested that sections 403.5(b), (c), and (d) of the GSA
regulations would permit an overnight hold-in-custody repurchase
transaction for which a financial institution is only contractually and
not physically in control of the underlying security and that these
provisions would not require a financial institution to break the
hold-in-custody repurchase transaction after the fact if it failed to
receive delivery of the security by the close of the trading day. It is
represented that such one day lags, which may occur infrequently as a
result of normal business operations, would fall within Treasury's
definition of temporary lag.
It is also claimed that it is operationally impossible to assure
that any security to be used for a new hold-in-custody repurchase
transaction on a given day would be, at the start of the day, already
in a financial institution's possession. Furthermore, holding
securities
{{8-31-90 p.8280.05}}already in a
financial institution's possession at the start of the trading day, in
anticipation of new hold-in-custody repurchase transactions that may or
may not materialize, could hinder the flow of securities over the
securities wire.
After consulting with the appropriate regulatory agencies for
depository institutions, the Securities and Exchange Commission (SEC)
and the National Association of Securities Dealers, and noting the
representations made by the requesting financial institution, we are
unable to concur with an interpretation of section 403.5 that would
permit a fail on an overnight repurchase transaction resulting form
normal business lags. A financial institution that does not have
securities at the end of the business day to back an overnight
repurchase transaction is in violation of the possession or control
requirement of section 403.5(d)(1)(vi) of the GSA regulations. The
concept of normal business lag as provided in section 403.5(d) may not
be applied to allow a financial institution to avoid possession or
control of securities for the entire term of an overnight repurchase
transaction. Normal business lag is intended to refer to intra-day lags
where a financial institution need not have possession or control of
securities at every given moment during the business day.
In order to remain in compliance with section 403.5, it is not
necessary for a financial institution to have in its possession or
control at the beginning of the day the securities that would be used
for all overnight hold-in-custody repurchase transactions. However,
even though a repurchase transaction may have been initiated, final
settlement of the transactions cannot take place if a financial
institution does not have the securities in its possession or control
at the close of the business day. It is suggested that it would be
prudent for a financial institution to examine its procedures and take
appropriate measures to ensure that sufficient securities are available
at the end of the day to cover all overnight repurchase transactions
that have been entered into with its customers.
In addition to the GSA regulations, financial institutions should be
aware that a policy statement on due bills has been issued by the
Office of the Comptroller of the Currency (OCC). Banking Circular 182
sets forth guidelines concerning the proper use of due bills by
national banks and the principles enumerated in the circular are
applicable to repurchase transaction. In particular, it discusses the
requirement that the customer be advised of the inability of a
financial institution dealer to consummate a transaction. It is our
understanding that your agency as a general matter supports the
guidelines contained in OCC Banking Circular 182.
Any enforcement action in response to a violation of the GSA rules
would be determined by the appropriate regulatory agency, after taking
into consideration the specific facts of the case.
This interpretation is being issued to each appropriate regulatory
agency for depository institutions. Pursuant to 17 CFR 400.2(c)(7)(i),
this letter will be immediately available to the
public.
Distinctions Between "Tri-Party" and "Hold-in-Custody"
Repurchase Agreement Transactions
DT-7
May 7, 1990
Richard L. Gregg
Commissioner
The Department has received a number of inquiries from government
securities broker-dealers and financial institutions regarding whether
the repurchase agreement transactions (repos) being conducted by their
institutions are subject to the hold-in-custody repo requirements set
out at 17 CFR 403.4(e) and 403.5(d) of the regulations promulgated
pursuant to the Government Securities Act of 1986 (GSA). In many
instances, the callers represented that the repos conducted by their
institutions were in fact tri-party repos, and thus not subject to the
hold-in-custody rules in sections 403.4(e) or 403.5(d) of the GSA
regulations. Additionally, some callers requested guidance in
determining whether the repos being effected by their institutions were
hold-in-custody or tri-party transactions.
{{8-31-90 p.8280.06}}
As a result of conversations with these callers, it became apparent
that much uncertainty exists regarding whether or not certain
transactions would be considered to be hold-in-custody repos. In light
of the many uncertainties and questions still being raised concerning
the distinction between hold-in-custody and tri-party repos, the
Department is issuing this clarification of the GSA regulations to
provide additional guidance to government securities broker-dealers,
financial institutions and other participants in repo transactions and
to make clear the Department's intent with respect to these
transactions.
Specifically, some entities represented that they were conducting
tri-party repos (i.e., a repurchase transaction involving a Repo
Seller, a Repo Buyer, and a separate custodian with specific
responsibilities to both parties) because they did not have possession
of the repo securities which had been delivered to a third-party
custodian institution, even though they (i.e., the Repo Seller) still
retained control over the securities. This issue of possession or
control of securities and the corresponding funds during the term of
the repo transaction is a primary factor in determining whether a
transaction will be considered a hold-in-custody or a tri-party repo. A
common misunderstanding appears to be a belief that repo transactions
that involve another custodian would not be considered
"hold-in-custody" transactions and, therefore, not subject to the
requirements of sections 403.4(e) or 403.5(d). However, the single
factor of another custodian's involvement does not, by itself,
determine whether a transaction is a tri-party or deliver-out repo,
rather than a hold-in-custody transaction. What must be examined (and
should be clearly stated in the governing written agreement) is the
role of the third party custodian, the custodian's relationship to the
Repo Buyer and Repo Seller, and the entity that ultimately exercises
control over the securities or funds during the course of the
transaction.
In a tri-party repo, an independent institution enters into a
tripartite agreement with the two counterparties to the transaction.
The third-party custodian assumes certain responsibilities with respect
to safeguarding the interests of both counterparties and is involved in
effecting the transfer of funds and securities between the two parties.
In a deliver-out repo, the securities are actually delivered to the
investor or its designated custodial agent who has no relationship with
the Repo Seller. A hold-in-custody repo is characterized by the
investor's counterparty (i.e., Repo Seller) retaining control of the
securities and by serving simultaneously throughout the transaction not
only as principal but also as the investor's custodial agent.
In the government securities market, and particularly with
book-entry securities, it is not uncommon for a broker-dealer or
financial institution to hold securities through another custodian
institution. For example, this occurs in connection with a
correspondent or clearing arrangement. Where an entity that is the Repo
Seller is holding securities that are the subject of a repo through
such a custodian institution, the Repo Seller would be considered to be
engaging in hold-in-custody repos if the custodian institution is
acting solely for the Repo Seller. The fact that the Repo Seller must
request the custodian institution to maintain the repo securities in an
account specifically designated for its Repo Buyers and may even
provide the custodian institution with a listing of the names of the
Repo Buyers does not change the hold-in-custody nature of the repo,
since the Repo Seller is still viewed as retaining control over the
repo securities. Additionally, repo transactions would also be
considered hold-in-custody if the Repo Seller is in a position to
control the funds of the Repo Buyer. For example, an arrangement where
the Repo Buyer has funds on deposit with the Repo Seller which are
invested in repos, without the funds either flowing through or the
funds transfer being independently verified by an intermediary, would
be considered a hold-in-custody repo. This is because the custodian of
the repo securities is unable to determine whether the funds have been
returned to the Repo Buyer when the custodian transfers the securities
back to the Repo Seller.
On the other hand, a repo transaction would not be considered to be
a hold-in-custody where the Repo Buyer instructs the Repo Seller to
deliver the securities against payment to a custodian institution that
is acting as custodian solely for the Repo Buyer and has no custodian
relationship with the Repo Seller (i.e., deliver-out repo). The
confusion arises in distinguishing among the various types of repo
arrangements where the Repo Buyer and
{{8-16-91 p.8280.07}}the Repo
Seller may have or be represented as having a relationship with the
same custodian institution.
In structuring a tri-party repo that would not be subject to the
requirements of sections 403.4(e) or 403.5(d) of the GSA regulations,
the Department believes that the parties to the written repurchase
agreement must include the Repo Seller, Repo Buyer and the third-party
custodian. Under this agreement, the custodian undertakes
responsibilities to act on behalf of both the Repo Seller
and the Repo Buyer. The custodian must be informed of the essential
terms of the specific repo transaction being conducted (e.g., types of
acceptable securities, purchase price, maturity, value of securities
including margins to be transferred). The information should be in
sufficient detail to enable the custodian to carry out its
responsibilities to both parties for verifying that sufficient cash has
been received by the Repo Seller and that eligible and proper
securities of value have been received on behalf of the Repo Buyer.
Upon verification, the funds should be transferred to the Repo Seller
and the securities transferred to the account of the Repo Buyer on a
simultaneous basis.
During the term of a tri-party repo, the custodian is responsible
for maintaining specific repo securities (i.e., specific CUSIP or
mortgage-backed security pool number and in an amount that is
tradeable), directly in the name of the Repo Buyer, free of any third
party lien, charge or claim. Therefore, pooling of securities is not
permitted under a tri-party repo, just as it is prohibited for hold-in
custody repos. In addition, these securities must also be segregated
from the Repo Seller's own securities that may be held at the
custodian. Thus, the custodian must be able to determine, on the basis
of its own books and records, the specific securities that it is
receiving and holding for an individual customer.
To accomplish this segregation, the custodian would normally be
expected to maintain separate funds and securities accounts for the
Repo Buyer and Repo Seller. The custodian is also responsible for
determining, throughout the term of the transaction, that the valuation
of all securities or cash in the Repo Buyer's account is sufficient. If
the securities or cash collateral is less than the required amount for
the transaction, the custodian should inform the Repo Buyer of the repo
collateral deficiency and then follow the instructions of the Repo
Buyer to satisfy the deficit.
In a tri-party repo, the custodian must exercise independent control
over the exchange of securities between the Repo Buyer and Repo Seller.
With regard to the funds, if the custodian is unable to independently
control the transfer of funds between the two counterparties, it must,
at a minimum, be able to independently verify the movement of the funds
between the Repo Buyer and Repo Seller. The Department is aware of
situations, particularly those involving sweep repos, in which some
financial institutions are investing customer funds in repos and are
attempting to structure the transactions as tri-party agreements by
using another custodian to maintain the repurchase securities. Unless
these transactions are structured in a manner whereby, at the unwinding
of the transaction, either the custodian has independent control over
the flow of funds, or alternatively it is able to independently verify
the movement of funds back to the Repo Buyer, it is the Department's
view that such arrangements cannot be considered tri-party repurchase
transactions, but are hold-in-custody repos. This is because the
custodian institution would not be involved in or be aware of the
actual movement of funds between the Repo Buyer and Repo Seller.
Since the custodian represents both parties, neither the Repo Buyer
nor the Repo Seller should be able to instruct the custodian to release
the funds or securities that are being held for the benefit of its repo
counterparty without first returning to the control of the custodian,
for the benefit of the counterparty, the appropriate funds or
securities. In those instances where the custodian does not have
control over movement of the funds, it must be able to confirm the
transfer of the funds back to the Repo Buyer before releasing
securities to the Repo Seller.
In the event substitution of securities is permitted under the terms
of the written agreement for a tri-party repo, the replacement
securities or other acceptable collateral must be delivered to the
custodian for the account of the Repo Buyer before, or simultaneous
with, the release of the original repo securities from the Repo Buyer's
account
{{8-16-91 p.8280.08}}back to the
account of the Repo Seller. Otherwise, the Department would consider
the transaction to have reverted back in a hold-in-custody arrangement
during the substitution process until such time as the replacement
securities were credited to the Repo Buyer's account.
The third-party custodian maintaining customer securities on behalf
of the Repo Buyer must, pursuant to 17 CFR 450.4(b)(1), issue a
safekeeping receipt or a confirmation acknowledging receipt of all
securities for the account of the Repo Buyer. The confirmation or
safekeeping receipt must identify and list specific securities. This
confirmation requirement applies to all depository institutions that
hold government securities as custodian for the account of a customer,
including securities held resulting from hold-in-custody, tri-party, or
deliver-out repo transactions. In addition, since the confirmation or
safekeeping receipt must list specific securities, pooling of
securities (i.e., the failure to identify specific securities) for any
type of repo transaction is not permitted.
Consistent with the view that the custodian should retain control
over the repo securities in a tri-party arrangement, the Department
believes that the written agreement should include a provision
providing that, in the event of default of the Repo Seller, the Repo
Buyer has the right, either directly or through instructions to the
third-party custodian, to dispose of the securities and apply the
proceeds in satisfaction of any Repo Seller liability.
This letter is intended to provide general guidance and direction
regarding distinctions between tri-party and hold-in-custody repos; it
is not meant to be an all inclusive list of criteria for reaching a
final determination in every situation. The facts and circumstances of
a particular transaction will dictate the ultimate conclusion regarding
the type of repo being conducted.
This letter is being sent to the Securities and Exchange Commission,
the appropriate regulatory agencies for depository institutions, the
National Association of Securities Dealers, and the New York Stock
Exchange. Pursuant to 17 CFR 400.2(c)(7)(i), this letter will be made
immediately available to the public.
Clarification of the Purposes of Treasury Form PD
1832
DT-8
July 1, 1991
Kenneth R. Papaj
Director, Government
Securities Regulations Staff
The purpose of this letter is to request your assistance in
advising your examiners and the institutions your agency supervises of
the misuse of a Treasury form pertaining to transactions in government
securities. We have recently received a number of calls regarding the
misuse of Form PD 1832, "Special Securities."
Form PD 1832 is to be used only for Treasury notes and bonds in
registered definitive form (i.e., certificated securities with the name
of the registered owner inscribed on the security). The form is used to
assign ownership of the security to another party, but is effective to
transfer ownership on the books of the Treasury only if the registered
definitive security accompanies the form. Form PD 1832 is reserved for
exceptional circumstances such as correction of an erroneous
assignment, obtaining the assignment of two or more geographically
separated assignors, or when there are multiple securities involved in
a transaction. Normally, assignments should be made by signing the
registered definitive security itself. Upon receipt at Treasury of the
Form PD 1832 and the accompanying security, the registered definitive
security is retired and a new security is issued in accordance with the
customer's instructions.
Form PD 1832 should not to be used to perfect or convey a security
interest in book-entry Treasury securities or agency securities such as
GNMAs or FNMAs. Over the last few months, Treasury has been advised of
a number of transactions in which parties are attempting to use the
Form PD 1832 to assign a security interest or transfer ownership
rights in such instruments as book-entry Treasury notes and bonds,
interest payment streams for book-entry Treasury securities, and GNMA
and FNMA securities. In at least
{{4-30-02 p.8280.09}}one of the
proposed transactions, representations were apparently made to a
broker-dealer that the Form PD 1832 was negotiable in the secondary
market. We have also been informed that some broker-dealers have
indicated that this form can be used to perfect a security interest in
these securities.
To protect banks, broker-dealers, and customers from entering into
transactions where this form may be misused, I am requesting your
assistance in disseminating information on the proper use and intended
purpose of Form PD 1832. I would appreciate your agency notifying the
institutions it supervises and your examiners concerning this matter.
Enclosed is suggested language that you may wish to consider using in
order to alert the institutions and examiners to the possible misuse of
Form PD 1832.
SUGGESTED NOTICE TO EXAMINERS, BROKER-DEALERS AND BANKS
We have recently been advised by the Department of the Treasury,
Bureau of the Public Debt, of the reported misuse of Form PD 1832,
"Special Form of Detached Assignment for United States Registered
Securities."
Form PD 1832 is used to certify assignments of registered definitive
Treasury securities. It is appropriately used only at the discretion of
Public Debt or a Federal Reserve bank, acting as Treasury's fiscal
agent, in the following circumstances.
• To correct a defective assignment already made on the back
of a registered definitive security,
• To accomodate owners required to sign a large number of
securities, or
• To obtain the assignment of two or more geographically
separated assignors.
Several incidents have been reported to Public Debt whereby Form PD
1832 was erroneously being used to represent, convey interest in, or
prove ownership of a security. The form is not intended for use without
an accompanying registered definitive Treasury security. As such, it
should not be used to assign or establish an interest in book-entry or
agency securities. Form PD 1832 does not by itself convey any interest
nor does it imply any ownership in securities described on its face.
Even when properly certified and accompanied by registered definitive
securities, this form is not to be used unless authorized by Public
Debt or a Federal Reserve bank.
Report any attempted misuse of Form PD 1832 or direct any questions
regarding the form to Walter Childs, Director, Division of Securities
Accounts, Bureau of the Public Debt at (202) 874-1210.
DT-8A
April 27, 1993
Kenneth R. Papaj
Director, Government Securities Regulations Staff
This letter is intended to alert you to the continuing misuse of
Form PD F 1832, "Special Form of Detached Assignment for United
States Registered Securities." I wrote to you on July 1, 1991,
concerning the improper use of this form and asked for your assistance
in informing your examiners and the institutions that your agency
supervises regarding its proper use.
Several recent incidents of attempted misuse of the form
necessitates this follow-up letter. I am again asking for your
cooperation in advising financial institutions, through whatever means
are available to you, of the intended purpose of Form PD F 1832 as
outlined below. This action will hopefully protect customers and
financial institutions from entering into transactions in which Form PD
F 1832 is used in an improper and potentially fraudulent manner. I
would appreciate receiving a copy of any communication you issue
concerning this matter.
Form PD F 1832 is used primarily to certify assignments of
registered definitive Treasury securities. It is appropriately used
only at the direction of Public Debt or a Federal Reserve bank, acting
as Treasury's fiscal agent, in the following circumstances:
{{4-30-02 p.8280.10}}
-- To correct a defective assignment already made on the back
of a registered definitve security,
-- To accommodate owners required to sign a large number of
securities, or
-- To obtain the assignment of two or more geographically
separated assignors.
The form may also be used to certify assignments of registered
agency securities for those agencies that have adopted the General
Regulations Governing U.S. Securities (31 CFR 306) if authorized by
Public Debt or a Federal Reserve bank.
Several incidents continue to be reported to Public Debt in which
Form PD F 1832 was represented as conveying interest in, or
transferring ownership of a security. In many of these cases, the
security, which was not delivered with Form PD F 1832, was represented
to be in bearer or book-entry form and held at a depository or in a
special account at Treasury. The form is not intended for use without
an accompanying United States registered definitive security. As such,
it should never be used to assign or establish an interest in
book-entry or bearer securities. Form PD F 1832 does not by itself
convey any interest nor does it imply any ownership in securities
described on its face. Even when properly certified and accompanied by
registered definitive securities, this form is not to be used unless
authorized by Public Debt or a Federal Reserve bank.
Public Debt is revising Form PD F 1832 so that it specifically and
clearly states that the form has no monetary value, is not evidence of
ownership of securities, and will not support a transaction unless
accompanied by the securities, except for securities previously
surrendered. This revision should serve to reduce the unauthorized use
of the form. I have enclosed a copy of the draft revision of the form.
Please direct any questions regarding Form PD F 1832 or report any
attempted misuse of the form to McKayla Braden, Director, Division of
Customer Services, Bureau of the Public Debt, at (202) 874-1260. I
appreciate your cooperation in this matter.
This letter is also being sent to each of the appropriate regulatory
agencies and self-regulatory organizations (National Association of
Securities Dealers and New York Stock Exchange) for government
securities broker-dealers.
[The page following this is 8280.13.]
{{10-31-93 p.8280.13}}
Interpretation Regarding the Proper Treatment of Government
Securities in Certain Repurchase Transactions
DT-9
June 21, 1993
Richard L. Gregg
Commissioner
The Government Securities Regulations Staff has received several
inquiries concerning the required timing of the allocation of
securities to customer accounts (i.e., repurchase agreement collateral)
in hold-in-custody repurchase transactions (hold-in-custody repos)
pursuant to the requirements set out in the regulations promulgated
pursuant to the Government Securities Act of 1986 (the "GSA,"
Pub. L. 99--571, 100 Stat. 3208, 15 U.S.C. 780--5). This interpretation
is intended to clarify the requirements of the GSA regulations in this
area.
Specifically, in accordance with 17 CFR 403.5(d)(1)(vi), any
financial institution that retains custody of securities that are the
subject of a repurchase agreement between the financial institution and
a counterparty must maintain possession or control of the securities
that are the subject of the repurchase agreement in accordance with
section 450.4(a). Pursuant to 17 CFR 450.4(a)(1), a depository
institution that holds government securities as custodian for the
account of a customer must maintain possession or control of the
government securities by segregating such securities from the assets of
the depository institution and keeping them free of any lien, charge or
claim of a third party.
There are also requirements under the GSA regulations (17 CFR Ch.
IV) that specific records be made and kept relating to the custody of
securities. Paragraph 404.4(a)(2) provides that government securities
brokers and dealers that are financial institutions must comply with
the recordkeeping requirements of sections 450.4(c), (d) and (f).
Pursuant to 17 CFR 450.4(c), records of government securities held for
customers shall be maintained and kept separate and distinct from other
records of the depository institution. Such records shall provide a
system for identifying each customer, and each government security (or
the amount of each issue of a government security issued in book-entry
form) held for the customer, and describe the customer's interest in
the government security. Further, paragraph 404.4(a)(3)(i)(A) of the
GSA regulations requires that government securities brokers and dealers
that are financial institutions make and keep current a securities
record or ledger reflecting separately for each government security as
of the settlement dates all long or short positions (including
government securities that are the subjects of repurchase or reverse
repurchase agreements) carried by such financial institutions for its
own account or for the account of its customers or others.
It is our understanding that the allocation (segregation) of
securities to customer accounts for hold-in-custody repos often occurs
as part of the end-of-the-day processing cycle. Recognizing the
importance of ensuring customer protection, no unnecessary delay of the
allocation process should occur. We also recognize that a certain
amount of time is required, after trading is completed, to finish the
normal processing of the day's transactions. However, to remain in
compliance with 403.5(d)(1), 404.4 and 450.4 of the GSA regulations, a
financial institution must complete the securities allocation process
for hold-in-custody repos prior to opening the next business day.
Further, for an allocation to be in compliance, the records of a
financial institution must identify and list the specific securities
that are allocated to each customer in authorized, transferrable
denominations.
One of the fundamental objectives that gave rise to the enactment of
the GSA, and the subsequent issuance of regulations thereunder, was
to strengthen customer protection in hold-in-custody repo
transactions. The requirement that financial institutions
maintain and allocate specific securities to specific customers is
aimed at protecting customer securities in the event of the failure of
a financial institution. Without timely and proper allocation, it may
not be clear if an interest in the securities has been conveyed to the
counterparty. The allocation requirement focuses on eliminating
duplicative use of
{{10-31-93 p.8280.14}}securities as
well as precluding pooling of securities (i.e., failing to identify and
record specific securities on the books and records of the
institution).
We have consulted with staffs of the Board of Governors of the
Federal Reserve System, the Federal Deposit Insurance Corporation, the
Office of the Comptroller of the Currency, and the Office of Thrift
Supervision. This letter is being sent to each of these agencies as
guidance. I would appreciate your assistance in advising your examiners
and the institutions that your organization supervises of this
information.
Pursuant to 17 CFR 400.2(c)(7), this letter will be made immediately
available to the public.
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