Self-Regulatory Organizations; Municipal Securities Rulemaking Board; National Association of Securities Dealers, Inc.; and New York Stock Exchange, Inc.; Order Approving Proposed Rule Changes Regarding the Confirmation and Affirmation of Securities Transactions

[Federal Register Volume 64, Number 92 (Thursday, May 13, 1999)]
[Notices]
[Pages 25940-25942]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-12139]


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SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41378; File Nos. SR-MSRB-98-06, SR-NASD-98-20, SR-NYSE-
98-07]


Self-Regulatory Organizations; Municipal Securities Rulemaking 
Board; National Association of Securities Dealers, Inc.; and New York 
Stock Exchange, Inc.; Order Approving Proposed Rule Changes Regarding 
the Confirmation and Affirmation of Securities Transactions

May 7, 1999.
    The Municipal Securities Rulemaking Board (``MSRB''), the National 
Association of Securities Dealers, Inc. (``NASD''), and the New York 
Stock Exchange, Inc. (``NYSE'') have filed with the Securities and 
Exchange Commission (``Commission'') proposed rule changes pursuant to 
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ 
proposing amendments to their confirmation/affirmation rules.\2\ 
Notices of the proposals were published in the Federal Register on 
April 13, 1998.\3\ The Commission received two comment letters.\4\ For 
the reasons discussed below, the Commission is approving the proposed 
rule changes.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ On February 18, 1998, the NYSE filed and on March 26, 1999, 
amended its proposed rule change (File No. SR-NYSE-98-07). On March 
5, 1998, the NASD filed and on December 22, 1998, and February 17, 
1999, amended its proposed rule change (File No. SR-NASD-98-20). On 
April 3, 1998, the MSRB filed and on April 16, 1999, amended its 
proposed rule change (File No. SR-MSRB-98-06). The amendments filed 
by the MSRB, NASD, and NYSE represent technical amendments to the 
proposed rule changes and as such do not require republication of 
notice.
    \3\ Securities Exchange Act Release Nos. 39830 (April 6, 1998), 
63 FR 18060 (NYSE); 39831 (April 6, 1998), 63 FR 18057 (NASD); 39833 
(April 6, 1998), 63 FR 18055 (MSRB). On May 1, 1998, the Commission 
extended the comment period for the proposals for thirty days. 
Securities Exchange Act Release No. 39944 (May 1, 1998), 63 FR 
25531.
    \4\ Letters from Mari-Anne Pisarri, Esq., Pickard and Djinis, on 
behalf of Thomson Financial Services (``Thomson'') (May 12, 1998) 
and Ronald J. Kessler, Chairman, Operations Committee, Securities 
Industry Association (``SIA'') (June 1, 1998).
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I. Description

    Currently, the confirmation/affirmation rules of the MSRB, NASD, 
and NYSE (collectively referred to as self-regulatory organizations or 
``SROs'') \5\ require the SROs' broker-dealer members to use the 
facilities of a securities depository \6\ for the electronic 
confirmation and affirmation of transactions in which the broker-dealer 
provides either delivery-versus-payment (``DVP'') or receive-versus-
payment (``RVP'') \7\ privileges to its customer. Broker-dealers 
generally extend DVP and RVP privileges only to their institutional 
customers.
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    \5\ The confirmation/affirmation rules are MSRB Rule G-
15(d)(ii), NASD Rule 11860(a)(5), and NYSE Rule 387(a)(5).
    \6\ The term ``securities depository'' is defined in the SROs' 
confirmation/affirmation rules as a clearing agency that is 
registered under Section 17A of the Act, 15 U.S.C. 78q-1.
    \7\ DVP privileges allow an institutional seller to require cash 
payment before delivering its securities at settlement. RVP 
privileges allow an institutional buyer to pay for its purchased 
securities only when the securities are delivered.
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    Certain vendors of electronic trade confirmation (``ETC'') services 
have requested that they be allowed to provide confirmation/affirmation 
services for DVP and RVP trades even though they are not registered 
clearing agencies. Under the rule changes, the SROs' broker-dealer 
members will be able to comply with the confirmation/affirmation rules 
by using the facilities of either a registered clearing agency or a 
``qualified vendor'' for the confirmation and affirmation of DVP and 
RVP transactions.\8\
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    \8\ Just being a qualified vendor will not entitle an ETC vendor 
to provide ``matching'' services (in which broker-dealer 
confirmations are matched with institutional allocation instructions 
to produce affirmed confirmations) as part of its confirmation/
affirmation system. The Commission has concluded that matching 
services may be provided only by a registered clearing agency or by 
an entity that has received an exemption from clearing agency 
registration. Securities Exchange Act Release No. 39829 (April 6, 
1998), 63 FR 17943.

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[[Page 25941]]

    In order to become a qualified vendor under the rule changes, an 
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ETC vendor will be required to certify to its customers that:

    (1) With respect to its electronic trade confirmation/
affirmation system, it has a capacity requirements, evaluation, and 
monitoring process that allows the vendor to formulate current and 
anticipated estimated capacity requirements;
    (2) Its electronic trade confirmation/affirmation system has 
sufficient capacity to process the specified volume of data that it 
reasonably anticipates to be entered into its electronic trade 
confirmation/affirmation service during the upcoming year;
    (3) Its electronic trade confirmation/affirmation system has 
formal contingency procedures, that the entity has followed a formal 
process of reviewing the likelihood of contingency occurrences, and 
that the contingency protocols are reviewed and updated on a regular 
basis;
    (4) Its electronic trade confirmation/affirmation system has a 
process for preventing, detecting, and controlling any potential or 
actual systems integrity failures, and its procedures designed to 
protect against security breaches are followed; and
    (5) Its current assets exceed its current liabilities by at 
least $500,000.

    In addition, a qualified vendor will be required initially and 
annually to submit to the SROs and to the Commission staff a report 
prepared by independent audit personnel (referred to in the rule 
changes as ``Auditor's Report''). Each Auditor's Report must: (1) 
verify the certifications described above; (2) contain a risk analysis 
of all of the entity's information technology systems; and (3) contain 
the written response of the entity's management to the Auditor's 
Report's verifications and risk analysis. The Auditor's Report must be 
deemed not unacceptable by Commission staff.\9\
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    \9\ At this time, the Commission staff intends to indicate that 
an entity's initial Auditor's Report is not unacceptable by issuing 
a letter to the entity stating that it will not recommend 
enforcement action against any of the SROs' member organizations 
that elect to use the confirmation/affirmation systems of the 
entity. Subsequent Auditor's Reports submitted to the Commission 
staff by the qualified vendor will be considered acceptable unless 
the Commission staff otherwise informs the qualified vendor.
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    Qualified vendors will be subject to ongoing requirements under the 
rule changes. For each transaction in which it provides confirmation/
affirmation services, a qualified vendor will be required to: (1) 
deliver a trade record to a registered clearing agency in the clearing 
agency's format; (2) obtain a control number for the trade record from 
the clearing agency; (3) cross reference the control number to the 
confirmation and subsequent affirmation of the trade; and (4) include 
the control number when delivering the affirmation of the trade to the 
clearing agency. A qualified vendor will be required to notify the SROs 
and the Commission staff in writing of any changes to its systems that 
significantly affect or have the potential to significantly affect its 
electronic trade confirmation/affirmation system. In addition, a 
qualified vendor will be required to supply supplemental information 
regarding its confirmation/affirmation system as requested by the SROs 
or by the Commission staff. If a qualified vendor intends to cease 
providing confirmation/affirmation services, it must notify the SROs 
and the Commission staff in writing.

II. Comment Letters

    The Commission received two comment letters in response to the 
notices of the SROs' proposed rule changes.\10\ The SIA Operations 
Committee stated that it supports the proposed rule changes. The 
Operations Committee expressed its belief that the proposed criteria 
should address the regulatory concerns associated with allowing new 
entrants into the clearance and settlement system while providing to 
the system the innovations and cost reductions that competition can 
produce.
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    \10\ Supra note 4.
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    Thomson stated that it was delighted that the SROs are amending 
their rules to allow commercial vendors to process institutional trade 
confirmations and affirmations.\11\ However, as discussed below, 
Thomson believes that the SROs' proposals should be changed (1) to make 
the initial and ongoing process of designating qualified vendors 
objective and self-executing and (2) to limit the audit requirements to 
the areas that pose the most risk to post-trade information processing 
systems.
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    \11\ Thomson's comment letter refers to differences in the 
proposed rule changes from a statement of principles agreed to 
between the SIA and Thomson. The NASD noted in the first amendment 
to its rule filing that it ``does not believe that the statement of 
principles is relevant, much less controlling, with respect to 
whether there is a statutory basis for the proposed rule change.''
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    Thomson stated that it supports the fundamental approach of the 
Auditor's Reports. However, Thomson believes that the scope of the 
Auditor's Reports is too broad. Thomson particularly objected to the 
requirement that the Auditor's Report contain an audit of all of the 
entity's information technology systems. Thomson stated that it 
believes that auditing the certification that the entity would be 
required to provide under the proposed rule changes is sufficient to 
address the risk factors related to allowing unregulated entities to 
provide confirmation/affirmation services.
    The Commission believes that the scope of the Auditor's Reports 
under the rule changes is reasonable. In particular, the Commission 
believes that the risk analysis component of the Auditor's Report is 
necessary to determine whether an entity should be a qualified vendor.
    Because electronic confirmation/affirmation services are critical 
to the settlement of institutional securities trades, a breakdown in 
the confirmation/affirmation system could have a significant negative 
impact on the entire clearance and settlement system. Moreover, 
problems or insufficiencies in any aspect of a qualified vendor's 
information technology system could adversely affect the qualified 
vendor's confirmation/affirmation system. As a result, the Commission 
believes that it is appropriate for the Auditor's Reports to contain a 
risk analysis of the entity's information technology systems.
    In addition, registered clearing agencies that provide 
confirmation/affirmation systems are already subject to extensive 
regulatory requirements. Among other things, registered clearing 
agencies must submit rule changes to the Commission for approval and 
are subject to inspections, including systems reviews, by the 
Commission staff. As a result, the Commission has continuous oversight 
and authority over registered clearing agencies' operations, including 
any confirmation/affirmation services they provide. Under the SROs' 
rule changes, qualified vendors will not be subject to such continuous 
oversight and authority. The Commission believes that the requirements 
under the rule changes with respect to the Auditor's Reports are 
reasonably intended to assure that the Commission and the SROs will be 
able to prevent an entity from becoming a qualified vendor if its 
confirmation/affirmation system poses a risk of compromising the safety 
and soundness of the national clearance and settlement system.
    Thomson objected to the idea that the Commission staff would issue 
a no-action letter to indicate that an entity's initial Auditor's 
Report is not unacceptable. Thomson stated that the process of becoming 
a qualified vendor should be largely self-executing in that an entity 
should become a qualified vendor automatically as long as its initial 
Auditor's Report does not contain any findings by the auditor of 
material

[[Page 25942]]

weakness. Thomson stated that under the self-executing process it 
supports, the Commission and the SROs ``would function more as report 
depositories than traditional application examiners.''
    The Commission believes that in order for Commission staff to 
adequately review an Auditor's Report to determine whether it is not 
unacceptable, the staff must do more than simply read the report to 
determine whether it contains a finding of material weakness. Under the 
rule changes, the Commission staff may deem an Auditor's Report 
unacceptable for any reason if it believes that the report demonstrates 
that an entity would not be capable of providing confirmation/
affirmation services in a manner that would not compromise the 
integrity of the national clearance and settlement system.
    Thomson also contended that there is no legal context in which the 
Commission staff may issue no action letters to qualified vendors. 
Thomson stated that the only party to which the Commission staff is 
authorized to recommend or not recommend enforcement action is the 
Commission itself and that any such recommendation or decision to not 
make a recommendation must be related to the federal securities laws or 
Commission rules promulgated thereunder. Thomson expressed concern that 
the proposed rule changes do not provide objective standards that the 
Commission staff will use when considering whether to grant the initial 
no-action letter.
    The Commission believes that the use of a no-action letter to 
indicate that an entity's initial Auditor's Report is not unacceptable 
is a reasonable method for indicating that an entity is a qualified 
vendor under the SROs' rules. Section 21 of the Act, which authorizes 
the Commission to investigate and to bring enforcement action with 
respect to violations of the rules of a self-regulatory organization by 
any person, provides a legal context for the issuance of a no-action 
letter to qualified vendors.\12\ The Commission also believes that the 
rule changes are reasonably designed to provide objective guidance to 
the Commission in its review of the Auditor's Reports and to the SROs 
to deny ``qualified'' status to and to terminate the ``qualified'' 
status of ETC vendors whose confirmation/affirmation services fall 
below acceptable standards.
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    \12\ 15 U.S.C. 78u.
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    Thomson stated that it agrees with the requirement that a qualified 
vendor notify the SROs and the Commission staff if it decides to stop 
providing confirmation/affirmation services. Thomson objected to a 
provision in the NASD's proposed rule change that states a qualified 
vendor may cease to be qualified if the Commission staff (1) deems an 
Auditor's Report unacceptable either because it contains any finding of 
material weakness or for any other identified reasons or (2) notifies 
the qualified vendor that it is no longer qualified.
    As noted above, the Commission staff may deem an Auditor's Report 
unacceptable for any reason if it believes that the report demonstrates 
that an entity would not be capable of providing confirmation/
affirmation services in a manner that would not compromise the 
integrity of the national clearance and settlement system. In addition, 
the Commission staff may revoke a no-action position if it determines 
that a revocation is consistent with the public interest or the 
protection of investors.

III. Discussion

    Under Section 19(b)(2) of the Act, the Commission is directed to 
approve the SROs' proposed rule changes if it finds that they are 
consistent with the requirements of the Act and the rules and the rules 
and regulations thereunder applicable to the SROs.\13\ Sections 
6(b)(5), 15A(b)(6), and 15B(b)(2)(C) of the Act \14\ require, among 
other things, that the SROs' rules be designed to foster cooperation 
and coordination with persons engaged in regulating, clearing, 
settling, processing information with respect to, and facilitating 
transactions in securities. Sections 6(b)(8), 15A(b)(9), and 
15B(b)(2)(C) of the Act \15\ also require that the SROs' rules not 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Act. For the reasons discussed 
below, the Commission believes that the SROs' proposed rule changes are 
consistent with their obligations under the Act.
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    \13\ 15 U.S.C. 78s(b)(2).
    \14\ 15 U.S.C. 78f(b)(5), 78o-3(b)(6), and 78o-4(b)(2)(C).
    \15\ 15 U.S.C. 78f(b)(8), 78o-3(b)(9), and 78o-4(b)(2)(C).
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    The Commission believes that the changes to the SROs' confirmation 
rules are consistent with the SROs' obligations under the Act because 
they will require unregulated entities that wish to provide 
confirmation/affirmation services to establish links and interfaces 
with a registered clearing agency. This requirement should increase 
cooperation and coordination among the SROs' members, registered 
clearing agencies, and entities that become qualified vendors under the 
rule changes.
    In addition, in reviewing the proposed rule changes the Commission 
has considered whether the proposed rule changes would impose any 
burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act. The Commission believes that 
the rule changes have been carefully designed to allow unregistered ETC 
vendors to provide confirmation/affirmation services for institutional 
trades in a manner which is not unduly burdensome for ETC vendors and 
which preserves the safety and soundness of the national system for the 
clearance and settlement of securities transactions. Therefore, the 
Commission believes that the SROs' proposed rule changes should not 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act.

IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposals are consistent with the requirements of the Act and in 
particular with the requirements of Section 17A of the Act and the 
rules and regulations thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule changes (File Nos. SR-MSRB-98-06, SR-NASD-98-20, 
SR-NYSE-98-07) be and hereby are approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-12139 Filed 5-12-99; 8:45 am]
BILLING CODE 8010-01-M