From: jim@nesfieldcapital.com Sent: Sunday, May 23, 2004 11:06 PM To: rule-comment@sec.gov Subject: File number S7?13?04 Jonathan Katz, Secretary Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549-0609 RE: SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 240 [Release No. 33-8398; 34-49405; IC-26384; File No. S7-13-04] RIN 3235-AJ19 Securities Transactions Settlement Dear Mr. Katz In the Introduction to the above referenced document, the reference to section 17A of the Securities Exchange Act of 1934 giving the Commission the direction to establish a national clearance and settlement system for securities transactions is flawed because the current state of technology allows for a seamless integration of trading to settlement in 3 seconds using Digitally Signed and Encrypted Contracts (DSEC). While DSEC is not industry practice and is asymmetric to what is envisioned, it serves the purpose and illuminates the lack of progressive thought directed to the Commission by legislative intent. To state it bluntly, Congress is ill-informed on matters relating to technology or has not bothered to update the intent of the exchange act. There is no difference between trading, clearance and settlement, corporate actions, and other activities related to the buying and selling of securities. There is this misperception, and, as long as separate entities are created or amended to fulfill legislative direction, more than the required moving parts are included in the engine. This will affect performance in the areas of surveillance of regulatory intent and increase both counter party risk and systemic risk. The Commission is mandated to follow along a path that is poorly lit. All the major features of DTCC/NSCC/SIAC have been gamed and discovered. After discovery, the amendments are adopted and another manually intensive form of surveillance is implemented. At this point, prior to the adoption of the SIA's suggestions (which would be akin to adopting Microsoft’s recommendations on secure software or like asking Saddam to hold a fair election), Congress should look at new, more realistic approaches to the regulations and the technological possibilities that are available. The SIA defines STP as "\3\ The Securities Industry Association describes STP ``as the Seamless integration of systems and processes to automate the trade process from end-to-end--trade execution, confirmation, and settlement--without manual intervention or the re-keying of data.'' ``STP Glossary,'' prepared by the SIA and available at http://www.sia.com/stp/other/Glossary_v2.3.xls.” This definition shows the basic flaw: the initial design has the segregation of the trading and clearance and settlement built in. Just as the previous design mandated prior to the creation of DTCC that the transfer agent be a critical part of clearance and settlement, DTCC could now join them along with the NSCC as non-functional parts of the process. By using DSECs, settlement banking regimes are no longer required, nor are massive depositories with excessive overhead due in no small part to the archaic regulatory perspective. Re-keying of data for client records, transaction records, and securities records would never have been necessary had standardized methods been adopted, but the largest impediment is the service providers, who have created cost structures for modernizing the securities processing industry beyond what can be considered reasonable or fair. However, the users' resistance to Capital Expenditures in the area of clearance and settlement seem to vanish when it comes to investing in trading and typical front office systems because participants consider them profit centers. The dawn of a new age will either be adopted by these participants or overtake them since the genie of capital markets is out of the bottle and other sovereign entities will stop looking to the United States for direction and move to adopt cheaper, more reliable systems like the one developed by Ian Grigg of Systemics, Inc. These systems have the ability to achieve T+0 and to remove counter party risk altogether. In addition, they allow for a continuous flow of information directly with the clients for the purposes of proxies and other events. The Mutual Funds industry votes proxies but has no means of communicating with its shareholders in a cost-effective manner. When using this type of system, this flow is not broken and is redirected automatically as ownership is changed. Eventually the issuers and shareholders will share real-time accounting information and the deductive interpretations of analysis might altogether disappear. In the case of Asset Backed Securities or any structured product, this line of communication might transmit the actual situation of assets within the pools and remove the unfair lending to cover shortfalls the Master Servicer now makes. The data being transmitted to the actual owner of the security in real time is possible today, but investors are shortchanged by myopic legislation, vested interest, and a general sense of if we don't talk about the risk, it will go away. Re-Keying can go away if it is done properly first and is bounced when presented in other than the accepted format. The issue of immobilized securities should have been considered a dead issue years ago since the only physical certificates might be questionable. In this role, DTCC serves a vital function and has removed the headache of Counterfeit Scripts. Counterfeit Script detection can be enhanced to a finer degree of performance by using DSECs, which would also remove some of the unfair practices employed by less-than-mentionable transfer agents who illegally remove the legends from lettered stock. Sincerely, James L. Nesfield Fisherman