[Federal Register: June 11, 2003 (Volume 68, Number 112)]
[Notices]
[Page 35037-35043]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr11jn03-186]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-47978; File No. SR-DTC-2003-02]
Self-Regulatory Organizations; The Depository Trust Company;
Order Granting Approval of a Proposed Rule Change Concerning Requests
for Withdrawal of Certificates by Issuers
June 4, 2003.
I. Introduction
On February 3, 2003, The Depository Trust Company filed with the
Securities and Exchange Commission (``Commission'') and on February 11,
2003, amended proposed rule change SR-DTC-2003-02 pursuant to section
19(b)(1) of the Securities Exchange Act of 1934 (``Act'').\1\ Notice of
the proposal was published in the Federal Register on February 22,
2003.\2\ Eighty-nine comment letters were received.\3\ For the
[[Page 35038]]
reasons discussed below, the Commission is granting approval of the
proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ Securities Exchange Act Release No. 47365, (February 13,
2003), 68 FR 8535 (February 21, 2003).
\3\ Letters from H. Glenn Bagwell, Jr., Esq. (March 6, 2003);
Bruce Barrett (March 4, 2003); Bruce M. Barrett (March 19, 2003);
Cristy Barrett (March 13, 2003); Jake Barrett (March 13, 2003);
Robert D. Becker, Senior Vice President, National City Bank (March
18, 2003); Lester Bianco, Director, Ingalls & Snyder LLC (April 4,
2003); Pete Bowman, Managing Director, First Clearing Corporation
(March 18, 2003); Michael R. Brennan, Vice President and Managing
Director of Operations, Ameritrade, Inc. (April 28, 2003); Earl D.
Bukolt, Managing Director and Chief Operating Officer, Sterne, Agee
& Leach, Inc. (April 21, 2003); Leonard W. Burningham, Esq. (March
21, 2003); Leonard W. Burningham, Esq. (March 22, 2003); Leonard W.
Burningham, Esq. (March 24, 2003); Neil C. Carfora, Senior Vice
President, State Street Corporation (March 11, 2003); Mark Cashion
(March 6, 2003); David L. Cermak, Senior Vice President and Director
of Operations, RBC; Dain Rauscher (April 21, 2003); Frank M.
Ciavarella, Cashiers Division, Prudential Securities Incorporated
(April 3, 2003); John Cirrito, Senior Managing Director and Chief
Operating Officer, ING Financial Markets LLC (March 17, 2003); Kevin
Cundy (March 6, 2003); Richard J. Curran, Director, Credit Suisse
First Boston LLC (April 14, 2003); Dennis Dejose (March 8, 2003);
Patricia Dowd, Patricia Dowd Inc. (March 5, 2003); Paul A. Ebeling
(March 11, 2003); Harry Filowitz, Vice President, Mizuho Trust &
Banking Co. (USA) (April 7, 2003); Mary L. Forgy, Chairperson, Bank
Depository User Group (March 14, 2003); Mary L. Forgy, Union
Planters Trust & Investment Group (March 13, 2003); Susan A.
Gessman, Assistant Vice President of Operations, Raymond James and
Associates (April 25, 2003); Russell Godwin, President, Medinah
Minerals Inc. (March 13, 2003); Jeff Hamel, President, Cashiers'
Association of Wall Street, Inc. (March 18, 2003); Edward Hazel,
Managing Director, Spear, Leeds & Kellogg (April 9, 2003); James
Hendricks (March 8, 2003); Joseph Hoofnagel, Jr. (March 8, 2003);
Gordon D. House (March 6, 2003); Tom Ittner, Director, National
Financial Services LLC (March 17, 2003); Kent N. Jacobson, President
and Chief Executive Officer, James Barclay Alan Inc. (March 7,
2003); Peter Johnston, Managing Director, Goldman, Sachs & Co.
(March 24, 2003); Jack Kennedy (March 8, 2003); Will Kernen (March
8, 2003); Patrick Kirby, Director, Salomon Smith Barney (March 14,
2003); Donald D. Kittell, Executive Vice President, Securities
Industry Association (March 11, 2003); Jeremy D. Kraus, Valesc
Medical Specialists (March 4, 2003); Philip Lanz, Managing Director,
Bear, Stearns Securities Corp. (April 11, 2003); Arthur Lee, Vice
President, Banc of America Securities LLC (March 18, 2003); Joseph
M. Liguori, Vice President, JP Morgan Securities, Inc. (April 14,
2003); Erick Lihme (March 8, 2003); Luiz Lima, Director, Americas
Regional Service Center, Citibank North America, Inc. (April 22,
2003); Lori Livingston, President and Chief Operating Officer,
Transfer Online, Inc. (March 5, 2003); Richard Mangiarelli,
President and Chief Operating Officer, Cybertel Communications
Corporations (March 5, 2003); John Masse, Executive Director, Morgan
Stanley (May 21, 2003); Thomas J. Mazzarisi, Executive Vice
President and General Counsel, JAG Media Holdings, Inc. (March 14,
2003); Joseph Meuse (March 5, 2003); Michael Moran, First Vice
President, National Investor Services Corp. (March 11, 2003);
Lawrence Morillo, Managing Director, Pershing LLC (April 3, 2003);
John O'Brien (March 11, 2003); Thomas J. O'Hara, Department Leader,
Edward Jones (April 15, 2003); John M. Osmanski (March 4, 2003);
David E. Patch (March 4, 2003); Dave Patch (March 6, 2003); D. Patch
(March 15, 2003); John L. Petersen, Esq., Petersen & Fefer, on
behalf of Blue Industries, Inc. (March 12, 2003); Ernest A.
Pittarelli, USB Warburg LLC (April 24, 2003); Robert M. Post (March
8, 2003); James E. Pratt, Esq., on behalf of Composite Holdings,
Inc. (March 27, 2003); Joe Raia (March 11, 2003); Richard Reincke,
Chief Operating Officer, Aegis Assessments, Inc. (March 3, 2003);
Peter Richardson (March 8, 2003); John Rideout (March 12, 2003);
Rodney J. Roncaglio (April 29, 2003); Robert S. Rondeau (May 20,
2003); Greg Rotman (March 14, 2003); David Salk (March 6, 2003);
Henry F. Schlueter, Esq., Schlueter & Associates, P.C. (March 12,
2003); Robert J. Scott, President and Chief Operating Officer, The
Auxer Group, Inc. (March 20, 2003); Joseph J. Selinger, Esq., Tobin,
Carberry, O'Malley, Riley & Selinger, P.C. (March 14, 2003); Marshal
Shichtman, Esq., Marshal Shichtman & Associates, P.C. (March 11,
2003); Scott Sieck (March 5, 2003); Steven Simonyi-Gindele,
President and Chief Executive Officer, ID Superstore (March 17,
2003); Maurisa Sommerfield, Executive Vice President, Charles Schwab
& Co., Inc. (April 15, 2003); Michael Sondow (March 4, 2003); Chris
Spencer, Chief Executive Officer, Wizzard Software Corporation
(March 11, 2003); Roger J. Steffensen (March 8, 2003); SuperVP
(March 20, 2003); Kristie Thompson, President, SIA Customer Account
Transfer Division (April 4, 2003); Larry E. Thompson, Managing
Director and Deputy Chief Counsel, The Depository Trust Company
(March 27, 2003); Leon Urbaitel, Chief Operating Officer,
StockTransfer.com (March 6, 2003); Brian Urkowitz, Merrill Lynch
(April 23, 2003); C. Michael Viviano, BNY Clearing (April 4, 2003);
Geoffrey F. Walsh, Chief Operating Officer, Solution Capital (March
7, 2003); and William J. Winter, Senior Vice President, A.G. Edwards
& Sons, Inc. (March 14, 2003).
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II. Description
Recently a number of issuers of securities have independently
requested that DTC withdraw from the depository all securities issued
by them.\4\ Generally, these issuers have also advised DTC that they
will not allow their securities to be reregistered in the name of DTC
or its nominee, Cede & Co. The securities of these issuers generally
became eligible for DTC services at the request of DTC's participants
so that they could utilize DTC's services, including its book-entry
transfer system. The securities are held by DTC in its nominee name for
the benefit of its participants. DTC has stated that, in its opinion,
these issuers have no legal or beneficial interest in the securities
they are requesting to be withdrawn from DTC.
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\4\ As explained in further detail by many of the commenters
opposing DTC's proposal, the issuers making these requests have
alleged that their securities have been the target of manipulative
short sellers.
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DTC's current rules and procedures provide for participants to
submit withdrawal requests if they wish to withdraw their securities
from DTC.\5\ However, DTC's current rules and procedures do not provide
for DTC to comply with a withdrawal request from an issuer without also
receiving instructions from its participants.
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\5\ See, e.g., Rules 2, 6, 9(A), and 9(B) of DTC's Rules.
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DTC's proposed rule change provides that upon receipt of a
withdrawal request from an issuer, DTC will take the following actions:
(1) DTC will issue an Important Notice notifying its participants of
the receipt of the withdrawal request from the issuer and reminding
participants that they can utilize DTC's withdrawal procedures if they
wish to withdraw their securities from DTC; and (2) DTC will process
withdrawal requests submitted by participants in the ordinary course of
business but will not effectuate withdrawals based upon a request from
the issuer.
DTC stated in its filing that the application of its procedures is
not affected by any purported approval of the request by the
shareholders or board of directors of the issuer.\6\
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\6\ DTC's current procedures and this proposed rule filing do
not apply to withdrawal requests submitted by issuers in situations
where an issue which should not have been made eligible and
deposited at DTC was inadvertently made eligible and deposited
(e.g., securities restricted pursuant to Rule 144 or Rule 145 under
the Securities Act of 1933). In such situations, DTC will continue
its practice of working with the issuer and its participants to exit
the security from DTC.
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III. Comment Letters
The Commission received 89 comment letters regarding the proposed
rule change.\7\ Forty-seven commenters submitted fifty-two comment
letters opposing the proposed rule change.\8\ Thirty-five commenters
submitted thirty-six comment letters supporting the proposed rule
change.\9\ DTC submitted a letter in response to certain issues raised
by comment letters opposing the rule change.
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\7\ Supra note 3.
\8\ Letters from Aegis Assessments, Inc., H. Glenn Bagwell,
Bruce Barrett, Bruce M. Barrett, Cristy Barrett, Jake Barrett, Blue
Industries, Inc., Leonard W. Burningham (three letters), Composite
Holdings, Inc., Kevin Cundy, Cybertel Communications Corporations,
Dennis Dejose, Patricia Dowd Inc., Paul A. Ebeling, James Hendricks,
Joseph Hoofnagle, Jr., Gordon D. House, ID Superstore, James Barclay
Alan Inc., Jack Kennedy, Will Kernen, Erick Lihme, JAG Media
Holdings, Inc., Medinah Minerals Inc., Joseph Meuse, John O'Brien,
John M. Osmanski, David E. Patch, Dave Patch, David Patch, Robert M.
Post, Joseph Raia, Peter Richardson, Rodney J. Roncaglio, Robert S.
Rondeau, Greg Rotman, David Salk, Henry F. Schlueter, Robert J.
Scott, Joseph J. Selinger, Marshal Shichtman, Scott Sieck, Solution
Capital, Michael Sondow, Roger J. Steffenson, StockTransfer.com,
SuperVP, Transfer Online, Inc., Valesc Medical Specialists, and
Wizzard Software Corporation.
\9\ Letters from A.G. Edwards & Sons, Inc., Ameritrade, Inc.,
Banc of America Securities LLC, Bank Depository User Group, BNY
Clearing, Cashiers' Association of Wall Street, Inc., Mark Cashion,
Charles Schwab & Co., Inc., Citibank North America, Inc., Credit
Suisse First Boston LLC, Edward Jones, First Clearing Corporation,
Goldman, Sachs & Co., Ingalls & Snyder LLC, ING Financial Markets
LLC, JP Morgan Securities, Inc., Merrill Lynch, Mizuho Trust &
Banking Co. (USA), Morgan Stanley, National City Bank, National
Financial Services LLC, National Investor Services Corp., Pershing
LLC, Prudential Securities Incorporated, Raymond James and
Associates, RBC Dain Rauscher, John Rideout, Salomon Smith Barney,
Securities Industry Association, Securities Industry Association
Customer Account Transfer Division, Spear, Leeds & Kellogg, State
Street Corporation, Stearns Securities Corp., Sterne, Agee & Leach,
Inc., Union Planters Trust & Investment Group, and USB Warburg LLC.
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A. Comment Letters Opposing DTC's Proposed Rule Change
A majority of the forty-seven commenters opposed to DTC's filing
believe that approval of the proposed rule change would allow DTC to
continue to facilitate, either directly or indirectly, short selling in
the over-the-counter securities market in violation of DTC's obligation
to promote the prompt and accurate clearance and settlement of
securities transactions.\10\ Seven of these commenters characterized
DTC's current settlement process as aiding and abetting illegal short
selling or as creating an environment that permits unregistered
securities offerings.\11\
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\10\ In addition to alleging that DTC facilitates abusive short
selling, some of these commenters took issue with the Commission's
regulation of DTC, broker-dealers, and other entities that the
commenters believe are responsible for the problems associated with
naked short selling.
\11\ Several of these commenters characterized the imbalance
between the number of shares trading through short selling and the
number of shares outstanding as an unregistered securities offering.
Others characterized this imbalance as ``counterfeiting
securities.'' Letters from H. Glenn Bagwell, Blue Industries, Inc.,
James Henricks, ID Superstore, Scott Sieck, Solution Capital, and
Michael Sondow.
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At least twenty-six commenters contended that an issuer should have
a
[[Page 35039]]
choice as to whether the company's securities are eligible for deposit
at DTC,\12\ particularly, as some of these commenters argued, when
making the securities eligible for deposit at DTC requires the issuer's
consent.\13\ Most of the twenty-six commenters stated that issuers
should have the right to withdraw their securities from DTC in order to
protect their shareholders and their share price from the alleged
negative consequences of naked short selling by broker-dealers.\14\
These commenters believe that by requiring certification and by
prohibiting ownership by nominees, including depositories, issuers will
better be able to track, address, or preclude naked short selling.\15\
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\12\ Letters from Aegis Assessments, Inc., H. Glenn Bagwell,
Blue Industries, Inc., Bruce Barrett, Cybertel Communications
Corporations, Dennis Dejose, James Hendricks, Gordon D. House, JAG
Media Holdings, Inc., James Barclay Alan Inc., Eric Lihme, Medinah
Minerals Inc., Joseph Meuse, John O'Brien, John M. Osmanski, David
E. Patch, Joseph Raia, Peter Richardson, Henry F. Schlueter, Robert
J. Scott, Joseph J. Selinger, Marshall Shichtman, Michael Sondow,
Super VP, Transfer Online, Inc., and Valesc Medical Specialists.
\13\ Letters from Henry F. Schlueter, Joseph J. Selinger, and
Marshal Shichtman.
\14\ Letters from Aegis Assessments, Inc., H. Glenn Bagwell,
Blue Industries, Inc., Cybertel Communications Corporations, Dennis
Dejose, James Hendricks, Gordon D. House, JAG Media Holdings, Inc.,
James Barclay Alan Inc., Erick Lihme, John O'Brien, John M.
Osmanski, David E. Patch, Joseph Raia, Peter Richardson, Henry F.
Schlueter, Robert J. Scott, Joseph J. Selinger, Marshall Shichtman,
Michael Sondow, Transfer Online, Inc., and Valesc Medical
Specialists.
\15\ Some commenters refer to allowing the transfer of
certificated positions registered only in the name of the final
beneficial owner as ``custody-only trading.''
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Ten commenters raised a number of concerns regarding the legal
basis for the proposal.\16\ Seven of the ten commenters stated that
DTC's refusal to honor issuers' withdrawal requests or to allow issuers
the option of not having securities deposited at DTC conflicts with
state law and that state corporation laws, not DTC rules, govern
whether a company can restrict securities so that all positions must be
certificated or so that just custody-only trading is allowed.\17\
Further, they contend that state law determines the conditions that
must be met for the proper transfer of securities. One commenter argued
that a transfer agent is the agent of the issuer and that unless the
issuer has elected to make its securities eligible at DTC, its transfer
agent is not subject to DTC rules and regulations or operational
arrangements but rather is subject to Commission and NASD rules and
regulations.\18\ Another of these commenters stated that if transfer
agents, which are agents of issuers and as such generally have a duty
to follow issuers' instructions including any restrictions imposed by
the issuer's by-laws or articles of incorporation, have obligations to
both the issuer and to DTC, transfer agents will be effectively
``frozen,'' and the parties will be forced to litigate their
disputes.\19\
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\16\ Letters from H. Glenn Bagwell, Jr., Bruce M. Barrett, JAG
Media Holdings, Inc., John M. Osmanski, David E. Patch, Greg Rotman,
Henry F. Schlueter, Joseph J. Selinger, Marshal Shichtman, and
Solution Capital.
\17\ Letters from Bruce M. Barrett, JAG Media Holdings, Inc.,
David E Patch, Henry F. Schlueter, Joseph J. Selinger, Marshal
Shichtman, and Greg Rotman.
\18\ Letter from Henry F. Schlueter.
\19\ Letter from Marshal Shichtman. The commenter did not
explain why he believed the transfer agent has an obligation to DTC.
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Four of the seven commenters questioned the need for the filing and
in particular questioned DTC's statement that it was only clarifying
its existing rules and procedures rather than promulgating a new
rule.\20\ Some of these commenters said that if this were true, DTC
would have either not filed at all or would have filed a rule
interpretation pursuant to Section 19(b)(3) of the Act,\21\ which would
not have required Commission approval. One of the seven commenters
observed that while DTC stated that its rules do not provide for
issuers' requests to withdraw their securities, DTC did not cite to any
rule prohibiting honoring such requests.\22\
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\20\ Letters from H. Glenn Bagwell, Jr., JAG Media Holdings,
Inc., John M. Osmanski, and David E. Patch.
\21\ Letters from JAG Media Holdings, Inc., John M. Osmanski,
and David E. Patch.
\22\ Letter from Joseph J. Selinger.
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Three commenters believe that the manner in which DTC handled this
``policy change'' was arbitrary, capricious, and detrimental to
companies, particularly in light of the fact that DTC has worked with
some companies to withdraw their securities but has refused to assist
other companies to withdraw their securities.\23\ Several commenters
also stated they did not understand how at least one company, such as
AT&T, could have the right to determine that its stockholders must hold
their stock in book-entry form but other issuers do not have the right
to determine that their stockholders must hold their stock in
certificated form.\24\
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\23\ Letters from JAG Media Holdings, Inc., David E. Patch, and
Henry F. Schlueter.
\24\ Letters from JAG Media Holdings, Inc., David E. Patch, and
Solution Capital.
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Eight commenters took issue with the fact that DTC does not
effectively work to protect the interest of the issuer or the issuer's
shareholders but rather works in the interest of its participants, the
same entities that profit from naked short selling.\25\ One of these
commenters suggested that this conflict of interest should disqualify
DTC from deciding whether an issuer could withdraw its securities.\26\
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\25\ Letters from Cristy Barrett, Jake Barrett, Joseph Meuse,
David Patch, Joseph Raia, Joseph J. Selinger, StockTransfer.com, and
Wizzard Software Corporation.
\26\ Letter from Joseph J. Selinger.
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Finally, eight commenters suggested that the Commission should deny
approval of DTC's proposal until the Commission or DTC can investigate
and consider appropriate regulation to address naked short selling or
until the public is given an opportunity to more fully comment on the
proposal.\27\ Some of these commenters argued that DTC's current course
of action (i.e., filing a proposed rule change) does not sufficiently
provide a vehicle for in-depth analysis or meaningful public comment.
Several of these commenters suggested that alternatives to DTC such as
issuers or transfer agents operating their own book-entry system or a
certificated, custody-only system, are available and could be used in
lieu of DTC.
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\27\ Letters from Aegis Assessments, Inc., Leonard W.
Burningham, David E. Patch, David Salk, Joseph J. Selinger, Marshall
Shichtman, StockTransfer.com, and Transfer Online, Inc.
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B. Comment Letters Supporting DTC's Proposed Rule Change
A majority of the thirty-five commenters supporting DTC's proposed
rule change expressed concern that permitting issuers to withdraw their
securities from DTC undermines the securities industry's long-term
efforts to streamline securities processing, settlement, custodianship
in the U.S. market, to achieve straight-through-processing (``STP''),
and to ultimately shorten settlement cycles. Twenty-four of these
commenters contended that one of the major stumbling blocks to
achieving STP involves the difficulties related to processing
certificates, which is primarily a manual process.\28\ The
[[Page 35040]]
industry, these commenters believe, has achieved success in
significantly reducing risk in the trading markets and in enhancing
processing efficiencies within the securities infrastructure supporting
book-entry clearance and settlement. In their view, much of the success
can be attributed to immobilizing stock certificates and mandating
book-entry settlement among financial institutions and their financial
intermediaries. Accordingly, many of the commenters claimed that a move
to certificated securities is a step backwards in the development of
the modern securities processing system and will hinder the industry's
efforts to reduce risk, cost, and inefficiencies for all parties
involved in securities transactions.\29\
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\28\ Letters from Ameritrade, Inc., Banc of America Securities
LLC, Bank Depository User Group, Cashiers' Association of Wall
Street, Inc., Mark Cashion, Citibank North America, Inc., Credit
Suisse First Boston LLC, Edward Jones, ING Financial Markets LLC, JP
Morgan Securities, Inc., Merrill Lynch, Mizuho Trust & Banking Co.
(USA), National Financial Services LLC, National Investor Services
Corp., Pershing LLC, Prudential Securities Incorporated, RBC Dain
Rauscher, Salomon Smith Barney, Stearns Securities Corp., Securities
Industry Association, Securities Industry Association Customer
Account Transfer Division State Street Corporation, Sterne, Agee &
Leach, Inc., USB Warburg LLC, and Union Planters Trust & Investment
Group. Several commenters referred to dematerialization or
immobilization as a ``building block'' to achieving STP or shorter
settlement cycles.
\29\ Letters from A.G. Edwards & Sons, Inc., Ameritrade, Inc.,
Banc of America Securities LLC, Bank Depository User Group, BNY
Clearing, Cashiers' Association of Wall Street, Inc., Citibank North
America, Inc., Edward Jones, Ingalls & Snyder LLC, ING Financial
Markets LLC, JP Morgan Securities, Inc., Merrill Lynch, Mizuho Trust
& Banking Co. (USA), Morgan Stanley, National City Bank, National
Financial Services LLC, National Investor Services Corp., Pershing
LLC, Prudential Securities Incorporated, John Rideout, Salomon Smith
Barney, Securities Industry Association, Securities Industry
Association Customer Account Transfer Division, Spear, Leeds &
Kellogg, State Street Corporation, Stearns Securities Corp., Sterne,
Agee & Leach, Inc., Union Planters Trust & Investment Group, and USB
Warburg LLC.
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Fourteen commenters specifically raised concerns that an increase
in the use of certificates will raise costs and cause significant
inconveniences for investors.\30\ They believe that increased costs
associated with transfers, lost certificates, custody, and trading
delays will ultimately be borne by investors. One commenter stated that
the withdrawal from DTC might require customer securities to be held in
the broker's vault in order to meet the customers' needs and will
increase costs associated with transactions, including transfer costs,
which are currently ranging from $50.00 to $100.00 per certificate.\31\
This commenter claims that these costs are hard to justify to
shareholders when the shareholder did not request a certificate.
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\30\ Letters from Ameritrade, Inc., Mark Cashion, Citibank North
America, Inc., First Clearing Corporation, Merrill Lynch, Mizuho
Trust & Banking Co. (USA), National Investor Services Corp.,
Pershing LLC, RBC Dain Rauscher, John Rideout, Salomon Smith Barney,
Securities Industry Association Customer Account Transfer Division,
Stearns Securities Corp., and Union Planters Trust & Investment
Group.
\31\ Letter from Raymond James and Associates. According to this
comment letter, Raymond James recently initiated a client
certificate transfer fee as a disincentive to requesting a
certificate. This fee, the commenter claims, has reduced certificate
requests by 67% over the past two years.
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Ten commenters contended that operating outside the DTC environment
would undermine the ability of broker-dealers to effectively complete
transactions on behalf of their customers.\32\ Forced withdrawals of
customer positions held in street name would prevent shareholders from
fully participating in services provided by their broker, such as
margin accounts, automated dividend payments or reinvestments, asset
management, proxy services, account transfers, and prompt processing of
corporate actions (particularly where old securities need to be
exchanged for new securities as required, for example, in mergers and
tender offers). Seven of the ten commenters also indicated that such an
action would result in an increase in trading delays and trade
failures, which would increase risk in the system.\33\
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\32\ Letters from Ameritrade, Inc., BNY Clearing, Mark Cashion,
First Clearing Corporation, Mizuho Trust & Banking Co. (USA),
National City Bank, National Investor Services Corp., RBC Dain
Rauscher, John Rideout, and Union Planters Trust & Investment Group.
\33\ Letters from Ameritrade, Inc., BNY Clearing, Mizuho Trust &
Banking Co. (USA), National City Bank, First Clearing Corporation,
RBC Dain Rauscher, and Union Planters Trust & Investment Group.
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Three commenters believe that the final decision regarding custody
and registration should reside with the beneficial owners or their
appointed agents and not with the issuers of such securities.\34\ These
commenters objected to imposing registration restrictions on beneficial
owners, because such registration restrictions would be disruptive to
market practices, would impose costs on investors, and would cause
inefficiencies in the market. Further, nine commenters noted that the
direct registration system (``DRS'')\35\ was specifically designed by
the industry to give shareholders an alternative to either holding a
certificate or holding in street name registration.\36\ Several
commenters pointed to AT&T's decision to dematerialize its securities
as further support of the industry's initiatives to dematerialize.\37\
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\34\ Letters from First Clearing Corporation, Mizuho Trust &
Banking Co. (USA), and John Rideout.
\35\ DRS allows a shareholder to hold a book-entry position in
his or her own name on the books of the issuer. As a result,
shareholders can enjoy the benefits of both holding their securities
in a book-entry system and being a ``named'' shareholder on the
issuer's record.
\36\ Letters from Banc of America Securities LLC, Edward Jones,
Merrill Lynch, Pershing LLC, Prudential Securities Incorporated, RBC
Dain Rauscher, Securities Industry Association Customer Account
Transfer Division, Stearns Securities Corp., and Sterne, Agee &
Leach, Inc.
\37\ Letters from Edward Jones, Pershing LLC, RBC Dain Rauscher,
and Stearns Securities Corp.
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Four commenters stated they believe DTC's proposed rule change
complies with its obligation under section 17A of the Act to promote
the prompt and accurate settlement of securities transactions.\38\ In
fact, one of these commenters stated that honoring issuers' request to
withdraw from DTC was inconsistent with section 17A.\39\ One commenter
expressed surprise that DTC's filing on this issue was necessary
because of the ability of an owner of a negotiable security to register
the securities in whatever name it wished has existed for a long time
under the Uniform Commercial Code and therefore should not be
restricted by the issuer.\40\
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\38\ Letters from A.G. Edwards & Sons, Inc., Banc of America
Securities LLC, Prudential Securities Incorporated, and Securities
Industry Account Customer Account Transfer Division.
\39\ Letter from Prudential Securities Incorporated.
\40\ Letter from A.G. Edwards & Sons, Inc.
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With regard to the naked short selling issue, one commenter
indicated that the withdrawal of securities from DTC would not have any
material or effective impact on the short selling concerns of
issuers.\41\ Another contended that short selling is vital to ensuring
the asset price reflects the underlying fundamentals of the asset and
thereby facilitates a more efficient market.\42\ This commenter noted
that as a result of the additional costs and trade delays associated
with certificate-only securities, some brokers are refusing to conduct
trades in issues that have been withdrawn from DTC, which has resulted
in an illiquid market for those securities.
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\41\ Letter from Citibank North America, Inc.
\42\ Letter from John Rideout.
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C. DTC's Response Letter to Opposing Comment Letters
DTC emphasizes in its response letter that the proposed rule change
does not constitute a departure from DTC's existing rules and
procedures approved by the Commission. Those rules, DTC contends,
govern requests to make shares eligible and enable participants to
withdraw shares on behalf of themselves or their customers from the DTC
system through DTC's withdrawal-by-transfer mechanism.\43\
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\43\ See e.g. Rules 2, 6, and 9 of DTC's Rules.
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Further, DTC states that issuers do not have continuing ownership
rights in shares they have sold into the marketplace and therefore
cannot control the disposition of shares already registered in DTC's
nominee name by directing that those shares be surrendered to the
transfer agent or by restricting their eligibility for book-entry
[[Page 35041]]
transfer at DTC.\44\ DTC contends that attempts by issuers to control
their publicly traded securities are improper and may constitute
conversion. DTC states that by purporting to exercise the rights of the
shareholders, issuers are interfering with the legal and beneficial
rights of DTC and its participants with respect to securities deposited
at DTC and with DTC's obligations under section 17A of the Act.
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\44\ DTC also noted that none of the securities where the issuer
is attempting to restrict the transferability of its shares bear any
legend, conspicuous or otherwise, noting the restrictions.
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DTC disagreed with the commenters' contention that it had an
obligation to take action to resolve the issues associated with naked
short selling because those issues arise in the context of trading and
not in the book-entry transfer of securities. DTC pointed out that if
beneficial owners believe that their interests are best protected by
not having their shares subject to book-entry transfer at DTC, then
they can instruct their broker-dealer to execute a withdrawal-by-
transfer, which will remove the securities from DTC and transfer them
to the shareholder in certificated form.
Finally, DTC contested certain commenters' assertion that issuers
cause their shares to become eligible at DTC and therefore have the
right to withdraw from DTC eligibility. DTC states that most shares are
made eligible at the request of participants and not issuers. But
regardless of how the shares are made eligible, DTC believes it
continues to own and hold the shares for the convenience and at the
request of its participants. DTC believes that if it were to exit
shares upon demand of an issuer, there is no mechanism to ensure that
the shares entrusted to DTC by its participants would be returned to
their rightful owners. This, DTC contended, would be inconsistent with
its obligations under section 17A.
IV. Discussion
Section 17A(b)(3)(F) of the Act requires that the rules of a
clearing agency be designed to promote the prompt and accurate
clearance and settlement of securities transactions and to remove
impediments to and perfect the mechanism of a national system for the
prompt and accurate clearance and settlement of securities
transactions.\45\ For the reasons described below, the Commission finds
that the rule change is consistent with section 17A of the Act.
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\45\ 15 U.S.C. 78q-1(b)(3)(F).
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Pursuant to section 17A of the Act, Congress set forth its finding
that the prompt and accurate clearance and settlement of securities
transactions, including the transfer of record ownership and
safeguarding of securities and funds related to clearance and
settlement activities, is necessary for the protection of investors and
those acting on behalf of investors.\46\ Inefficient clearance and
settlement procedures, Congress found, impose unnecessary costs on
investors and those acting on their behalf.\47\ Congress vested with
the Commission the authority and responsibility to regulate,
coordinate, and direct the operations of all persons involved in
processing securities transactions toward the goal of establishing a
national system for the prompt and accurate clearance and settlement of
transactions in securities (``National Clearance and Settlement
System'') in an effort to increase efficiency and reduce risk.\48\ The
Commission's approval of DTC's registration as a clearing agency
constituted an important step in its efforts to facilitate the
development of a National Clearance and Settlement System and a
significant step in achieving the goals established by Congress.\49\
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\46\ 15 U.S.C. 78q-1(a)(1)(A).
\47\ 15 U.S.C. 78q-1(a)(1)(B).
\48\ 15 U.S.C. 78q-1(a)(1)(A)(i). Congress expressly envisioned
the Commission's authority to extend to every facet of the
securities handling process involving securities transaction within
the United States, including activities by clearing agencies,
depositories, corporate issuers, and transfer agents. See S. Rep.
No. 75, 94th Cong., 1st Sess. at 55 (1975).
\49\ Exchange Act Release No. 20221 (September 23, 1983), 48 FR
45167 (October 3, 1983).
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As a registered clearing agency, DTC has adopted rules under
section 19(b) of the Act to act as a depository that operates a
centralized system for the handling of securities certificates through
book-entry movements.\50\ Generally, those rules, including adoptions,
deletions, or changes to DTC's constitution, articles of incorporation,
bylaws, rules, or stated policies, practices, and interpretations, must
be filed with the Commission and must be approved by the Commission if
the Commission finds the rule change consistent with the Act.\51\
Furthermore, DTC can only act in accordance with its rules. DTC has
adopted rules that permit deposits of securities into DTC by
participants \52\ and rules that permit withdrawals from DTC by
participants and pledgees.\53\ However, DTC has not adopted rules that
permit issuers to withdraw securities from DTC. Accordingly, a
procedure allowing issuers to withdraw securities from DTC would have
to be filed and approved by the Commission. DTC has not filed such a
rule change.
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\50\ As a registered clearing agency, DTC is a self-regulatory
organization and as such, must file with the Commission any proposed
rule or rule change pursuant to section 19 of the Act. 15 U.S.C.
78s(b).
\51\ Section 3(a)(27) of the Act defines the term ``rules of a
clearing agency.'' The Commission's role in the approval of such
rules is described in section 17A and section 19(b) of the Act. 15
U.S.C. 78q-1 and 15 U.S.C. 78s.
\52\ DTC has informed the Commission that issuers of book-entry-
only securities (i.e., some corporate debt and most municipal
securities) enter into a contract with DTC whereby the issuer
deposits their securities into DTC and DTC then credits the
securities to the accounts of participants. See also note 55 infra
and accompanying text.
\53\ See e.g. Rules 2, 6, and 9 of DTC's Rules.
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In accordance with its rules, DTC accepts deposits of securities
from its participants (i.e., broker-dealers and banks), credits those
securities to the depositing participants' accounts, and effects book-
entry movements of those securities.\54\ The securities deposited with
DTC are registered in DTC's nominee name, Cede & Co. (making DTC's
nominee the registered owner of the securities) and are held in
fungible bulk. Each participant or pledgee having an interest in
securities of a given issue credited to its account has a pro rata
interest in the securities of that issue held by DTC. Among other
services it provides, DTC provides facilities for payment by
participants to other participants in connection with book-entry
deliveries of securities, collects and pays dividends and interest to
participants for securities, and provides facilities for the settlement
of institutional trades. By centralizing and automating securities
settlement, by reducing the movement of publicly traded securities in
the U.S. markets, and by facilitating the prompt and accurate
settlement of securities transactions, DTC serves a critical function
in the National Clearance and Settlement System.
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\54\ See e.g. Rule 6 of DTC's Rules. All deposits, whether made
by a participant or, in the case of book-entry-only securities, by
an issuer must be credited to a participant's account at DTC.
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DTC's rules also accommodate withdrawal requests from participants
or under certain conditions, from pledgees.\55\ Securities credited to
a participant's or pledgee's account may be withdrawn in certificated
form (if the issue is not dematerialized).\56\ DTC's rules, both prior
to and after the approval of the clarification which is the subject of
this rule filing, obligates and allows DTC to take instructions only
from its participants.
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\55\ See e.g. Rules 2, 6, and 9 of DTC's Rules.
\56\ See e.g. Rule 6 of DTC's Rules, By-Laws and Organization of
Certificate.
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Some commenters opposing DTC's proposed rule change contend that
issuers should have a choice as to whether their securities are made
[[Page 35042]]
eligible for deposit at DTC. \57\ In this way, these commenters argue,
issuers would be better able to protect their shareholders from the
negative effects naked short selling has on their securities' share
price.\58\ Securities deposited at DTC are registered in the name of
Cede & Co. and are held beneficially for DTC participants, who in turn
may hold the securities beneficially for their customers.\59\ Since DTC
participants and their customers, not issuers, have ownership interest
in the securities, DTC participants and their customers have the
authority to determine whether to deposit securities with DTC or not.
Participants deposit certificates with DTC in order to avail themselves
of the efficiencies and safeguards provided by DTC. It would not be
consistent with DTC rules to allow issuers to withdraw securities which
they have not deposited at DTC or have no ownership interest.
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\57\ Some commenters argued that because some issuers sign an
Operating Agreement or Letter of Representation with DTC in order to
make their shares eligible at DTC, they should retain the right to
withdraw their securities. DTC has informed the Commission that as a
general rule only those issuers who issue in ``book-entry-only''
form (i.e., certain debt and municipal securities where no
certificate is available) sign an Operating Agreement with DTC.
Furthermore, DTC's Underwriting Service Guide, which describes DTC's
eligibility requirements and deposit process, makes clear that
generally only issuers of book-entry-only securities must execute a
Letter of Representation to make the securities eligible for
deposit. Since most equity securities make certificates available,
participants make most deposits of securities into DTC.
\58\ A short sale is generally a sale of a security that the
seller does not own or as effectuated by the delivery of borrowed
securities within the required settlement timeframe. Although the
Commission notes that a ``naked short sale'' is not a defined term,
it generally refers to where a seller sells a security without
owning or borrowing the security and does not deliver when delivery
is due.
\59\ DTC participants holding securities on behalf of a customer
are generally obligated to act pursuant to their customers'
instructions.
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Furthermore, the issues surrounding naked short selling are not
germane to the manner in which DTC operates as a depository registered
as a clearing agency. Decisions to engage in such transactions are made
by parties other than DTC. DTC does not allow its participants to
establish short positions resulting from their failure to deliver
securities at settlement. While the Commission appreciates commenters'
concerns about manipulative activity, those concerns must be addressed
by other means.\60\
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\60\ See Rhino Advisors, Inc. and Thomas Badian: Lit. Rel. No.
18003 (February 27, 2003); See also SEC v. Rhino Advisors, Inc. and
Thomas Badian, Civ. Action No. 03 civ 1310 (RO) (Southern District
of New York).
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Several commenters claim that DTC is acting arbitrarily by
permitting some issuers to withdraw their securities while prohibiting
others from withdrawing their securities because DTC did accommodate a
few earlier requests from issuers in the belief that they were unusual
circumstances. However, DTC only withdrew these securities based upon
instructions made by participants pursuant to DTC's rules and
procedures. DTC bore the substantial expense resulting from
coordinating the communications and actions among DTC participants, the
transfer agent, and the issuer in order to accommodate each issuer's
request. When it became clear to DTC that many more issuers intended to
attempt to withdraw their securities from DTC, it decided that it would
no longer bear the substantial additional cost and expense of time in
accommodating such requests. In none of the situations where DTC
assisted an issuer in having its securities withdrawn did DTC act on an
issuer's instructions. DTC facilitated the issuer by having DTC
participants issue instructions to withdraw the securities.
With regard to commenters' contention that state law permits
companies to adopt certain restrictions on publicly traded securities,
this filing does not address the validity of such restrictions since
the securities that are the subject of this filing are securities which
are registered in the name of (i.e., legally owned) Cede & Co. prior to
the imposition of any restrictions. The securities of issuers, such as
the ones that recently attempted to withdraw their securities from DTC,
were issued without restrictions or notice of an adverse claim, and no
restrictions were imposed on or claims made against the securities when
DTC participants deposited the securities at DTC or when the transfer
agent registered them in the name of Cede & Co.
While not a direct subject of this rule filing, we note that
actions by some issuers of publicly traded securities to require
transfer only by certificate \61\ and to restrict ownership of the
securities by a depository or financial intermediary could result many
of the inefficiencies and risks sought to be avoided when Congress
promulgated section 17A of the Act.\62\ We also note in this connection
that section 17A(e) directs the Commission to use its authority ``to
end the physical movement of the securities certificate in connection
with settlement among brokers and dealers of securities transactions by
means of the mails or other means or instrumentalities of interstate
commerce.'' \63\ Consistent with this directive, the Commission has
encouraged the use of alternatives to holding securities in
certificated form in an effort to improve efficiencies and decrease
risks associated with processing securities certificates. Among other
things, the Commission has approved the rule filings of self-regulatory
organizations that require their members to use the facilities of a
securities depository for the book-entry settlement of all transactions
in depository-eligible securities \64\ and require that, before any
security can be listed for trading, it must have been made depository
eligible if possible.\65\ More recently the Commission has approved the
implementation and expansion of DRS.\66\
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\61\ One commenter questioned how AT&T could choose to
dematerialize but other issuers cannot choose to issue in
certificated form only. AT&T is incorporated in the State of New
York and trading on the New York Stock Exchange (``NYSE''). New York
law permits companies to issue in book-entry-only and NYSE rules
permit listed companies to not offer certificates provided the
issuer is participating in DRS pursuant to NYSE rules. However,
prior to AT&T dematerializing, the vast majority of AT&T's stock was
immobilized at DTC in order to facilitate book-entry transfers at
DTC. Only individuals holding certificates were practically effected
by AT&T's decision to dematerialize.
\62\ We note that in the late 1960s and early 1970s, the
securities industry experienced a ``Paperwork Crisis'' that nearly
brought the industry to a standstill and directly or indirectly
caused the failure of large number of broker-dealers. This crisis
primarily resulted from increasing trade volume coupled with
inefficient, duplicative, and extensively manual clearance and
settlement systems particularly with securities certificates, poor
records, and insufficient controls over funds and securities.
Securities and Exchange Commission, Study of Unsafe and Unsound
Practices of Brokers and Dealers, H.R. Doc. No. 231, 92nd Cong., 1st
Sess. 13 (1971). Congress held extensive hearings to investigate the
problems and ultimately enacted the Securities Acts Amendments of
1975. Securities Acts Amendments of 1975: Hearings on S. 3412, S.
3297, S. 2551 Before the Subcomm. On Securities of the Senate Comm.
on Banking, Housing and Urban Affairs, 92nd Cong., 2nd Sess. (1972).
\63\ 15 U.S.C. 78q-1(e). See also supra note 46 and accompanying
text.
\64\ Securities Exchange Act Release No. 32455 (June 11, 1993),
58 FR 33679 (June 18, 1993) (order approving rules requiring
members, member organizations, and affiliated members of the New
York Stock Exchange, National Association of Securities Dealers,
American Stock Exchange, Midwest Stock Exchange, Boston Stock
Exchange, Pacific Stock Exchange, and Philadelphia Stock Exchange to
use the facilities of a securities depository for the book-entry
settlement of all transactions in depository-eligible securities
with another financial intermediary).
\65\ Securities Exchange Act Release No. 35798 (June 1, 1995),
60 FR 30909 (June 12, 1995) (order approving rules setting forth
depository eligibility requirements for issuers seeking to have
their shares listed on the exchange).
\66\ DRS provides an investor with the ability to register her
securities in her own name on the issuer's records and to
efficiently transfer by book-entry movements her securities
positions to her broker. Using DRS, an investor can register a
position directly with the issuer and can electronically move the
position to a broker of choice for disposition within the current
settlement timeframes as well as within any future shortened
settlement cycle.
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[[Page 35043]]
The use of certificates can result in significant delays and
expenses in processing securities transactions and can raise safety
concerns associated with lost, stolen, and forged certificates. The
concerns associated with lost certificates was dramatically
demonstrated during the September 11, 2001, tragedy when tens of
thousand of certificates maintained in broker-dealers' vaults either
were destroyed or were unavailable for transfer.
Accordingly, for the reasons stated above the Commission finds that
the rule change, which clarifies that DTC's rules only permit it to
honor its participants' requests to withdraw securities, is consistent
with section 17A of the Act.
V. Conclusion
On the basis of the foregoing, the Commission finds that the
proposed rule change is consistent with the requirements of the Act and
in particular with the requirements of section 17A(b)(3)(F) 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 change
(File No. SR-DTC-2003-02) be and hereby is approved.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\67\
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\67\ 17 CFR 200.30-3(a)(12).
J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 03-14642 Filed 6-10-03; 8:45 am]
BILLING CODE 8010-01-P