

[Federal Register: April 20, 2006 (Volume 71, Number 76)]
[Notices]               
[Page 20428-20429]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr20ap06-66]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53655; File No. SR-DTC-2006-03]

 
Self-Regulatory Organizations; The Depository Trust Company; 
Order Approving Proposed Rule Change to Amend the Criteria Used to 
Place Participants on Surveillance Status

April 14, 2006.

I. Introduction

    On February 3, 2006, The Depository Trust Company (``DTC'') filed 
with the Securities and Exchange Commission (``Commission'') proposed 
rule change SR-DTC-2006-03 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 March 14, 2006.\2\ The 
Commission received no comment letters in response to the proposed rule 
change. For the reasons discussed below, the Commission is approving 
the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 53435 (March 7, 2006), 
71 FR 13198.
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II. Description

Overview

    DTC has developed certain criteria for placing participants on 
surveillance. Specifically, all broker-dealers from which DTC requires 
the submission of FOCUS or FOGS reports and banks from which DTC 
requires the submission of CALL reports \3\ are assigned a rating that 
is generated by entering financial data of the participant into a risk 
evaluation matrix (``Matrix'') that was developed by

[[Page 20429]]

credit risk staff.\4\ Those participants with a ``weak'' rating (i.e., 
deemed to pose a relatively higher degree of risk to DTC) are placed on 
an internal ``watch list'' and are monitored more closely. All 
participants that do not fall into the categories of banks and broker-
dealers mentioned above are not currently included in the Matrix 
process but are monitored by DTC's credit risk staff using financial 
criteria deemed relevant by DTC.\5\
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    \3\ A small number of DTC member banks which submit CALL reports 
are not assigned a rating. Because these banks do not make loans and 
do not take deposits as part of their business activities, their 
CALL reports do not contain information on asset quality and/or 
liquidity. Asset quality and liquidity are among the financial 
figures used in the Matrix. Since these figures would be zero in the 
Matrix for these banks, their Matrix results would not adequately 
portray their financial status. DTC has therefore concluded that 
these banks do not lend themselves to appropriate analysis using the 
Matrix.
    \4\ The Matrix is used by DTC and its affiliated clearing 
agencies, the Fixed Income Clearing Corporation (``FICC'') and the 
National Securities Clearing Corporation (``NSCC''). In using the 
Matrix, credit risk staff uses the financial data of each applicable 
DTC participant and the financial data of each applicable member of 
FICC and NSCC. In this way, each applicable DTC participant, FICC 
member, and NSCC member are rated against each other.
    \5\ DTC will continually evaluate the matrix methodology and its 
effectiveness and will make such changes as it deems prudent and 
practicable within such time frames as it determines to be 
appropriate. DTC will update the Commission staff periodically on 
its evaluations of the Matrix.
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Procedures

    Credit risk staff approaches its analysis of participants in the 
following manner. First, the required information of designated broker-
dealers and banks are entered into the Matrix, and a rating for each 
participant is generated. Low-rated participants are placed on the 
watch list. At this point, credit risk staff may downgrade a particular 
participant's rating based on various qualitative factors. For example, 
one qualitative factor might be that the participant in question 
received a qualified audit opinion on its annual audit. In order for 
DTC to protect itself and its participants, it is important that credit 
risk staff maintain the discretion to downgrade a participant's Matrix 
rating and thus subject the participant to closer monitoring. All rated 
participants, including those on the watch list, are monitored monthly 
or quarterly, depending upon the participant's financial filing 
frequency, against basic minimum financial requirements and other 
parameters.
    All broker-dealer participants included on the watch list are 
monitored more closely than those not on the watch list. This means 
that they are monitored for various parameter breaks which may include, 
but are not limited to, such things as a defined decline in excess net 
capital over a one month or three month period, a defined period loss, 
a defined aggregate indebtedness/net capital ratio, a defined net 
capital/aggregate debit items ratio, or a defined net capital/
regulatory net capital ratio. All bank participants included on the 
watch list are also monitored more closely for watch list parameter 
breaks which may include, but are not limited to, such things as a 
defined quarter loss, a defined decline in equity, a defined tier one 
leverage ratio, a defined tier one risk-based capital ratio, and a 
defined total risk-based capital ratio.
    Credit risk staff also monitors those participants not included in 
the Matrix process using similar criteria.\6\ These criteria may 
include, but are not limited, to such things as failure to meet minimum 
financial requirements, experiencing a significant decrease in equity, 
or a significant loss. This class of participants may be placed on the 
watch list based on credit risk staff's analysis of this information. 
DTC continues to reserve the right to place a participant on the watch 
list for failure to comply with operational standards and 
requirements.\7\
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    \6\ Participants that are not included in the Matrix are: the 
banks discussed in footnote 3, United States (``U.S.'') branches and 
agencies of non-U.S. banks, non-U.S. central securities 
depositories, and U.S. government sponsored enterprises.
    \7\ Participants are required to meet the standards of financial 
condition, operational capability, and character set forth in DTC 
Rule 2 (Participants and Pledgees).
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III. Discussion

    Section 19(b) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
such proposed rule change is consistent with the requirements of the 
Act and the rules and regulations thereunder applicable to such 
organization. Section 17A(b)(3)(F) of the Act requires that the rules 
of a clearing agency be designed to facilitate the safeguarding of 
securities and funds which are in its custody or control or for which 
it is responsible.\8\ The Commission finds that DTC's proposed rule 
change is consistent with this requirement because it improves DTC's 
member surveillance process which should better enable DTC to safeguard 
the securities and funds which are in its custody or control or for 
which it is responsible.
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    \8\ 15 U.S.C. 78q-1(b)(3)(F).
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IV. 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 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 change (File No. SR-DTC-2006-03) be and hereby 
is approved.
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    \9\ 17 CFR 200.30-3(a)(12).

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\9\
Jill M. Peterson,
Assistant Secretary.
[FR Doc. E6-5933 Filed 4-19-06; 8:45 am]

BILLING CODE 8010-01-P
