

[Federal Register: August 16, 2006 (Volume 71, Number 158)]
[Notices]               
[Page 47276-47278]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr16au06-141]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54288; File No. SR-NASDAQ-2006-008]

 
 Self-Regulatory Organizations; The NASDAQ Stock Market LLC; 
Order Granting Approval of a Proposed Rule Change Requiring Securities 
be Eligible To Participate in a Direct Registration System

August 8, 2006.

I. Introduction

    On April 27, 2006, The NASDAQ Stock Market LLC (``Nasdaq'') filed 
with the Securities and Exchange Commission (``Commission'') proposed 
rule change SR-NASDAQ-2006-008 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 June 7, 2006.\2\ Two comment 
letters were received.\3\ For the reasons discussed below, the 
Commission is granting approval of the proposed rule change.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 53913 (May 31, 2006), 71 
FR 33024 (June 7, 2006) [File No. SR-NASDAQ-2006-008].
    \3\ Letters from Noland Cheng, Chairman, SIA Operations 
Committee, Securities Industry Association (June 27, 2006) and Paul 
Conn, President, Global Capital Markets, Computershare Limited, and 
Charlie Rossi, Executive Vice President, Computershare Investor 
Services (July 28, 2006).
    \4\ Concurrent with the Commission's approval of Nasdaq's rule 
change, the Commission is also approving in separate orders similar 
rule changes proposed by the American Stock Exchange LLC (``Amex'') 
and the New York Stock Exchange LLC (``NYSE''). Securities Exchange 
Act Release Nos. 54290 (August 8, 2006) [File No. SR-Amex-2006-40] 
and 54289 (August 8, 2006) [File No. SR-NYSE-2006-29]. The 
Commission has also published notice of a similar rule changed 
proposed by NYSE Arca, Inc. Securities Exchange Act Release No. 
54126 (July 11, 2006), 71 FR 40768 (July 18, 2006) [File No. SR-
NYSEArca-2006-31].
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II. Description

    The Direct Registration System (``DRS'') allows an investor to 
establish either through the issuer's transfer agent or through the 
investor's broker-dealer a book-entry position on the books of the 
issuer and to electronically transfer her position between the transfer 
agent and the broker-dealer of her choice through a facility currently 
administered by The Depository Trust Company (``DTC'').\5\ DRS, 
therefore, enables an investor to have securities registered in her 
name without having a securities certificate issued to her and to 
electronically transfer her securities to her broker-dealer in order to 
effect a transaction without the risk and delays associated with the 
use of securities certificates.
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    \5\ Currently, the only registered clearing agency operating a 
DRS is DTC. For a detailed description of DRS and the DRS facilities 
administered by DTC, see Securities Exchange Act Release Nos. 37931 
(November 7, 1996), 61 FR 58600 (November 15, 1996), [File No. SR-
DTC-96-15] (order granting approval to establish DRS) and 41862 
(September 10, 1999), 64 FR 51162 (September 21, 1999), [File No. 
SR-DTC-99-16] (order approving implementation of the Profile 
Modification System).
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    Investors holding their securities in DRS retain the rights 
associated with securities certificates, including such rights as 
control of ownership and voting rights, without having the 
responsibility of holding and safeguarding securities certificates. In 
addition, in corporate actions such as reverse stock splits and 
mergers, cancellation of old shares and issuance of new shares are 
handled electronically with no securities certificates to be returned 
to or received from the transfer agent.
    In order to reduce the number of transactions in securities for 
which settlement is effected by the physical delivery of securities 
certificates and thereby reduce the risks, costs, and delays associated 
with the physical delivery of securities certificates, Nasdaq is 
proposing to add new Section (l) to its Rule 4350 to require that all 
listed securities be eligible to participate in DRS.\6\ While the rule 
change requires that issuers' securities be eligible for DRS, it does 
not require issuers to participate in DRS operated by DTC and would not 
mandate the elimination of physical certificates. As a result, subject 
to applicable state law and the company's governing documents, an 
investor could still elect to receive a certificate if the issuer chose 
to make certificates available.
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    \6\ The exact text of the Nasdaq proposed rule change is set 
forth in its filing, which can be found at http://www.complinet.com/nasdaq/display/display.html?rbid=1705&elementid=26
.

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    Because currently the only DRS operated by a registered clearing 
agency is the DRS operated by DTC, in order for a security to be 
eligible to participate in DRS, an issuer will be required to use a 
transfer agent that meets DTC's DRS transfer agent requirements, 
including insurance and connectivity requirements. As a result, some 
transfer agents acting for Nasdaq issuers may have to make changes to 
comply with these requirements. Certain issuers may also have to make 
amendments to their governing documents, such as their by-laws, to be 
eligible to issue securities that are not represented by certificates. 
To allow sufficient time for any of these changes that need to take 
place, Nasdaq will implement the proposed rule change January 1, 2008, 
for the securities of issuers with securities already listed on Nasdaq 
or another listed marketplace at the time the rule change is approved. 
Companies listing for the first time should have greater flexibility to 
adopt any changes required to have their securities DRS eligible, and 
therefore, the rule change will be applicable to new listings beginning 
January 1, 2007. The requirement will not apply to non-equity 
securities that are held in book-entry-only form.

III. Comment Letters

    The Commission received two comment letters in support of the 
proposed rule change.\7\ The SIA Operations Committee (``SIA''), an 
industry organization representing broker-dealers, stated that the 
effect of the proposed rule change will be to reduce significantly the 
number of transactions in securities for which settlement is effected 
by the physical delivery of securities certificates thereby reducing 
costs, risks, and delays associated with physical settlement. The SIA 
also contended that by increasing the number of DRS-eligible 
securities, the proposed rule change is an important step in reducing 
the number physical certificates, a goal the SIA has long supported in 
its efforts to promote immobilization and dematerialization.
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    \7\ Supra note 3. The SIA and Computershare's comment letters 
were written in support of the three similar proposed rule changes 
filed by Amex, Nasdaq, and NYSE. Supra note 4. The NYSE Arca's 
proposed rule change was noticed by the Commission subsequent to the 
date the commenters submitted their comment letters.
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    Computershare, a registered transfer agent, stated that the 
proposed rule change will help immobilize and eventually dematerialize 
certificates in the U.S. market, which it believes will result in 
benefits such as cost savings,

[[Page 47277]]

increased efficiency, more accurate and timely trade settlements, and 
reduced risk of loss for investors. Computershare noted however that 
some challenges remain to be overcome in the broker-dealer community 
before these benefits can be realized. For example, Computershare 
contended, among other things, that broker-dealers are not sufficiently 
educating their employees or their customers about the inherent risks 
associated with owning certificates or the benefits of owning in DRS. 
In addition, Computershare stated that certain current industry 
processing practices also need to be changed. Specifically, it believes 
that the industry should ``default to DRS,'' a process whereby 
customers of broker-dealers would obtain only a statement of their 
positions held on the issuer's records rather than a certificate unless 
the customer contacted the issuer's transfer agent directly to obtain a 
certificate. Computershare urged the Commission to review and modify 
current regulation to address these issues.

IV. Discussion

    Section 6(b)(5) of the Act requires, among other things, that the 
rules of an exchange be designed to prevent fraudulent and manipulative 
acts and practices, to promote just and equitable principles of trade, 
to foster cooperation and coordination with persons engaged in 
regulating, clearing, settling, processing information with respect to, 
and facilitating transactions in securities, to remove impediments to 
perfect the mechanism of a free and open market and a national market 
system, and, in general, to protect investors and the public 
interest.\8\ For the reasons described below, the Commission finds that 
the rule change is consistent with Section 6(b)(5) of the Act.
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    \8\ 15 U.S.C. 78f(b)(5).
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    The use of securities certificates has long been identified as an 
inefficient and risk-laden mechanism by which to hold and transfer 
ownership.\9\ Because securities certificates require manual 
processing, their use can result in significant delays and expenses in 
processing securities transactions and present the risk of certificates 
being lost, stolen, or forged. Many of these costs and risks are 
ultimately borne by investors.\10\ Congress has recognized the problems 
and dangers that the use of certificates presents to the safe and 
efficient operation of the U.S. clearance and settlement system and has 
given the Commission responsibility and authority to address these 
issues.\11\
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    \9\ Securities Exchange Act Release No. 49405 (March 11, 2004), 
69 FR 12922 (March 18, 2004), [File No. S7-13-04] (Securities 
Transaction Settlement Concept Release).
    \10\ Id.
    \11\ 15 U.S.C. 78q-1(a)(2)(A). Congress expressly envisioned the 
Commission's authority to extend to all aspects of the securities 
handling process involving securities transactions 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).
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    Consistent with its Congressional directives, in its efforts to 
improve efficiencies and decrease risks associated with processing 
securities transactions, the Commission has long advocated a reduction 
in the use of certificates in the trading environment by immobilizing 
or dematerializing securities and has encouraged the use of 
alternatives to holding securities in certificated form. 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 \12\ and that require any security 
listed for trading must be depository eligible if possible.\13\ More 
recently the Commission has approved the implementation and expansion 
of DRS.\14\
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    \12\ 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).
    \13\ Securities Exchange Act Release No. 35798 (June 1, 1995), 
60 FR 30909 (June 12, 1995), [File Nos. SR-Amex-95-17; SR-BSE-95-09; 
SR-CHX-95-12; SR-NASD-95-24; SR-NYSE-95-19; SR-PSE-95-14; SR-PHLX-
95-34] (order approving rules setting forth depository eligibility 
requirements for issuers seeking to have their shares listed on the 
exchange).
    \14\ In 1996, the NYSE modified its listing criteria to permit 
listed companies to issue securities in book entry form provided 
that the issue is included in DRS. Securities Exchange Act Release 
No. 37937 (November 8, 1996), 61 FR 58728 (November 18, 1996), [File 
No. SR-NYSE-96-29]. Similarly, the NASD modified its rule to require 
that if an issuer establishes a direct registration program, it must 
participate in an electronic link with a securities depository in 
order to facilitate the electronic transfer of the issue. Securities 
Exchange Act Release No. 39369 (November 26, 1997), 62 FR 64034 
(December 3, 1997), [File No. SR-97-51]. On July 30, 2002, the 
Commission approved a rule change proposed by the NYSE to amend 
Section 501.01 of the NYSE Listed Company Manual to allow a listed 
company to issue securities in a dematerialized or completely 
immobilized form and therefore not send stock certificates to record 
holders, provided the company's stock is issued pursuant to a 
dividend reinvestment program, stock purchase plan, or is included 
in DRS. Securities Exchange Act Release No. 46282 (July 30, 2002), 
67 FR 50972 (August 6, 2002), [File No. SR-NYSE-2001-33].
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    While the U.S. markets have made great progress in immobilization 
and dematerialization for institutional and broker-to-broker 
transactions, many industry representatives believe that the small 
percentage of securities held in certificated form (mostly by retail 
customers of broker-dealers) impose unnecessary risk and 
disproportionately large expense to the industry and to investors. In 
an attempt to address this issue, Nasdaq's rule change, along with 
those of Amex and the NYSE, should help expand the use of DRS. As a 
result, risks, costs, and processing inefficiencies associated with the 
physical delivery of securities certificates should be reduced, and the 
perfection of the national market system should be promoted. 
Additionally, those investors holding securities in listed securities 
covered by the rule change that decide to hold their securities in DRS 
should realize the benefits of more accurate, quicker, and more cost-
efficient transfers; faster distribution of sale proceeds; reduced 
number of lost or stolen certificates and a reduction in the associated 
certificate replacement costs; and consistency of owning in book-entry 
across asset classes.
    The Commission realizes that some issuers and transfer agents may 
bear expenses related to complying with the rule change. In order to 
make a security DRS-eligible, issuers of listed companies must have a 
transfer agent which is a DRS Limited Participants.\15\ In order to 
make an issue DRS-eligible, issuers may need to amend their corporate 
governing documents to permit the issuance of book-entry shares. The 
Commission believes, however, that the long-term benefits of increased 
efficiencies and reduced risks afforded by DRS outweigh the costs that 
some issuers and transfer agents may incur. Furthermore, the time 
frames built into the proposal should allow issuers sufficient time to 
make any necessary changes to comply with the rule change.
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    \15\ For a description of DTC's rules relating to DRS Limited 
Participants, see Securities Exchange Act Release Nos. 37931 and 
41862. Supra note 5.
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    While the propose rule change should significantly reduce the 
number of transactions in securities for which settlement is effected 
by the physical delivery of securities certificates, the proposed rule 
change will not eliminate the ability of investors to obtain securities 
certificates after the settlement of securities transactions provided 
the issuer has chosen to issue certificates. Such investors can 
continue to contact the issuer's transfer agent,

[[Page 47278]]

either directly or through their broker-dealer, to obtain a securities 
certificate.
    Accordingly, for the reasons stated above the Commission finds that 
the rule change, is consistent with Nasdaq's obligation under Section 
6(b) of the Act to foster cooperation and coordination with persons 
engaged in regulating, clearing, settling, processing information with 
respect to, and facilitating transactions in securities, to remove 
impediments to perfect the mechanism of a free and open market and a 
national market system, and, in general, to protect investors and the 
public interest.

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 6(b)(5) 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-NASDAQ-2006-008) be and 
hereby is approved.
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    \16\ 17 CFR 200.30-3(a)(12).

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\16\
Nancy M. Morris,
Secretary.
[FR Doc. E6-13416 Filed 8-15-06; 8:45 am]

BILLING CODE 8010-01-P
