
[Federal Register: December 29, 2008 (Volume 73, Number 249)]
[Notices]               
[Page 79528-79530]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr29de08-102]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-59111; File No. SR-FICC-2007-04]

 
Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Approving a Proposed Rule Change Relating to Applicant and Member 
Disqualification Criteria

December 17, 2008.

I. Introduction

    On April 30, 2007, the Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission'') a 
proposed rule change pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'').\1\ On February 7, 2008, and March 19, 
2008, FICC amended the proposed rule change. On July 9, 2008, the 
Commission published notice of the proposed rule change to solicit 
comments from interested persons.\2\ The Commission received two 
comment letters in response to the proposed rule change.\3\ For the 
reasons discussed

[[Page 79529]]

below, the Commission is approving the proposed rule change, as 
amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 58128, 73 FR 40893 (July 
16, 2008).
    \3\ Letters from Susanne Trimbath, Ph.D., STP Advisory Services, 
LLC (Aug. 27, 2008) and Nikki M. Poulos, Managing Director, General 
Counsel, FICC (Nov. 7, 2008).
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II. Description

    The proposed rule change will amend FICC's Government Securities 
Division's (``GSD'') and Mortgage Backed Securities Division's 
(``MBSD'') (collectively, ``Divisions'') rules concerning applicant and 
member disqualification criteria by making the Divisions' rules 
consistent with the rules of FICC's affiliated clearing agencies, the 
National Securities Clearing Corporation (``NSCC'') and The Depository 
Trust Company (``DTC''). The proposed rule changes cover the following 
areas:

1. Management Consideration of Disqualification Criteria \4\

    Prior to this rule change, GSD's membership qualification rules 
required FICC's Board of Directors to determine whether the presence of 
certain negative factors affecting a membership application should 
constitute the basis for denying membership to such applicant. 
Information that might have disqualified an applicant (referred to in 
GSD's rules as ``disqualification criteria'') include the applicant 
being subject to a statutory disqualification \5\ or conviction of 
various crimes such as bribery. The disqualification criteria in GSD's 
rules similarly apply as standards for continued membership.
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    \4\ GSD Rule 2A, Section 3(d).
    \5\ The definition of ``statutory disqualification'' is found at 
15 U.S.C. 78c(a)(39).
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    Under the rule change, FICC will amend GSD's disqualification 
criteria to allow FICC's management, instead of FICC's Board, to 
determine whether the presence of a potential disqualifier should 
prevent an entity from obtaining or continuing membership in GSD. Such 
change would conform to the rules of MBSD, DTC, and NSCC, which allow 
such determinations to be made by management.

2. Associated and Affiliated Persons

    GSD's and MBSD's rules also apply certain applicant and member 
disqualification criteria to persons ``associated'' (in GSD's rules) or 
``affiliated'' (in MBSD's rules) with the applicant or member firm. 
FICC states that it is not always practical for it to ascertain which 
individuals are ``associated'' or ``affiliated'' with a particular 
entity and therefore proposes to amend these rules to conform them to 
its internal surveillance procedures and make them consistent across 
both Divisions. Accordingly, references to persons ``associated'' or 
``affiliated'' with the member or applicant are being changed to 
references to ``controlling management,'' which include those officers 
of the applicant or member that are currently screened by FICC's Risk 
Management department pursuant to internal procedures.\6\ In addition, 
FICC will add language to its rules to require applicants to inform 
FICC as to any member of its controlling management that is or becomes 
subject to statutory disqualification.
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    \6\ New GSD Rule 1 and MBSD Article I (``The term `controlling 
management' shall mean the Chief Executive Officer, the Chief 
Financial Officer, and the Chief Operations Officer, or their 
equivalents, of an applicant of Participant.'').
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3. Monitoring of Objective Disqualification Criteria

    GSD's disqualification criteria is being amended to reflect an 
approach that such criteria should be objectively and practically 
monitored. Specifically, FICC will delete one disqualification 
criterion that refers to an applicant being subject to ``closer than 
normal'' surveillance by a regulatory body. FICC states that this event 
might not be reported in a regulatory background check.
    In addition, prior to this rule change, MBSD's rules contained only 
two criteria that could be the basis for denial of a membership 
application. These were: (i) An applicant's subjection to a statutory 
disqualification or similar order by another examining authority and 
(ii) an applicant or an associated person of the applicant making a 
misstatement of a material fact in connection with its membership 
application or thereafter. Under this rule change, MBSD will add GSD's 
remaining disqualification criteria relating to unlawful acts by the 
applicant's or member's Controlling Management or the applicant's or 
member's suspension or expulsion from a self-regulatory organization. 
These additions to MBSD's rules will result in both Divisions having 
identical disqualification criteria.
    Finally, FICC will add a provision to both Divisions' rules that 
clarifies FICC's right to deny membership to an applicant or member if 
FICC learns of any factor or circumstance that might impact the 
suitability of that particular applicant or member as a participant.

4. Additional Changes

    FICC will make the following changes to provide additional 
uniformity among the rules of the Divisions, NSCC, and DTC:
    (i) Adding to both Divisions' disqualification criteria violations 
of the Investment Company Act and Investment Advisers Act,\7\ since 
those statutes apply to their current membership base.
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    \7\ 15 U.S.C. 80a-1 et seq. and 15 U.S.C. 80b-1 et seq., 
respectively.
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    (ii) Amending GSD's definition of ``self-regulatory organization'' 
to include those entities that are foreign equivalents. The same 
definition for ``self-regulatory organization'' would be added to 
MBSD's rules.
    (iii) Removing the word ``willful'' from both Divisions' 
disqualification criteria concerning an applicant's or an applicant's 
controlling management's violation of the specified federal statutes or 
any rule or regulation promulgated thereunder. FICC believes that a 
violation of these provisions, whether or not willful, should be 
considered as a potential disqualification criterion.
    (iv) Deleting references in GSD's rules to Section 153 of Chapters 
25 and 47 of Title 18 of the United States Code (``Code'') because the 
crimes covered by these statutes (i.e., embezzlement, forgery, false 
statements, etc.) are captured by the current disqualification 
criteria. References to those portions of the Code that deal with mail 
and wire fraud (Sections 1341, 1342 and 1343) would remain. This 
provision will also be added to MBSD's rules.
    Changes are being made to the cease to act provisions of GSD's 
rules (Rule 21, ``Restrictions on Access to Services'') in order to 
ensure consistency within the rules and across the Divisions.

III. Comment Letters \8\

    Susanne Trimbath, PhD., of STP Advisory Services, LLC, suggested 
that FICC should also consider an entity's ability to deliver 
securities for settlement when determining an applicant's or member's 
suitability as a participant. Ms. Trimbath pointed out that this 
recommendation is consistent with the Section 17A(a)(5)(C) of the Act 
\9\ and claimed thatthe cost of FICC members failing to deliver 
securities at settlement is significant and harms fellow FICC members 
and investors.
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    \8\ See supra note 3.
    \9\ 15 U.S.C. 78q-1(a)(c)(5) (``A registered clearing agency may 
summarily suspend and close the accounts of a participant who * * * 
is in default of any delivery of funds or securities to the clearing 
agency.'').
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    Nikki Poulos, FICC's General Counsel, responded to Ms. Trimbath's 
comment. While Ms. Poulos acknowledged securities transactions fails as 
a serious issue for the securities industry, she argued that FICC has 
attempted to reduce the risks posed by fails.\10\

[[Page 79530]]

Moreover, Ms. Poulos believes that including a participant's fails as a 
criterion by which FICC would have to assess participation ``would only 
create more risks in that these open obligations would be processed (or 
not) outside of FICC, without the benefit of, i.e., re-netting.''
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    \10\ See, e.g., Securities Exchange Act Release Nos. 52157 (July 
28, 2005), 70 FR 44959 (Aug. 4, 2005) [FICC-2005-11] (establishing a 
daily fail netting process basis allowing participants to net 
outstanding fail obligations with current settlement activity in 
order to reduce risk exposure among FICC participants) and 54487 
(Sept. 22, 2006), 71 FR 58025 (Oct. 2, 2006) [FICC-2005-17] (FICC 
assumes certain fails of blind brokered repurchase transactions at 
GSD and obtains financing as necessary in connection with such 
assumptions).
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IV. Discussion

    Section 17A(b)(3)(F) of the Act requires, among other things, that 
the rules of a clearing agency be designed to assure the safeguarding 
of securities and funds which are in its custody or control or for 
which it is responsible.\11\ The proposed rule change should enhance 
FICC's surveillance and assessment of applicants' and members' 
regulatory conditions. In addition, the proposed rule change will 
harmonize both of FICC's division's application and membership 
requirements and will make clear to all applicants and members of the 
breadth of information that FICC will require and review in order to 
develop an accurate risk profile to evaluate an applicant's or member's 
condition. Accordingly, the proposed rule should strengthen FICC's 
ability to mitigate financial risk to itself and to its members and 
therefore should enhanced FICC's ability to assure the safeguarding of 
securities and funds that are in its custody or control or for which it 
is responsible.
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    \11\ 15 U.S.C. 78q-1(b)(3)(F).
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    The Commission also agrees that the issue of ``fails'' is a serious 
one for the securities industry. The Commission will continue to 
monitor developments in this area and will use its regulatory authority 
if needed to better ensure that appropriate safeguards are in place to 
facilitate the prompt and accurate clearance and settlement of 
securities transactions and to protect investors. In this regard, the 
Commission expects FICC, as a self-regulatory organization and 
registered clearing agency, to similarly continue to scrutinize its 
participants' effectiveness in delivering funds and securities in 
fulfillment of their obligations when using FICC's clearing facilities.

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 Section 17A \12\ of the Act and the rules and regulations 
thereunder.\13\
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    \12\ 15 U.S.C. 78q-1.
    \13\ In approving the proposed rule change, the Commission 
considered the proposal's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\14\ that the proposed rule change (File No. SR-FICC-2007-04), as 
amended, be and hereby is approved. For the Commission by the Division 
of Trading and Markets, pursuant to delegated authority.\15\
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    \14\ 15 U.S.C. 78s(b)(2).
    \15\ 17 CFR 200.30-3(a)(12).

Florence E. Harmon,
Acting Secretary.
[FR Doc. E8-30786 Filed 12-24-08; 8:45 am]

BILLING CODE 8011-01-P
