SECURITIES AND EXCHANGE COMMI$SI°l'BLIC. :I . t) V1 q 1
Agency decision
Ask Donna
What actually matters in this document.
Text
AC'l
ìCA
SECTION
UNITED
STATES RUI,E \1r~S
SECURITIES AND EXCHANGE COMMI$SI°l'BLIC. :I . t) V1 q 1
WASHINGTON. D.C. 20549 AVAILABILIT . j \ \ ~
DIVISION OF
INVESTMENT MANAGEMENT
July 10, 1997
VI FACSIM AN AI MA
Dr. Evgeni Zogrski
Magig Dirtor
Maceoni Stock Exchange
20 Mito HadzivasIlev Str.
P.O. Box 852
9100 Skopje
MACEDONI
Dea Dr. Zogrski:
Than you for your letter (undated), which we reived on June 25, 1997. You ask
whether the currnt and future custoal and cleag system in Maceoni qua as eligible
foreign cnstodis under Rule 17f-5 under the Investment Company Act of 1940 (the
"Investment Company Act"). You also ask whether the sta of the U:S. Securities and
Exchange Commssion (the "SEC") must investigate the .Maceoni Stock Exchange (the
"MSE") before it ca issue a no-action rense.
You state tht two institutions operate the cleace and seement systm in Maceoni,
the MSE and the
Payment Oprationa Service (kown as "ZPP"). You stte tht ZPP is
respnsible for the setement of both money and seurities trsfers on the MSB. You. expla
that the trsfer of securities is made ditly with ZPP, which oprate on beha of the MSE
as a "centr regir" for al securities offciay liste on the p:rar and senda markets.
You state tht sha held by ths centr regiter generay ar in certcate form, although
shaholders may decide to have their holdigs demateri. You alo stte tht under the
currnt law,' al companesIi on the MSE must trsfer their sha regirs. to the centt
regiter. Companes tht ar not lite may voluntay trsfer their sha regiters to the
centr regiter. Under a new law, al joint stok companes wil be reuir to kee their shar
registres with the centr register tht wil be establihed in Maceoni.
Section 17(f) of the Investment Company Act sets fort the custo reuirments for
U.S.-registere mangement investment companes ("funds"). Rule 17f-5 thereunder permts
funds to maita their asset outside the United S~te provided tht the assets ar held by
Dr. Evgeni Zogrski
July 10, 1997
Page 2
"eligible foreign custods" tht mee cert reuirments that ar spifed in the rule. Unti
rently, a foreign securities depsitory or cleag agency tht wanted to qua as an eligible
foreign custod was reuir to operate (i) the centr system for hadlg, or (ü) a
trsnational system for the centr handlg, of securities or equivalent bok-entres in that
countr. i On May 12, 1997., the Commssion amended Rule l7f-5.2 Among other thgs, the
amended rule no longer requires that a foreign securities depository or cleag agency operate
"the centra system for handlg securities or equivalent book-entres." It is now suffcient ü
the securities depository or cleag agency operates "a system for the centr handlg of
securities or equivalent book-entres," provided that the depsitory is regulated by a "foreign
rinci regulatory authority. ,,3
As was the case before
the rent amendments, Rule 17f-5 is self-operative and does not
reuire a foreign institution that satifies the derintion of II eligible foreign custod" to obta
the prior approval of the SEe before serving as an eligible foreign custodi for U.S.-registere
funds. Furter, ü an institution mees the derintion, and no legal issue is preented, the SEe
sta, as a matter of
policy, wil not issue an approval or no-action letter. Custody
argements
i Former Rule 17f-5(c)(2)((il) and (iv). Section 3(a)(23)(A) of the Securities Exchange
Act of 1934 defines "cleag agency" generay as an intermedar that makes payments or
deliveries in connection with' trsactions in securities. The term includes any entity, such as
a securities depository, that (i) acts as a custodi of securities in connection with a system for
the centr handlg of securities wherey al securities of a parcular class or series of an issuer
deposited with the system ar trted as fungible and may be trsferr, loaned, or pledged
by bokkeeing without physica delivery of securities certcates, or (ii otherwis permts or
faciltates the setement of seurities without physica delivery of securities certcates.
Rule 17f-4 under the Investment Company Act dermes a "securities depsitory
II as a
"system for the centr handlg of securities where al securities of any parcula clas or series
of any issuer depsited with the system ar trte as fungible and may be trsferr or
pledged by bokkeeing entr without physica delivery of seurities. II Rule 17f-5(c)(2)(il)
II in cert countres. '
refers to both seurities depsitories and cleag agencies beuse a foreign seurities depsitory
may be known as a "cleag agency
2 The amendments bee effective on June 16, 1997.
3 Amended Rule 17f-5(a)(1)(ü). "Foreign rmancia regulatory authority" is generay
any
foreign securities authority or governenta boy, or self-regulatory organtion or membership
organtion, empowere to adminhiter or enforc laws regulatig fiduciaes, trsts, commercia
lendig, insurace, trdig in fiancia instrments and commodty futures CQntrcts, or other
rmancial activities. See Section 2(a)(50) of the Investment Company Act.
Dr. Evgeni Zogrski
July.10, 1997
Page 3
with foreign institutions tht do not mee the reuirments of Rue 17f- 5 ar evaluate on a case
by-ce basis. Thus, if ZPP oprate a system for the centr hadlg of securities or
equivalent bok-entres in Maceoni, and is regulate by a Maceoni "ficia regulatory
authority, II ZPP would be an "eligible foreign custo II for puipses of Rule 17f-5, and would
not nee the approval of the SEe to provide custo services to U.S. funds. We suggest that
the MSE consult an attorney familiar with the U.S. federa securities liws to determine whether
ZPP satisfies the eligible foreign custodian requirments under amended Rule 17f-5.
With ret to your secnd question, the sta does not conduct an on-site investigation
prior to, or in connection with, issuing a no-action letr. The st.detrmes wheter or not
to issue a no-action letter based on the facts and rereentations Contaed in writtn
and may also
submissions. The sta may ask queStions, by telephone or corrndence,
reuest that these submissions be supplemented in writig.
I am sendig with ths letter a copy of the SEe release adoptig amended Rule 17f-5.
You wil fmd the text of the amended rule at the end of the releae. If you have any further
questions, please contact me at (202) 942-0660 or (FAX (202) 942-9659.
Sincerely,
Edward J. Rubenstein
Senior Counsel
cc: Anthony Rada, Regiona Ditor, Fincla Servce Volunter.Coips
Attchment (with aiai copies only)
Macedonian Stock Exchange
Mr. John V. O'Hanlon
Assistat Chief C\)unsel
US Securties and Exchange Comrrssion
Washington DC, 20549
Dear Mr. O'Hanlon:
On the basii; of our on-going consultations with the Financial Services Volunteer Corps (FSVC), which
has been advising us on the procedures regarding the issuance of a No-Action lettr from the US SEC, I
would like to formally request clarfication of our status as a foreign custodian as specified by the
regulation l7f-5 of the US SEC.
Specifically, we would like to know if the Macedonian Stock Exchange wil need to be investigated by
the US SEC pursuant to the issuance a No Action lettr, or if
the custodial and clearng fuctions
curently in place, as well as futue ones as planed in our new Securties Law, satisfy the requirements
specified in 17f-5 for an eligible foreign custodian.
I have atd a deption of ou cuent custoal and clearng sysm, wluch is based on a
contracal agment with ZPP (our central payments system) for your review, as well as excerpts
from our Secties Law wluch outlnes the framework for the creation of a new clearng and depository
house for Macedonia
Please indicate in your response if it wil be necessar for the US SEC to investigate our curent and
futue systems toward the issuance of a No Action letter, or if these satisfy the necessar requiements
for an eligible foreign custodan.
Sincerely,
"~~.¡
/'.~
'-i
Managing Qirector /Î
Dr. E~ Zografski
cc:
IvIr. Ned Rubenstein (US SEC)
Attched:
(1) letter describing curent custodial-clearng system
(5) pages from curent Securities Law showing provisions for creation of new
Clearng -
Depository House in Macedonia
Attachment 1
I wil tr to clarify the basis of the current concet of cleace and settlement system
in Macedonia. Also, I would like to remind you tht tlis system was set up from the
very beginning of the offcial opening of the MSE in March, 1996. The provisions in
the new Law on issuace and tráing securties wil impose some changes. but we are
in Ùle middle of a legally prescribed "period of adjustment" to the new legislation so
we are going to explain only the present system (acording to Ùle new law a Clearing
and Depo House as a joint stock company will be established.)
Two institutions are involved in operating the clearance and settlement - MSE and
Payment Operationa Service (or ZPP according co the Macedonian abbreviation.)
MSE has signed contrct with ZPP by which ZPP is responsible to do the settlement of
both the money tranfer and transfer of securities traded on the MSE. Actuly,
cleaing and settlement is haed by the MSE though designated accum with the
ZPP. Settlement of shares for now, is T + 5 and for bonds T + 1.
During Ùle settement period of 5 days, MSE Certfication Office confirrr Ùle identity
off shares being traded, brokers who did the tre, quantity, and price execute. At
T+S the MSE sends data to ZPP who checks all documents once agai, checks the
all brokers involved on that particular settement day, and if
accunts opened at ZPP of
everying is correct caies out the money an securities tranfer. The settement of
trons is on the net basis.
The trfer of the securties is made directly with ZPP which operate on behalf of tle
MSE as a Centrl Register for all seurities officially liste on the first and secnd
makets. The Centr Register is in certificated form, although shareholders may
decide to have their holdings demateriaiz. It is a condition of listing requirements
that listed companies trfer theír shae register to the Central Register.
For those companes dmt are not listed, tranfer of their share register to the Centr
register is vohimtarily in this very moment (acrding to the new Lawall joint stock
companies are obliged to keep share register in the Central Register that will be
established in Macedonia).
f
7
, Attachment 2
¿
2.3 Settlement of tran~actioos and keeping cerlcates in group depository
Arcle 135
A cleang-depository hous may be founded for me puiose of clearing and
settement of rractions with 1Dng-ter securûes and keeping ceficates in a group
centr depository (in both matenalízcd and dematerialze fonn).
joint-stock company.
The Cieariog-depository house is founded as a
founde'C of a clearg-depository house may be
participants on
the Ex.chage,
Macedonìa.
the Republic of
Macdonia and the National Ban of
the Republic of
Article 136
The clearng-depository house may provide serices to authorized parcipats
on the Exchange.
Arcle 137
A clea-depository house may issue only ordna, restered shares of the
sae tye.
Bach of me foundin shaeholders may diecùy or indirectly hold up to LO %
the clearng-deposiioxy hous. ,.
ofuie capi1 of
Shares of a clearig-depository hous ar not listed on the Exchange.
Article 138
The Commission grts a licene .for work of a. clearng-depository house.
The Comnssion shall grt the licens of paa 1 above only if il is satisfieà
tht the cleang--epositotY house meets following requirements:
_ that it is qualified for quick and cuaent settlement ofliabilities under locked
trdes;
~ tht it provides safety in the keeping of securities;
~ tht it has established rues for me:i:bershp such Ùlat enables membership for
all parcipats on the market approved by lhc: Secuties and Exchange Commissìoii~
~ tht it protectS the interests of investDrs and the puhlic; and
_ that it be cquipped in ter of sta. technology and organization for the
purose of prper cDnduct of its business.
Any more detaled conditions for issuing an approval for estblishment and
operuon of a deang..epsitory house are set by the Securities and Exchange
Coinssioo.
Arcle 139
Employees in a cleag-depository hous who have acess to infDrition
related to securties handled b)' the cleang-deposÏt(1) hous roay not be membe~ of
bodies or perform activities on behaf ofbrkeige rums, i.e. bans.
APR 21 '87 12: 10
+ 385 1 455 i 649
PAGE. ØØ2
.97 10: 59 FR FSVC - NEW YORK
: F sue ZR6REB HR
FFlX NO.;
212 983 9847 TO 01 138514551649
. i8~ i 4~~i 64~
84-27-97 12 :g,p
P.08
P .8J
Artde 140
The cleang-depository house sha set the cleaing procures in cOoopcration
with the Exchange.
Arcle 141
FoX' its clearng and seement serices to companies, the clea-depository
house shall charge a pro'\ìsion set by the clearing-depsitory house itslf.
The provision of par 1 above is subject to approval by the Commission.
Artcle 142
An authoried paricipat failig to meet liabilties from transactions with
securties or violates the genera acts on the basis of which the clearng-depository
house opetes, shal be temporaly or pennanently baned frm the clearg and
settement procedure, followig a consent of the Comission.
Artcle 143
Aùthorized pacipats shl meet their ficialliabilties though segregate
accounts with the payment operaonal SeMce institution. '
Arcle 144
The payment operationa seice intution failtates the trafer of fuds for
trtions in long-ter secuties~ in accordance with instnic:tions from.
settement of
the cleanug-daJsiiory house.
The payment opeational serice initution repons to the cleaing--epository
house and the authorized pacipat on the ficia position on the account of the
latter.
Artcle 145
AUU10red parcipants sha ptovide sucien fuds on their segregated
accounts for settlement of all concluded trctions.
Arcle 146
The clearg-depository house shal eslih a Reserve Fund.
The Reserve Fund sha be contrbuted to by authoñzed parcipants.
Fwids from the Reserve Fund shall be us by the cleag-depository house to
settle tractions of an autoried parcipant on whose segregated account there are
no suffcient fus to cover for its libilties.
The maner and amount of contbutions to the Resere: Fund by each
authorized parcipat are set by the cleang-depositol) house.
Artc:e 147
APR 21 '97 12: ira
+ 885 1 4551 649
PAGE . øø~
,132,'
97 113: 59 FR FSVC - NEW YORK
. ..,. I"",...
Uil' ,..:'" ~ L."o..c.ø r.""
. 5L2.9..~~¿9..~~7 TO 011.38514551649
U'T ... "' .... .VUl P.09
An authorizd rinicipant whose liabilities have been setted v.ith funds frm
the Resere Fund sha pay back into the Fund the amount used tor the purpose of
settling his liabilties, plus a commission for use of fiances froID the Fund.
The amount of the commion for use of fin8XCCS from the Fund and the
dead-line for payment of such comiission are set by the clearng-depositoJ) house.
Artele 148
The clea:ing~deposìtory house sh keep securties of al authorid
parcipants an other companes under an outside and easily recognized mar
separately from its own securties and the securties of other autoried paricipants
and companes.
Under ~ception of para. 1 above, the cleang-depository house may estblish
a group depository for keeping in safe custody securties of the same tye and
interchangeable securities.
Article i 49
The cleang-depository house may not lend secuties entrst to it for safe
custody.
Arcle iso
The cleang-depository house shall have the obligation to kee secuties in
safe custody with an appropriate care of a depsitoiy and shall underte all steps
nece to secure and help implement nght of authoried parcipats emerging
from the depositd sc:itics.
If not stated othei in the agreement for depositig securties between
compaes and the clearng-depsitory hous, th lattr shall have an obligaüon to
chage on behaf of the' authoried pacipant all ma.tued intaests, principal and other
rights emerging from the depsited securties.
The cleang-depository house shall without delay place at. the dispsa of the
authorized paricipant all ihf: funds whch it has recei.ved 01' behalf of such a
paCipoml.
Arcle 151
The cleacing-depositoiy hous may keep securities with another dq)sjto1j but
shall have the sae resnsibilty for such securtii:s as if it kept them with itself.
Artcle 152
The cleang-dositoI) house shal not be held reponsible for securties
deposited for keeping in sae cusody with another depository upon a wrinen reuest
by the authorized paicipant itself.
Artcle 153
¡:PR 21 · 97 12: i 0
+ 385 i 455 i 649
PAGE. ØØ4
. 2' 97 1 i : øø FR FSVC - NEW YORK
212 983 9847 TO ø i 138514551649
1 ø
0"= F S u t ZR8RE8 HR FRX ND_: · 385 i 4551 64~ 84-27-97 12:57P P.p .e5
The cIcarg-depository house shn matan seurties and Keep reord of the
securties of eah autho1Ìed pacipat seprately.
AMicle 154
The clcarng-depository hDus sli ma13n reord of~
_ authorize pacipants whose securties are depsite with the clearingdepository house;
_ tyes, nomi vaues, quaty and other data relevant for the deposited
~urties;
- executed rights emergig from securities; and
- changes in the balce oitb deposited securties.
Artcle 155
Trafer of secunties deposited with a cleang-depository house shall be
cared out through reflectig the chges in ownership onto the accountS of deposited
securties of auroni:d parcipants.
The clearg-depositoiy house shall provide a balance on the sccunties account
equa to the balance on the accoun for deposited seurties of each individua
authorized parcipant.
Aitcle 156
The authoni;ed parcipat shlleave sufcient quatity of securities with the
clearg-depsitoxy house, in order to faciltate the trer of securties on tbe basis of
conçluded trctions on the Exchange.
Arcle 157
In the event that the baance on the account of an auorized parcipant is not
suffcient for irsfc(' of secities trded on th Exchan. the cleang-depository
hous shaH notify the authorid parcipant and the Exchange without delay, if the
securities in queston are listed securties.
Aricle 158
The clea-depositoiy hous shl, at least once a month report to the
Commission of the baance on the accounl for deposited securties and othei relevant
data tht it is due to record under ths Law.
Aride 159
The sueilance over the wo~k of the cleang-depository house shall be
conducted by the Commission.
Artcle 160
APR 2 i ' 97 12: 1 i
+ 385 i 455 i 649
PAGE. eøs
00~ft~~~~
FR FSVC -r,ø
NEW
YORK
~11u: ~
r ~~
I'Y..
2~9~
1 2 983
9847 TO
0 1U~-¿,-"
1 3ß 5 1 455
1 649 P~_DD
.11
& ~~vJ
0.7
J¿.~/~
While conducting sureillae over the work of the cleain-depository hous,
th Commssion may ask for:
- report and liormaton on trctions;
- report of an any additional inormion about a completed audit;
- changes to any act reguating the operation of the clearin-depository
house.
Artçle 161
If the sueilanoe over the work of the elcarg-dcpository housc reveas any
violation of reguations for tr in securities, the Commission may underte the
following mea:
- parally or completely prohibit certn activities of employee of the
cleaing-depository house with special authorities;
- temporarly or permanently prohibit any activities, in accordance with this
Law.
Artcle 162
In the event of reveaed irrguarnes, the cost of inspecton shall be born by
the cleang-depQsitory hO\le.
APR 2 i ' 97 i 2 : 1 1
T :385 i 455 i 64.9
PAGE. eelS
** TOTAL PAGE. ø 1 1 **
other law requires that a notice of
ACTON: Final rue.
SUMMARY: The Export Administrtion
Regulations tElJirovide that the ,
Burau ofEXort Adniistration (BXAl
may
exportei's, individually or
iioim
though amendment 'to ,the EAR, that a,
license isnxiidforexport or "
reexporttò cert entities. The KA
conta ä-listofsuch imtities.This rue
adds ~hatt:EieêtraÍcsLTD,'(aldi ·
Ltd.) 'loc~ted iii
BahartElcçtrniês,
26923
16, 1997 / RuleS' and Regulations
Federal Register / Vol. 62, No. 95 / Friday, May
proposed rulemàkg and an
opportity
for,
public comment be
given for ths final.nie. Ilecause a-
notice of proposed rulemàkg and il,
opportity forpublicco~entar not
required tobe, giyenfor tlis ru!lUAder
5 U.S.C; '553.ot'y lly other .law, the
RegUlatoty' '
requirements of the
(5 U.S~C,601et seq:lar.
not aPillicáble: ," .',,' , " "', "
Flexjbilty .Act
SECURitiEs AND EXCHANGJ;
COMMISSION
17 CFR Part 270
S7~3-5) ,
(Release,Nos.IC-65; 15-108; File No.
RIN 3235E98 '
of Investment Company'
Assets Outsldllthe ,Viilted StaliisCustody,
Therefore,ths regiap.on is issu,edin
fialfoni~,Aitloti8h ,there is, no fo~àI
Clnnment ,period, piibliccommentson
AGENêY: seè\itiés and Exchaige
EFFECTVe DATE: j'4is rÜle is effective
this regation
May i6,199?
basis. Comments should be
submitted to Sharn Cook, Reguatory
Policy Division, Burau ofExort~,
Adminstration,; Deparent of
èommerce, P.O.
,Box
273; Washigton, :
SUMMARY: The Commission is, adoptig
1ndla;to thåimUty list, aidreq~s a ,
licensë.for export fir '~,e~port' of all
itenissúbjèçtto tae EA: ' '
ar welcome on a,
continuig
FOR FURTHERINFOflMATION CONTACT:
Exporter
Eileen M. Albanese, Offce of
Export . _
Adminstrtion, Telephone: (202) 482
ServICesjB:ûau of
0436. "
DC 20044::,d , " ",'., ' " '
Lit 'of SubjecJs ini5 CFrar744
SUPPLEMENTARY JNFORMATION:
. ~ .' :'. :. .., " . .: 1
BackguiuL ,,", . ..
Gener8 'Prhibition Five (§736;Z(b)(5)
of
the
EAR) prohibits export
tò
cert
end-users 'or end-uses Withoútaliç:ense.
In the form of Supplement No.4 to par
744, BXAIIaitàan "Entity List" to
provide noüce iiioimg the piibHc of
rergdi:p~t~~~~!~::~~'~~ '
Accordingly, .part. 44 of the Exort
par 730-774) is amended, as follows:
1. Theauthônty citàtioÍi for
15 CF .
par 744 continues to read a~ follo\\s:
Althöugh the Export Administrtion
Authority: 50 U.S.C. app. 2401 et seq.; 50
U.S.C.1701 et seq.; 22 U.S.C. 3201 et seq.;
requirementS. '",'
Act (EAA) expired on Aiigust 20,1994,
invoked the International
Emergency Economic PowerS -,ct aid ,
contiued in effect; -to the extent
,permtted :by làw, theproVisiåns of the
EAandthe EAR li Executive Order
12924 of Augûr 19,1994.
the Prsident
RulemakgReq~ments
1. This,finalrule has been determined
to be llot signficiit for :puroses of
Executive Order
12866. - , , , ' '
'2. Notw~stidigany other '
a,
provision oflaw,ths'rule involves
collection of inormation subject to the
Paperwork R~dùction' Àcto!19R0. (.~4
U.S,C. 3501,et saq;). This,collection has
ben approved by the Offce qf ",'
under contrl
Mangementaìd Budget
42U.S.C. 2139a;E.O.12058, 43FR 20947,3
CFR, 1978 Camp., p.179;E.O. 12851,58 FR
33181, 3 CFR,1993',Comp.,.-p. 608; E.O",
12924, 59 FR43437. 3
CFR;
1994 Comp., p.
917;E.O.12938,59FR 59099,3 CFR,1994, '
Comp., p. 950; Notice of August 15, 1995 (60
4. The
provisions
,of
the
553) requirng notice of
proposed
rulemakg, the opportUnty for pulic
parcipation, aid il delay in effective
date, are inapplicable because ths
regulation involves a milta and
foreign afairs fuction of the' United
States (5 U.S.C. 553(a)(1)). Furer,no
investmentcompanes with 'grater ,
, fleXibilty in managig their foreign
custody .argeøents ,consistent with
of invE!stiÊmt coaipany,
assets. The, amendments also exp'and thê'
class of foreign ban andsecurUes
the safekeeping
deposit!lries thatniy serve as
EFFECTVE ,DATE:1:e .aendments \\l,
become effeGtiveJuIe 16,1997.
FÒR FURTHER INFORMATION CONTACT:
Robin S. Gross, StaffAttorIey, or Nadya
B. Roytblat, Assistat Chief, Offce of
Reguatory Policy; at (202) 942-0690,
Securities and Exchange Commssion,
Divisian of InvestmentMangement,
450 1"ifStret~,N;W., Mail Stop'1Q-2,
Washington, D.C: 20549. R.equests for
formal interpretive
advice should be
CoUnel '
diected to the Offce of Chief
PART
,.
744AMENDED)
2. SuppleIIent-Na:4,to'par 744 is
amended'by~ddîg,in.aphabetical,
,entity: , "
order, the folloWig
'~Bh~tElectrni~ LTD,,(ak"faht '
Electrnics; Ltd.)
locted in India, for all
iteiIsiibjéctothild~".'" ,
Dated:
May 12,t997.
with Federaism,:iplications sufcient
Adminstrtive-Prcedur,Act (5 U.S.C.
comp¡iy assets outside the .unit~d '
States. The aiendments provide, ' ,
at (202) 942-0659, ,Division of '
Iin S. Bai; "
assessmêiitùider Executive Order
12612.
govern~ thë custody of investient '
FR 42767, l\ugut 17,1995); and Nollce'of
Actng Assistant Secretarfor Export '
to wart prepartion of a Federaism
amendments to the 'I1e Wider the
Investment Coml'iiY Act()f 1940 that
August 14, 1996(61 FR 425:27).
number 0694-088:' ' ',', ..'
, 3. This Me'doës:iofcontapolicies
ACTON: Final rule.'
AdmstrtioiiRegulations (15 CFK , , inve~tment coIIpany cUstodian., '
such licensing
certaÍn Êmtities subject to
Commission. '"
Administtion. '
(FR Dòc. 97~12805Filëd 5:1S-!!7;8:45 iil
B1WNG COE 351o-,
Investment Management, -Securties and
Exchange Commsion; 450
Fif
Stret, .
N.W., MailStòp'10-, Washigton, D.C.
20549. , , '
SUPPLEMENARY
INFORMATIoN: The'
SecurtiesandEXclige CoÌnission
adoptig ,
("Commssion"ltoday is
aiendmeIits to rue 17f--5 Ú 7 CF '
270.17f~5) UIder:themvestment
Company Act-of 1940 (15 U.S.C. 80a)
(the "Investmént Company Act" or
"Act").'
.. ,.j...
T~billOf CoDle~ts .
I; ExeCutive Sumii ,
ii.
Intrductan and BackuId,
m. DiscuSsion '. ,
A. Deision toPIace Fund Assets in a
Countr , ,
1,
Backund , *
2. Amended Rwe
B. pelegatiãn of Boaid Responsibilties
i.Selectig Delegates '
2. Delegate's Stadar of
Ce
3. Board Oversigt; Delegate Report
C. Selectig, Contrctg with, and
Monitorig a Fòreigi Custodian, '
26924
Federal Register / VoL 62, No. 95 / Friday, May 16, 1997 /Rules ,and Regulations
1. Selecting a Foreign Custodian
a. General Standard
b. Specified Factors
ì. Practices. Procedures and Intemal
select a foreign custodian and monitor
ii. Financial Strength and Reputation
iii. Jurisdiction
2. Foreign Custody Contract
a. Indemnifcation and Insurance
longer required to approve foreign
custody arangements annually.' '
Controls' ~ '
b. Liens
Withdrawing Fund Assets .
D. Eligible Foreign Custodians
1. Foreign Banks and TrutGompanies
2. Affliated Foreign Custodians
3. Securities Depositories
E. Assets Maintained in Foreign Custody
F. Caadian Funds
Iv. Effective Date; Compliance Dates
on
Competition. EffCiency and Capital
V. Cost/Benefit Analysis and Effects.
Anlysis .
Formation: '
Final
Regulatory Flexibilty
VII. Paperwork Reduction Act
vi. Statutory Authority ,
Text ofR-ule
II. Introd~ction lUd Background
The Commission is amending rule
17f-5 under the
,Investment Company
'Act to, provide registered inanàgement
companies ("finds") greater
flexibilty in managing their
custody arangements available to
fudi;.5 The rule permits funds to
maintain' their assets overseas, subject to
detailed fiiidings by the fud's board of
directors with respect to the decision to
plac~ fund assets in a parcular countr
and with respect to each foreign custody
i Investing in
arrangement. 6 Fund assets may be
fund with placed in the custody of an "eligible
significant operational issues, one' of
foreign custodian": (i) A foreign bai or
which is the availabilty of appropriate
trst company ("foreign bank") that has
custodians for fund
assets. Maintaining more than $200 milion in shareholders'
seCliities Outside of their primar
equity; (ii) a majorttycowned subsidiar
market can add significant costs to
of a U.S. bânk or bank holding company
investing in that market and may
more
("U.S. bank subsidiar") that has
preclude foreign investment.2 The
than $100 riilion in shareholders'
foreign markets may present a
availabilty of custodial arangements in
foreign markets where a fud invests,
therefore, is very important.
Section 17(f) of the Act generally
permits a fund to maintain its assets
foreign '
custody arrangements. The amendments
17f".5 was adopted; fuds seeking-to
maintain their assets outside the United
States could use only foreign branches
of D.,S. banks as their foreign
custodians.4
i Based on available data. the Commission staff
estimates that at the end of February 1997.
approximately 1,666 portfolios with assets of nearly
$411 bilion have investment objectives that
contemplated significant foreign investments. See
also Karen Damato, Mutual Funds Drew $24 Bilion
instead that the selection of a foreign
custodian be based on whether the
fund's.assets wil be subject to
reasonable care
if maintained by
that
custodian, after considering all factors
relevant to the safekeeping of fund
assets, including the custodian's
financial strength, its practices and
procedures, and internal controls.
The amendments eliminate the
consideration of "prevailng countr
risks," i.e., risks associated with
invéstment in a paricular countr
rather than placing assets with a
paricular custodian. The
Commission
has concluded that prevailng countr
risks are investment risks appropriately
considered by a fund's board or
investment adviser when deciding
whether the fund should invest in a
paricular countr, rather thai çustodial
be addressed in rule 17f-5.
The amendments also permit fund
directors to playa more traditonal
risks to
oversight role with respect to the '
custody of fund assets, overseas.
Directors may delegate their duties to
Duringlanuary. Wall St. J., Feb.
that mut;t be approved by
board
the fid's
'of directors and contain certain
specified provisions.8 "
By 1995 the Commission had become
concerned that the rule's provisions ,
unnecessarilyres,tricted foreign custody
securities depositories that may serve as
custodians of fund assets by eliminating
capital requirements that have ,
suitable custodians without first
obtaining administrative relief from the
Comnussion. The amended rule requires
depository that operates either the
central system for the handling of
securities in that countr or a
transnational system for the central
the custody of å U.S. bank and
, handling of securites'? Finally, the
its foreign branches, a member of a U.S.
fund's foreign custody arangements
secUrties exchange, ,the fund itSelf,- or a
must he gover¡:ed by a,writen contract
expand the class of foreign banks and ,
precluded funds from using otherwise
equity; or (ii) a foreign securities
only in
, U.S. securties depository.3 Before rule'
I. Executive Sumary
t..
'and are no
In 1984 the Commission adopted rule
17f-5, which expanded the foreign
their assets overseas.
3. Monitoring Custody Arangements and
investment
or aU.S; or foreign bank;
A growing number of fuds invest
c. Omnibus Accounts
d. Depository Aringements .
VI. Summar of
a fund's foreign custody arangements to
the fund's investment adviser, officers,
13,1997, at C1
(disciissing recent increased investor int.erest in
funds that invest overseas).
2 Moving securities away from tlieir primary'
market may entail additional costs in connection
with hiring a servicing agent in the primary locality
to collect and disseminate information with respect
to the securities, transferring the securitiès to an
eligible custodian and procuring insurance for
possible loss~n transit, ann ex~hanging coupons for
interest or dividends or' for'new. shares in '
connection 'with a nghts offering. See EXemption for
Custody of Securities by Foreign Bank and Foreign
Securities Depositories, Invesllent Company Act
Release No. 12354 (Apr. 5; 1962) (47,FR 16341,
16342 (April16, 1982)) (hereinafter 1982 Proposing
Release). Funds also may lie prevented ,fri;m, or
delayen in, sellng the securities if they arè unable
,to make timely delivery to prospective purchasers
in the primarymarkel. rd. In addition, thebestprice
for a foreign security typically may be obtained in
its primary market. rd.
315 V.S.C. BOa-17(f. Bank custodians must be
subject to federal or state regulation and have at
least $500,000 in aggregate capital, surplus, and
undivided profits. Investment Company Act
sections 2(a)(5) (15 V.S.C. BOa-2(a)(5)) (defining
bank). and 26(a)(1) (15 V.S.C. 80a-26(a)(1))
(containing the $500.000 capital requirement). See
arrangements. In addition, the
Commission became concerned that the
rule placed unnecessar burdens on
fund directors that detracted from the
. amount of time they could devote to the
many other important duties they are
assigned u,nder the Act.9 In JulY 1995,
the Commission proposed amendments
to rule 17f-5 in response to these
concerns. To make the rule's
requirements for board involvement in
custody matters more consistent with
the board's traditional oversight role,
the proposed amendments would have
permitted fud boards to delegate their
S Exemption for Custody of Investment Company
Assets Outside the V,nited States, Investment
Compiiny Act Release No. 14132 (~ep.l. 7, 1984) (49
FR 3'6080 (Sept: 14. 1984)) (release adopting rule
17f-5) (hereinafter 1984 Adopting Release). For an
administrative history, of rule 17f-,5, see Custody of
Investment Company Assets Outside the United
States, Investment Company'
Act Release
No. 21259
(July 27; 1995) (60 FR 3~592 (Aug. 2. 1995)) .
(hereinafter PropoSing Release) 'at n.8.
"The fund's board of directors must determine
that the custody arrangements are consistent with
the best interésts ofthe fund and its shareholders
(the "best interests determination"). Rule 17f
5(a)(1)(i) through (ii). Notes to the current rule
enumerate certain factors that the fund's board
members of a U.S. securities exchange). rule 17f
2 (17 CFR 270.17'-2) (custody by funds
should consider in making the best interests
determination. The rule also requires the board to
morÍitor the fund's foreign 'custody arrangements
themselves), rule 17f-4 (17 CFR 270.17f-4) (custody
by V.S. securities depositories), and rule 17f-6 (17
CFR Z70.17f-6) (custody by futures commission
merchants and commodity dea'ring organizations).
alid to approve each arangement at least annually.
Rule 17f-5(ii)(2). (3).
7Rule 17f-5(c)(2) (i) through (iv).
· Rule 17f-5(a)(1)(iii) (A) through (F).
also rule 17f-1 (17 CFR 270.17f-1) (custody by
· See 1982 Proposing Release. supra note 2, at n.7
and accompanying text.
· See Proposing Release. supra no
17 and accompanying texl.
Ie 5, at nn.15
26925
Federal Register / VoL 62, No. 95 / Friday, May 16, 1997 / Rules and Regulations
responsibilties to approve and monitor
foreign custody arrangements. To better
risks"). For example, a country's
ineffcient settlement practices ,
reflect modern commercial custody
practices, the proposed amendments
constitute a risk of investing in that
would have revised the standar~ to be
used in evaluating a fund's foreign
custody arrangements to one that
focuses on whether the custodial
arangement afforded "reasonable
protection" for fund assets.
10 The
proposed amendm~nts also would have
expanded the class of foreign banks,
U.S. bank subsidiaries and securities
depositories that could serve as fund
custodians, and eliminated the
requirement that the fund's foreign
custody contract contain certain
specified provisions.
The Commission received letters from
28 commenters. The commenters
generally supported the proposed
amendments, particularly those
provisions that would have permitted a
fund's board to delegate its
responsibilties to select and monitor
foreign custodians to the fund's
investment adviser, offcers, or a U.S. or
foreign bank. The Commission is
adopting the proposed amendments
with several modifications that reflect,
in part, the commenters' suggestions.
The Commission believes that the
amendments, as adopted, wil provide
significant additional flexibility for
funds without reducing the level of
investor protection afforded by the
current rule.
A. Decision to Place Fund Assets in a
Country
1. Background
Maintaining fund assets outside the
United States involves risks that relate
to the paricular custodian (e.g., the risk
that the custodian selected wil not
exercise the appropriate level of care
with regard to fund assets, or that the
custodian may not have the financial
strength, prac;tices, and procedures in
1
In addition, maintenance of fund assets
overseas exposes the fund to systemic
risks that may affect the abilty of any
custodian to safeguard fund assets in
that countr ("prevailing countr
laThe factors that the rule specifies should be
considered in this regard would have been revised
to focus on safekeeping rather than investment risks
(particularly the factors relating to the decision to
place fund assets in a country).
ii These issues also may be present when a fund's
assets are maintained in the United States. Section
17(0, however, by limiting domestic custody
arrangements to U.S. banks and certain other
arrangements subject to Co~mission regulation,
provides some assurance that custody arrangements
\
wil have appropriate safeguards, See supra note 3
and accompanying text.
custodian. Both of these types of risks
have been addressed by rule 17f-5, and
were to be addressed by the proposed
amendments.12
The Proposing Release requested
comment whether the rule should
continue to address prevailing countr
The Commission also is concerned
that restrictions on a fund's approach to
prevailng countr risks may have the
effect of denying funds and their
risks.13 A number of commenters
shareholders overseas investment
suggested that it should not. These
commenters asserted that prevailng
countr risks are inherently investment
risks because they are an inextricable
opportunities, parcularly in
developing markets. Such a result is
inconsistent with the overall approach
of the Investment Company Act, which
part of the fund's decision- to invest in
generally does not limit a fund's abilty
foreign securities. These commenters
therefore urged the Commission to treat
the decision to place fund assets in a
'countr as a decision to be made by the
such a result is not mandated by section
17(0, the legislative history of
which
suggests that the section was intended
to assume investment risks.
14 Moreover,
fund's board or its investment adviser in , primarily to prevent misappropriation
the context of deciding to invest in that
of fund assets by persons having access
countr, and as separate from the
to assets of the fund. t5
establishment of
particular foreign
custody arangements under rule 17f-5.
2. The Amended Rule
These comments have caused the
Commission to reconsider the proposed
approach. Once a decision has been
made to invest in a country, prevailing
countr risks cannot be avoided, except
by maintaining assets outside of the
countr-an alternative that is often not
possible or practicable. For that reason,
prevailng countr risks would seem
inherently a part of the investment risks
III. Discussion
place to safeguard the fund's assets).!
countr, regardless of the level of care
that can be provided by a particular
associated with the decision to invest in
a particular countr and should be
considered by a fund's board or
investment adviser before the fund
invests in a foreign countr. Inclusion of
prevailng countr risks in rule 17f-5,
therefore, wollld appear inconsistent
with the nature of those risks.
12 Rule 17f-5 currently requires a fund's board of
directors to determine that maintaining the fund's
assets in a particular country is consistent with the
best interests of the fund and its shareholders. Rule
17f-5(a)(1)(i). Note 1to the rule requires the board,
in making this determination, to consider the effects
of applicable foreign law on the safekeeping of fund
assets; the likelihood of expropriation,
nationalization, freezing, or confiscation of the
fund's assets; and any reasonably foreseeable
overseas.
..~
The proposed amendments would have narrowed
diffculties in repatriating the fund's assets kept
the scope of the prevailng country risks
determination to factors that have a closer nexus to
safekeeping considerations. A fund's
board of
directors or its delegate would have been required
to determine that custody of the fund's assets in a
particular countr could be maintained in a manner
Based upon these considerations, the
Commission has decided not to address
prevailng countr risks in rule 17f-5.
Rather, the Commission believes that
such risks should be carefully
considered by a fund's board or its
investment adviser before the fund
invests in a foreign countr, and, if
16
material, disclosed to fund investors.
Accordingly, the amended rule focuses
exclusively on the selection and
monitoring of an eligible foreign
custodian.
The ameni;ents are'not intended
and should not be construed, however,
to dimillish the importance of
considering the financial infrastructure
of a foreign country when deciding to
invest in that countr. For example, the
countr's settlement systems and
practices can have a significant effect on
the liquidity and investment
characteristics of fud assets.1 The
14 But see, e.g., rule 2a-7 under the Investment
Company Act (17 crn 270.2a-7) (establishing
various limitations on permissible investments for
money market funds).
IS See Proposing Release. supra note, at n.5;
Thomas Harman, Eligible Foreign C\lstodians and
the Investment Company Act of 1940,46 Bus. Law
1377 (1991).
that provided reasonable protection for the fund's
'6 Funds' disclosure obligations are governed by
assets after considering all factors relevant to the
safekeeping of such assets including: (i) The
prevailng practices in the country for the custody
of the fund's assets; (ii) whether the countr's laws
, other provisions of the securities laws. See, e.g.,
Item 4(c) of Form N-1A (17 CFR 239.15A) (the
registration form for open-end funds), and Item 8.3
wil affect adversely the safekeeping of the fund's
assets, such as by restricting the access of the fund's
independent public accountants to a custodian's
books and records, or by affecting the.,fund's ability
to recover its assets in the event of a custodian's
bankruptcy or the loss of assets in a custodian's
control; and (iii) whether special arrangements that
mitigate the risks of maintaining the fund's assets
in the country would be used.
13 Proposing Release, supra note 5, at nil, 62-65
and accom pan ying text.
of Form N-2 (17 CFR 274.11a-1) (the registration
form for closed-end funds). These Items require
disclosure in the fund's prospectus of the principal
risk factors associated with investing in the fund.
See also Proposing Release, supra note, at nn.175,
176 and accompanying text.
17 A country's settlement systems, for example,
may not require that payment for securities
purchased by a fund be made only upon delivery
of those securities, or that securites sold by a fund
be delivered only upon receipt of payment for the
Continued
26926
Federal Register, / Vol. 62, No. 95 / Friday, May 16, 1997 / Rules and Regulations
amendments similarly are not intended
to diminish the contribution that the
fund's global custodian may make in
deciding to place fund assets in a
B. Delegation of Board Responsibilites
, The Commission pròposed amending
foreign countr.IS Commenters ~ .'
representing fundt; and custodians
contract with, and monitor foreign
agreed that global custodians are a
"primar source of information
concerning the financial systems and
practices of foreign piarkets." 19 The
Commission, therefore, expects that
fund boards and investment advisers, in
making foreign investment decisions,
'wil continue to seek
and rely on ,
information and opinions provided by
the fund's custod~an when the
custodian has experience with regard tò
foreign custody services.20
securities ("'delivery vs. payment procedures"').
Delivery vs. payment procedures can afford
custodians to the fund's investment
adviser, offcers or a U.S. o'r foreign
bank. This approach was intended to'
permit fund boards to playa more
traditional oversight role in connection
a fud's foreign cuatody
arargements,2\ This approach also
with
sought to recognize that in discharging
their responsibilties under the rule,
directors rely heavily on the analysis
and recommendations of the fund's
counsel and
investment adviser, legal
global custodian.22 Most commenters
strongly supported the proposed
amendments permitting delegation of
signifcant protections from losses if the other pary
bo!Ud responsibilities and they are
to a trnsaction defaults on its obligations. See. e,g.,
adopted substantially as proposed.23
Thirty, Clearance and Settlement Systems
in the World's Securities Markets 11 (Mar. 1989).
The fact that a foreign market's settlement practices
Group of
do not incorporate these procedures ',should be
carefully considered by the fund's board or
investment adviser in deciding to invest in the
countr. ,
A country's settlement systems and practices also
may present problems in accounting for fund assets
(e.g, establishing whether the fund owns the
securities or has received dividends or other'
entitlements). See, e.g., Buttonwood Ii¡temational
Group, Emerging Markets on the Net: India.
SecuritÙ,s Infrastructure a Big Problem for
Investors, at http://ww.buttonwood.com/p-i/
1996es/india.html (discussing, among other things,
diffculties resulting from the p~ocess of registering
changes in ownership of securities).
18 See, e.g., John Paul Lee & Richard Schwarz,
Global Custody: A Guide for the Nineties (1990)
(noting that today the safekeeping of a fund's
foreign investments typically is effected through the
fund's primar or "'global" custodian, which uses
a world-wide network of custodians with which it
has established relationships); Gordon Altman
Butowsky Weitzen Shalov & Wein, a Practical
Guide to the Investment Company Act 30 (1993)
(indicating that the fund's custodian typically
provides the board with information concerning
foreign legal restrictions and the qualifications of
foreign custodians).
",Letter from Baker & McKenzie to Jonathan G.
Katz, Secretary, Securities and Exchange ,
Commission (Nov. 3, 1995), File No. S7-23-95. at
7-8; see also Letter from the Investment Company
Institute to Jonathan G. Katz, Secretar, Securities
and Exchange Commission (Oct. 5, 1995), File No.
S7-23-95, at 9. Custodian commenters suggested
that their role in this regard may expand under the
amended rule and emphasized that funds and their
global custodians "'are parers, not adversares, in
seeking to ensure that fund assets held outside the
United States are properly safeguarded." Letters
from.Baker & McKenzie to Jonathan G. Katz,
Secretar, Securities and Exchange Commission
(June 7,,1996 and Sept. 10,1996), File No. S7-23
95, at 3 ani; 2, respectively.
2°The Comnission always has recognized the
extent to which fund boards rely on third party
experts in addressing prevailng country risks. See
1984 Adopting Release, supra note 5, at n.12 and
accompanying text. The failure of a fund's board to
obtain information from reliable sources concerning
\
the rule to permit a fund's board to
delegate its, responsibilities to select,
the financial systems and practices of foreign
markets in which the fund makes signif'cant
investments may in certain instances violate the
directors' duty of care under applicable corporate
1. Selecting Delegates
Under the proposed,amendments, the
board would have been required to find
that it is reasònable to rely on the
delegate to perform the delegated
foreign
custody arangements. Most
commenters that addressed this aspect
of the proposal supported the proposed
standard, but suggested that the
Commission discuss the factors to be
considered
in determining whether
reliance on a delegate is reasonable.
The Commission is adopting the
proposed reasonable reliance
standard.24 As stated in the Proposing
Release, factors typically involved in
makng this determination include the
expertise of the delegate and, if
applicable, the delegate's intended use
of third pary experts in performing its
responsibilties.25 Other relevant factors
may include, for example, the board's
abilty to monitor the delegate's
performance or, in the case of a delegate
that is a foreign.bank, the fud's abilty
to obtain jursdiction over the delegate
in the U.S. should problems arise in the
delegate's performance of its duties.26
The delegate's
financial strengt also is
relevant in analyzing its abilty to
perform its responsibilties and '
indemnify the fund if the delegate fails
to adhere to the requisite standard of
responsibilties related to the fund's
care.27
and fiduciar law. See, e.g., Task Force on the Fund
the board's responsibilties under the
Certain commenters suggested that
Director's Guidebook, Federal R-egulation of
Securities Committee, Section of Business Law,
American Bar Association, "Fund Director's
Guidebook," 52 Bus. Law. 229, 237 (1996)
("Compliance with the duty, of care under state law
rule be delegable solely to the fud's
custodian bank as the entity most
qualified to provide such
services. The
is based on diligence applied to the ordinar and
the board should have the flexibilty to
extraordinary needs of the fund"including' . .
5(b)(1)). '
obtaining and reviewing information on which to
base decisions, and making appropriate inquiries
under particular circumstances. ") The Commission
does not believe that the amendments wil
discourage fund boards and investment advisers'
from seeking the type of information they need to
fulfill their responsibilties. Cf. Letter from State
Street Bank to Jonathan G. Katz, Secretary,
Securities and Exchange Commssion (Nov. 3,
1995), File No. S7-23-95, at 11 (suggesting that
"competitive forces" may place incentives on
custodian banks to, assume greater responsibilty for
decisions to place fund assets in for,eigr countrJes).
The amendments"do not affect in aiy way the
extent to which a ct1stodian's opinions' and reports
may be relied upon by the fud'i¡board or thi:
investment adviser, or the custol'ian's legal liabilty
to the fund with respect to any such opinions or
reports. .
text. '
21 See Proposing Release, supra note 5, at;nn.24
26 and accompanying,
22 See supra notes 18-20 aid accompanying text.
See also; Glorianne Stromberg, Reglatory
Strategies for the Mid.'90s; Recommendations for
, Regulating Investment Funds in Canada (prepared
for the Caadian Securites Administrators) 242
(Jan. 1995) (suggesting it is unlikely tlat an .
individual fund or its investment adviser wil have
the expertise or bargaining power to deal with
numerous and varied foreign custodians thoughout
the world).
23 While cOl1enters generally supported
delegation, a number of commenters suggested that
custodian banks should not serve as delegates for
the decision to place fund assets in a country. It is
not necessary to address this issue in the amended
rule, however, because the decision to place fund
assets in the country is outside the scope of the
ameñded rule. See supra Section IILA. ofthis
Release.
Commission continues to believe that
"Amended rule 17f-5(b)(1) (17 CFR 270.17f
os See Proposing Release, supra note :¡, at n.28
and accompanying text. '
26 If the delegate is a foreign bank, it must be a
"qualified foreign bank" (i.e., regulated as either a
banking institution or trst company by the
government of the 'countr under whose laws it is
organized or any agency thereof). See amended rule
17f-5(d)(6) (17 CFR 270.17f-5(d)(6)). U.S. bank
delegates must be subject to federal or state
regulation
by virtue of the definition of bank in
section 2(a)(5) of the Act (15 USC 80a-2(a)(5)).
27 The amendments, as proposed, would have
required a U.S. bank delegate to have all aggegate
of capital, surplus and ,undivided profits ("CSP") of
$500,OOß-the aggregate CSPrequired for a U.S.
bank to serve as a custodian for fund assets., See
section 17(1)(1) of the Act (1-5 U.S.C. 80a-17(1)(1))
(requiring ba custodians to meet the
qualifications prescribed by,
section 26(a) ofthe Act
(15 U.S.C. 80a-26(a)) for the trustees of unit
investment trsts). The Proposing Release requested
comment whether foreign bank delegates should
'meet speeific capital standards. Commenters were
divided on this point. One commenter supported a
minimum capital requirement for foreign bank
delegates to avoid the inequity of subjecting only
U.S. banks to minimum capital requirements. Other
commenters suggested that, since the financial '
factor in
deciding to use it as a custodian for fund assets, the
aggregate CSP requirement, or other minimum
strength of a foreign custodian would be a
financial standards for delegates,'were unnecessar.
Consistent with the approach of focusing on
financial strength, rather than specified minimum
capital (as discussed in Section II.D.l of this
Release), the amended rule does not require a U.S.
bank delegate to have a specified CSP.
Federal Register / Vol. 62, No. 95 / Friday, May 16, 1997 / Rules and Regulations
delegate foreign custody decisions to the
entity it determines is in the best
position to evaluate the particular
delegated aspects of the fund's foreign
custody arangements.28 For eXaple,
under the delegation provisions of the
amended rule, one delegate may assume
responsibilty for evaluating ban
custodians, while another may be
liable for losses despite exercising
reasonable care.
The amended rule requires a delegate
to exercfse reasonable care in
performing the'delegated duties.3o The
rule makes clear that reasonable care, in
this context, requires the delegate to
exercise the care, prudence and
dilgence that
a person having the
26927
provision should provide fund boards
with the flexibilty to tailor the
reporting requirements to the fund's
parcular circumstances. Consistent
with the provision, a fund's board
could, for example, require the reports
at the next
regularly scheduled board
meeting, as originally proposed. The
board also may require the report more
responsible for evatuating depositories.
responsibilty for the safekeeping of
or less frquently (e.g., within 30, 60 or
The Commission notes that the terms
of the delegation must be agreed upon
by the board and the delegate. The
potential deli;gate must agree to assume
fund assets would exercise.3! This
provision is designed to ensure that
delegates adhere to a thshold standard
as the
the event or annually)
90 days of
board determines is reasonable and
appropriate.
C. Selecting. Contracting With, and
Monitoring a Foreign Custodian
1. Selecting a Foreign Custodian
the delegated responsibilties and the
of care. Fund boards and their delegates
may agree that the delegate should
delegate and the fud's board may agree
adhere to a higher standard of care.
to guidelines and procedures under
3. Board Oversight; Delegate Reporting
which the delegate wil exercise its
responsibilties. If a foreign countr, for
example, has a depository that, as a
practical matter, must be used if the
fud is going to place assets in that
countr ("compulsory depos.tory"), the
, fud's board may conclude that the
investIent adviser would be the
appropriate delegate for evaluating the
compulsory depository.29
2. Delegate's Standard of Care
The Proposing Release requested
comment whether the rule should
provide a standard of care to be used by
a delegate in makng custodial
decisions. Several commenters
suggested that the rule should provide
guidance in this regard. These
commentersexpressed the view that if
the Commission did not clarify this
aspect of the amendments, the
delegation provisions would be
unworkable because potential delegates
would be unwiling to risk being held
2. Similarly. a fund's board could select as
The Commission is amending the
a. General Standard
Rule 1n-5 curently requires a fund's
board to fiiid that the fud's foreign
custody arangements are consistent
fund's foreign custody arangements
with the best interests of the fud and
annually. The amended rule does
the board its sharholders.35 Consistent with the
require the delegate to provide
goal of requiring foreign custody
with writen report notifying it of the
arangements to be evaluated based on
placement of the fud's ~.ssets with a
the level of safekeeping they wil afford
parcular custodian.32 The delegate also
fund assets, the Commission proposed
must provide written reports to the
amending the rule to require a finding
board concerning any material change
that the fud's foreign custody
in the fund's foreign custody
arangement wil provide "reasonable
arangements ("material change
protection" for fund assets. The
report").33 These reports are intended
proposed reasonable protection
to faciltate the board's oversight of the
standard was intended to facilitate
delegate's performance. Commenters
generally agreed that delegate reportng evaluation of foreign custody
rule, as proposed. to no longer require
the board to review or approve the
isThedesirable.
'
proposed amendments would
atangements by focusing exclusively on
scheduled meetings. The amended rule
the safekeeping of fund assets. ,
Several commenters viewed the
proposed reasonable protection
standard as a results-oriented standard
that could effectively render the entity
makng the determination a guarantor
against any loss of fund assets in foreign
custody. A number of commenters
recommended that the rule require
based,on the cirumstances of the fud's
provide "reasonable care" for the fund's
have required the reports to be provided
no later than the next reguarly
scheduled board meeting following the
event necessitating'the report. One
commenter expressed concerns about
the application of this requirement to
fund boards that do not have regularly
with a geographic region. See Andrew Sollnger,
Breking Away, Institutional Investor 171 (Sept.
1991) (noting that U.S. custodians may use different
instead that the selection of a fund's
requires material change reports to be
foreign custodian be based on a
provided at such times as the fund's
board deems reasonable and appropriate determination that the custodian wil
subcustodiiin networks for diffetent georaphic
regions).
foreign custody arange~ents.34 This
assets in ìts custody ("reasonable care
standard"). The commenters suggested
S(b)(3)). '
that this standard of care would be more
delegate the entity having the greatest expertse
29 The amendments, as proposed, would have
expressly addressed compulsory depositories, and
would have required the evaluation of a
compulsory depository to be made in the context
of the decision tò'place fund assets in that countr.
This approach was designed to address the
expectation that, because of the depository's
compulsory nature, the fund's custodian would
decline to assume the responsibility for evaluating
, it. The Commission recognized, however, that
conceptually the decision to use a compulsory
depository appeared to fall within the scope of the
rule's provisions governing the selection of
paricular custodians, The rule. as proposed to be
JOAmended rule 17f-5(1)(3) (17 CFR 270.17f
31 A substantially similar standard of care was
suggested by fund and custodian commenters. See
also infra note 36, (discussing a custodian's
standard of care under Aricle 8 of the Uniform
Commercial Code ("U.C.C.")).
32 Amended rule 17f-s(b)(2) (17 CFR 270.17f
S(b)(2)).
331d. A material change in the fund's
arrangements would include, for example, a
delegate's decision to remove the fund's assets from
amended. would have required the fund's board or
a paricular custodian. A material change also could
its delegate to make the same findings with respeCt
to a compulsory depository as those required for the
selection of any other type of foreign custodian. See
Proposing Release. supra note 5. at n.71. Because
as a change in control resulting from a sale of the
the amended rule does not address the decision to
place fund assets in a country, the Commission has
concluded that it is not necessary for the rule to
distinguish between compulsory depositories and
other typés of foreign custodians,
include events that may adversely affect a foreign
custodian's financial or operational stjengt, such
custodian's operations, If appropriate, tbe material
change report would discuss the reasons for
continuing to maintain the fund's assets with a
paricular custodian.
)4 Amended rule 17f-S(bJ'2) (17 CFR 270.17f
S(b)(2)).
consistent with the way in which
custqdians traditionally have cared out
their responsibilties.36 Commenters
also not~d that a reasonable protection
J5 Rule 17f-5(a)(2).
36 For example. the newly revised Arcle 8 of the
U.C.C. (which has been adopted in 29 states,as of
December 1996), addresses the duty of care to be
exercised by a custodian (or other "securities
intermediary"). Section 8-504 provides that in the
absence of an agreement, the custodian should
exercise "due care iii accordance with reasonable
commercial standards." (Section 8-509 recognizes
that regulatory law may impose a higher standard.)
Note 4 to Section 8-504 observes that "(the duty of
care includes both care in the intermediaries' own
operations and care in the selection of other
intermediaries through whom the intermediar
holds the assets in question."
26928
Federal Register / Vol. 62, No. 95 / Friday, May 16, 1997 / Rules and Regulations
standard would suggest that the level of
custodial protection that is deemed
fund. '
"reasonable" would vary from fund to
In proposing the reasonable
protection standard, the Commission
emphasized that the d~legate would not
be required to find that fud assets
could never be lost while in the foreign
custodian's possessipn.lnstead, the
degree of care with respect to fund
assets.
b. Specified Factors
The amended rule requires the
Foreign Custody Manager to consider all
factors relevant to the safekeeping of
fund assets. The rule identifies several
specific factors that the Foreign Custody
Manager must consider when selecting
a foreign custodian. '
focus would have l1een on the
reasonableness of a custodian's
i. Practices, Procedures and Internal
protections for the fund's assets, based
,Controls
on all relevant factors and, in paricular,
The amended rule states tlat the
those factors that would have been
foreign custodian's practices,
specified in the rule.37 rhus; the
procedures, and internal controls are
proposed standard was not intended to
among the factors that must be
be substantially different than the
considered in deciding whether the
reasonable care standard suggested by
the commenters. Nonetheless,
recognizing the benefits of using
terminology curently used and
commonly understood by parcipants
in fund custodial arangements, the
Commission has decided to adopt a
"reasonable, care" standard as suggested
by 'commenters. The use of this
terminology also underscores the
objective nature of the standard for
determining whether a fund's custodial
arangements in a paricular' countr
satisfy a "reasonableness" standard.
The amended rule requires the fund's
board or its delegate (the "Foreign
Custody Manager") to determine that
the fund's assets wil be subject to
reasonable care if maintained with the
foreign custodian.38 This determination
would bebased on standards applicable
fund's aSSets wil be subject,to
reasonable care.41 As noted in the
Proposing Release, thè protections
provided by custodians within a foreign
countr can var widely.42 The
amended rule specifies certain
additional factors that should be
considered in assessing thè custodian's
internal controls: The physical
protections the custodian makes
available for certificated securities (e.g.,.
the use of vaults or other facilities), the
custodian's method of keeping custodial
records (e.g., the use of computers,
microfim or paper records), as well as
security and data protection practices
(e.g., alarm systems and the use of pass
codes and back-up procedures for
electronically stored information). The
proposed amendments
would have
treated these factors as related to the
decision to place fund assets iIi a
In making this determination, the
Foreign Custody Manager must consider countr.43 Commenters suggested, and
all factors relevant to the safekeeping of 'the Commission agrees, that these
factors also should be considered in
fund assets, inctuding the custodian's
selecting a paricular foreign
practices, procedures and internal
custodian.44
controls, its financial strength, ,
to custodians in the relevant market.39
reputation andsaiding; and whether
ii. Financial Strength and Reputation
The amended rule requires the
Foreign Custody Manager to consider
whether the' foreign custodian has the
requisite financial strength to .provide
reasonable care for fund assets.45
Particular emphasis should be placed on
evaluating the custodian's financial
strength, since the amended rule no
longer requires the foreign custodian to
have a specified minimum shareholders'
equity.46 As noted in the Proposing
Release; in considering financial
strength, the Foreign Custody Manager
should assess the
adequacy of the
custodian's capital with a view of
protecting the fund against the risk of'
loss from a custodian's insolvency.47
In additon, consideration must be
givèn to the custodian's, reputation and
standing generally. Thè amended rule
does not limit the Foreign Custody
Manager to considering the foreign
custodian's reputatioIiin the coUntr
where the custodian is located. This
approach seeks to provide greater
flexibilty to evaluate a custodian's
reputation, based on the facts and
circumstances relevant to
the parcular
custodian (such as the custodial services
it provides in other furisdictionsj.48
iii. Jurisdiction
The amended rule also requires the
. Foreign Custody Manager to assess the
likelihood of U.S. jurisdiction over and
enforcement of judgments against a
foreign custodian.49 This provision is
designed to allow the Foreign Custody
Manager to consider vaious factors,
including whether a foreign custodian
has branch offces in the United States.
The Foreign Custody Manager should
evaluate other jurisdictional and
enforcement means such as wl:ether the
jurisdiction over and enforce judgments 5(c)(1)(i)).' ,
4' Amended rule 17f-5(c)(1-)(i) (17 CFR 270.17f
foreign custodian ha:.sappoIntec;I an
agent for service of 'process in the
against the custodian.4O The .
Commission
notes that the reasonable
care standard is merely
a theshold
standard, and that fund boards and their
42 See Proposing Release, supra 'note 5, at nn.88
89 and accompanying text. For example, if delivery
vs. payment procedures are nót par of the
settlement practices of a paricular foreign market,
some custodians in that market might provide
safeguards that address the lack òf such procedures,
while others might not. See. e.g., Deparent of
the
United States or has consented to '
jurisdiction in this countr. The
Commission recognizes that U.S.
jurisdiction may not be obtainable over
the fud wil be able to obtain
delegates have the flexibilty to' agree
that the delegate wil select foreign
custodians that wil exercise a higher
)7 See Proposing Release, supra note 5, at n.80
and accompanying text.
3" Amended rule 17f-5(c)(1) (17 CFR 270 17f
5(c)(1)).
3. ¡d. As notedin the Proposing Release, supra
note 5, at nn.88-a9 and accompanying text, while
reference to U.S. standards may be relevant in
determining whether the fund's assets wil be
maintained with reasonable care, the rule does not
require parity between foreign and U.S. custodial
arrangements.
40Amended rule 17f-5(c)(1) (i) though (iv) (17
CFR 270.17f-5(c)(1) (i) through (iv)).
Treasury, Offce of
Comptroller of
the Currency,
Emerging Markel Countiy Products and Trading
Activities 20 (Dec. 1995) (discussing alternatives to
delivery vs. payment procedures). Such differences
among custodians should be considered in
certain foreign depositories and other
custodians, and an affrmative finding of
U.S. jurisdiction would not be rèquired;
Rather, the existence or absence of U.S.
jurisdiction would have to be
ç:onsidered in makng the overall
determining whether a paricular custodian wil
provide reasonable care for. fund assåis. See supra
note 17 (discussing the deliveiyvs. payment
procedures). ..
43 See Proposing Release, supra note 5, at n.54
and accompanying text.
.. See Letter from Chase Manhattan Bank to
Jonathan G. Katz, Secretary, Securities and
Exchange Commission (Oct. 6, 1995), File No. S7
23-95, at n.4 (noting that the use of vaults and
computers, for example. is important with respect
to any paricular foreign custodian).
"Amended rule 17f-5(c)(1)(ii) (17 CFR 270.17f
5(cJ(1)(ii)).
46 See infra, Section II.D.l of this Release:
47 See Proposing Release, supra note, at nn.125
131 and accompanying text.
""Amended rùle 17f-5(cJ(1)(ii) (17 CFR 270.17f
5(c)(1)(ii)). The amended rule no longer addresses
a custodian's effciency and relative costs.
4' Amended rule 17f-5(c)(1)(iv) (17 CFR 270.17f
5(cJ(1)((v)).
Federal Register / Vol. 62, No. 95 / Friday, May 16, 1997 / Rules and Regulations
determination that the custodian wil
provide reasonable care for fund assets.
2. Foreign Custody Contract
Rule 17f-5 currently require§ a fund's
foreign custody arrangements to be
governed by a written contract that the
fund's board determines is in the best
interests of the fund and which contains
specified provisioni;.5o The proposed
amendments wmi-ia have eliminated the
requirement that specific provisions be
included in the contract but would have
required the Foreign Custody Manager
to determine that the contract would
provide reasonable protection for fund
assets. Although a small number of
commenters supported the proposed
approa.ch, commenters generally favored
retaining the contract requirements in
the rule as benefitting funds and their
shareholders. The commenters asserted,
rule's
among other things, that the
requirements have resulted in
international standards for foreign
custody agreements that have served to
protect investors.
In light of these comments, the
Commission has concluded that the
amended rule should continue to
require foreign custody arangeme,nts to
be governed by a written contract.
Consistent with the new standard for,
evaluating foreìgn custody
arrangements, the amended rule
requires that the Foreign Custody
Manager determine that the contract
wil pi;ovide reasonable care for fund
assets.51 The amended rule also retains
the specific ,contract reqtiirements.52 In
addition, the amended rule permits the
contract to contain alternative
provisions in lieu of those specified in
the rule: The Foreign Custody Manager
must determine that the alternative
provisions, in their entirety, wil
level of
provide the same or a greater
care and protection for fund assets as
the specified provisions, in their
entirety.
53 This change should provide
50Rule 17f-5(a)(1)(iii). The contract generally
must provide that: (Al The fund will be
indemnified and its assets insured in the event of
loss; (B) the fund's assets wil not be subject to liens
or other claims in favor of the foreign custodian or
its creditors; (C) the fund's assets wil be freely
transferable without the payment of money; (0)
records wil be kept identifying the fund's assets as
belonging to the fund; (E) the fund's independent
public accountants will be given access to those
records or confirmation of the contents of those
records; and (F) the fund wil receive periodic
reports. including notification of any transfers to or
from the fund's account. Rule 17f-5(a)( 1 )(iiiJ(A)
through (F),
5' Reasonable care, in this context. would be
determined by reference to the same standards used
in selecting the foreign custodian.
52 t\mended rule 17f-5(c)(2)(i) (17 CFR 270,17f
5(c)(2J(i)),
"Amended rule 17f-5(c)(2)(ii) (17 CFR 270.17f
5(c)(2)(ii)),
funds and their custodians with the
flexibilty to take advantage of
innovations that are consistent with
investor protection. Finally, as
26929
fund assets, and in establishing
monitoring procedures with respect to
the custodial arrangement.60 The
Foreign Custody Manager, for example,
specified contract
the
discussed below ,
requirements have been modified to
reflect commenters' suggestions and
should consider adopting procedures for
staffinterpretive positions.
liens is kept to a minimum or explore
reasonable alternatives to cash deposits.
c. Omnibus Accounts
In an "omnibus account" structure,
the assets of more than one custodial
customer are contained in,
an account
a. Indemnification and Insurance
Rule 17f-5 currently requires the
foreign custody contract to provide that
the fund wil be adequately indemnified
and its assets adequately insured in the
event of loss.
54 This provision has been
interpreted as permitting the contract to
provide for indemnifcation (but not
insurance) if the indemnification
arrangements would adequately protect
the fund.55 In response to the
assuring that the amount maintained in
deposit accounts that could be subject to
tlat has been established, typically by
and in the name of an intermediar
custodian, with a foreign bank or
securities depository. Rule 17f':5
currently requires the foreign custody
contract to provide that adequate
commenters' suggestions, the
Commission has clarified the provision
in rule 17f-5 to reflect this
records wil be maintained identifying
claims or rights arising i.der '
but pursuant to rules or practices of the
depository.65 To accommodate the use
the assets in foreign custody as
belonging to the fund.61 Althoughthe
56 The amended rule
interpretation.
Commission staff has ta~'en the position
specifies that the contract must provide that the current rule does not prescribe
for indemnification or insurance
a specific manner for keeping custodial
arangements (or any combination of the records, and therefore does not prohibit
foregoing) such that the fund wil be
omnibus accounts,62 several
adequately protected against the risk of commenters recommended arending
loss of assets held in accordance with
the rule to specifically recognize the
57
the contract.
permissibility of omnibus accounts.
The amended rule provides
that the
b. Liens
custodian's records may either identify
Rule 17f-5 currently requires the
the assets as belonging to the fund or as
foreign custody contract to provide that being held by a third party for the
the fund's assets wil not be subject to
bénefit of the fund.63 The amended rule
any right, charge,.security interest, lien
therefore recognizes that in an omnibus
or claim of any kind in favor of the
account structure, the securities
foreign custodian or its creditors except depository's books may show that the
a claim of payment for the safe custody
custodian is the owner
of the fund's
or admiiiistration of the fund's assets.58
assets. The amended rule makes clear,
Commenters suggested that in many
however, that the fund's interest in the
jurisdictions, cash deposits may become account should be reflected on the
subject to creditors' claims if a
books of the custodian.64
custodian becomes bankrpt. The rule
d. Depository Arrangements
as amended addresses this issue by
providing that the prohibition against
The Commission understands that
liens does not apply to cash deposits
foreign depository arangements
that may become subject to creditors'
typically are governed not by contract,
bankruptcy, insolvency, or other similar
laws.59 If a fund places assets with a
custodian in a jurisdiction in which the
deposits can become subject to a lien,
the Foreign Custody Manager should
take this factor into account in
determining whether the foreign
custodian has the requisite financial
strength to provide reasonable care for
54 Rule 17f-5(a)(1)(iiiJ(A),
55 See Investment Company Institute (Nov. 4.
1987).
56 Amended rule 17f-5(cJ(2)(iJ(A) (17 CFR
270.17f-5(C)(2J(i)(A)).
55, '
57 See Investment Company Institute, supra note
5. Rule 17f-5(a)(1)(iii)(ß),
59 Amended rule 17f-5(cJ(2)(iJ(B) (17 CFR
270,17f-5(c)(2)(iJ(B)).
60 See infra Section I1.C.3 of this Release.
6. Rule 17f-5(a)(1)(iii)(0).
62 See State Street Bank & Trust Company (Feb,
28, 1995).
6J Amended rule 17f-5(c)(2)(i)(0) (17 CFR
270.17f-5(c)(2)(i)(0)).
64 ¡d, A conforming change has been made to
paragraph (c)(2)(i)(F) of the rule. which requires
that the fund receive notice of any transfers of fund
assets to or from the custodian. This notice
provision requires notice of transfers to or from
third party accounts. Amended nile 17f-5(c)(2)(i)(F)
(17 CFR 270.17f-5(c)(2)(i)(F)).
65 Typically, the contractual arrangement
pursuant to which fund assets are held in a foreign
depository involves an eligible foreign bank that is
itself a subcustodian of the fund's U.S. custodian.
Rule 17f-5 currently does not require the foreign
depository to be party to the fund's foreign custody
Coniinul~d
..
26930
Federal Register / Vol. 62, No. 95 / Friday, May 16, 1997 / Rules and Regulations
of these depositories, the Commission is
all factors that affect the foreign
amending rule 17f-5 to clarify that the
provisions required to be in the custody
contract may be reUected in the rules or
abilty to provide custodial services,
established practic~s or procedures of
the depository, or in any cOmbination of
the foregoing.~
custodian's financial strength and its
involving an unaffiliated primar
Commenters strongly supported these
custodian of the fud and a foreign sub-
provisions concerning board oversight
custodian.72 As discussed above, a
and monitoring of foreign custodial
custodian's financial strength is an
replaces these provisions with a
requirement that the Foreign Custody
Manager establish a system to monitor
the appropriateness of maintaining the
fund's assets with a particular custodian
and the fund~s foreign custody
contract.6S Commenters supported these
amendments.
If a foreign custody arangement no
paricipants currently use arangements
including credit and market risks.7!
amendments.
Under the amended rule, any foreign
bank or trst company that is subject to
3. Monitoring Custody Arrangements
foreign ban or trst company
and Withdrawing t"und Assets
regulation, as wéii as any U.S. bank
Rule 17f-5 curently contains detailed subsidiar, may bean eligible foreign
arangements.'67 The amended rule
The Commission understands,
however, that a number of market
important factor to be considered in
selecting a foreign custodian. The
amended rule requires the Foreign
Custody Manager to evaluate the
financial strength of a foreign custodian
in determining whether the fund's
assets wil be subject to reasonable care
if maintained with that custodian.73
2. Affiliated Foreign Custodians
custodian that is affiliated with the
fund.7s The Commission is of the view
that such an arrangement, provided it is
strctured with appropriate oversight
and controls by the unaffliated
intermediar (i.e., the primar
custodian), may adequately address the
concerns of selfccustody. The risks of
misappropriation of fund as'sets are
mitigated when the custody
arangement is entered into by, and
operated though, an un.affiliated
intermediar custodian and is subject to
adeqllate independent scrutiny.
The Commission believes that this
generally would be the case when the
subcustodian in an omnbus account in the
fund's assets are held by Øi~ foreign
name of the primar custodian, so as to
preclude specific identification of fud
assets by the affliated sub-custodian. In
its assets from the custodian as soon as
addition, adequàte inyolvement by an
reasonably practicable.69 Rula 17f-5's
unaffliated custodian would require
monitoring requirement is intended to
from being affliated persons of the fund that the sub-custodian be permitted to
result in the Foreign Custody Manager
or affiiated persons of such persons.
settle transactions involving fund assetS
receiving suffcient and timely
The Commission proposed this
solely on receipt OfiIlstrctions from
'to permit it to respond to
information
approach because rule 17f-2 under the
the primar custodian (which, in tur,
material changes in the fund's foreign
receives its instrctions from the
custody arangement. The amended rule Investment Company Act, the rule that
governs funds' self-custody
fund).76 The primar custodian also
focuses on the importance of takng
arangements and has been interpreted
should closely monitor the fund's
,prompt action based on the
by the Commission staff to apply to
account to assure that unauthorized
circumstances presented. For example, a
affliated custody arangements,
transactions have not occurred, and the
fuIid that places substantially all of its
appeared to be unworkabl,e in the
fund's auditors should review and test
assets with one custodian in a single
foreign custody context'4 '
the monitoring and control safeguards
countr may require more time to
Commenters generally disagreed with for fund assets.
withdraw those assets than a fund that
the proposed prohibition, arguing that it
has placed only a small percentage of its would be paricularly troublesome in
3. Securities Depositories
custodian in a
assets with a particular
certain markets where there is a limited
Rule 17f-5 curently includes among
particular countr.
number of eligible 'custodians. In
eligible foreign custodians a foreign
response to these comments, and upon
D. Eligible Foreign Custodians
securitfes depository or clearing agency
longer meets the requirements of the
Rule 17f-5 curently does not address
amended rule, the fud must withdraw
affliated foreign custody arangements.
amendments,
Under the proposed
eligible foreign banks and trst
companies would have been prohibited
1. Foreign Banks and Trust Companies
Rule 17f-5 curently limits the class
of "eligible foreign custodians" to
foreign bank and trust companies that
furter consideration of the issue, the
have more than $200 milion in
wil consider the issues raised by
Commission is not including the
proposed prohibition on foreign
affiiated custody arang~ents in rule
17f-5 as amended; The Commission
shareholders' equity and U.S. bank
foreign affliated custody arangements
subsidiares that have more than $100
when it considers comprehensive
amendments to rule 17f-2.
milion in shareholders' equity.70 The
Commission proposed eliminating these
requirements in favor of a more flexible
. standard that allows the Foreign
Custody Manager to take into account
7' See Proposing Release, supra note 5. at nn.124
126 and accompanying text.
72 Amended rule 17f-5(a)(1) (17 CFR 270.17f
5(a)(1)).
73 See supra Section II.C.1.b.ii of this Release.
contract. See Proposing Release, supra note 5, at nn.
98-100 and accompanying text.
"Amended rule 17f-5(c)(2) (17 CFR 270.17f
5(c)(2)).
.7 Rule 17f-5(a) (2) through (4).
68 Amended rule 17f-5(c)(3)(i) (17 CFR 270.17f
5(c)(3)(i)).
.
69 Amended rule 17f-5(c)(3)(ii) (17 CFR 270.17f
\
5(c)(3)(ii)). Current rule 17f-5(a)(4) requires fund
assets to be withdrawn within 180 days under these
circumstances.
70 Rule 17f-5(c)(2)(i), (ii).
74 See Proposing Release, supra note 5, at n.138;
that operates the only system for the
central handliig of securities or
equivalent book-entres in a countr (the
~'only system requirement~).77 The only
system requirement was designed to
ensure a countr's interest in
establishing iid maintaining a
the
depository's integrity. Because
requirement has been uiiei:essarily
restrictive, the Commission proposed to
eliminate it's COInenters uniformly
supported the proposed change.
The amended rule requires a
securities depository or clearing agency
that acts as a system for the central
Pegasus Income and Capital Fund, Inc. (Dec. 31.
1977) (to guard against potential abuses resulting
from control over fund assets by related persons,
rule 17f-2 (17 CFR 270.17f-2) has been applied to
affliated custody arrangements). Rule 17f-2 ,
requires, among other things, that fund assets be
maintained in a bank that is subject to state or
federal regulation; the fund's assets also must be
subject to CommissioQ inspection and verified by
an independent public accountant. Rule 17f-2(b).
(d). (e) (17CFR 270.17f-2(b), (d). (e)).
75 See supra note 18 and accompanying text
(discussing primary custodians).
7. The affiiated sub-custodian should not share
personnel with other affiiates of the fund (e.g., the
fund's investment adviser) to assure the integrity of
the safeguards for fund assets.
77 Rule 17f-5(c)(2)(ii).
7' See Proposing Release, supra note 5, at nn.155
156 and accompanying text.
26931
Federal Register / Vol. 62, No. 95 / Friday, May 16, 1997 / Rules and Regulations
handling of securities or equivalent
book-entries to be regulated by a foreign
financial regulatory authority.79 The
Commission believes that foreign '
regulation of a depository demonstrates
a countr's interest in the depository's
safety, thus achieving the Commission's
objective.
E. Assets Maintained in Foreign Custody
F. Canadian Funds
Rule 17f-5 curently contains special
provisions governing the foreign
custody arangements of Canadian
funds registered in the United States.84
To address jurisdictional concerns
underlying section 7(d) of the Act, these
provisions are more restrictive than
those applied to U.S. funds and allow
Canadian funds to maintain their assets
Rule 17f-5 currently permits a fund to only in overseas branches of U.S.
use foreign custody arangements for its banks.85 Because Canadian funds have
foreign securities, cash, and cash
not sought to register under the Act for
equivalents.8o Rule 17f-5 defines foreign some time, and very few Canadian
securities to include those that are
funds curently offer their shares in the
issued and sold primarily outside the
United States, the proposed
United States by foreign and U.S.
amendments would have made limited
issuers.81 By restricting the types of
conforming changes in the foreign
securities that may be maintained
custody requirements applicable to
outside the United States, the rule seeks Canadian funds.
to establish a nexus between its scope
The Commission received one
and its purpose (i.e., to give fuds the
comment letter addressing Canadian
flexibilty to keep abroad assets that are funds. The commenter suggested ,that
purchased or intended to be sold
Canadian funds be permitted to use
abroad). In addition, rule 17f-5
foreign custody ar,angeIients on the
curntly lipiits the cash and cash
same basis as their U.S. counterpars.
equivalents that a fund may maintain
, The amended
rule generally reflects this
outside the United States to amounts
approach. As under,the curent rule,
that are reasonably' necessar to effect
however, ii Canadian fund's assets must
the fund's foreign securities
be kept in the custody of an overseas
trsactions.82
branch of a U.S. bank. In addition, if the
The Proposing Release requested
Canadian fund's board delegates its
comment whether the rule should
responsibilities under the rule, the only
continue to restrict the types of
delegates are the fund's
securities and amounts of cash and cash permissible
offcers, investment adviser or a U.S.
equivalents that a fund may maintain
bank.86
outside the United States. One
commenter suggested that this provision IV. Effective Date; Compliance Dates
may not permit a fund to maintain
The amendments to rule 17f-5
investments in other assets, such as
become effective thirty days after
foreign currencies, for which the
publication in the Federal Register.
primar market is outside of the United Funds that wish to rely on the amended
States. To better reflect these types of
rule prior to the effective date of the
investment practices, the amended rule amendments may do so. Funds that
permits a fund to maintain in foreign
have established foreign custody
custody any investment (including
arangements in accordance with rule
foreign currencies) for which the
17f-5 prior to the effective date of these
primar market is outside the United
amendments ("existing foreign custody
States.83
19 Amended rule 17f-5(a)(1)(ii) (17 CFR 270.17f
includes'
5(a)(1)(ii)). Rule 17f-5 currently also,
arangements") must bring lhe.:e
arrangements into compliance with the
amended rule (i.e.. have
,the fund's
among eligible foreign custodians a security
depository or clearing agency, incorporated or
organized under the laws of a countr other than
the United States, that "operates" a transnational
system for the central handling of securities or
equivalent book-entries. The amended rule refers to
securities depositories or clearing agencies that "act
as" such transnational systems. Amended rule 17f
5(a)(1)(ii) (17 CFR 270.17f-5(a)(1)(ii). This change
is intended to recognize that in some instances the
service provider that operates or administers the
transnational system may be organized under the
laws of the United States (e.g., as a foreign branch
of a U.S. bank). .
8°Rule 17f-5(a).
81 Rule 17f-5(c)(1).
82 Rule 17f-5(a).
8) Amended rule 17f-5(c) (17 CFR 270.17f-5(c)).
As a result of this change, the rule no longer refers
to "foreign securities" (which had been defined as
securities "issued and sold primarily outside of the
United States"). The "primar market" formulation
is designed to encompass foreign securities a~ well
as other types of investments.
84 Rule 174f-5(b)
as Section 7(d) of the Investment Company' Act
(15 U,S.C. 80a-7(d)) prohibits foreign investment
compánies from publicly offering their securities in
the United States unless the Commission issues an'
order permitting registration under the Act. Rule
7d-i under ¡he Investment Company Act (17 CFR
270.7d-l) sets forth conditions governing
applications by Caadian funds that seek
Commission orders pursuant to section 7(d). Among
other conditons. rule 7d-1 'provides that the assets
of Caadian funds are to be held in the United
States by a U.S. bank. except as provided under rule
17¡-5. Rule 7d-l(b)(8)(v) (17 CFR 270.7d
1 (b)(8)(v)).
8. Amended rule 17f-5(d) (1), (2) (17 CFR
270.17f",5(d) (1). (2)),
board make the findings required by the
amended rule or appoint a delegate to
do so) within one year of the effective
date of these amendments. The one year
period is designed to give funds the
flexibilty to bring an existing foreign
custody arangement into compliance
with the amended rule either when that
arangement would have been subject to
the fund board's annual review, as was
required by ,the rule before these
amendments, or at any board meeting
within the one year period.
V. Cost/enefit Analysis and Effects on
Competition, Effciency and Capital
Formation .
The amendments to rule 17f-5 seek to
give funds greater flexibilty in their
foreign c\lstody arangements consistent
with investor protection. The amended
rule permts a fud's board to delegate
its
responsibilties to select
and monitor
a fund's foreign custody arangements
and no longer requires the board to
approve these arangements anually.
The amended rule does require
delegates to provide fund boards with
written reports regarding certain aspects
of the foreign custody arangements.
This requirement is designed to
faciltate board oversight and protect
fund shareholders. The potential costs
associated with this requirement are not
expected to be significant, and are likely
to be much less than the costs
associated with the current requirement
of providing fund boards with
information pertaining to their annual
review of foreign custody arangements.
The amendments also expand the
class of foreign banks and securities
depositories that may serve as
custodians of fund assets overseas.
These amendments give funds greater
flexibilty in
selecting foreign
custodians and eliminate the need for
funds to request administrative relief for
certain foreign custody arangements.
Section 2(c) of the Investment '
Compaiy Act provides that whenever
the Commission is engaged in
rulemaking and is required to consider
or determine whether an action is
necessar or appropriate in the public
interest, the Commission must consider,
in addition to the protection of
i.nvestors, whether the action wil
promote efficiency, competition, and
capital formation.8 The Commission
has considered the amendments to rule
17f-5 in light of these standards. The
Commission believes that the
amendments are consistent with the
public interest and wil promote
effciency and competition because the
amendments (i) permit fund directors to
8715 U.S.C. 80a-2(c).
Federal Register I Vol. 62, No. 95 I Friday, May 16, 1997 I Rules and Regulations
26932
playa more traditional oversight role
with respect to the custody of fund
assets overseas, (ii) better focus the
scope of the rule on safekeeping
considerations, and (iii) expand'the
class of eligible foreign banks and
securities depositories that may serve as
custodians of fund assets. The
Code of Federal Regulations is amended
The amendments to rule 17f-5, among as follows:
VII. Paperwork ~eduction Act
other things (i) permit a fund's board of
directors to delegate its responsibilties
under the rule upon a finding that it is
reasonable to rely on the' delegate to
amendments wil håve no adverse effect
perform the delegated responsibilities,
and (ii) require the delegate to notify the
board of the placement of the fund's
assets with a paricular foreign
on capital formati~n.
custodian and of any material change in
Final Regulatory
Flexibilty Analysis
arangements. These provisions
Commission also believes that the
VI. Sumary of
A summary of the Initial Regulatory
Flexibility Analysis, which was
prepared in accordance with 5 U.S.C.
603, was published in Investment
Company Act Release No. 21259. No
comments were received on that '
Analysis. The Commission has prèpared
a Final Regulatory Flexibilty Analysis
("FRFA") in accordance with 5 U.S.C.
604. The FRFA states that the objective
of the amendments is to give funds
greater flexibilty in their foreign
custody arrangements by permitting
fund boards to delegate their
responsibilties to select and monitor
foreign custodians, and by expanding
the class of eligible foreign custodians.
The FRFA provides that approximately
194 funds and 242 investment advisers
that are small entities may be effected
by the amendments. The FRF A explains
that the amendments seek to reduce ,
burdens on all funds, including those
that are sma)l entities, and that the
amended
'rule's compliance
requirements are necessary for the
safekeeping of fund assets and investor
protection. Finally, the FRF A states that
in adopting the
amendments the
, Commission considered (a) the
establishment of dífering compliance
requirements that take into account the
resources available to small entities; (b)
simplification of the rule's requirements
for small entities; (c) the use of
performance rather than design
standards; and (d) an exemption from
the rule for small entities. The FR A
states that the Commission concluded
that different requirements for small
entities are not necessar and would be
inconsistent with investor protection,
and that the amended rule incorporates
performance standards to the extent
practicable. Cost-benefit information
reflected in the "Cost/Benefit Analysis"
section of this Release also is reflected
the fund's foreign custody
constitute a "collection of information"
requirement within the meaning of the
Paperwork Reduction Act of 1995 (44
U.S.G. 3501), because making the
finding and providing the notices are
necessar to be able to rely on the ~
amended rule for foreign custody
arrangements. An agency may not
conduct or sponsor, and a person is not
required to respond to, a collection of
information unless it displays a
currently valid control number.
Accordingly, the Commission
submitted the proposed amendments to
the Office of Management and Budget
("OMB") pursuant to 44 U.S.C. 3507 .
and received approval of the
amendments" "collection of
information" requirements (OMB
control number 3235-0269). As
discussed in section IILA. of this
Release, the Commission has
determined not to adopt the proposed
amendment requiring a fund's board to
1. The authority citation for part 270
continues to read, in part, as follows:
Authority: 15 V.S.C. 80a-1 et seq., 80a-37,
80a-39 unless oth\lrwise noted;
*
*
*
*
*
2. Section 270.17f-5 is revised to read
as follows:
§ 270.17f-Æ. Custody of investment
company assets outside the United States.
(a) Definitons. For purposes of this
section:
(1) Eligible Foreign Custodian means
an entity that is incorporated or
organized under
'the laws of a countr
other than the United States and that is:
(i) A Qualified Foreign Bank or a
majority-owned direct or indirect
subsidiar of a U.S. Bank or bank-
holding company;
(ii) A securities depository or clearing
agency that acts as a system for the
central handling of securities or
equivalent book-entries in the countr
that is regulated by a foreign financial'
regulatory authoritý as defined under
section 2(a)(50) of the Act (15 U.S.G.
80a-2(a)(50)); or
(iii) A securities depository or
clearing agency that acts as a
transnational system for the central
confidential by the partieii to the extent
that the Commission obtaÎIis access to
or organized under the laws of the
handling of securities or equivalent
book-entries.
(2) Foreign Custody Manager means a
The Commiss'ion believes that this is not
Fund's or a Registered Canadian Fund's
a material change for purposes of
board of directors or any person serving
collection of information requirements
as the board's delegate under paragraphs
and wil not have any impact on the
(b) or (d) of this section.
Commission's estimate öf total burden
(3) Fund means ainanagement
hours. The amended rule does not
investment company registered under
require that the collection of
the Act (1.5 U.S.C. 80a)
and incorporated
information be made public or kept
the collection of information through its
inspection program, the information
generally would not be available to third
parties.
VIII. Statutory Authority
United States or of a state.
(4) Qualified Foreign Bank means a
banking institution or trst company.
incorporated or organiZ'ed under the
laws of a countr other than the United
States, that is regu.1ated as such by the
countr's government or an agency of
,the country's government.
The Commission is amending rule
(5) Registered Canadian Fund means
17f-5 pursuant to the authority set forth
a management investment company
in sections 6(c) and 38(a) of the
Investment Company Act of 1940 (15
U.S.G. 80a-6(c), 80a-37(a)).
List of Subjects in 17 CFR Par 270
Gross, Mail Stop 10-2, Securities and
Exchange Commission, 450 Fifth Street,
NW., Washington, DC. 20549.
preamble, Title 17, Chapter II of the
be obtained by contacting Robin S.
REGULATIONS,
INVESTMENT
COMPANY ACT OF 1940
make a finding that placing fund assets
in a particular countr would provide
reasonable protection for fund assets.
Investment companies, Reporting and
recordkeeping requirements, Securities.
Text of Rule
For the reasons set out in the
in the FRF A. A copy of the FRF A may
PART 270-RULES AND
incorporated or organized under the
laws of Canada and registered under the
Act pursuant to the conditions of
§ 270.7d-1.
(6) Securities Depository means a
system for the central handling of
securities as defined in § 270.17f-4(a).
(7) U.S. Bank means an entity that
(i) A banking institution organized
under the laws of the United States;
is:
Federal Register / Vol. 62, No. 95 / Friday, May 16, 1997 / Rules and Regulations
(ii) A member bank of the Federal
Reserve System;
(iii) Any other banking institution or
trust company organized under the laws
)
of any state or of the United States\
whether incorporated or not, doing
business under the laws of any state or
of the United States, a substantial
portion of thë business of which
consists of receiving deposits or
exercising fiduciary pbwers similar to
those permitted to national banks under
the authority of the Comptroller of the
Currency and which is supervised and
examined by State or Federal authority
having supervision over banks, and
which is not operated for the purpose of
evading the provisions of this section, or
(iv) A receiver, conservator, or other
liquidating agent of any institution or
firm included in paragraphs (a)(7)(i),
(ii), oJ¡ (iii) of this section.
(b) Delegation. A Fund's board of
directors may delegate to the Fund's
investment adviser or offcers or to a
U.S. Bank or to a Qualified Foreign
Bank the responsibilities set forth in
(i) The custodian's practices,
procedures, and internal controls,
including, but not limited to, the
physical protections available for
certificated securities (if applicable), the
method of keeping custodial records,
and the security and data protection
practices;
(ii) Whether the custodian has the
requisite financial strength to provide
reasonable care for Fund assets;
(ii) The custodian's general
reputation and standing and, in the case
of a Securities Depository, the
depository's operating history and
number of participants; and
(iv) Whether the Fund wil have
jurisdiction ov'er and be able to enforce
judgments against the custodian, such
as by virtùe of the existence of any
offces of the custodian in the United
States or the custodian's consent to
service of process
in the United States.
(2) Contract. The Fund's foreign .
26933
safekeeping of the Fund's assets,
including, but not limited to,
notification of any transfer to or from
the Fund's account or a third party
account containing assets held for the
benefit of the Fund.
(ii) Such contract may contain, in lieu
of any or all of the provisions specified
in paragraph (c)(2)(i) of this section,
such other provisions that the Foreign
Custody Manager determines wil
provide, in their entirety, the same or a
greater level of care and protection for
Fund assets as the specified provisions,
in their entirety.
(3)(i) Monitoring the Foreign Custody
Arrangements. The Foreign Custody
Manager must have established a system
to monitor the appropriateness of
maintaining the Fund's assets with a
particular custodian under paragraph
(c)(l) of this section, and the contract
governing the Fund's arangements
under taragraph (c)(2) of this section.
custody arangements must be governed
(ii) I an arangement no longer meets
the requirements of this section, the
Fund must withdraw its assets from the
a Securities Depository, by such a
paragraphs (c)(l), (c)(2), or (c)(3) of this
custodian as soon as reasonably
contract, by the rules or established
section, provided that:
practicable.
practices or procedures of the
(1) The board determines that it is
depository, or by any combination of the
(d) Registered Canadian Funds. Any
reasonable
to rely on the delegate to
Registered Canadian Fund may place
foregoing) that the Foreign Custody
perform the delegated responsibilties;
and maintain outside the United States
Manager has determined wil provide
(2) The board requires the delegate to reasonable care for Fund assets based on any investments (inclúding foreign
provide written reports notifying the
currencies) for which the primar
the standards specified in paragraph
board of the placement of the Fund's
market is outside the United States, and
(c)(l) of this section.
assets with a particular custodian and of
such'cash and cash equivalents as are
(i) Such contract shall include
any material change in the Fund's
arrangements, with the reports to be
provided to the board at such times as
the board deems reasonable and
appropriate based on the circumstances
of the Fund's foreign custody
arrangements; and
(3) The delegate'agrees to exercise
by a written contract (or, in the case of
provisions that provide:
(A) For indemnification or insurance
reasonably necessar to effect the
such contract;
of an overseas branch of a U.S. Bank
Fund's transactions in such
arrangements (or any combination of the investments, in accordance with the
foregoing) such that the ,Fund wil be
requirements of this section, provided
adequately protected against the risk of that:
loss of assets held in accordance with
(1) The assets are placed in the care
that has aggregate capital, surplus, and
reasonable care, prudence and dilgence
undivided profits of a specified amount,
such as a person having responsibility
which must not be less than $500,000;
for the safekeeping of Fund assets
favor of the custodian or its creditors
would exercise, or to adhere to a higher ,except a claim of payment for their safe
(2) The Foreign Custody Manager is
standard of care, in performing the
custody or administration or, in the case the Fund's board of directors, its
delegated responsibilties.
of cash deposits, liens or rights in favor investment adviser or offcers, or a U.S.
(c) Selecting an Eligible Foreign
Custodian. A Fund may place and
maintain in the care of an Eligible
Foreign Custodian any investments
(including foreign currencies) for which
the primar market is outside the
United States, and such cash and cash
equivalents as are reasonably necessary
to effect the Fund's transac;tions in such
investments, provided that:
(1) The Foreign Custody Manager
determines that the Fund's assets wil
be subject to reasonable care, based on
the standards applicable to custodians
in the relevant market, if maintained
with the custodian, after considering all
factors relevant to the safekeeping of
such assets, including, without
limitation:
(B) That the Fund's assets wil not be
subject to any right, charge, security
interest, lien or claim of any kind in
of creditors of the custodian arising
under bankrptcy, insolvency, or
similar laws;
(C) That beneficial ownership for the
Fund's assets wil be freely transferable
without the payment of money or value
and '
Bank.
May 12, 1997.
By the Commission.
Mararet Ii McFarland,
Deputy Secretaiy.
other than for safe custody or '
(FR Doc. 97-12881 Filed 5-15-97; 8:45 am)
administration;
BiLLING COOE 801lHl-P
(D) That adequate records wil be
maintained identifying the assets as
belonging to the Fund or as being held
by a third party for the benefit of the
Fund;
(E) That the Fund's independent
public accountants wil be given access
to those records or confirmation of the
contents of those records; and
(F) That the Fund wil receive
periodic reports with respect to the
EQUAL EMPLOYMENT OPPORTUNITY
COMMISSION
29 CFR Part 1601
Increased Fine for Notice Posting
Violations
AGENCY: Equal Employment
Opportunity Commission.
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.