Credit by Brokers and Dealers

FEDERAL RESERVE SYSTEM

12 CFR Part 220

[Regulation T; Docket No. R-0840]

Credit by Brokers and Dealers

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Proposed rule.

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SUMMARY: As part of its review of Regulation T, the Board is proposing

three substantive amendments to two areas of the regulation. One

proposal specifies that customers must meet initial margin calls or

make full cash payment for securities purchased at a broker-dealer

within two business days of the standard settlement period and includes

related technical amendments. The other amendments would exempt certain

brokers and transactions involving U.S. government securities from the

regulation.

DATES: Comments should be received on or before August 15, 1994.

ADDRESSES: Comments, which should refer to Docket R-0840, may be mailed

to Mr. William Wiles, Secretary, Board of Governors of the Federal

Reserve System, 20th Street and Constitution Avenue, NW., Washington,

DC 20551. Comments addressed to Mr. Wiles may also be delivered to the

Board's mail room between 8:45 a.m. and 5:15 p.m., and to the security

control room outside of those hours. Both the mail room and the

security control room are accessible from the courtyard entrance on

20th Street between Constitution Avenue and C Street, NW. Comments may

be inspected in Room B-1122 between 9 a.m. and 5 p.m., except as

provided in Sec. 261.8 of the Board's Rules Regarding the Availability

of Information, 12 CFR 261.8.

FOR FURTHER INFORMATION CONTACT: Scott Holz, Senior Attorney or Angela

Desmond, Senior Attorney, Division of Banking Supervision and

Regulation (202) 452-2781; for the hearing impaired only,

Telecommunications Device for the Deaf (TDD), Dorothea Thompson (202)

452-3544.

SUPPLEMENTARY INFORMATION: On August 18, 1992, the Board published an

advance notice of proposed rulemaking (Advance Notice) requesting

public comment in connection with a general review of Regulation T.\1\

The review is not yet complete, but the Board believes that certain

developments since the publication of the Advance Notice warrant the

publication of three proposed amendments in two areas.

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\1\Docket No. R-0772, 57 FR 37109, August 18, 1992.

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I. Three Day Settlement (T+3).

In light of the adoption by the Securities and Exchange Commission

(SEC) of a rule shortening the standard settlement period for

securities transactions from five to three business days (T+3), the

Board proposes to shorten the time periods specified in Regulation T

for customers to meet margin calls or make full cash payment by a

corresponding two days. Related amendments would raise the de minimis

amount below which liquidation of unpaid transactions is not required

from $500 to $1000, require brokers seeking extensions of the payment

periods to obtain them from their designated examining authority

(``DEA''), and clarify that foreign settlement periods are used to

calculate when restrictions in the cash account are applied to foreign

securities.

Regulation T has always required cash payment for securities

purchases within seven business days of trade date. The seven day

period was initially chosen for the cash account because it was felt

that a customer should have no obligation to pay for securities before

they were delivered. The two days permitted beyond settlement date

provide a short period of time for resolution of problems before the

broker is required to act under Regulation T, i.e. either obtain an

extension on the customer's behalf (if it is determined that a valid

reason exists) or sell out the customer's position.

The Board's Advance Notice was issued before the SEC proposed its

rule adopting a T+3 settlement period. The Advance Notice mentioned the

Group of Thirty's recommendation of a world-wide settlement standard of

T+3 and said the Board ``may consider shortening the time for customer

payment once the settlement period is shortened from the current five

days.'' The Board supported the SEC when it proposed requiring T+3

settlement, calling the proposal ``an important and achievable step''

to reduce potential systemic disturbances to financial markets and to

the economy. The SEC also received several comment letters stating that

the implementation of T+3 settlement will require the Federal Reserve

to address the possible shortening of its Regulation T payment periods.

Those letters were forwarded to Board staff for consideration in the

context of the ongoing Regulation T review.

The Board proposes to reword Regulation T to specifically

incorporate the standard settlement cycle and the current two day

cushion. Instead of requiring payment within ``seven business days,''

the regulation would require payment within ``one payment period,''

with ``payment period'' being defined as the standard settlement period

in the United States plus two business days. This will not change the

operation of the rule at this time, but once the new language is put

into place the conversion to T+3 next year will automatically result in

a reduction in the amount of time brokers can give their customers to

pay for securities or meet initial margin calls. Future changes in

settlement periods by the SEC will similarly be automatically reflected

in the Board's rule without the necessity of further amendment.

The payment periods in Regulation T can be extended for exceptional

circumstances if the broker applies to a self-regulatory organization

(SRO) for an extension. In 1988, the New York Stock Exchange (NYSE)

sought SEC approval of a rule that would require a broker seeking a

Regulation T extension to obtain the extension from the NYSE if the

NYSE is the broker's DEA. The proposal was noted by the Board in the

Advance Notice, as was a suggestion by the Credit Division of the

Securities Industry Association that brokers be permitted to grant

customer extensions without approval of an SRO. The SEC approved the

NYSE rule filing in May 1994.\2\ In its approval order, the SEC stated

that it does not agree with assertions that the objectives of the

Securities Exchange Act of 1934 (the ``Act'') could be better met by

implementing a uniform system of sharing extension information. As to

the other objections raised by commenters (and also raised with the

Board pursuant to the Advance Notice), the SEC found that ``the

regulatory benefits from the NYSE rule outweigh any competitive

concerns raised by the commenters.'' Finally, the SEC said it does not

agree with those commenters who argue that broker-dealers should not be

required to submit requests for extensions of time to either their DEA

or any SRO. The Board believes, along with the SEC, that a good case

has been made to restore to the broker's DEA sole responsibility for

granting and monitoring extensions of time and the language proposed by

the Board today reflects this conclusion.

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\2\59 FR 26826, May 24, 1994; Securities Exchange Act Release

34073, May 17, 1994.

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II. Government Securities

In light of the recent enactment of the Government Securities Act

Amendments of 1993, the Board proposes to exempt most transactions

involving government securities from the restrictions of Regulation T.

This would be accomplished with two separate but related actions.

First, Regulation T would exclude government securities brokers and

dealers who register with the SEC under section 15C of the Securities

Exchange Act of 1934 (the ``Act'') from the definition of ``creditor''

in Regulation T. Second, general broker-dealers effecting customer

transactions that could be effected by a section 15C broker-dealer

would be able to record the transactions in a new government securities

account in which the other restrictions in Regulation T would not

apply.

Before the enactment of the Government Securities Act of 1986,

brokers-dealers who limited themselves to transactions in government

securities were not subject to a comprehensive regulatory scheme and

were not required to be registered with the SEC. Although such brokers

were within the definition of ``creditor,'' there was no practical way

to enforce Regulation T for them. The Government Securities Act of 1986

required SEC registration of all nonbank government securities brokers

and dealers under a new section 15C of the Act. The Government

Securities Act of 1986 also added the term ``government securities'' to

the Act.

The Advance Notice invited comment on two areas involving

government securities: repurchase agreements (``Repos'') and the

borrowing and lending of securities. The Advance Notice explained that

the Board has not specified the exact treatment of repurchase

agreements while noting that repos of government securities do not

raise credit issues under Regulation T because the good faith loan

value of such securities is often close to 100 percent of their current

market value. Many of the commenters suggested that the Board create a

new account for exempted securities that could be used for transactions

such as Repos and forward transactions. Most of the commenters

supported exempting government securities from Sec. 220.16 of

Regulation T. This would allow loans of government securities without

the current requirement that a broker document that the reason for the

borrowing stems from a short sale or failure to receive securities

required for delivery.

Under today's proposal, whenever a general broker-dealer effects a

transaction for a customer that could be effected by a section 15C

broker, the transaction could be recorded in a new government

securities account. The account would allow these transactions to be

effected without regard to other restrictions in Regulation T. The

account would be permissive; brokers could continue to let customers

who wish to use the cash or margin account for transactions involving

government securities do so. It would allow institutional customers who

cannot or will not use a margin account to engage in government

securities transactions not specifically authorized in the cash

account. For example, the government securities account could be used

to effect purchases of government securities on credit or for cash as

well as repurchase and reverse repurchase agreements. Borrowing and

lending of government securities could also be effected in the proposed

account without being subject to the ``permitted purpose'' requirement

in Sec. 220.16 of Regulation T that requires brokers to limit and

document the reasons for their securities borrowings. The account would

also permit net settlement of offsetting purchases and sales of

government securities. Government securities purchased or deposited in

a margin account would still be subject to the current Regulation T

rules and would therefore still be available to finance the purchase of

other securities in a margin account.

The Board is not proposing to include additional types of exempted

securities, such as municipal securities, in the proposed government

securities account. Government securities constitute an unusually deep

and liquid market and are subject to a unique scheme of regulation, as

evidenced by the Government Securities Act of 1986.

Regulatory Flexibility Act

The Board believes there will be no significant economic impact on

a substantial number of small entities if this proposal is adopted.

Comments are invited on this statement.

Paperwork Reduction Act

No additional reporting requirements or modification to existing

reporting requirements are proposed.

List of Subjects in 12 CFR Part 220

Banks, banking, Bonds, Brokers, Commodity futures, Credit, Federal

Reserve System, Investment companies, Investments, Margin, Margin

requirements, National Market System (NMS Security), Reporting and

recordkeeping requirements, Securities.

For the reasons set out in the preamble, the Board proposes to

amend 12 CFR Part 220 as follows:

PART 220--CREDIT BY BROKERS AND DEALERS (REGULATION T)

1. The authority citation for Part 220 is revised to read as

follows:

Authority: 15 U.S.C. 78c, 78g, 78h, 78q, and 78w.

Sec. 220.1 [Amended]

2. In Sec. 220.1 the word ``seven'' in the first sentence of

paragraph (b)(1) is revised to read ``eight''.

3. Section 220.2 is amended as follows:

a. A new sentence is added to the end of paragraph (b).

b. Paragraph (h) is revised.

c. Paragraphs (w) through (aa) are redesignated as paragraphs (x)

through (bb) and new paragraph (w) is added.

The additions and revisions read as follows:

Sec. 220.2 Definitions.

* * * * *

(b) * * * Creditor does not include a broker or dealer registered

only under section 15C of the act.

* * * * *

(h) Examining authority means:

(1) The national securities exchange or national securities

association of which a creditor is a member; or

(2) If a member of more than one self-regulatory organization, the

organization designated by the SEC as the examining authority for the

creditor.

* * * * *

(w) Payment period means the number of business days in the

standard securities settlement cycle in the United States plus two

business days.

* * * * *

4. In Sec. 220.4, the figure ``$500'' in paragraph (d) is revised

to read ``$1000'' and paragraph (c)(3) is revised to read as follows:

Sec. 220.4 Margin account.

* * * * *

(c) * * *

(3) Time limits. (i) A margin call shall be satisfied within one

payment period after the margin deficiency was created or increased.

(ii) The payment period may be extended for one or more limited

periods upon application by the creditor to its examining authority

unless the examining authority believes that the creditor is not acting

in good faith or that the creditor has not sufficiently determined that

exceptional circumstances warrant such action. Applications shall be

filed and acted upon prior to the end of the payment period or the

expiration of any subsequent extension.

* * * * *

5. In Sec. 220.8, the figure ``$500'' in paragraph (b)(4) is

revised to read ``$1000'' and paragraphs (b)(1)(i) introductory text,

(b)(1)(ii), (b)(3), (c)(2)(i), and (d) are revised to read as follows:

Sec. 220.8 Cash account.

* * * * *

(b) * * *

(1) * * *

(i) Within one payment period of the date:

* * * * *

(ii) In the case of the purchase of a foreign security, within one

payment period of the trade date or the date on which settlement is

required to occur by the rules of the foreign securities market,

provided this period does not exceed the maximum time permitted by this

part for delivery against payment transactions.

* * * * *

(3) Shipment of securities, extension. If any shipment of

securities is incidental to consummation of a transaction, a creditor

may extend the payment period by the number of days required for

shipment, but by not more than one additional payment period.

* * * * *

(c) * * *

(2) * * *

(i) Within one payment period of the trade date, or in the case of

the purchase of a foreign security, within the period specified in

paragraph (b)(1)(ii) of this section, full payment is received or any

check or draft in payment has cleared and the proceeds from the sale

are not withdrawn prior to such payment or check clearance; or

* * * * *

(d) Extension of time periods; transfers. (1) Unless the creditor's

examining authority believes that the creditor is not acting in good

faith or that the creditor has not sufficiently determined that

exceptional circumstances warrant such action, it may upon application

by the creditor:

(i) Extend any period specified in paragraph (b) of this section;

(ii) Authorize transfer to another account of any transaction

involving the purchase of a margin or exempted security; or

(iii) Grant a waiver from the 90 day freeze.

(2) Applications shall be filed and acted upon prior to the end of

the payment period, or in the case of the purchase of a foreign

security within the period specified in paragraph (b)(1)(ii) of this

section, or the expiration of any subsequent extension.

6. Section 220.18 is redesignated as Sec. 220.19 and new

Sec. 220.18 is added to read as follows:

Sec. 220.18 Government securities account.

In a government securities account, a creditor may effect and

finance transactions involving government securities, provided the

transaction would be permissible for a broker or dealer registered

under section 15C of the act.

By order of the Board of Governors of the Federal Reserve

System, June 27, 1994.

William W. Wiles,

Secretary of the Board.

[FR Doc. 94-16033 Filed 6-30-94; 8:45 am]

BILLING CODE 6210-01-P