Credit by Brokers and Dealers

FEDERAL RESERVE SYSTEM

12 CFR Part 220

[Regulation T; Docket No. 0840]

Credit by Brokers and Dealers

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Final rule.

-----------------------------------------------------------------------

SUMMARY: The Board is adopting amendments to Regulation T. The

amendments are part of the Board's review of Regulation T and respond

to rulemaking by the Securities and Exchange Commission (SEC)

concerning settlement of securities transactions and Congressional

action concerning government securities. The proposed amendments were

published for public comment in the Federal Register on July 1, 1994.

The amendments address two general areas: payment periods for

securities purchases and transactions in government securities. The

amendments concerning payment periods will reduce by two days the

amount of time customers have to meet initial margin calls or make full

cash payment for securities at the same time the SEC reduces the

standard settlement period by two days, require broker-dealers seeking

an extension of this time period to obtain the extension from their

designated examining authority if the balance due is $1000 or more, and

revise regulatory language in the cash account so that the time periods

within which extensions must be obtained and when the ``90-day freeze''

may be lifted are consistent for certain transactions in which

settlement exceeds the standard settlement period. The amendments

concerning transactions in government securities will exempt from

Regulation T those broker-dealers registered with the SEC solely as

government securities brokers or dealers and create a new account for

customers of general broker-dealers that permits transactions in

government securities to be effected without regard to other provisions

of the regulation.

EFFECTIVE DATE: November 25, 1994.

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: The proposed amendments are part of the

Board's general review of Regulation T (Docket R-0772) and were

published for public comment on July 1, 1994 (59 FR 33923). Twenty-two

comments have been received. The comments on the proposed amendments

concerning transactions in government securities were supported by all

commenters, although some asked for additional amendments. The comments

concerning the proposed reduction in payment periods were mixed, with

some commenters in favor, some opposed, and some requesting a delay in

the amendments' effectiveness. The related payment period issues were

generally supported by the commenters, with the exception of the

requirement that extensions be obtained solely from the broker-dealer's

examining authority and the use of language that will automatically

reduce the payment periods if the standard settlement cycle is reduced.

Comments on these issues were also mixed.

The Board is adopting the proposed amendments substantially as

proposed. Technical changes have been made in the regulatory language

and structure to respond to comments and clarify the intent of the

amendments. The two general areas are discussed below.

I. Payment Periods

A. T+3 and Shortening of Payment Periods

1. Introduction. On October 6, 1993, the SEC adopted Rule 15c6-

1,1 which establishes a standard three business day settlement

cycle for most securities transactions in the United States, effective

June 1, 1995. Regular settlement is presently effected in five business

days. This new standard is often referred to as ``T+3,'' meaning

regular settlement will occur three business days after trade date.

Regulation T contains a seven day time period within which brokers must

obtain cash or margin deposits from their customers. The seven day

payment period in Regulation T is based on the current five day

settlement period.

---------------------------------------------------------------------------

\1\17 CFR 240.15c6-1; 58 FR 52891 (October 13, 1993).

---------------------------------------------------------------------------

The Board proposed shortening the payment period in Regulation T by

the same amount of time that SEC Rule 15c6-1 shortens the standard

settlement cycle. Instead of changing the phrase ``seven business

days'' to ``five business days,'' the proposal defined a new term,

``payment period,'' to represent the number of days in the standard

settlement cycle plus two business days. This formulation allows the

regulation to be amended immediately without changing the current

payment period. Once SEC Rule 15c6-1 becomes effective next June, the

regulation will automatically require payment within five business

days. Although the definition of payment period refers to settlement

date, Regulation T remains a trade date based regulation. The use of

the phrase ``payment period'' is meant to be an alternate way of

requiring payment within seven business days until June 1995 and five

business days thereafter, unless the SEC acts to further change the

standard settlement cycle. Future changes by the SEC would be

automatically incorporated in the Board's rule without the necessity of

further amendment.

2. Issues raised by commenters. Comments on the proposal to shorten

the payment periods in conjunction with the SEC's shortening of the

standard settlement cycle were focused on three issues: whether the

payment periods should be shortened, whether the proposed language

clearly accomplishes this goal, and whether future reductions in the

standard settlement period should be automatically accommodated or

reviewed by the Board.

a. Shortening the payment period by two days. The Board is adopting

the proposed amendments, subject to the clarification discussed in

section b below. Many of the commenters who oppose shortening the

payment periods had written to the SEC last year to oppose its T+3

proposal. The Board and the SEC both have responsibilities in the area

of settlement and clearance. Shortening the Regulation T payment

periods is consistent with (if not required by) the SEC's adoption of a

three day settlement cycle. A failure to adjust the payment periods

would lessen the overall benefits to be realized from the transition to

T+3 and increase risk to the broker-dealer community since they will

have to settle trades amongst themselves in the shortened time frame

while allowing their customers' behavior and payment patterns to remain

unchanged. Increased risk to broker-dealers also affects customers with

cash and securities at those firms. Adoption of the proposed amendments

by the Board does not reduce the two-day period currently provided to

resolve payment problems, but merely clarifies that two days beyond the

usual settlement date should be sufficient to resolve any mistakes in

the payment process.

Some of the commenters opposed to shortening the payment periods in

conjunction with the shortening of the standard settlement cycle

believe that the mail system does not permit funds to be delivered

within this time frame. However, the increased use of fax machines and

money market mutual funds provide alternate ways for customers to make

prompt payment for their securities purchases. Although the Board

shares the concerns expressed about investors who rely on the mail to

pay for securities, it believes that most investors will be able to

adjust to the shortened periods. Indeed, the Bachmann Task Force on

Clearance and Settlement Reform in U.S. Securities Markets, which

recommended to the SEC that the standard settlement cycle be reduced to

T+3, stated that it ``believes that current customer behavior practices

should not be an obstacle to shortened settlement provided there is

strong leadership from within the industry and educational efforts to

address customer and account executive concerns.''\2\ Many of the

commenters stressed the fact that the brokerage industry is already

educating customers about the approach of T+3 settlement and the

changes this will entail. The Board is of the view that the successful

implementation of T+3 includes a reduction in the Regulation T payment

periods. It is expected that broker-dealers will be working with

customers who may have difficulty making prompt payment. A delay in the

effectiveness of shortening the payment periods would not necessarily

improve the educational process, which is already well underway at most

firms, and might serve as an excuse for others to delay their

educational efforts.

---------------------------------------------------------------------------

\2\57 FR 27819 (June 22, 1992).

---------------------------------------------------------------------------

b. Uniform payment period. The proposed term ``payment period'' was

defined as the two business days beyond ``the standard securities

settlement cycle in the United States.'' This phrase was meant to refer

to the current five day settlement cycle for most securities

transactions until SEC Rule 15c6-1 becomes effective next June, at

which time the Board's regulation would be referring to the three day

period established in the SEC rule. Additional language has been added

to the definition of payment period to clarify this point. Some

commenters believed the reference to a ``standard settlement cycle''

depends on the type of security being purchased, so that trades

involving standardized options or government securities, both of which

settle the day after trade date, would have to be paid for by the third

business day after trade date. Although broker-dealers can require

payment for transactions by settlement date of the particular trade,

Regulation T establishes a standard period within which customers must

make payment even though certain securities settle in less than the

current five day period. It was not the intent of the Board to change

this general policy.

c. Impact of further reductions in settlement periods. As noted in

the request for public comment, one of the reasons for using the phrase

``payment period'' instead of a fixed number of days was to ensure that

future reductions in the settlement cycle would be automatically

reflected in Regulation T, without the need for further amendments.

Commenters were evenly split on whether the Board should be forced to

review the Regulation T payment periods whenever the standard

settlement cycle is altered. The proposed language has been retained.

In light of the fact that investors are expected to pay for securities

on settlement date, tying the payment period to the standard settlement

cycle merely codifies the Board's current position that two business

days should be sufficient to insure that a failure to receive the

customer's payment is not due to an error or other exceptional

circumstance.

B. Granting of Extensions of Time by a Broker-dealer's Examining

Authority

If a customer has not made full cash payment or met an initial

margin call within the payment period, the broker-dealer must liquidate

the customer's position. However, if exceptional circumstances exist,

the broker-dealer can obtain an extension for its customer. Regulation

T currently permits any self-regulatory organization (SRO) to grant

these extensions. A New York Stock Exchange (NYSE) rule recently

approved by the SEC requires broker-dealers for whom the NYSE is the

designated examining authority (DEA) to obtain these extensions only

from the NYSE.\3\ Although the Board could leave Regulation T unchanged

and most broker-dealers would still be required to go to their DEA

instead of any SRO, the Board proposed amending Regulation T to require

that extensions be granted only by a broker-dealer's DEA. This decision

was based on analysis of the comments received by the Board in response

to its advance notice of proposed rulemaking concerning the current

review of Regulation T and the SEC's consideration of the NYSE rule

filing. No new information was presented in this area. The Board is

therefore adopting the requirement that extensions be granted by a

broker-dealer's DEA.

---------------------------------------------------------------------------

\3\NYSE Rule 434; SEC approval: 59 FR 26826 (May 24, 1994);

Securities Exchange Act Release 34073 (May 17, 1994).

---------------------------------------------------------------------------

C. Technical Amendments Concerning Foreign Securities

The Board proposed technical amendments to the cash account to

clear up confusion resulting from its 1990 amendment allowing payment

for foreign securities to be tied to the appropriate foreign settlement

period. The amendments would clarify that this longer period is also

used to determine when extensions of time must be obtained and when the

``90-day freeze'' may be lifted for foreign securities. Two securities

trade associations point out that the cash account establishes three

other situations in which settlement regularly exceeds the standard

settlement cycle: unissued securities, ``when-issued'' securities, and

refunded securities.\4\ These commenters suggest the proposed language

be revised to consistently refer to the various time periods in

determining when extensions are required and when the ``90-day freeze''

may be lifted. These amendments have been redrafted to accommodate this

suggestion.

---------------------------------------------------------------------------

\4\See Sec. 220.8(b)(1)(i)(B)-(D) of Regulation T.

---------------------------------------------------------------------------

D. De Minimis Amount

The required liquidation of customer purchases for which payment

has not been received within the required time currently does not apply

to amounts of $500 or less. The Board proposed doubling this amount to

$1000 in light of the ten years that had passed since the amount was

last increased. This increase was supported by a wide variety of

commenters. The increase to $1000 will still reduce the regulatory

burden on broker-dealers and their examining authorities by reducing

the number of extensions that must be requested and processed.

II. Government Securities

Two amendments were proposed to exempt most transactions in * * *

government securities from Regulation T. The first exempts those

brokers and dealers who effect customer transactions only in government

securities (Section 15C Brokers). The second amendment effectively

exempts transactions involving government securities for customers of

general securities broker-dealers by allowing the transactions to be

effected in a new government securities account. All of the commenters

supported these two proposed amendments.

A. Exemption from Regulation T for Brokers and Dealers Whose Activities

are Limited to Government Securities

The scope of Regulation T, as stated in section 220.1(b)(1), is

``all financial relations between a customer and a creditor.'' In order

to exempt Section 15C brokers from Regulation T, the Board proposed

excluding them from the definition of creditor in section 220.2(b) of

the regulation. The Public Securities Association (PSA) and the

Securities Industry Association (SIA) suggest that the exclusion be

moved to the scope section, so that Section 15C brokers would still be

defined as ``creditors'' when they are not dealing with ``customers.''

For example, the commenters point out that the term ``creditor'' is

used in the broker-dealer credit account to describe permissible

transactions between broker-dealers. In light of these comments, the

exclusion has been moved to the scope section of Regulation T.

B. Government Securities Account

The second amendment proposed in the area of government securities

was the creation of a new government securities account. This account

would allow general broker-dealers to effect customer transactions that

could be effected by Section 15C Brokers without regard to other

restrictions in Regulation T.

In addition to general support of the proposal, commenters focused

on two areas: the regulatory language used to describe the account and

whether additional securities and other financial instruments should be

included in its scope.

1. Description. The government securities account was proposed for

``transactions involving government securities, provided the

transaction would be permissible for a broker or dealer registered

under section 15C of the act.'' The PSA and the SIA both suggest

deletion of the reference to Section 15C Brokers because they believe

it is confusing and unnecessary. They argue that section 15C does not

establish permissible and impermissible classes of transactions in

government securities. However, section 15C(b)(7) of the Act prohibits

government securities brokers and dealers from effecting ``any

transaction * * * in any government security in contravention of any

rule under this section.'' The regulatory language for the government

securities account has been redrafted to clarify that it is available

for transactions involving government securities as long as the

transaction is not prohibited under section 15C or any of the rules

thereunder.

2. Scope. The PSA, SIA, SIA-Credit Division and one broker-dealer

suggest that all exempted securities, including municipal securities,

be included in the new account. A second broker-dealer would include

foreign sovereign debt that meets the margin requirements of Regulation

T. In addition, three of these commenters believe that all

nonconvertible debt securities that meet the margin requirements of

Regulation T should be eligible for the account and one of these

commenters would like ``money market instruments'' such as certificates

of deposit, bankers acceptances and commercial paper to be covered by

the new account. All of these suggestions will be considered in the

course of Board's review of Regulation T, with an opportunity for

public comment. As explained in the request for public comment on the

proposed government securities account, the rationale for the new

account stems from the unique regulatory scheme established for U.S.

government securities and brokers and dealers in that market.

Regulatory Flexibility Act

The Board certifies that this final rule will not have a

significant economic impact on a substantial number of small entities.

Paperwork Reduction Act

This regulation imposes no additional reporting requirements or

modification to existing reporting requirements.

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, 12 CFR part 220 is amended

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.

2. Section 220.1 is amended as follows:

a. The word ``seven'' in the first sentence of paragraph (b)(1) is

revised to read ``eight''.

b. A new paragraph (b)(3) is added to read as follows:

Sec. 220.1 Authority, purpose, and scope.

* * * * *

(b) * * *

(3) This part does not apply to transactions between a customer and

a broker or dealer registered only under section 15C of the Act.

3. Section 220.2 is amended as follows:

a. Paragraph (h) is revised.

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

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

The revisions and additions read as follows:

Sec. 220.2 Definitions.

* * * * *

(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, as defined

in SEC Rule 15c6-1 (17 CFR 240.15c6-1) under the Act, plus two business

days. Until June 1, 1995, payment period means seven 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 the period specified in paragraph (b)(1) 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.

Sec. 220.18 [Redesignated as Sec. 220.19]

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 is not prohibited by section 15C of the Act or any rule

thereunder.

By order of the Board of Governors of the Federal Reserve

System, October 18, 1994.

Jennifer J. Johnson,

Deputy Secretary of the Board.

[FR Doc. 94-26357 Filed 10-24-94; 8:45 am]

BILLING CODE 6210-01-P