Confirmation of Transactions; Final Rule SECURITIES AND EXCHANGE COMMISSION
Federal RegisterNov 17, 1994
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SUMMARY: The Commission is adopting amendments to Rule 10b-10 under the
Securities Exchange Act of 1934 that will require brokers and dealers
to provide customers immediate written notification of information
relevant to their securities transactions. Consistent with the
Commission's investor protection mandate and in keeping with
innovations in securities products and markets, the amendments will
require brokers and dealers to provide information concerning customer
transaction costs in specified NASDAQ and exchange-listed securities,
the status of certain unrated debt securities, the status of certain
non-SIPC member broker-dealers, and the availability of information
regarding asset-backed securities.
EFFECTIVE DATE: April 3, 1995.
FOR FURTHER INFORMATION CONTACT: Catherine McGuire, Chief Counsel, C.
Dirk Peterson, Senior Counsel, or Terry R. Young, Attorney (202/942-
0073), Division of Market Regulation, Securities and Exchange
Commission, 450 Fifth Street, NW., Mail Stop 7-10, Washington, DC
20549.
SUPPLEMENTARY INFORMATION:
I. Introduction and Summary
A. Price Transparency
During the past year, the Commission has initiated efforts to
further improve the efficiency of, and to protect investors in, the
municipal securities and other debt markets. In September 1993, the
Commission's Division of Market Regulation published the Staff Report
on the Municipal Securities Market (``Staff Report''),1 which
contained several recommendations to improve the municipal securities
market. The Staff Report recommended, among other things, riskless
principal mark-up disclosure as a means of providing greater
information to investors purchasing municipal securities.2 The
Staff Report noted that, unlike the equity markets where mark-ups and
mark-downs3 are disclosed to investors in non-market maker
riskless principal transactions and principal transactions in
``reported securities,''4 mark-ups are not disclosed in any
principal transaction in municipal securities.5 Thus, investors of
municipal securities are constrained in their ability to compare
transaction costs among broker-dealers and across markets. The Staff
Report identified this ability as one of the benefits of mark-up
disclosure.6
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\1\Staff Report on the Municipal Securities Market (September
1993).
\2\Staff Report, at 16 and 18.
\3\For purposes of this release, references to mark-ups also
will apply to mark-downs or commission equivalents.
\4\See infra note 71 for a discussion of ``reported
securities.''
\5\Staff Report, at 15-16.
\6\Id. at 16.
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In addition to enhanced confirmation disclosure, the Staff Report
discussed the overall benefits of price transparency and the need for
greater transparency in the municipal securities market.7 Notably,
price transparency enhances market liquidity and depth, and fosters
investor confidence,8 while a lack of price information impairs
market pricing mechanisms, weakens competition, and prevents investors
from monitoring the quality of their executions.9
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\7\Staff Report, at 20 and 36.
\8\Testimony of Arthur Levitt, Chairman, U.S. Securities and
Exchange Commission, Concerning International Markets and
Individuals Before the Committee on Banking, Housing, and Urban
Affairs, U.S. Senate, September 28, 1994.
\9\See Brandon Becker, Director, Division of Market Regulation,
Address at 19th International Organization of Securities Commissions
Annual Conference (1994).
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To address some of the recommendations contained in the Staff
Report, on March 9, 1994, the Commission issued for comment proposed
Rule 15c2-13 under the Securities Exchange Act of 1934 (``Exchange
Act'')10 to require disclosure of mark-ups in riskless principal
transactions in municipal securities. Because the same benefits of
mark-up disclosure apply to other debt transactions, the Commission
proposed amendments to Rule 10b-10 (``Rule'') under the Exchange Act
that would require riskless principal mark-up disclosure for debt
securities other than municipal securities.11
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\1\0Securities Exchange Act Release No. 33743 (March 9, 1994),
59 FR 12767 (``Proposing Release'').
\1\1The Commission previously proposed disclosure requirements
of mark-ups in riskless principal transactions on three other
occasions. See Securities Exchange Act Release No. 15220 (Oct. 6,
1978), 43 FR 47538 (proposing mark-up disclosure for riskless
principal transactions in municipal securities); Securities Exchange
Act Release No. 13661 (June 23, 1977), 42 FR 33348 (proposing mark-
up disclosure by non-market makers in riskless principal equity and
debt securities, but not municipal securities); and Securities
Exchange Act Release No. 12806 (Sept. 16, 1976), 41 FR 41432
(proposing mark-up disclosure by non-market makers in riskless
principal transactions involving equity and debt securities).
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Since the Proposing Release was issued for comment on March 9,
1994, municipal market participants have proposed significant new ways
of making pricing information more widely available to investors. The
Municipal Securities Rulemaking Board (``MSRB'') has taken the first
step toward a system that will make publicly available price
information for municipal securities transactions on a next day basis.
Recently, the MSRB stated that its ``ultimate goal for the
[transparency] program is to collect and make available transaction
information in a comprehensive and contemporaneous manner (footnote
omitted) * * * [and] wishe[d] to reiterate to the Commission its
commitment to these goals.''12 The Public Securities Association
(``PSA'') also has proposed a system to publicize municipal securities
price information. These proposals will create the infrastructure
necessary to enhance transparency in the market, and when fully
implemented, will provide last sale reporting for virtually all
municipal securities transactions.
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\1\2Letter from Robert H. Drysdale, Chairman, MSRB, to Arthur
Levitt, Chairman, SEC (Nov. 3, 1994), at pp. 1-2. Available in
Public Reference File No. S7-6-94.
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The Commission is encouraged by these developments, and after
careful consideration, has determined to defer the riskless principal
mark-up proposal for six months13 in anticipation of meaningful
progress by the industry toward enhanced price transparency in the
municipal securities market. The riskless principal mark-up proposals
would provide better information only to a certain segment of
transactions in the debt markets. The industry's efforts to improve
transparency, on the other hand, ultimately will result in enhanced
price disclosure for all transactions. Moreover, better dissemination
of price information will benefit investors by providing them with
useful information at the time they are making their investment
decision, rather than after-the-fact when the confirmation is received.
If, at the end of the six-month period, industry initiatives to improve
price transparency have not progressed to the Commission's
satisfaction, however, the Commission may reconsider the riskless
principal mark-up proposal in light of existing alternatives.
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\1\3Recently, the MSRB set forth a tentative schedule for the
completion of each of the four phases of its proposal: phase one
(inter-dealer transactions, January 1, 1995); phase two (addition of
time of trade and institutional customer transactions, December
1995); phase three (addition of retail customer transactions,
November 1996); and phase four (more contemporaneous trade
reporting, April 1997). See Letter from Robert H. Drysdale,
Chairman, MSRB, to Arthur Levitt, Chairman, SEC, (Nov. 3, 1994), at
pp. 3-7. Available in Public Reference File No. S7-6-94.
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B. Other Disclosures
In addition to the riskless principal mark-up proposals, the
Commission proposed several other amendments designed to improve
confirmation disclosure so that customers can better evaluate their
securities transactions. Specifically, the Commission proposed
amendments to Rule 10b-10 that would require broker-dealers to disclose
(1) mark-ups in connection with transactions in certain NASDAQ and
regional exchange-listed securities; (2) if they are not members of the
Securities Investor Protection Corporation (``SIPC''); (3) information
relevant to certain types of collateralized debt instruments; and (4)
if a debt security has not been rated by a nationally recognized
statistical rating organization (``NRSRO''). Proposed Rule 15c2-13
contained a similar provision requiring broker-dealers to disclose the
unrated status of a municipal security.
The Commission also requested comment on the broader issue of
whether the shortened settlement period of three days (``T+3
Settlement'') will have an effect on the future utility of the
confirmation and whether some information currently required in the
confirmation could be shifted to an account statement.14 In
addition, the Commission proposed adding a preliminary statement to
Rule 10b-10 designed to clarify that the Rule is not intended as a safe
harbor from the general antifraud provisions of the federal securities
laws.15
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\1\4See Proposing Release, supra note 10, at 59 FR 12767-68.
\1\5Id. at 59 FR 12772.
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In response to the request for comment, the Commission received 344
comment letters, the majority of which addressed the mark-up disclosure
proposals for riskless principal transactions. Commenters included
regional and national broker-dealers, industry associations, financial
institutions, law firms, insurance companies, and individual
investors.16 The comments presented a range of views with respect
to the proposals and the effects that the proposed disclosure
requirements may have on broker-dealers, investors, and markets.
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\1\6The comment letters and a summary of comments have been
placed in Public Reference File No. S7-6-94, which is available for
inspection in the Public Reference Room.
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After a review of the comments, the Commission is adopting the
proposed amendments to Rule 10b-10 that require disclosure if a debt
security is not rated by an NRSRO, with a modification to exclude all
government securities from the disclosure requirement; mark-up
disclosure in connection with transactions in certain NASDAQ and
regional exchange-listed securities; disclosure if a broker-dealer is
not a member of SIPC, except for certain transactions in investment
company shares by non-SIPC member firms that do not handle customer
funds or securities; and disclosure with respect to the availability of
information with respect to transactions in collateralized debt
securities. The Commission also is adopting the preliminary note to
Rule 10b-10. To allow firms the appropriate time to adapt their systems
to accommodate these disclosure requirements, the proposals will become
effective April 3, 1995.
In addition, that portion of Rule 15c2-13 that would require
disclosure if a municipal security was not rated by an NRSRO has been
deferred and will be withdrawn if the MSRB acts to adopt similar
amendments to its confirmation rule, Rule G-15.17 The MSRB
recently reiterated its willingness to amend Rule G-15 to require
disclosure if a municipal security is not rated by an NRSRO.18
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\1\7MSRB Rule G-15, MSRB Manual (CCH) 3571.
\1\8Letter from Robert H. Drysdale, Chairman, MSRB, to Arthur
Levitt, Chairman, SEC (Nov. 3, 1994). Available in Public Reference
File No. S7-6-94.
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II. Description of Amendments
A. Role of the Confirmation
The Commission's confirmation rule, Rule 10b-1019 under the
Exchange Act,20 generally requires a broker-dealer effecting a
customer transaction in securities (other than U.S. Savings Bonds or
municipal securities) to provide written notification to its customer,
at or before completion of a transaction, that discloses information
specific to the transaction. The confirmation requires, among other
things, the disclosure of: The date, time, identity, and number of
shares bought or sold;21 the capacity of the broker-dealer;22
the net dollar price and yield of a debt security;23 and, under
specified circumstances, the amount of compensation paid to the broker-
dealer and whether payment for order flow is received.24 For over
50 years, the customer confirmation has served basic investor
protection functions by conveying information allowing investors to
verify the terms of their transactions; alerting investors to potential
conflicts of interest with their broker-dealers; acting as a safeguard
against fraud; and providing investors the means to evaluate the costs
of their transactions and the quality of their broker-dealer's
execution.
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\1\917 CFR 240.10b-10.
\2\015 U.S.C. 78a et seq.
\2\117 CFR 240.10b-10(a)(2).
\2\217 CFR 240.10b-10(a)(1).
\2\317 CFR 240.10b-10(a)(4)(i); and 17 CFR 240.10b-10(a)(5).
\2\417 CFR 240.10b-10(a)(7) (ii) and (iii); 17 CFR 240.10b-
10(a)(8)(i)(A); and 17 CFR 240.10b-10(a)(8)(i)(B).
Recently, the Commission proposed for comment additional
disclosures relevant to payment for order flow, which would include
for monetary payment for order flow, the range of payments received
on a per share basis and on an aggregate basis annually. For non-
monetary payment for order flow, the Commission proposed requiring
disclosure of an estimate of the range of payment for order flow on
a per share basis and on an aggregate basis annually. See Securities
Exchange Act Release No. 34903 (Oct. 27, 1994), 59 FR 55014.
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1. T+3 Settlement
In the Proposing Release, the Commission requested comment on the
future utility of the confirmation once T+3 Settlement is implemented
on June 7, 1995.25 Rule 10b-10 requires that a confirmation be
sent at or before completion of a customer transaction.26
Commenters noted that T+3 Settlement will diminish the confirmation's
usefulness as a customer invoice and questioned the practicability of
requiring the disclosure of additional information on a document that
an investor will receive after already having made his or her
investment decision and tendering funds or securities.27
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\2\5T+3 Settlement was adopted in Securities Exchange Act
Release No. 33023 (Oct. 6, 1993), 58 FR 52891.
\2\6Rule 15c1-1 under the Exchange Act defines ``the completion
of the transaction.'' 17 CFR 240.15c1-1(b).
\2\7See, e.g., Letters from A. George Saks, Executive Vice
President, Secretary, and General Counsel, Smith Barney (Aug. 1,
1994); Robert M. Sweeney, Vice President/Assistant Comptroller,
Gibraltar Securities Co. (June 14, 1994); William J. Jester, Jr.,
Chemical Banking Corp. (June 14, 1994); and Kurt D. Halvorson, Vice
President & Controller, AmeriTrade (May 27, 1994), to Jonathan G.
Katz, Secretary, SEC.
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Notwithstanding the shortened settlement period of T+3 and the
possibility that an investor may receive the confirmation after payment
has been made, the Commission believes that the confirmation will
continue to serve important investor protection functions. T+3
Settlement's implementation merely may mean that the confirmation may
take on a different role. Some firms may continue to use the
confirmation as a customer invoice, while financing positions when
customer payment is received after settlement date. For other firms,
the confirmation may not continue to serve in all circumstances as an
invoice of a transaction because ordinary confirmation delivery and
transfer of customer funds and securities may not be feasible within a
three-day settlement cycle.28 Rather, the confirmation may serve
primarily as written evidence of the contract between the customer and
broker-dealer.29 As a written record of the transaction, the
confirmation will continue to provide investors the necessary
information to assist them in evaluating the quality and accuracy of
their trades while assisting them in correcting mistakes and verifying
the terms of their transactions. Accordingly, while T+3 Settlement may
affect the mechanics of settlement, it will not eliminate the
confirmation's investor protection functions.
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\2\8One commenter suggested that the Commission reevaluate the
meaning of ``give or send'' under Rule 10b-10 in light of T+3
Settlement and current technology, such as electronic messaging, E-
mail, direct computer links, telefax, and fax modems. See Letter
from Sullivan & Cromwell, to Jonathan G. Katz, Secretary, SEC (July
15, 1994).
In the Proposing Release, the Commission recognized the use of a
facsimile machine to send customer confirmations. See Proposing
Release, supra note 10, at 59 FR 12767 n.5. To the extent that a
customer has a facsimile machine, a broker-dealer would fulfill its
confirmation delivery obligation if it sent the confirmation via
facsimile transmission. The staff also has allowed, under specified
conditions, confirmations to be sent by other electronic means. See
Letter regarding Thomson Financial Services, Inc. (Oct. 8, 1993).
The Commission agrees that T+3 Settlement may encourage
alternatives to the mail system for sending confirmations and that a
flexible approach may be necessary to accommodate T+3 Settlement
with existing technology. The Commission, however, believes that
each approach should be viewed on a case-by-case basis, as has been
previous practice, to ensure the safety and reliability of the
confirmation transmission.
\2\9Under the current text of the Uniform Commercial Code, the
confirmation serves as a written record of the transaction, thus
satisfying the statute of frauds. Uniform Commercial Code Section 8-
319 states that a ``contract for the sale of securities is not
enforceable by way of action or defense unless * * * there is some
writing signed by the party against whom enforcement is sought or by
his authorized agent or broker, sufficient to indicate that a
contract has been made for sale of a stated quantity of described
securities at a defined or stated price.'' A confirmation, bearing
the broker-dealer's letterhead or some other identifying marking,
generally fulfills that requirement. Revised Article 8 of the
Uniform Commercial Code, which was endorsed recently by both the
American Law Institute and the National Conference of Commissioners
on Uniform State Laws, would omit current Section 8-319. Due to the
prior difficulties in applying Section 8-319 to the sale of
securities over the telephone and the more common use of electronic
means for securities transactions, proposed Section 8-113 states
that ``[a] contract or modification for the sale or purchase of a
security is enforceable whether or not there is a writing signed or
record authenticated by a party against whom enforcement is sought,
even if the contract or modification is not capable of performance
within one year of its making.''
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2. Periodic Account Statement
The Commission also requested comment on the feasibility of
transferring information currently disclosed on the confirmation to a
periodic account statement.30 Many commenters addressing this
issue opposed such a use of the periodic account statement and noted
that it was not the appropriate document to convey particularized trade
information.31 Rather, as one commenter indicated, account
statements are intended to summarize the activity and status of an
account; they are not intended to convey information regarding the
features and risks of each individual securities transaction.32
Other commenters, however, noted that, as investors increasingly rely
upon periodic account statements, the confirmation will diminish as a
primary disclosure device.33 At this time, the Commission has
determined to retain the confirmation as the basic transaction
disclosure document and use the account statement, the account opening
document, or annual disclosure requirements as needed to supplement or
summarize confirmation disclosures.
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\3\0See Proposing Release, supra note 10, at 59 FR 12768.
\3\1See, e.g., Letters from A. George Saks, Executive Vice
President, Secretary, and General Counsel, Smith Barney (Aug. 1,
1994); Barry H. Zucker, President & CEO, J.B. Hanauer & Co. (June
20, 1994); and Jon S. Corzine, Goldman, Sachs & Co. (June 15, 1994),
to Jonathan G. Katz, Secretary, SEC.
\3\2See, e.g., Letter from Donald E. Walter, Compliance
Director/Principal, Edward D. Jones & Co., to Jonathan G. Katz,
Secretary, SEC (July 15, 1994). Another commenter noted that
transferring confirmation information to an account statement may
clutter the account statement and make it less readable. See Letter
from Barry H. Zucker, President & CEO, J.B. Hanauer & Co., to
Jonathan G. Katz, Secretary, SEC (June 20, 1994).
\3\3See, e.g., Letters from Robert M. Sweeney, Vice President/
Assistant Comptroller, Gibraltar Securities Co. (June 14, 1994);
William J. Jester, Jr., Chemical Banking Corp. (June 14, 1994); and
Kurt Halvorson, Vice President & Comptroller, AmeriTrade (May 27,
1994), to Jonathan G. Katz, Secretary, SEC.
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The Commission noted in the Proposing Release, however, that a
customer may waive the receipt of an immediate confirmation in the
context where a fiduciary has discretion over the customer's
account.\34\ The Commission noted that, in its view, the account,
rather than the fiduciary, was the customer for purposes of Rule 10b-
10. To effect a valid waiver, the broker-dealer must (1) obtain from
the customer a written agreement that the fiduciary receive the
immediate confirmation; and (2) send to the customer a periodic report,
not less frequently than quarterly, containing the same information
that would have been contained in an immediate confirmation.\35\ The
customer may not waive this periodic report.\36\
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\34\See Proposing Release, supra note 10, at 59 FR 12767 n.3.
\35\To satisfy this requirement, a broker-dealer may deliver,
directly to its customer, duplicate confirmations representing each
of the customer's transactions for the prior period, together with
the customer's account statement. This procedure would allow
investors to rely on the account statement to monitor their
accounts, while referring to the confirmation for the details of
each specific trade. Investors already look to old confirmations for
details which are not present on the account statement, and this
procedure would allow investors to continue to rely on their
confirmations and their account statements in substantially the same
way.
\36\Some concerns have been raised with respect to the
application of this policy and its relationship with Rule 409 of the
New York Stock Exchange (``NYSE''). See, e.g., letter from Kevin J.
Mackay, President/Compliance and Legal Division, Securities Industry
Association (``SIA''), to Jonathan G. Katz, Secretary, SEC (July 22,
1994). Specifically, Rule 409(b) permits NYSE member firms to send a
confirmation to a non-member person holding power of attorney over a
customer account if ``either (A) the customer has instructed the
member organization in writing to send such confirmations,
statements, or other communications in care of such person, or (B)
duplicate copies are sent to the customer at some other address
designated in writing by him.'' NYSE Rule 409, 2 NYSE Guide (CCH)
2409.
Under the Commission's position articulated above, a customer
who waived receipt of the immediate confirmation would receive more
information with his quarterly account statement than that currently
required under NYSE Rule 409. To the extent the rules of the NYSE,
or any self-regulatory organization, conflict with the Commission's
stated policy, the more restrictive requirement would govern. Thus,
a NYSE member wishing to take advantage of a waiver would be
required to adhere to these Commission requirements in addition to
any obligations imposed by Rule 409.
The SIA argued that this position would (1) lead to duplicative
efforts on the part of broker-dealers because broker-dealers already
will have sent trade information to the fiduciary in an immediate
confirmation; (2) depart from standard industry practice; and (3)
require expensive system changes to comply with the position. The
Commission emphasizes that this substitution of quarterly statements
for the immediate confirmation is optional. No broker-dealer is
required in the first instance to include all relevant trade
information in a quarterly statement; however, if the broker-dealer,
with the written authorization of the customer, wishes to omit
sending the customer an immediate confirmation and instead send it
to the account fiduciary, then the requirements of written
instructions from the customer and a non-waiveable periodic report,
as described above, must be satisfied in order to effect a valid
waiver. These requirements are necessary to allow investors to
monitor their accounts in the absence of a transaction-by-
transaction report in the confirmation.
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The requirement to send a periodic report is intended to ensure
that the beneficial owner of the account receives material information
needed to verify the transaction in the account.\37\ As the Commission
noted in the release originally adopting Rule 10b-10, the Rule is not
intended to require a broker-dealer dealing with the trustee of a plan
to deliver statements to plan participants where the trustee is the
shareholder of record of the securities being purchased or sold. In
those instances, the Rule would require the broker-dealer to deliver a
confirmation, or upon written request, a periodic report, only to the
trustee.38 A beneficiary of the trust would be required to receive
an immediate confirmation, or upon written request, the periodic
report, only if that beneficiary was a beneficial owner of the trust
assets on the books of the broker-dealer, enjoying the rights and
privileges of beneficial ownership.
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\37\The requirement to send a periodic report to the customer,
if the customer has requested in writing that the immediate
confirmation be sent to the customer's fiduciary, applies only if
the broker-dealer has an existing duty under Rule 10b-10 to send an
immediate confirmation directly to the customer in the absence of
such a written request. This requirement therefore would not apply
to paragraph 10b-10(b), which governs purchases and sales of
securities in a money market fund, as defined in newly amended
paragraph 10b-10(b)(1), a periodic plan, as defined in paragraph
10b-10(d)(5), and an investment company plan, as defined in
paragraph 10b-10(d)(6). Paragraph (b) of Rule 10b-10 permits, upon
written request of the customer, written statements containing the
information specified in that paragraph to be sent not less
frequently than quarterly, directly to the customer or some other
person designated by the customer for distribution to the customer.
Because there are circumstances, not enumerated specifically in
Rule 10b-10, that would make compliance with the rule unduly
burdensome, paragraph 10b-10(f) authorizes the Commission to exempt
broker-dealers from the rule's requirements with regard to specific
transactions or specific classes of transactions for which the
broker or dealer will provide alternative procedures to effect the
purposes of Rule 10b-10. This authority has been delegated to the
Division of Market Regulation. 17 CFR 200.30-3(a)(32).
\38\Securities Exchange Act Release No. 13508 (May 5, 1977), at
n.24.
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The Commission also believes that the broker-dealer can satisfy its
obligation to send a confirmation to the customer if it sends the
confirmation to a custodian of the customer authorized to receive
securities and disburse funds for the customer.\39\ The custodian in
question must not be affiliated with a broker-dealer or an investment
adviser or have any role in choosing the broker-dealer or investment
adviser used;\40\ and the customer must retain the right to request
that the confirmation be sent directly to the customer, at no extra
charge by the custodian or broker-dealer. Moreover, an account
custodian may not choose to receive a periodic report in place of an
immediate confirmation.
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\39\The custodian must not hold itself out as a broker-dealer or
an investment adviser. But see Investment Advisers Act Release No.
1406 (March 16, 1994), 59 FR 13464 (proposing a rule to require
investment advisers to ensure that custodians of investment adviser
client accounts provide the client or its designee with account
statements not less than quarterly).
\40\Securities orders must be placed by the customer or the
customer's investment adviser, not the custodian.
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3. Preliminary Note
The Commission proposed adding a preliminary note to Rule 10b-10
clarifying that the Rule is not intended as a safe harbor from
disclosure obligations imposed by the general antifraud provisions of
the federal securities laws.41 This note is intended to respond to
claims made by litigants that Rule 10b-10 prescribes all the necessary
disclosure relevant to a customer's securities transaction.42 A
few commenters addressed the inclusion of the preliminary note to Rule
10b-10, with equal support for43 and opposition to44 the
note. One supporter suggested that the Commission could accomplish the
same purpose of clarification in an interpretative release.45 One
opponent of the preliminary note argued that its existence would lead
to frivolous claims against broker-dealers.46
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\4\1See Proposing Release, supra note 10, at 59 FR 12772.
\4\2See, e.g., Shivangi v. Dean Witter Reynolds, Inc., 637 F.
Supp. 1001 (S.D. Miss. 1986), aff'd, 825 F.2d 885 (5th Cir. 1987);
Krome v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 637 F. Supp.
910, 915-16 (S.D.N.Y. 1986); and Ettinger v. Merrill Lynch, Pierce,
Fenner & Smith, Fed. Sec. L. Rep. (CCH) 93,102 (E.D. Pa. 1986),
rev'd, 835 F.2d 1031 (3d Cir. 1987).
\4\3See, e.g., Letters from Donald E. Walter, Compliance
Director/Principal, Edward D. Jones & Co. (July 11, 1993); and
Douglas L. Kelly, Director/Law & Compliance Division, A.G. Edwards &
Sons, Inc. (June 13, 1994), to Jonathan G. Katz, Secretary, SEC.
\4\4See, e.g., Letters from A.B. Krongard, Chief Executive
Officer, Alex. Brown & Sons, Incorporated (July 14, 1994); and
Jeffrey Rubin, President, InterCapital Assets, Inc. (June 13, 1994),
to Jonathan G. Katz, Secretary, SEC.
\4\5Letter from Douglas L. Kelly, Director/Law & Compliance
Division, A.G. Edwards & Sons, Inc., to Jonathan G. Katz, Secretary,
SEC (June 13, 1994). This commenter also suggested that if a note
were added to Rule 10b-10, a similar note also should precede Rule
15c2-13. At this time, the Commission is not adopting Rule 15c2-13.
\4\6Letter from A.B. Krongard, Chief Executive Officer, Alex.
Brown & Sons, Incorporated, to Jonathan G. Katz, Secretary, SEC
(July 14, 1994).
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After reviewing the comments, the Commission is adopting the
preliminary note to Rule 10b-10. The Commission is not persuaded that
the existence of the preliminary note would lead to any additional
litigation against broker-dealers. The preliminary note is merely
making explicit a longstanding position that the antifraud provisions
of the federal securities laws may impose, given the circumstances,
greater disclosure than what may be required by a specific rule or
regulation.47
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\4\7See supra note 42. One commenter argued that the preliminary
note provides no useful guidance because the Commission has not
articulated a set of guidelines concerning disclosure requirements
in addition to those required in a prospectus and under the Exchange
Act. See Letter from Sullivan & Cromwell, to Jonathan G. Katz,
Secretary, SEC (July 15, 1994), at pp. 2-3.
The Commission does not intend to specify key disclosure items
under the antifraud provisions of the federal securities laws. Each
circumstance is different and determining the materiality of any
particular item of disclosure depends on the facts and circumstances
of each case.
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B. Mark-Up and Mark-Downs in Riskless Principal Transactions in Debt
Securities
The majority of comment letters addressed the proposed amendments
to Rule 10b-10 and the portion of proposed Rule 15c2-13 that would
require mark-up disclosure of riskless principal trades in debt
securities.48 Generally, most commenters opposed the proposals on
the grounds that the requirements would have detrimental effects on
competition and market liquidity; would cause compliance difficulties;
would create customer confusion; and are not based upon findings of
abusive practices in the debt market.
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\4\8Of the 344 comment letters received, 313 addressed the mark-
up disclosure proposals.
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It has been argued by some commenters that greater price
transparency in the municipal market could achieve similar goals as
riskless principal mark-up disclosure without the alleged negative
effects purported to result from mark-up disclosure.49 Since the
proposals were published for comment in March, progress has been made
to develop price transparency in the debt markets. In particular, the
MSRB has proposed a program that ultimately would provide same day
price reporting of all transactions in municipal securities, including
same day reporting of retail trades. This program is to be implemented
in four phases. As proposed, the first phase of the MSRB program will
collect reports of interdealer transactions and make available to the
public daily high-low and average price figures for the most frequently
traded issues (initially defined as those trading at least four times
during the day).50 These requirements will be expanded in phase
two to include institutional customer transactions. The third phase
will expand the daily reporting requirements to include retail customer
transactions, and phase four will advance reporting times closer in
time to the transaction, such as by the end of day or within a
specified time period following the trade. In the initial phases of the
MSRB's proposal, information regarding the prices and volume of
transactions in approximately 80 to 240 issues would be reported each
day. As each phase is implemented, the MSRB will review closely this
information and system operations, with a view toward reflecting a
greater number of issues and transactions in the reports.
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\4\9See, e.g., Letters from A.B. Krongard, Chief Executive
Officer, Alex. Brown & Sons, Incorporated (July 14, 1994); James D.
McKinney, Partner and Manager of Fixed Income Dept., William Blair &
Company (July 13, 1994); Thomas W. Masterson, Chairman, Masterson
Moreland Sauer Whisman, Inc. (July 13, 1994); G. Frederick Kasten,
Jr., President and Chief Executive Officer, Robert W. Baird & Co.,
Incorporated (June 15, 1994); and Rauscher Pierce Refnes, Inc. (June
14, 1994), to Jonathan G. Katz, Secretary, SEC.
\5\0To implement phase one, the MSRB, pursuant to Rule 19b-4 of
the Exchange Act, has filed with the Commission a proposed rule
change to amend Rule G-14 of the MSRB Rules, which, once approved,
will require the reporting of interdealer municipal securities
transactions to a designee (e.g., the National Securities Clearing
Corporation) for compilation in a daily report and for use by
regulators.
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In addition to the proposal by the MSRB, the PSA has proposed two
initiatives to convey municipal securities pricing information to
retail investors. First, the PSA proposes to develop a generic scale
and yield curve for AAA-insured revenue bonds. This information, which
will be made available to daily newspapers, is intended to provide
customers with grade information on the price and yield of a
representative range of bonds. Second, the PSA proposes to establish a
900-number which investors could call to obtain price information
regarding particular municipal securities.
Although the MSRB's initiative is in a developmental stage, the
Commission believes it ultimately could provide the public with
improved information about the price of municipal securities. If widely
published, this information would allow investors to better assess the
prices provided by their broker-dealers in a municipal securities
trade. In light of these proposals, the Commission has decided to defer
for a period of six months adoption of that part of Rule 15c2-13
requiring the disclosure of mark-ups for riskless principal
transactions in municipal securities.
The Commission has deferred adoption of the riskless principal
mark-up disclosure proposal in order to ascertain whether the proposed
price information systems can provide more meaningful benefits to
investors in the long-term and to assess the progress of the industry
in developing the proposed systems. Price transparency, if fully
developed, will provide better market information to investors on a
timely basis (e.g., before the transaction). Potentially, price
transparency also could provide investors the ability to determine the
value of their municipal securities purchased in principal
transactions. The proposed mark-up disclosure, on the other hand, would
have provided cost information to investors only in riskless principal
transactions and would not have applied to other principal
transactions, the majority of transactions in the debt market. Price
transparency, if fully developed, meets investors' need for information
without focusing on only one portion of the market, which commenters
argued could lead to a deleterious restructuring of the market, thus
reducing market liquidity and narrowing the available choices of
securities sold to customers.51
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\5\1See, e.g., Letters from Philip T. Colton, Maun & Simon (June
14, 1994); Lawrence T. Lewis, III, Managing Director, Clark Melvin
Securities Corporation (June 8, 1994); and Adam Crews, President/
Chief Executive Officer, Crews & Associates, Inc. (June 1, 1994), to
Jonathan G. Katz, Secretary, SEC.
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The Commission recognizes that these benefits depend on the sound
design and successful implementation of transparency proposals. Their
value to investors further depends on widespread availability of the
information, and customer understanding of how it should be used. At
the end of six months, the Commission will assess the need for further
action based upon the prospects for the availability of meaningful
pricing information to a broad range of investors about a full range of
securities. If such information is not likely to be available, the
Commission will explore alternatives to better provide information to
fixed income investors. To this end, the Commission similarly is
deferring the proposed amendment to Rule 10b-10 requiring mark-up
disclosure for other debt securities. While the Commission believes it
is appropriate to address transparency in municipal securities
initially because of the presence of a large proportion of individual
investors in that market, during the deferral, the Commission expects
the industry to address the extent to which customer price information
can be increased in debt markets other than the municipal securities
market. The Commission recognizes that the government, corporate, and
mortgage securities markets have different levels of price information
publicly available. For example, GovPx, a joint venture of primary
dealers and interdealer brokers formed in 1990, provides to investors
real-time quotations, trade prices, and volume information for U.S.
Treasury and other government securities via a worldwide network of
12,000 terminals. In addition, the National Association of Securities
Dealers, Inc. (``NASD'') developed the Fixed Income Pricing System
(``FIPS''), which collects, processes, and disseminates real-time firm
quotations for 30 to 50 of the most liquid, high yield bonds traded in
the over-the-counter market.52 The Commission expects the industry
to review the availability of information to investors in each of these
markets and consider methods of increasing transparency as an
alternative to riskless principal disclosure in these markets.
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\5\2See Securities Exchange Act Release No. 32019 (March 19,
1993), 58 FR 16428 for a discussion of the order approval allowing
the NASD to implement FIPS.
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Even though the Commission is deferring the adoption of riskless
principal mark-up disclosure, the Commission continues to believe that,
absent transparency in the debt markets, the disclosure of the dealer's
cost along with the mark-up would be of use to customers in assessing
the value of their debt securities. In the absence of progress on
transparency, the Commission will revisit its riskless principal
proposal. The Commission also may consider whether to require the
disclosure of all mark-ups in principal transactions based on the
underlying inventory costs,53 or the prevailing market
price54 or to mandate alternative price transparency systems.
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\5\3To comply with this disclosure, broker-dealers would have to
assign a value to a security bought into inventory on either a last
in, first out or first in, first out accounting basis.
\5\4See 17 CFR 240.15g-4 and Securities Exchange Act Release No.
30608 (April 13, 1992), 57 FR 19022 for a discussion of compensation
disclosure requirements for transactions in penny stocks.
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The Commission strongly believes that real progress is needed in a
timely fashion to achieve the goal of better customer information for
market prices in the debt market. Achievement of this goal will add
strength to and confidence in the debt markets, to the benefit of both
broker-dealers and investors.
C. Disclosure of Unrated Securities
The Commission also published for comment a requirement to
disclose, if applicable, that certain debt securities have not been
rated by an NRSRO.55 The proposal excluded government securities
defined under Section 3(a)(42) (A) and (B) of the Exchange Act,56
but requested specific comment on whether other securities should be
excluded from this disclosure.57 In addition, specific comment was
requested whether the MSRB should implement the disclosure requirement
with respect to municipal securities, rather than the
Commission.58
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\5\5See Proposing Release, supra note 10, at 59 FR 12770.
\5\6Securities exempt from the proposed rating disclosure would
include (1) securities that are direct obligations of the U.S., or
in which the U.S. has guaranteed the principal or interest; or (2)
securities which are issued or guaranteed by corporations in which
the U.S. has a direct or indirect interest and which the Secretary
of Treasury has designated for exemption. 15 U.S.C. 78c(a)(42)(A)
and (B).
\5\7Proposing Release, supra note 10, at 59 FR 12770.
\5\8Id.
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Of the 43 commenters that addressed this disclosure proposal, 24
supported the proposal.59 Some commenters believed that the
disclosure requirement did not go far enough and indicated that
specific ratings also should be disclosed on the confirmation.60
In particular, commenters believed that the confirmation should bear
all ratings of securities, particularly those rated below investment
grade.61
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\5\9See, e.g., Letters from A.B. Krongard, Chief Executive
Officer, Alex. Brown & Sons, Incorporated (July 14, 1994); David C,
Clapp, Chairman, MSRB (June 15, 1994); and Douglas L. Kelly,
Director, Law and Compliance, A.G. Edwards & Sons, Inc. (June 13,
1994), to Jonathan G. Katz, Secretary, SEC.
Alex. Brown & Sons, Incorporated sought clarification that a
bond rated by a single NRSRO, but not necessarily other NRSROs,
nonetheless would be excluded from the disclosure requirement.
(Letter from A.B. Krongard, Chief Executive Officer, Alex. Brown, to
Jonathan G. Katz, Secretary, SEC (July 14, 1994), at p.6). The rule
language states that a broker-dealer would be required to disclose
when a security was not rated by an NRSRO. Accordingly, if a single
NRSRO has rated a security, then it follows that no disclosure would
be required.
\6\0See, e.g., Letters from Grant T. Callery, Vice President/
General Counsel, NASD (July 26, 1994); and Robert Reeves, Sr. Vice
President, Ferris Baker Watts, Incorporated (June 14, 1994), to
Jonathan G. Katz, Secretary, SEC.
\6\1One commenter argued that disclosure of ratings, and in
particular ratings below investment grade, would better assist
investors in comparing an unrated security that may be of a high
credit quality with one that, while rated, may be of lesser credit
quality. See Letter from James H. Morgan, President/Chief Operating
Officer, Interstate/Johnson Lane, to Jonathan G. Katz, Secretary,
SEC (June 14, 1994). The Commission will revisit the issue of
whether Rule 10b-10 should require the disclosure of ratings for
corporate debt securities once commenters have responded to a recent
Commission proposal addressing the feasibility of disclosing ratings
in a prospectus. See Securities Act Release No. 7086, (Aug. 31,
1994), 59 FR 46304.
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Ten commenters opposed the disclosure requirement on the grounds
that requiring this disclosure may be unhelpful to investors. They
argued that such disclosure may cause investors to believe that unrated
securities are inferior to rated securities, when the unrated security
may pose less risk than a rated security, particularly a security rated
below investment grade.62 They noted that such disclosure does not
explain the reasons why a security may not have a credit rating--
notably that smaller, but no less sound, issuers may not wish to bear
the expense of obtaining a credit rating.63 Commenters also
questioned why the Commission excluded from the disclosure requirement
only government securities defined under Section 3(a)(42)(A) and (B) of
the Exchange Act.64 In particular, Freddie Mac argued that
securities issued by government sponsored enterprises (``GSEs''),
including those issued by Freddie Mac, also should be excluded from the
disclosure requirement. Freddie Mac argued that, because of the
market's assessment of the creditworthiness of GSEs, it makes little
economic sense for a GSE to bolster its creditworthiness with an
independent rating.65 Finally, some commenters believed that the
MSRB should adopt any rule affecting the municipal securities market;
other commenters were neutral whether the Commission or the MSRB
implemented rulemaking.
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\6\2See, e.g., Letters from Sullivan & Cromwell (July 15, 1994);
R. Fenn Putman, Chairman, PSA (June 20, 1994); and Jon S. Corzine,
Goldman, Sachs & Co. (June 15, 1994), to Jonathan G. Katz,
Secretary, SEC.
\6\3One commenter noted that rural issuers would be harmed by
the disclosure requirement because the size of a rural issue makes
bearing the expense of obtaining a rating economically impractical.
See Letter from Ian B. Davidson, Chairman, and Kreg A. Jones, Chief
Operating Officer, D.A. Davidson & Co., to Jonathan G. Katz,
Secretary, SEC (June 14, 1994).
\6\4See, e.g., Letter from Mitchell Delk, Vice President/
Government and Industry Relations, Freddie Mac, to Jonathan G. Katz,
Secretary, SEC (June 15, 1994).
\6\5Freddie Mac also described the anomalous situation in which,
on the one hand, GSE securities would be subject to the disclosure
requirement, but on the other hand, rated private label asset-backed
securities would not, even though the underlying securities were GSE
securities and primarily responsible for the rating. See Letter from
Mitchell Delk, Vice President/Government and Industry Relations,
Freddie Mac, to Jonathan G. Katz, Secretary, SEC (June 15, 1994), at
pp. 2-3.
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After considering the comments, the Commission is adopting the
proposed amendments to Rule 10b-10 requiring disclosure if a debt
security, other than a government security, has not been rated by an
NRSRO. Such disclosure would be more meaningful to the investor if it
is made together with the description of the security. As noted in the
Proposing Release, this disclosure is not intended to suggest that an
unrated security is inherently riskier than a rated security.66
Rather, the disclosure is intended to alert customers that they may
wish to obtain further information or clarification from their broker-
dealers. In most cases, this disclosure should verify information that
was disclosed to the investor prior to the transaction. If a customer
was not previously informed of the security's unrated status, then
confirmation disclosure may prompt a dialogue between the customer and
broker-dealer.
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\6\6Nevertheless unrated municipal bonds, which make up
approximately 33% of the market, in the aggregate have a higher
default rate than do rated bonds. See Municipal Bond Defaults--The
1980's Decade in Review 1-2, at 1, J.J. Kenny Co., Inc. (1993).
According to this study on default rates between January 1, 1980 to
December 31, 1991, 628 unrated issues defaulted compared with 98
rated issues. According to data provided by the Securities Data
Company, unrated debt defaults make up approximately 75% of all
defaults. See also Public Securities Association, An Examination of
Non-Rated Municipal Defaults 1986-1991 4 (Jan. 8, 1993).
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The Commission agrees with commenters that all ``government
securities'' should be excluded from the unrated debt disclosure
requirement, not just those defined under Section 3(a)(42)(A) and (B)
of the Exchange Act.67 Therefore, government securities meeting
the definition under sub-paragraphs (C) and (D) of Section 3(a)(42),
which includes securities issued by GSEs, will be exempt from the
disclosure requirement. The Commission, however, does not intend to
expand the class of securities subject to the exclusion beyond those
defined as government securities in Section 3(a)(42).
---------------------------------------------------------------------------
\6\715 U.S.C. 78c(a)(42).
---------------------------------------------------------------------------
The non-rated debt proposal for municipal securities was contained
in proposed Rule 15c2-13. In its comment letter, the MSRB stated that,
``[t]he Board agrees with the Commission that, while the fact that a
bond is unrated is not necessarily indicative of problems, disclosure
of the fact would be helpful to investors.''68 The MSRB also noted
that, if the Commission determined that such information was needed by
investors in debt securities, it would amend its confirmation rule,
Rule G-15, and require disclosure if a municipal security has not been
rated by an NRSRO.69 Inasmuch as other confirmation requirements
for municipal securities are currently set forth in Rule G-15 of the
MSRB, the Commission is willing to defer this portion of the proposal
to allow the MSRB to adopt the requirement as part of its rules, and
will withdraw it after the MSRB has taken action.
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\6\8Letter from David C. Clapp, Chairman, MSRB, to Jonathan G.
Katz, Secretary, SEC (June 15, 1994).
\6\9Id.
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D. Disclosure of Mark-Ups and Mark-Downs in Certain NASDAQ and
Exchange-Listed Securities
As part of the amendments to Rule 10b-10, the Commission proposed
requiring the disclosure of mark-up information for principal
transactions in certain securities quoted on NASDAQ or listed on
regional exchanges.70 This proposal covered securities that are
subject to last sale reporting, but are not technically ``reported
securities'' under Rule 11Aa3-1 of the Exchange Act.71 As noted in
the Proposing Release, the NASD adopted amendments to its confirmation
rule requiring the disclosure of mark-up information in principal
transactions in securities that are not NASDAQ/NMS securities--i.e.,
NASDAQ Small Cap Securities.72 The purpose of the proposed
amendment is to consolidate disclosures already required under NASD
rules. Because last sale information is available for regional
exchange-listed securities, the Commission proposed to extend the
disclosure requirements to those securities, in addition to Small Cap
Securities. By adopting this proposal, the confirmation rule will treat
all equity securities subject to last sale reporting similarly,
irrespective of their trading markets.
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\7\0See Proposing Release, supra note 10, 59 FR 12770.
\7\117 CFR 240.11Aa3-1(a)(4). This provision defines ``reported
security'' as any exchange-listed equity security or NASDAQ security
for which transaction reports are made available on a real-time
basis pursuant to an effective transaction reporting plan. An
``effective transaction reporting plan'' refers to a transaction
reporting plan that the Commission has approved pursuant to Rule
11Aa3-1. 17 CFR 240.11Aa3-1(a)(3).
Reported securities currently include:
1. NASDAQ securities that meet standards set forth in the
National Market System Securities Designation Plan (``NASDAQ/NMS
securities).
2. Certain securities listed on a national securities exchange
that meet standards of the transaction reporting plan known as the
Restated Consolidated Tape Association Plan. This would include
securities that are registered or admitted to unlisted trading
privileges on a national securities exchange, including securities
listed on various regional exchanges, and that substantially meet
NYSE or American Stock Exchange, Inc. original listing criteria.
\7\2NASD Schedule to By-Laws, Schedule D, pt. XI, Section 3,
NASD Manual (CCH) 1867D.
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The two comments that addressed this requirement supported the
proposal.73 Accordingly, under Rule 10b-10, broker-dealers
effecting principal transactions in Small-Cap NASDAQ and regional
exchange-listed securities that are subject to last-sale reporting will
be required to disclose on the confirmation the reported trade price,
price to the customer, and the difference, if any, between the two
prices.
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\7\3See Letters from Robert F. Price, Chairman/Federal
Regulation Committee, SIA (July 15, 1994); and Kurt D. Halvorson,
Vice President/Controller, AmeriTrade (May 27, 1994), to Jonathan G.
Katz, Secretary, SEC.
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E. Disclosure of Coverage by the Securities Investor Protection
Corporation
In order to reduce investor confusion concerning a firm's SIPC
coverage,74 the Commission proposed to amend Rule 10b-10 to
require affirmative disclosure, if applicable, when a broker-dealer is
not a member of SIPC and when an account is carried by a non-SIPC-
member broker or dealer. Generally, the Securities Investor Protection
Act of 1970 requires broker-dealers registered with the Commission
under Section 15(b) of the Exchange Act to be members of SIPC. Certain
types of broker-dealers registered under Section 15(b), as well as all
broker-dealers registered as government securities brokers and dealers
under Section 15C of the Exchange Act, are excluded from SIPC
membership.75
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\7\4SIPC, a non-profit, membership corporation, was established
under the Securities Investor Protection Act of 1970. SIPC is funded
by assessments on its members and interest earned on fund assets.
The fund is used to protect securities customers of SIPC-member
broker-dealers that fail financially. 15 U.S.C. 78aaa et seq. For
example, in the event of the failure of a SIPC member firm, SIPC
provides protection up to $500,000 for claims for cash and
securities (although claims solely for cash are limited to $100,000)
of each customer. 15 U.S.C. 78fff-3(a)(1).
\7\5In addition to government securities brokers and dealers,
the following broker-dealers are not required to be members of SIPC:
(1) Persons whose principal business in the determination of SIPC
(and with Commission approval) is conducted outside the U.S.; and
(2) persons whose business consists exclusively of (a) the
distribution of shares of registered open-end investment companies
or unit investment trusts, (b) the sale of variable annuities, (c)
the business of insurance, or (d) the business of rendering
investment advisory services to registered investment companies or
insurance company separate accounts. 15 U.S.C. 78ccc(a)(2)(A) and
78lll(12).
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Many commenters addressing this issue supported the Commission's
proposal to inform customers when their broker-dealers are not SIPC
members.76 Other commenters generally agreed with requiring the
disclosure, but disagreed that the confirmation was the appropriate
disclosure medium and suggested that non-membership status in SIPC be
disclosed in a periodic account statement or opening account
document.77 Commenters opposing the disclosure initiative argued
that the disclosure would be misleading to investors in that they would
believe that they are at greater risk when dealing with a non-SIPC
firm.78 The Investment Company Institute (``ICI'') argued that
requiring ``negative disclosure'' concerning the lack of SIPC coverage
is contrary to the reasons certain persons are exempted from the
membership requirement in the first instance--namely, excluded broker-
dealers present limited risks to investors because they do not hold
customer funds.79
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\7\6See, e.g., Letters from Ronald S. Plaine, President,
Comerica Securities (undated); David M. Beckius, Vice President/Sr.
Attorney, Dean Witter Reynolds, Inc. (July 14, 1994); and William E.
Kramer, Assistant Vice President, Nomura Securities International,
Inc. (July 15, 1994), to Jonathan G. Katz, Secretary, SEC.
\7\7See, e.g., Letters from William E. Kramer, Assistant Vice
President, Nomura Securities International, Inc. (July 15, 1994);
A.B. Krongard, Chief Executive Officer, Alex. Brown & Sons,
Incorporated (July 14, 1994); and R. Fenn Putman, Chairman, PSA
(June 21, 1994), to Jonathan G. Katz, Secretary, SEC.
\7\8See, e.g., Letters from Lawrence J. Latto, Shea & Gardner
(June 17, 1994); and Peter C. Clapman, Sr. Vice President/Chief
Counsel, College Retirement Equities Fund (June 15, 1994); to
Jonathan G. Katz, Secretary, SEC.
\7\9See Letter from Paul Schott Stevens, General Counsel, ICI,
to Jonathan G. Katz, Secretary, SEC (June 15, 1994). See also Letter
from Fred J. Franklin, Vice President/Chief Compliance Officer,
Aetna Life Insurance and Annuity Co., to Jonathan G. Katz,
Secretary, SEC (June 14, 1994).
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The Commission, consistent with its authority under the Government
Securities Act Amendments of 1993,80 is adopting the proposed
amendment to ensure that customers are not led to believe that their
accounts are subject to protection beyond what actually is the
case.81 This disclosure is relevant and meaningful to investors.
Further, the confirmation is the best vehicle to convey this
information to customers on a transaction-specific basis, particularly
in situations where a customer is dealing with affiliated broker-
dealers and one or more of the affiliates is not a SIPC member.
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\8\015 U.S.C. 78O-5(a)(4).
\8\1The legislative history of the Government Securities Act
Amendments of 1993 discussed SIPC coverage and the exemption from
SIPC coverage afforded to government securities brokers and dealers.
The Government Accounting Office noted that the gap in SIPC coverage
could be confusing to investors and recommended, among other things,
that the lack of SIPC coverage be disclosed. The amendments
ultimately took a disclosure approach and authorized the Commission
to require disclosure of non-SIPC status of government securities
brokers and dealers. S. Rep. No. 422, 103rd Cong., 1st Sess. 16
(1993). The same reasons to require this disclosure of government
securities brokers and dealers applies to other broker-dealers that
are exempt from SIPC coverage.
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The Commission agrees, however, that certain instances exist where
this disclosure should not apply.82 For instance, the ICI stated
that in some cases when a broker-dealer contracts with an investment
company for the distribution of fund shares, customers purchasing such
shares will send their purchase money directly to the fund's transfer
agent.83 The transfer agent then will issue shares to the customer
against receipt of the purchase money and send the money to the fund's
custodian bank. In this situation, customer funds are not handled by
the broker-dealer. In addition, the ICI argued that the transfer agent
or fund underwriter, when sending the confirmation on behalf of the
broker-dealer, may not know the SIPC status of a particular broker-
dealer. Accordingly, the disclosure provision contains an exclusion
that is intended to apply only in cases where the non-SIPC broker-
dealer does not receive or handle in any form customer funds or
securities in connection with a purchase or redemption of registered
open-end investment company or unit investment trust shares and the
customer sends its purchase money or securities to the fund, its
transfer agent, its custodian, or its designated agent, none of whom
are associated persons of the broker-dealer. Furthermore, checks may
not be made payable to the broker-dealer, and the broker-dealer may not
handle any customer checks in connection with the transaction.
Otherwise, the broker-dealer would be required to disclose its non-SIPC
status. Therefore, if a broker-dealer, including a fund underwriter,
receives customer funds or securities and promptly forwards funds or
securities to the investment company, transfer agent, custodian, or
other designated agent, the confirmation would have to disclose the
non-SIPC status of the broker-dealer.
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\8\2Some commenters believed that the proposed disclosure was
inconsistent with a letter, Letter regarding Benjamin M. Vandegrift
(Dec. 21, 1993), issued by the Division of Investment Management.
The disclosure requirement adopted today recognizes the position
taken in the letter, reserving the right to revisit SIPC-related
disclosure issues.
\8\3See Letter from Paul Schott Stevens, General Counsel, ICI,
to Jonathan G. Katz, Secretary, SEC (June 15, 1994), at 2, n.5.
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F. Disclosures Relating to Asset-Backed Securities
In 1983, the Commission adopted amendments to Rule 10b-10 to
require disclosure of yield information on a customer confirmation,
recognizing that such information is important to investors when
evaluating the merits of investing in various debt securities.84
Currently, Rule 10b-10 requires the disclosure of (1) the yield to
maturity, if the transaction is effected on the basis of dollar
price;85 (2) the dollar price calculated from yield, if the
transaction is effected on a yield basis;86 and (3) if effected on
a basis other than dollar price or yield to maturity, and the yield to
maturity will be less than the represented yield, then both the yield
to maturity and the represented yield.87
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\8\4See Securities Exchange Act Release No. 19687 (Apr. 18,
1983), 48 FR 17583.
\8\517 CFR 240.10b-10(a)(4)(ii) and (5)(i).
\8\617 CFR 240.10b-10(a)(5)(ii).
\8\717 CFR 240.10b-10(a)(5)(iii).
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Rule 10b-10 exempts from the yield disclosure requirements any
instrument that is a ``participation interest in notes secured by liens
upon real estate continuously subject to prepayment.''88 Since the
adoption of the yield disclosure requirements, structured financings
have expanded to include securities backed by mortgage notes,
automobile loans, computer leases, consumer debt, and other
receivables. These asset-backed securities raised similar problems of
variable yield. Accordingly, the Commission proposed to expand the
range of securities subject to the exemptions from yield disclosure to
include asset-backed securities that are not insulated from prepayment
risk or susceptible to an accurate forecast of yield.89
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\8\817 CFR 240.10b-10(a)(4)(ii) and (5)(iii). Essentially, this
exemption was aimed at mortgage pass-through notes that were issued
or guaranteed by the Government National Mortgage Association,
Federal National Mortgage Association, and the Federal Home Loan
Mortgage Corporation.
\8\9See Proposing Release, supra note ------, at 59 FR 12771.
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In addition, the Commission proposed to require particularized
disclosures in connection with transactions in collateralized mortgage
obligations (``CMOs'').90 Specifically, the Commission proposed
amendments that would require broker-dealers to disclose on the
confirmation the particular CMO's (1) estimated yield; (2) weighted
average life; and (3) prepayment assumptions underlying the
yield.91
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\9\0CMOs are collateralized pools of residential mortgage loans
that are divided into multiple tranches (sometimes as many as 15 to
20) which can be tailored to a broad spectrum of investors or
particularized to the cash flow needs of a single or discrete group
of investors. Like other asset-backed securities, the rate of
prepayment on the underlying collateral of CMOs is influenced by
changes in interest rates and shifts in the general economy, which
in turn may affect the actual maturities of CMOs as prepayment
speeds accelerate or decrease. CMOs are priced on the basis of the
estimated weighted average life of individual CMO tranches. As
interest rates decline, prepayments increase, with a corresponding
shortening of weighted average life. Conversely, an increase in
interest rates results in a lengthening of maturity.
\9\1Proposing Release, supra note ------, at 59 FR 12771.
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Some commenters supported the Commission's proposal to require
disclosure of CMO information and noted that such disclosures were
provided to investors as a matter of course, either in a confirmation
or other disclosure statements.92 Other commenters opposed
confirmation disclosure of the estimated yield, weighted average life,
and prepayment assumptions on the grounds that the confirmation is not
an appropriate disclosure vehicle to convey the information.93 In
addition, commenters opposed disclosing such complex information in a
confirmation because it could not be accomplished in a meaningful way
due to the document's limited size and space.94 Many commenters
noted that detailed discussions concerning particular aspects of CMOs
are contained in the prospectus or other offering documents that are
sent to investors prior to the time in which they make their investment
decisions.95
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\9\2See, e.g., Letters from David M. Beckius, Vice President/Sr.
Attorney, Dean Witter Reynolds, Inc. (July 14, 1994); Silas L.
Matthies, Sr. Vice President, Norwest Securities, Inc. (June 14,
1994); Rauscher Pierce Refsnes, Inc. (June 14, 1994); and Bill
Duepree, Jr., President, Morgan Keegan & Co., Inc. (June 1, 1994),
to Jonathan G. Katz, Secretary, SEC.
\9\3Commenters noted that investors receive disclosure documents
containing numerous models depicting different prepayment
assumptions. These commenters questioned which of the multiple
assumptions would be disclosed in the confirmation. See, e.g.,
Letters from Robert F. Price, Chairman/Federal Regulation Committee,
SIA (July 15, 1994); and R. Fenn Putman, Chairman, PSA (June 21,
1994), to Jonathan G. Katz, Secretary, SEC.
\9\4See, e.g., Letters from Robert F. Price, Chairman, Federal
Regulation Committee, SIA (July 15, 1994); R. Fenn Putman, Chairman,
PSA (June 21, 1994); and Mitchell Delk, Vice President Government
and Industry Relations, Freddie Mac, (June 15, 1994), to Jonathan G.
Katz, Secretary, SEC.
\9\5See, e.g., Letters from Kathryn S. Reimann, Sr. Vice
President, Lehman Brothers, Inc. (July 14, 1994); R. Fenn Putman,
Chairman, PSA (June 21, 1994); and Mitchell Delk, Vice President/
Government and Industry Relations, Freddie Mac (June 15, 1994), to
Jonathan G. Katz, Secretary, SEC.
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No comments were received regarding the proposal to expand the
range of instruments that would be exempted from the yield disclosure
requirements. Because some instruments are not subject to predictable
forecasts of the yield, the Commission is adopting amendments exempting
asset-backed instruments that are continuously subject to prepayment.
The exemption would apply only to those instruments that are not
insulated from prepayment risk or otherwise susceptible to an accurate
forecast of yield.96
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\9\6This position codifies a no-action position in Letter
regarding Merrill Lynch, Pierce, Fenner & Smith (Oct. 19, 1988),
granting no-action with respect to the yield disclosure requirements
for those mortgage and asset-backed securities that are not subject
to an accurate forecast of yield. The staff noted that if an
accurate forecast of yield could be made, then the yield should be
disclosed in the confirmation.
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In addition, in light of the comments concerning the proposed CMO
disclosure, the Commission is modifying the amendment requiring the
disclosure of prepayment assumptions, weighted average life, and
estimated yield of a CMO. The Commission recognizes that broker-dealers
intend confirmations to be brief, and thus size limitations may affect
the detail of disclosure that may be practically and meaningfully
conveyed to the customer. Thus, while yield information is important to
investors of CMOs, as well as all mortgage and asset-backed securities,
the Commission agrees that these securities contain complexities that
are difficult to explain using single figures in a confirmation.
Accordingly, rather than require the disclosure in the confirmation of
specific numbers identifying the estimated yield, weighted average
life, and prepayment assumptions underlying the yield, the Commission
is adopting a requirement that broker-dealers include on the
confirmation a statement alerting investors that their yields are
subject to fluctuation depending on the speed in which the underlying
note or receivable prepays and that specific information is available
upon written request of the customer.97
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\9\7This approach builds upon an alternative suggested by one
commenter that rather than the proposed disclosure, the Commission
impose a requirement that a broker-dealer print a legend on the
confirmation. See Letter from Mitchell Delk, Vice President/
Government and Industry Relations, Freddie Mac, to Jonathan G. Katz,
Secretary, SEC (June 15, 1994).
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While information concerning prepayment assumptions and pricing of
CMOs and other asset-backed securities may be contained in disclosure
documents at the offering stage, this type of detailed information has
not been as readily available in the secondary market for some asset-
backed securities and to some investors.98 Under the Rule, as
adopted, such information would be required to be sent to customers
upon written request. In addition, if in fact a CMO or other asset-back
security is sold solely on the basis of one yield amount, the yield and
underlying assumptions should be disclosed on the confirmation, as well
as the legend stating that these items may vary.99 This is
consistent with those commenters that noted that they disclose yield
information in CMO transactions as a matter of course.100 The
antifraud provisions of the federal securities laws would require that
any information provided upon request reflect changes or developments
in the characteristics of the asset-backed security.
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\9\8The Commission recognizes the positive efforts made to
educate and provide information to investors in the CMO market. For
example, the PSA developed a brochure entitled, ``Investors Guide to
Real Estate Mortgage Investment Conduits (REMICs),'' which is
approved by the NASD as an investor education tool. In addition, one
commenter stated that prepayment information and interest rate
information are available to dealers and investors in the secondary
market through various vendors and proprietary services. This
commenter also indicated that for those market participants that do
not have access to this information, they should be able to obtain
it from the selling broker-dealer. See Letter from Mitchell Delk,
Vice President/Government and Industry Relations, Freddie Mac, to
Jonathan G. Katz, Secretary, SEC (June 15, 1994).
\9\917 CFR 240.10b-10(a)(5)(i). See also Securities Exchange Act
Release No. 19687 (Apr. 18, 1983), 48 FR 17583. The Commission is
concerned that in some cases asset-backed securities may be sold to
retail investors on the basis of a single yield figure, without
adequate disclosure that this yield can vary based upon prepayment
speeds. This inadequate disclosure would potentially violate self-
regulatory organization and Commission antifraud rules. In addition,
to make this disclosure complete, a broker-dealer would need to
disclose that the single yield may vary.
\1\00See supra note 92.
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III. Effects on Competition and Regulatory Flexibility Act
Considerations
Section 23(a)(2) of the Exchange Act101 requires that the
Commission, when adopting rules under the Exchange Act, consider the
anticompetitive effects of those rules, if any, and balance any
anticompetitive impact against the regulatory benefits gained in terms
of furthering the purposes of the Exchange Act. The Commission believes
that adoption of the amendments to Rule 10b-10 will not impose any
burden on competition not necessary or appropriate in furtherance of
the purposes of the Exchange Act.
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\1\0115 U.S.C. 78w(a)(2).
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The Commission has prepared a Final Regulatory Flexibility Analysis
(``FRFA'') regarding the amendments to Rule 10b-10, in accordance with
5 U.S.C. 604. The FRFA notes the potential initial costs of operational
and procedural changes that may be necessary to comply with the
amendments. In addition, the FRFA notes the benefits to investors of
increased disclosure that will result from these amendments. The
Commission believes that the benefits of added disclosure outweigh the
costs that will be incurred by industry participants in complying with
these amendments.
A copy of the FRFA will be available for inspection and copying in
the Commission's Public Reference Section, 450 Fifth Street, N.W.,
Washington, D.C. 20549.
List of Subjects in 17 CFR Part 240
Reporting and recordkeeping requirements, Securities.
Statutory Basis and Text of Amendments
For the reasons set forth in the preamble, the Commission hereby
amends Part 240 of Chapter II of Title 17 of the Code of Federal
Regulations as follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
1. The authority citation for Part 240 continues to read in part as
follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77eee, 77ggg,
77nnn, 77sss, 77ttt, 78c, 78d, 78i, 78j, 78l, 78m, 78n, 78o, 78p,
78q, 78s, 78w, 78x, 78ll(d), 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-
37, 80b-3, 80b-4 and 80b-11, unless otherwise noted.
* * * * *
2. Section 240.10b-10 is amended by adding a preliminary note prior
to paragraph (a), revising paragraphs (a) and (b), removing paragraph
(c), redesignating paragraphs (d) through (f) as paragraphs (c) through
(e), adding a heading to newly designated paragraph (d), revising the
introductory text of paragraph (d) and the introductory text of
paragraph (d)(6), and adding paragraph (d)(10) to read as follows:
Sec. 240.10b-10 Confirmation of transactions.
Preliminary Note. This section requires broker-dealers to disclose
specified information in writing to customers at or before completion
of a transaction. The requirements under this section that particular
information be disclosed is not determinative of a broker-dealer's
obligation under the general antifraud provisions of the federal
securities laws to disclose additional information to a customer at the
time of the customer's investment decision.
(a) Disclosure Requirement. It shall be unlawful for any broker or
dealer to effect for or with an account of a customer any transaction
in, or to induce the purchase or sale by such customer of, any security
(other than U.S. Savings Bonds or municipal securities) unless such
broker or dealer, at or before completion of such transaction, gives or
sends to such customer written notification disclosing:
(1) The date and time of the transaction (or the fact that the time
of the transaction will be furnished upon written request to such
customer) and the identity, price, and number of shares or units (or
principal amount) of such security purchased or sold by such customer;
and
(2) Whether the broker or dealer is acting as agent for such
customer, as agent for some other person, as agent for both such
customer and some other person, or as principal for its own account;
and if the broker or dealer is acting as principal, whether it is a
market maker in the security (other than by reason of acting as a block
positioner); and
(i) If the broker or dealer is acting as agent for such customer,
for some other person, or for both such customer and some other person:
(A) The name of the person from whom the security was purchased, or
to whom it was sold, for such customer or the fact that the information
will be furnished upon written request of such customer; and
(B) The amount of any remuneration received or to be received by
the broker from such customer in connection with the transaction unless
remuneration paid by such customer is determined pursuant to written
agreement with such customer, otherwise than on a transaction basis;
and
(C) For a transaction in any subject security as defined in
Sec. 240.11Ac1-2 or a security authorized for quotation on an automated
interdealer quotation system that has the characteristics set forth in
Section 17B of this Act (15 U.S.C. 78q-2), a statement whether payment
for order flow is received by the broker or dealer for transactions in
such securities and the fact that the source and nature of the
compensation received in connection with the particular transaction
will be furnished upon written request of the customer; and
(D) The source and amount of any other remuneration received or to
be received by the broker in connection with the transaction: Provided,
however, that if, in the case of a purchase, the broker was not
participating in a distribution, or in the case of a sale, was not
participating in a tender offer, the written notification may state
whether any other remuneration has been or will be received and the
fact that the source and amount of such other remuneration will be
furnished upon written request of such customer; or
(ii) If the broker or dealer is acting as principal for its own
account:
(A) In the case where such broker or dealer is not a market maker
in that security and, if, after having received an order to buy from a
customer, the broker or dealer purchased the security from another
person to offset a contemporaneous sale to such customer or, after
having received an order to sell from a customer, the broker or dealer
sold the security to another person to offset a contemporaneous
purchase from such customer, the difference between the price to the
customer and the dealer's contemporaneous purchase (for customer
purchases) or sale price (for customer sales); or
(B) In the case of any other transaction in a reported security, or
an equity security that is quoted on NASDAQ or traded on a national
securities exchange and that is subject to last sale reporting, the
reported trade price, the price to the customer in the transaction, and
the difference, if any, between the reported trade price and the price
to the customer.
(3) Whether any odd-lot differential or equivalent fee has been
paid by such customer in connection with the execution of an order for
an odd-lot number of shares or units (or principal amount) of a
security and the fact that the amount of any such differential or fee
will be furnished upon oral or written request: Provided, however, that
such disclosure need not be made if the differential or fee is included
in the remuneration disclosure, or exempted from disclosure, pursuant
to paragraph (a)(2)(i)(B) of this section; and
(4) In the case of any transaction in a debt security subject to
redemption before maturity, a statement to the effect that such debt
security may be redeemed in whole or in part before maturity, that such
a redemption could affect the yield represented and the fact that
additional information is available upon request; and
(5) In the case of a transaction in a debt security effected
exclusively on the basis of a dollar price:
(i) The dollar price at which the transaction was effected, and
(ii) The yield to maturity calculated from the dollar price:
Provided, however, that this paragraph (a)(5)(ii) shall not apply to a
transaction in a debt security that either: (A) Has a maturity date
that may be extended by the issuer thereof, with a variable interest
payable thereon; or
(B) Is an asset-backed security, that represents an interest in or
is secured by a pool of receivables or other financial assets that are
subject continuously to prepayment; and
(6) In the case of a transaction in a debt security effected on the
basis of yield:
(i) The yield at which the transaction was effected, including the
percentage amount and its characterization (e.g., current yield, yield
to maturity, or yield to call) and if effected at yield to call, the
type of call, the call date and call price; and
(ii) The dollar price calculated from the yield at which the
transaction was effected; and
(iii) If effected on a basis other than yield to maturity and the
yield to maturity is lower than the represented yield, the yield to
maturity as well as the represented yield; Provided, however, that this
paragraph (a)(6)(iii) shall not apply to a transaction in a debt
security that either:
(A) Has a maturity date that may be extended by the issuer thereof,
with a variable interest rate payable thereon; or
(B) Is an asset-backed security, that represents an interest in or
is secured by a pool of receivables or other financial assets that are
subject continuously to prepayment; and
(7) In the case of a transaction in a debt security that is an
asset-backed security, which represents an interest in or is secured by
a pool of receivables or other financial assets that are subject
continuously to prepayment, a statement indicating that the actual
yield of such asset-backed security may vary according to the rate at
which the underlying receivables or other financial assets are prepaid
and a statement of the fact that information concerning the factors
that affect yield (including at a minimum estimated yield, weighted
average life, and the prepayment assumptions underlying yield) will be
furnished upon written request of such customer; and
(8) In the case of a transaction in a debt security, other than a
government security, that the security is unrated by a nationally
recognized statistical rating organization, if such is the case; and
(9) That the broker or dealer is not a member of the Securities
Investor Protection Corporation (SIPC), or that the broker or dealer
clearing or carrying the customer account is not a member of SIPC, if
such is the case: Provided, however, that this paragraph (a)(9) shall
not apply in the case of a transaction in shares of a registered open-
end investment company or unit investment trust if:
(i) The customer sends funds or securities directly to, or receives
funds or securities directly from, the registered open-end investment
company or unit investment trust, its transfer agent, its custodian, or
other designated agent, and such person is not an associated person of
the broker or dealer required by paragraph (a) of this section to send
written notification to the customer; and
(ii) The written notification required by paragraph (a) of this
section is sent on behalf of the broker or dealer to the customer by a
person described in paragraph (a)(9)(i) of this section.
(b) Alternative Periodic Reporting. A broker or dealer may effect
transactions for or with the account of a customer without giving or
sending to such customer the written notification described in
paragraph (a) of this section if:
(1) Such transactions are effected pursuant to a periodic plan or
an investment company plan, or effected in shares of any open-end
management investment company registered under the Investment Company
Act of 1940 that holds itself out as a money market fund and attempts
to maintain a stable net asset value per share: Provided, however, that
no sales load is deducted upon the purchase or redemption of shares in
the money market fund; and
(2) Such broker or dealer gives or sends to such customer within
five business days after the end of each quarterly period, for
transactions involving investment company and periodic plans, and after
the end of each monthly period, for other transactions described in
paragraph (c)(1) of this section, a written statement disclosing each
purchase or redemption, effected for or with, and each dividend or
distribution credited to or reinvested for, the account of such
customer during the month; the date of such transaction; the identity,
number, and price of any securities purchased or redeemed by such
customer in each such transaction; the total number of shares of such
securities in such customer's account; any remuneration received or to
be received by the broker or dealer in connection therewith; and that
any other information required by paragraph (a) of this section will be
furnished upon written request: Provided, however, that the written
statement may be delivered to some other person designated by the
customer for distribution to the customer; and
(3) Such customer is provided with prior notification in writing
disclosing the intention to send the written information referred to in
paragraph (c)(1) of this section in lieu of an immediate confirmation.
* * * * *
(d) Definitions. For the purposes of this section:
* * * * *
(6) Investment company plan means any plan under which securities
issued by an open-end investment company or unit investment trust
registered under the Investment Company Act of 1940 are purchased by a
customer (the payments being made directly to, or made payable to, the
registered investment company, or the principal underwriter, custodian,
trustee, or other designated agent of the registered investment
company), or sold by a customer pursuant to:
* * * * *
(10) Asset-backed security means a security that is primarily
serviced by the cashflows of a discrete pool of receivables or other
financial assets, either fixed or revolving, that by their terms
convert into cash within a finite time period plus any rights or other
assets designed to assure the servicing or timely distribution of
proceeds to the security holders.
* * * * *
By the Commission.
Dated: November 10, 1994.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-28450 Filed 11-16-94; 8:45 am]
BILLING CODE 8010-01-P
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