Implementing Regulations for the Government Securities Act of 1986

DEPARTMENT OF THE TREASURY

Office of the Under Secretary for Domestic Finance

17 CFR Part 403

RIN 1505-AA42

Implementing Regulations for the Government Securities Act of

1986

AGENCY: Office of the Under Secretary for Domestic Finance, Treasury.

ACTION: Final rule.

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SUMMARY: The Department of the Treasury (``Department'') is issuing in

final form amendments to the regulations issued under the Government

Securities Act of 1986, as amended (the ``Government Securities Act''

or ``GSA''). The amendments implement a buy-in requirement for

mortgage-backed securities that are in a fail to receive status for

more than 60 calendar days; and all government securities that are

needed to complete a customer sell order (other than a short sale) if

the securities have not been received from the customer within 30

calendar days after the settlement date for all government securities

except mortgage-backed securities, or 60 calendar days after the

settlement date for mortgage-backed securities. The final rule adopts

without substantive change the buy-in requirements for mortgage-backed

securities in a fail to receive status that were prescribed in the

proposed rules published for comment on April 17, 1991. However, the

time frames for buy-ins of customer sell orders have been revised in

the final rule in response to comments received on the proposed rules.

These requirements apply to all entities that are required to register

or provide notice of their status as government securities brokers and

dealers.

EFFECTIVE DATE: April 29, 1994.

FOR FURTHER INFORMATION CONTACT: Ken Papaj (Director), or Lee Grandy

(Government Securities Specialist), Public Debt, Government Securities

Regulations Staff, 999 E Street, NW., room 515, Washington, DC 20239-

0001, (202) 219-3632. (TDD for hearing impaired: (202) 219-9274.)

SUPPLEMENTARY INFORMATION:

I. Background

The GSA regulations currently require a government securities

broker or dealer to take prompt steps to obtain possession or control

of customers' fully paid or excess margin securities that have been in

a fail to receive status for more than 30 calendar days through a buy-

in procedure or otherwise. However, mortgage-backed securities are not

subject to this buy-in requirement since the Department suspended the

application of this rule to such securities in the GSA regulations that

were issued in July 1987.1 In addition, the current GSA

regulations do not impose a buy-in requirement for customer sell orders

where the government securities broker or dealer has not obtained the

securities from its customer. A temporary rule imposing such a

requirement on registered government securities brokers and dealers was

suspended in the July 1987 GSA regulations issued by the

Department.2

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\1\ 52 FR 27910, 27920-21 and 27948-50 (July 24, 1987).

\2\ 52 FR 27910, 27921-22 and 27948-50 (July 24, 1987).

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On April 17, 1991, the Department proposed for comment amendments

to sections 403.1, 403.4, and 403.5 of the GSA regulations.3 The

proposed amendments prescribed buy-in requirements for: (i) Mortgage-

backed securities in a fail to receive status for more than 60 calendar

days, and (ii) customer sell orders (other than short sales) in which

the securities were not received from the customer within ten business

days after the settlement date.

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\3\ See 56 FR 15529 (April 17, 1991). The rule changes to these

three sections of the GSA regulations would make the buy-in

requirements applicable to all classes of government securities

brokers and dealers that were required to register or file notice

pursuant to section 15C(a)(1) of the Securities Exchange Act of 1934

(15 U.S.C. 78o-5(a)(1)). Section 403.1 would apply to registered

brokers and dealers that were required to file notice as government

securities brokers and dealers with the Securities and Exchange

Commission; section 403.4 would apply to registered government

securities brokers and dealers (i.e., those entities that were

required to register with the SEC); and section 403.5 would apply to

financial institutions that were required to file notice as

government securities brokers and dealers with their respective

appropriate regulatory agency.

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The proposed rule was intended to subject mortgage-backed

securities to a 60 calendar day buy-in requirement, rather than the 30

calendar days applicable to other government securities due to the

unique nature of the mortgage-backed market, particularly the lengthy

settlement cycle. The reader is referred to the preamble to the

proposed rule4 for a more detailed discussion of the Department's

reasons for adopting a 60 calendar day time frame for buy-ins of

mortgage-backed securities. The proposed rulemaking also included buy-

in rules for customer sell orders that would apply to all government

securities brokers and dealers, including financial institutions.

Specifically, the provisions proposed that if a government securities

broker or dealer executes a customer sell order (other than a short

sale) and the broker or dealer has not obtained the securities from the

customer within ten business days after the settlement date, then the

broker or dealer would be required to close out the transaction with

the customer by purchasing securities of like kind and quantity. The

Department specifically requested comments concerning the

appropriateness of the ten-day time frame.

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\4\ See 56 FR 15529, 15530-31 (April 17, 1991).

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The comment period for the proposed rules closed on June 17, 1991.

Only one letter5 was received in response to the proposed rule

changes. The commenter supported the 60-day buy-in time frame for

mortgage-backed securities in a fail to receive status but opposed the

proposed rule for customer sell orders. However, the commenter

suggested modifications to the time frame for buy-ins of customer sell

orders if Treasury decided to adopt such a rule.

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\5\Letter from Peter J. Murray, Chairman, Government Securities

Operations Committee, Public Securities Association (PSA) and Laura

E. LoCosa, Chairperson, Mortgage-Backed Securities Operations

Committee, PSA, to Kenneth Papaj, Director, Government Securities

Regulations Staff, Bureau of the Public Debt, Department of the

Treasury, dated June 17, 1991 (hereinafter ``June 17, 1991 PSA

Letter'').

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Treasury did not issue these rules in final form prior to the

expiration of its rulemaking authority on October 1, 1991. Treasury's

authority under the GSA was permanently reauthorized on December 17,

1993, hence the long delay in finalizing these rules.

II. Section-by-Section Analysis of Proposed Changes

A. Buy-Ins for Fails To Receive

The Department is now adopting without significant change

amendments to paragraphs 403.1, 403.4(g) and 403.5(c)(1)(iii) that were

proposed in April 1991. These provisions would require all government

securities brokers and dealers that are required to register or file

notice pursuant to 15C(a)(1) of the Exchange Act to take prompt steps

to obtain possession or control of mortgage-backed securities that are

in a fail to receive status for more than 60 calendar days through a

buy-in procedure or otherwise.6 The Public Securities Association

(PSA), which was the only commenter on the proposed rules, supported

the 60 calendar day time frame for buy-ins of mortgage-backed

securities, stating that ``* * * the proposal is a reasonable

approach.''7 This time frame reflects the recommendations made in

July 1989 by an industry-wide task force established by the PSA.8

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\6\The term mortgage-backed securities includes only those

mortgage-backed securities that are included in the definition of

``government securities'' as set out in section 3(a)(42) of the

Exchange Act (15 U.S.C. 78c(a)(42)).

\7\June 17, 1991 PSA Letter, supra note 5, at 2.

\8\Letter from Marianna Maffucci, Vice President and Assistant

General Counsel, Public Securities Association, to Kenneth Papaj,

Director, Government Securities Regulations Staff, Bureau of the

Public Debt, Department of the Treasury, and Michael Macchiaroli,

Assistant Director, Division of Market Regulation, Securities and

Exchange Commission, dated July 10, 1989.

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As discussed in more detail in the preamble to the proposed rules,

the Department is adopting a longer buy-in time frame for fails to

receive for mortgage-backed securities than the 30-calendar day time

frame in place for other government securities. This longer time period

is appropriate given the normally longer settlement cycle for mortgage-

backed securities (which is often as long as 30 days),9 the

complexities of these instruments and the scarcity in the market of

specified pools. To avoid abnormal settlements,10 the Department

reiterates that any buy-in accomplished pursuant to these rules would

be allowed to settle on the next regularly scheduled settlement date

for that particular class or pool of mortgage-backed securities.

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\9\The PSA has developed a system to standardize the settlement

process for mortgage-backed securities. See Public Securities

Association, ``Uniform Practices for the Clearance and Settlement of

Mortgage-Backed Securities and Other Related Securities'' at 15-1

(1988). This system has proven successful in alleviating operational

workloads during the heaviest settlement periods, which has

contributed to a reduction in the high fail rates for mortgage-

backed securities.

\1\0A settlement date other than the regularly scheduled

settlement date can be requested, however, the buyer pays a premium

for this abnormal settlement.

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The Department understands that the PSA will implement buy-in

procedures for mortgage-backed securities similar to those in place for

other government securities. We believe that reliance on procedures

that are already familiar to the broker-dealers should facilitate the

implementation of this rule and view efforts to standardize the

operational procedures as a positive step.

B. Buy-Ins for Customer Sell Orders

The Department's proposed rules included a requirement to buy-in

customer sell orders (other than a short sale) in cases where the

government securities broker or dealer had not obtained the securities

from the customer within ten business days after the settlement date.

For registered government securities brokers and dealers the Department

was proposing to add paragraph 403.4(l) which incorporated by reference

paragraph (m) of SEC Rule 15c3-3 (17 CFR 240.15c3-3(m)), with one

modification pertaining to the definition of a short sale.11 This

rule has been suspended by the SEC with respect to exempted securities

since 1973, including government securities.12 A companion buy-in

rule for customer sell orders that would apply to financial

institutions that are required to file notice as government securities

brokers and dealers was also proposed in April 1991 by adding new

paragraph 403.5(g) to the GSA regulations.

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\1\1 The proposed rule also included an amendment to section

403.1 which would make paragraph 403.4(l) apply to registered

brokers and dealers that were required to file notice as government

securities brokers and dealers with the SEC.

\1\2 Securities Exchange Act Release No. 10093 (April 10, 1973),

38 FR 12103 (May 9, 1973).

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In its comment letter, the PSA stated that the ten-day buy-in rule

for customer sell orders should not be adopted because it has minimal

customer protection benefits. The PSA noted that improvements in the

settlement processes and the fact that most Treasury, agency and

government mortgage-backed securities are now in book-entry form have

resulted in increased deliveries and fewer overall fails. For those few

fails that may still occur, the PSA stated that ``[b]roker-dealers have

business incentives to clean up fails to limit their market

exposure.''13 For mortgage-backed securities, the ten-day buy-in

time frame would be problematic since it would require delivery of

securities outside of the regularly scheduled settlement cycles. The

PSA suggested that, if Treasury believes a buy-in rule for customer

sell orders must be adopted, the time frame should be consistent with

the applicable buy-in time frames for fails to receive.

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\1\3June 17, 1991 PSA Letter, supra note 5, at 3.

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The Department continues to believe that buy-in rules for customer

sell orders are needed to strengthen customer protection because a

customer's failure to deliver a security to an executing broker or

dealer could result in that broker's or dealer's failure to deliver to

another counterparty. Further, these rules will prevent customers from

taking advantage of market fluctuations by refusing to deliver a

security to a broker or dealer when the price rises after a sell order

has been executed.

In response to the comments made by the PSA, the Department is

revising the buy-in time frame for customer sell orders in new

paragraphs 403.4(l) and paragraph 403.5(g), applicable to registered

government securities brokers-dealers and financial institution

government securities broker-dealers, respectively, from ten business

days to 30 calendar days for all government securities, except

mortgage-backed securities, and to 60 calendar days for all government

mortgage-backed securities.14 These time frames are consistent

with the buy-in requirements for fails to receive addressed above. The

Department also modified the customer sell order rules to permit the

use of alternatives other than purchasing securities (e.g., securities

may be borrowed, substituted or bought back) in closing out orders.

Again, this is consistent with the buy-in rules for fails to receive.

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\1\4The Department is also adopting without change, the

amendments to section 403.1, which requires registered broker-

dealers to comply with paragraph 403.4(l).

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The buy-in rules for customer sell orders continue to provide an

exemption for short sales, which are the primary cause for non-

deliveries. This should significantly reduce the number of fails

subject to these requirements. Similar to buy-ins of mortgage-backed

securities that are in a fail to receive status, broker-dealers will be

allowed to effect buy-ins for customer sell orders of mortgage-backed

securities at the next regularly scheduled settlement cycle.15

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\1\5The SEC's buy-in requirement for customer sell orders has

been suspended with respect to exempted securities. See Securities

Exchange Act Release No. 10093 (April 10, 1973), 38 FR 12103 (May 9,

1973). It is the Department's understanding that SEC staff intends

to recommend to the Commission a proposal to lift the suspension of

paragraph (m) of Rule 15c3-3 with respect to exempted securities and

amend the provision in a manner that would conform with Treasury's

final rule in paragraph 403.4(l) as it relates to government and

mortgage-backed securities.

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Finally, the Department is also adopting without change

redesignated paragraph 403.5(h), which will now grant the appropriate

regulatory agencies for financial institutions the authority to extend

the 30- and 60-calendar day time frame for buy-ins of customer sell

orders if a financial institution broker-dealer requests an extension.

No comments were received on this provision.

C. Effective Dates

The final rules become effective April 29, 1994. This will provide

sufficient time for all government securities brokers and dealers to

become acquainted with the new requirements and to implement operating

procedures. Additionally, the lead time will enable the PSA to finalize

and distribute buy-in procedures it is developing for the industry.

In its comment letter, the PSA requested that the Treasury's buy-in

rules be enacted contemporaneously with the Commission's amendments to

Rule 15c3-3(d)(2) and (m). Since Treasury's rules apply to all

government securities brokers and dealers, and given the Department's

understanding that the buy-in rules to be proposed by the Commission

will conform to those adopted herein, the Department believes that

there is no compelling reason to defer implementation until the

Commission acts.

III. Special Analysis

The Department has determined that this action does not constitute

a ``significant regulatory action'' for the purposes of Executive Order

12866 (58 FR 51735, October 4, 1993). Accordingly, it was not subject

to review under the Executive Order by the Office of Information and

Regulatory Affairs, Office of Management and Budget.

In the preamble to the proposed rules, the Department certified

that these amendments would not have a significant economic impact on a

substantial number of small entities. Accordingly, a regulatory

flexibility analysis was not prepared. In reviewing the final rules

being adopted herein and after considering the comments received on the

proposed rules, the Department has concluded that there is no reason to

alter the previous certification that these rules will not have a

significant economic impact on a substantial number of small entities.

Since these final rules contain no new collections of information,

the requirements of the Paperwork Reduction Act (44 U.S.C. 3504(h)) are

inapplicable.

List of Subjects in 17 CFR Part 403

Banks, Banking, Brokers, Government securities.

For the reasons set out in the Preamble, 17 CFR part 403 is amended

to read as follows:

PART 403--PROTECTION OF CUSTOMER SECURITIES AND BALANCES

1. The authority citation for part 403 is revised to read as

follows:

Authority: Sec. 101, Public Law 99-571, 100 Stat. 3209; sec.

4(b), Public Law 101-432, 104 Stat. 963; sec. 102, sec. 106, Public

Law 103-202, 107 Stat. 2344 (15 U.S.C. 78o-5(b)(1)(A), (b)(4)).

2. Section 403.1 is revised to read as follows:

Sec. 403.1. Application of part to registered brokers and dealers.

With respect to their activities in government securities,

compliance by registered brokers or dealers with Sec. 240.8c-1 of this

title (SEC Rule 8c-1), as modified by Secs. 403.2 (a), (b) and (c),

with Sec. 240.15c2-1 of this title (SEC Rule 15c2-1), with

Sec. 240.15c3-2 of this title (SEC Rule 15c3-2), as modified by

Sec. 403.3, and with Sec. 240.15c3-3 of this title (SEC Rule 15c3-3),

as modified by Secs. 403.4 (a)-(d), (e)(2)-(3), (f)-(i), and (l),

constitutes compliance with this part.

3. Section 403.4 is amended by revising paragraph (g) and by adding

new paragraph (l) after paragraph (k) to read as follows:

Sec. 403.4. Customer protection--reserves and custody of securities.

* * * * *

(g) For the purposes of this section, Sec. 240.15c3-3(d)(2) of this

title ismodified to read as follows:

``(2) Securities included on its books or records as failed to

receive more than 30 calendar days, or in the case of mortgage-backed

securities, more than 60 calendar days, then the government securities

broker or government securities dealer shall, not later than the

business day following the day on which such determination is made,

take prompt steps to obtain possession or control of securities so

failed to receive through a buy-in procedure or otherwise; or''

* * * * *

(l) For purposes of this section, the suspension of Sec. 240.15c3-

3(m) of this title (38 FR 12103, May 9, 1973) is no longer effective

and the paragraph is modified to read as follows: ``(m) If a government

securities broker or government securities dealer executes a sell order

of a customer (other than an order to execute a sale of securities

which the seller does not own, which for the purposes of this paragraph

shall mean that the customer placing the sell order has identified the

sale as a short sale to the government securities broker or dealer) and

if for any reason whatever the government securities broker or

government securities dealer has not obtained possession of the

government securities, other than mortgage-backed securities, from the

customer within 30 calendar days, or in the case of mortgage-backed

securities within 60 calendar days, after the settlement date, the

government securities broker or government securities dealer shall

immediately thereafter close the transaction with the customer by

purchasing, or otherwise obtaining, securities of like kind and

quantity. For purposes of this paragraph (m), the term ``customer''

shall not include a broker or dealer who maintains a special omnibus

account with another broker or dealer in compliance with section 4(b)

of Regulation T (12 CFR 220.4(b)).

* * * * *

4. Section 403.5 is amended by revising paragraph (c)(1)(iii); by

redesignating paragraph (g) as paragraph (h) and revising newly

redesignated paragraph (h); and by adding new paragraph (g) to read as

follows:

Sec. 403.5. Custody of securities held by financial institutions that

are government securities brokers or dealers.

* * * * *

(c)(1) * * *

(iii) Take prompt steps to obtain possession or control of

securities failed to receive for more than 30 calendar days, or in the

case of mortgage-backed securities, for more than 60 calendar days; or

* * * * *

(g) If a financial institution executes a sell order of a customer

(other than an order to execute a sale of securities which the seller

does not own, which for the purposes of this paragraph shall mean that

the customer placing the sell order has identified the sale as a short

sale to the financial institution) and if for any reason whatever the

financial institution has not obtained possession of the government

securities, except mortgage-backed securities, from the customer within

30 calendar days, or in the case of mortgage-backed securities within

60 calendar days, after the settlement date, the financial institution

shall immediately thereafter close the transaction with the customer by

purchasing, or otherwise obtaining, securities of like kind and

quantity.

(h) The appropriate regulatory agency of a financial institution

that is a government securities broker or dealer may extend the period

specified in paragraphs (c)(1)(iii) and (g) of this section on

application of the financial institution for one or more limited

periods commensurate with the circumstances, provided the appropriate

regulatory agency is satisfied that the financial institution is acting

in good faith in making the application and that exceptional

circumstances warrant such action. Each appropriate regulatory agency

should make and preserve for a period of not less than three years a

record of each extension granted pursuant to this paragraph, which

contains a summary of the justification for the granting of the

extension.

Dated: February 14, 1994.

Frank N. Newman,

Under Secretary for Domestic Finance.

[FR Doc. 94-4402 Filed 2-25-94; 8:45 am]

BILLING CODE 4810-39-W