Regulations Governing Book-Entry Treasury Bonds, Notes and Bills

SUMMARY: The Department of the Treasury is publishing a final rule

that, on and after the effective date, will govern Treasury bonds,

notes, and bills (Treasury securities) in book-entry form held in the

commercial book-entry system. The rule incorporates recent and

significant changes in commercial law addressing the holdings of

securities in book-entry form through financial intermediaries. The

rule replaces existing Treasury regulations that contain outdated legal

concepts.

EFFECTIVE DATE: January 1, 1997. The incorporation by reference of

certain publications listed in the regulations is approved by the

Director of the Federal Register as of January 1, 1997.

FOR FURTHER INFORMATION CONTACT: Walter T. Eccard, Chief Counsel (202)

219-3320, or Cynthia E. Reese, Deputy Chief Counsel, (202) 219-3320.

Copies of the final rule are being made available for downloading from

the Bureau of the Public Debt home page at the following address:

http:\\www.ustreas.gov/treasury/bureaus/pubdebt/pubdebt.html.

SUPPLEMENTARY INFORMATION:

I. Background

On March 4, 1996, the Department published a proposed rule that

would govern securities held in the commercial book-entry system, now

referred to as the Treasury/Reserve Automated Debt Entry System

(``TRADES''). 61 FR 8420. Eleven written comment letters were received

in response to that proposed rule. All but one of the comment letters

were very supportive of the proposed rule. Most commenters recommended

adoption of the proposed rule with various suggested clarifications.

The Department found the comments extremely useful in making the

revisions described herein. Although some minor comments are not

addressed, all comments have been considered in the formulation of this

final rule.

As indicated in the March 4 release, Treasury will include

commentary on TRADES in the Code of Federal Regulations. This

commentary can be found in Appendix B.

Comments from several persons overlapped and those comments

addressed three general areas:

(1) The scope of federal preemption and related issues involving

state variations on Revised Article 8 of the UCC as well as Treasury

procedures and notice regarding acceptance of state enactments of

Revised Article 8;

(2) Coordination as to timeframes and notices to facilitate

revision and issuance of parallel rules for book-entry securities of

Government Sponsored Enterprises (GSEs) to conform to the final TRADES

rule; and

(3) The need for further explanation and clarification, especially

the inclusion of hypotheticals, to illustrate how TRADES will apply to

a variety of transaction scenarios of varying complexity, including the

application of the federal law to transactions involving clearing

banks.

II. General Comment Discussion

In the March 4 proposal, Treasury set forth its conclusion that,

because of the size and importance of the Treasury market, uniformity

of treatment of holders of interests in Treasury securities was

essential. In addition, Treasury set forth in some detail the reasons

it had concluded that Revised Article 8 was an appropriate vehicle to

use to obtain that uniformity. As of March 4, 13 states had adopted

Revised Article 8. As of the date of this release 28 states 1 have

adopted Revised Article 8 and it has been introduced in 4 additional

states and the District of Columbia.2 This remarkable progress

reflects strong support for the legal concepts set forth in Revised

Article 8 and supports Treasury's decision to base TRADES on Revised

Article 8, which is incorporated by reference in this final rule.

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\1\ Alabama, Alaska, Arizona, Arkansas, Colorado, Idaho, Iowa,

Illinois, Indiana, Kansas, Kentucky, Louisiana, Maryland,

Massachusetts, Minnesota, Mississippi, Nebraska, New Mexico,

Oklahoma, Oregon, Pennsylvania, Texas, Utah, Vermont, Virginia,

Washington, West Virginia, Wyoming.

\2\ California, District of Columbia, Hawaii, New York, Ohio.

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In the March 4 release, Treasury proposed achieving uniformity for

Treasury securities in two ways. First, Section 357.10(a) established a

rule of Federal preemption in describing the rights and obligations of

Treasury and the Federal Reserve Banks. Second, TRADES established a

choice of law rule that mandated use of Revised Article 8 in the event

the state determined by the application of the choice of law rule had

not adopted Revised Article 8.

Commenters generally supported Treasury's conclusion that

uniformity was important for the market and investors in Treasury

securities. In addition commenters were supportive of the use of

Revised Article 8 to achieve this uniformity. Three different

questions, however, were raised about the manner in which Treasury

achieved uniformity and used Revised Article 8.

A. Federal Preemption

First, 5 commenters questioned whether Secs. 357.10(c) and

357.11(d) were intended to be a complete or limited preemption of a

state's law if the state had not adopted Revised Article 8. As set

forth in the March 4 release, the preemption in TRADES is limited. See

the commentary in Appendix B. In order to clarify this issue, Treasury

has adopted language in both Secs. 357.10(c) and 357.11(d) suggested by

a commenter to make the limited nature of the preemption clearer. This

language provides that, if a state has not adopted Revised Article 8,

that state's laws shall be viewed as though that state had adopted

Revised Article 8.

Second, 4 commenters noted that while in the discussion section of

the March 4 release Treasury stated that minor variations made by a

state in adopting Revised Article 8 would not affect Treasury's

conclusion that a state had adopted Revised Article 8, the language of

the proposed rule had no similar qualification. Further, commenters

noted that while the standard in the commentary seemed appropriate,

determination of what constituted minor variations could be difficult.

In response to these comments, and in an attempt to provide certainty,

Treasury is taking the following actions. Treasury has reviewed the

form of Revised Article 8 adopted by the 28 states 3 that have

adopted Revised Article 8 as of the date of this release and has

concluded that the changes made by these states indeed are minor.

Therefore, Treasury has concluded that they all are substantially

similar to Revised Article 8. Accordingly, if either Sec. 357.10(b) or

357.11(a) directs a person to one of these 28 states, the provisions of

Secs. 357.10(c) and 357.11(d) are not applicable. In addition, as

additional states adopt Revised Article 8, Treasury will, after review

of the statute, publish in the Federal Register a notice setting forth

its conclusion as to whether Secs. 357.10(c) and 357.11(d) remain

applicable to those states.

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\3\ See Note 1 supra.

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[[Page 43627]]

Third, a commenter raised a question of what Treasury would do in

the event a state adopted Revised Article 8 and then subsequently

amended Revised Article 8 in a fashion that resulted in an

unsatisfactory lack of uniformity. Treasury believes such an event is

unlikely. In addition, once Treasury has announced its determination

that a state has adopted Revised Article 8, the market is entitled to

rely on that decision.4 Nonetheless, if such an unlikely event

were to occur, Treasury has the authority to take the action that would

result in Secs. 357.10(c) and 357.11(d) (or their equivalent) being

reapplied. Any such action would be published in the Federal Register.

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\4\ One commenter noted that Article 9 is currently being

revised, which could lead to the result that a state could adopt

different Article 9 provisions than are included in the Article 8

conforming amendments. Treasury does not anticipate that such an

event would result in the need to reapply Secs. 357.10(c) and

357.11(d). If that were necessary, Treasury would take the same

action, after notice, as described herein.

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B. Action With Respect to GSEs

Several commenters noted that market participants and practitioners

were concerned about coordination among Treasury and other GSEs that

issue book-entry securities. The assumption is that the substance of

any such regulations will be substantially identical to the Treasury

proposed rule. Treasury is working with the GSEs and their regulators

toward the goal of having the effective dates of all final book-entry

regulations timed to coincide. One commenter specifically suggested

delaying the effective date of the final TRADES rule to provide

sufficient lead time to GSE issuers. Treasury understands the market's

desire for simultaneous adoption of book-entry rules substantially

similar to TRADES for GSEs. While adoption of rules for GSEs is subject

to the control of the various GSEs and the entities that promulgate

their rules, Treasury has taken several steps to facilitate the

simultaneous adoption of parallel GSE rules. These steps have included

meetings with representatives of the GSEs and their regulators to

inform them of the actions Treasury was taking with respect to TRADES

and the timetable for adoption of TRADES. Consistent with this

supportive approach, Treasury has determined that it will, at the

request of the Federal Farm Credit Banks Funding Corporation, delay the

effectiveness of TRADES until January 1. That should permit sufficient

time for rules similar to TRADES to be in place for GSEs by the

effective date of TRADES.

C. Request for Hypotheticals

Several commenters suggested that Treasury include in the

Commentary to the final regulations various hypotheticals to illustrate

the manner in which selected transactions would be treated under the

TRADES regulations.

Initially, Treasury notes that Revised Article 8 provides numerous

hypotheticals that explain the operation of Revised Article 8. Treasury

has studied those hypotheticals carefully and believes that they are

very useful in understanding Revised Article 8. In light of those

hypotheticals, and since TRADES is based, in large measure, on Revised

Article 8, Treasury has concluded that developing hypotheticals

explaining the operation of Revised Article 8 is unnecessary. On the

other hand, TRADES does provide for an interaction of federal and state

law. Since the results in a particular factual situation could depend

on which law is applicable, Treasury has concluded that hypotheticals

that illustrate what law would apply in different situations would be

useful. Accordingly, the Commentary contains hypotheticals to explain

the interaction of federal and state law.

III. Other Comments

In addition to the general comments described above, Treasury

received a number of other comments. Many of these included technical

drafting suggestions.

One commenter noted concerns with the tiered nature of the

commercial book-entry system and indicated that investors may not be

aware of how the commercial book-entry system works. Treasury agrees

that it is important that investors understand the operation of both

the book-entry system and TRADES. The discussion in the March 4

Proposed Rule was designed to promote that understanding. In addition,

the inclusion of a commentary on TRADES in the Code of Federal

Regulations is another effort to promote an understanding of both

TRADES and the book-entry system. Furthermore, Treasury plans to

continue its investor education efforts in the coming months.

One commenter questioned the use of the term ``Security

Entitlement'' to describe the interest of a Participant in a Treasury

book-entry security. The commenter noted that the term ``Security

Entitlement'' is used in Revised Article 8 and its use in TRADES to

describe the interest of a Participant could be confusing. Treasury

considered using different terms to describe this interest but

concluded that Security Entitlement was the most useful. In order to

avoid confusion, there was language in the commentary in the March 4

release that attempted to make it clear that the term ``Security

Entitlement'' has a special meaning in TRADES. Additional language has

been added to the commentary to clarify this further. Due to Treasury's

obligation to pay a Participant (see Sec. 357.13(b)), the interest of a

Participant and a person holding in TREASURY DIRECT are, in practical

terms, the same since both the Participant and the person holding in

TREASURY DIRECT have a direct claim against the United States.

One commenter proposed adding a new defined term, ``State,'' and

made certain other drafting changes to the definitions. Those

suggestions mainly clarify the meaning intended by Treasury in the

March release and were adopted. In adopting these drafting suggestions,

Treasury concluded that a new defined term, ``Adverse Claim'' was

needed. This definition is based on the definition of that term in

Revised Article 8. By adding this term, Treasury is able to adopt the

suggestions that it delete the general incorporation reference in the

definition section that appeared in the March release. Section 357.2 is

complete and reference to other definitions is unnecessary.

One commenter found the language of Sec. 357.10(b) unclear and

proposed drafting suggestions to clarify its meaning. Section 357.10(b)

decribes the law that governs security interests granted to Federal

Reserve Banks. The Commentary, and hypotheticals included in the

commentary, explain how Sec. 357.10(b) works. In addition Treasury has

redrafted Sec. 357.10(b) in order to make its meaning clearer.

Several comments stated that Sec. 357.11(c) should be modified to

conform to the choice of law rule in Section 9-103(6)(f) of Revised

Article 8. Treasury agrees with this comment and has made changes to

Sec. 357.11(c). In particular, Treasury agrees that it is appropriate

to delete reference to priority so that, as provided in

Sec. 357.11(a)(5), the law of the Securities Intermediary's

jurisdiction governs on this issue.

Procedural Requirements

This final rule does not meet the criteria for a ``significant

regulatory action'' pursuant to Executive Order 12866.

The notice and public comment procedures requirements of the

Administrative Procedure Act are inapplicable, pursuant to 5 U.S.C.

553(a)(2).

As no notice of proposed rulemaking was required, the provisions of

the

[[Page 43628]]

Regulatory Flexibility Act (5 U.S.C. 601, et seq.) do not apply.

There are no collections of information contained in this final

rule. Therefore, the Paperwork Reduction Act does not apply.

List of Subjects in 31 CFR Part 357

Bonds, Electronic funds transfer, Federal Reserve System,

Government securities, Incorporation by reference, Securities.

For the reasons set forth in the preamble, title 31, chapter II,

subchapter B, part 357 is amended as follows:

PART 357--[AMENDED]

1. The authority citation for part 357 continues to read as

follows:

Authority: 31 U.S.C. chapter 31; 5 U.S.C. 301; 12 U.S.C. 391.

2. Sections 357.0 and 357.1 are added to read as follows:

Sec. 357.0 Dual book-entry systems.

(a) Treasury securities shall be maintained in either of the

following two book-entry systems:

(1) Treasury/Reserve Automated Debt Entry System (TRADES). A

Treasury security is maintained in TRADES if it is credited by a

Federal Reserve Bank to a Participant's Securities Account. See subpart

B of this part for rules pertaining to TRADES.

(2) TREASURY DIRECT Book-entry Securities System (TREASURY DIRECT).

A Treasury security is maintained in TREASURY DIRECT if it is credited

to a TREASURY DIRECT account as described in Sec. 357.20. Such accounts

may be accessed by investors in accordance with subpart C of this part

through any Federal Reserve Bank or the Bureau of the Public Debt. See

subpart C of this part for rules pertaining to TREASURY DIRECT.

(b) A Treasury security eligible to be maintained in TREASURY

DIRECT under the terms of its offering circular or pursuant to notice

published by the Secretary may be transferred to or from an account in

TRADES from or to an account in TREASURY DIRECT in accordance with

Sec. 357.22(a).

Sec. 357.1 Effective date.

Subpart B of this Part, the definitions of ``Adverse Claim,''

``Book-entry Security,'' ``Entitlement Holder,'' ``Federal Reserve Bank

Operating Circular,'' ``Funds Account,'' ``Issue,'' ``Participant,''

``Participant's Securities Account,'' ``Person,'' ``Revised Article

8,'' ``Securities Intermediary,'' ``Security Entitlement,'' ``State,''

and ``Transfer Message'' and revisions to the definitions of

``Security'' and ``TRADES,'' and Secs. 357.42 and 357.44 and the

revisions to Sec. 357.41 are effective January 1, 1997. All other

provisions in effect prior to January 1, 1997, remain in effect.

3. Section 357.3 is redesignated Sec. 357.2, in the definition of

``depository institution'' paragraphs (a) through (f) are redesignated

as paragraphs (1) through (6), the definition of ``security interest

and pledge'' is removed, the definitions of ``Security'' and ``TRADES''

are revised, and the remaining definitions are added in alphabetical

order as follows:

Sec. 357.2 Definitions.

* * * * *

Adverse Claim means a claim that a claimant has a property interest

in a Security and that it is a violation of the rights of the claimant

for another Person to hold, transfer, or deal with the Security.

* * * * *

Book-entry Security means, in subpart B of this part, a Treasury

Security maintained in TRADES and, in subpart C of this part, a

Treasury Security maintained in TREASURY DIRECT.

* * * * *

Entitlement Holder means a Person to whose account an interest in a

Book-entry Security is credited on the records of a Securities

Intermediary.

* * * * *

Federal Reserve Bank Operating Circular means the publication

issued by each Federal Reserve Bank that sets forth the terms and

conditions under which the Reserve Bank maintains Book-entry Securities

accounts and transfers Book-entry Securities.

* * * * *

Funds Account means a reserve and/or clearing account at a Federal

Reserve Bank to which debits or credits are posted for transfers

against payment, book-entry securities transaction fees, or principal

and interest payments.

* * * * *

Issue means a group of securities, as defined in this section, that

is identified by the same CUSIP (Committee on Uniform Securities

Identification Practices) number.

* * * * *

Participant means a Person that maintains a Participant's

Securities Account with a Federal Reserve Bank.

Participant's Securities Account means an account in the name of a

Participant at a Federal Reserve Bank to which Book-entry Securities

held for a Participant are or may be credited.

Person means and includes an individual, corporation, company,

governmental entity, association, firm, partnership, trust, estate,

representative and any other similar organization, but does not mean or

include the United States or a Federal Reserve Bank.

* * * * *

Revised Article 8 means Uniform Commercial Code, Revised Article 8,

Investment Securities (with Conforming and Miscellaneous Amendments to

Articles 1, 3, 4, 5, 9, and 10) 1994 Official Text. Revised Article 8

of the Uniform Commercial Code is incorporated by reference in this

Part pursuant to 5 U.S.C. 552(a) and 1 CFR part 51. Article 8 was

adopted by the American Law Institute and the National Conference of

Commissioners On Uniform State Laws and approved by the American Bar

Association on February 14, 1995. Copies of this publication are

available from the Executive Office of the American Law Institute, 4025

Chestnut Street, Philadelphia, PA 19104, and the National Conference of

Commissioners on Uniform State Laws, 676 North St. Clair Street, Suite

1700, Chicago, IL 60611. Copies are also available for public

inspection at the Department of the Treasury Library, Room 5030, Main

Treasury Building, 1500 Pennsylvania Avenue, NW., Washington DC 20220,

and at the Office of the Federal Register, 800 North Capitol Street,

NW., Suite 700, Washington DC.

Securities Intermediary means:

(1) A Person that is registered as a ``clearing agency'' under the

federal securities laws; a Federal Reserve Bank; any other person that

provides clearance or settlement services with respect to a Book-entry

Security that would require it to register as a clearing agency under

the federal securities laws but for an exclusion or exemption from the

registration requirement, if its activities as a clearing corporation,

including promulgation of rules, are subject to regulation by a federal

or state governmental authority; or

(2) A Person (other than an individual, unless such individual is

registered as a broker or dealer under the federal securities laws)

including a bank or broker, that in the ordinary course of its business

maintains securities accounts for others and is acting in that

capacity.

Security means a bill, note, or bond, each as defined in this

section. It also means any other obligation issued by the Department

that, by the terms of the applicable offering circular or announcement,

is made subject to this part. Solely for purposes of this part, it also

means:

(1) The interest and principal components of a security eligible

for

[[Page 43629]]

Separate Trading of Registered Interest and Principal of Securities

(``STRIPS''), if such security has been divided into such components as

authorized by the express terms of the offering circular under which

the security was issued and the components are maintained separately on

the books of one or more Federal Reserve Banks; and

(2) The interest coupons that have been converted to book-entry

form under the Treasury's Coupons Under Book-Entry Safekeeping Program

(``CUBES''), pursuant to agreement and the regulations in 31 CFR part

358.

Security Entitlement means the rights and property interest of an

Entitlement Holder with respect to a Book-entry Security.

* * * * *

State means any State of the United States, the District of

Columbia, Puerto Rico, the Virgin Islands, or any other territory or

possession of the United States.

* * * * *

TRADES is the Treasury/Reserve Automated Debt Entry System, also

referred to as the commercial book-entry system.

* * * * *

Transfer Message means an instruction of a Participant to a Federal

Reserve Bank to effect a transfer of a Book-entry Security maintained

in TRADES, as set forth in Federal Reserve Bank Operating Circulars.

* * * * *

4. Subpart B, consisting of Secs. 357.10 through 357.14, is added

to read as follows:

Subpart B--Treasury/Reserve Automated Debt Entry System (TRADES)

Sec. 357.10 Law governing rights and obligations of United States

and Federal Reserve Banks; rights of any Person against United

States and Federal Reserve Banks.

Sec. 357.11 Law governing other interests.

Sec. 357.12 Creation of ``Participant's Security Entitlement;

security interests.

Sec. 357.13 Obligations of United States; no Adverse Claims.

Sec. 357.14 Authority of Federal Reserve Banks.

Subpart B--Treasury/Reserve Automated Debt Entry System (TRADES)

Sec. 357.10 Law governing rights and obligations of United States and

Federal Reserve Banks; rights of any Person against United States and

Federal Reserve Banks.

(a) Except as provided in paragraph (b) of this section, the rights

and obligations of the United States and the Federal Reserve Banks with

respect to: A Book-entry Security or Security Entitlement and the

operation of the Treasury book-entry system; and the rights of any

Person, including a Participant, against the United States and the

Federal Reserve Banks with respect to: A Book-entry Security or

Security Entitlement and the operation of the Treasury book-entry

system; are governed solely by Treasury regulations, including the

regulations of this Part, the applicable offering circular (which is 31

CFR part 356, in the case of securities issued on and after March 1,

1993), the announcement of the offering, and Federal Reserve Bank

Operating Circulars.

(b) A security interest in a Security Entitlement that is in favor

of Federal Reserve Bank from a Participant and that is not recorded on

the books of a Federal Reserve Bank pursuant to Sec. 357.12(c)(1), is

governed by the law (not including the conflict-of-law rules) of the

jurisdiction where the head office of the Federal Reserve Bank

maintaining the Participant's Securities Account is located. A security

interest in a Security Entitlement that is in favor of a Federal

Reserve Bank from a Person that is not a Participant, and that is not

recorded on the books of a Federal Reserve Bank pursuant to

Sec. 357.12(c)(1), is governed by the law determined in the manner

specified in Sec. 357.11.

(c) If the jurisdiction specified in the first sentence of

paragraph (b) of this section is a State that has not adopted Revised

Article 8 (incorporated by reference, see Sec. 357.2) then the law

specified in paragraph (b) of this section shall be the law of that

State as though Revised Article 8 had been adopted by that State.

Sec. 357.11 Law governing other interests.

(a) To the extent not inconsistent with these regulations, the law

(not including the conflict-of-law rules) of a Securities

Intermediary's jurisdiction governs:

(1) The acquisition of a Security Entitlement from the Securities

Intermediary;

(2) The rights and duties of the Securities Intermediary and

Entitlement Holder arising out of a Security Entitlement;

(3) Whether the Securities Intermediary owes any duties to an

adverse claimant to a Security Entitlement;

(4) Whether an Adverse Claim can be asserted against a Person who

acquires a Security Entitlement from the Securities Intermediary or a

Person who purchases a Security Entitlement or interest therein from an

Entitlement Holder; and

(5) Except as otherwise provided in paragraph (c) of this section,

the perfection, effect of perfection or non-perfection and priority of

a security interest in a Security Entitlement.

(b) The following rules determine a ``Securities Intermediary's

jurisdiction'' for purposes of this section:

(1) If an agreement between the Securities Intermediary and its

Entitlement Holder specifies that it is governed by the law of a

particular jurisdiction, that jurisdiction is the Securities

Intermediary's jurisdiction.

(2) If an agreement between the Securities Intermediary and its

Entitlement Holder does not specify the governing law as provided in

paragraph (b)(1) of this section, but expressly specifies that the

securities account is maintained at an office in a particular

jurisdiction, that jurisdiction is the Securities Intermediary's

jurisdiction.

(3) If an agreement between the Securities Intermediary and its

Entitlement Holder does not specify a jurisdiction as provided in

paragraph (b)(1) or (b)(2) of this section, the Securities

Intermediary's jurisdiction is the jurisdiction in which is located the

office identified in an account statement as the office serving the

Entitlement Holder's account.

(4) If an agreement between the Securities Intermediary and its

Entitlement Holder does not specify a jurisdiction as provided in

paragraph (b)(1) or (b)(2) of this section and an account statement

does not identify an office serving the Entitlement Holder's account as

provided in paragraph (b)(3) of this section, the Securities

Intermediary's jurisdiction is the jurisdiction in which is located the

chief executive office of the Securities Intermediary.

(c) Notwithstanding the general rule in paragraph (a)(5) of this

section, the law (but not the conflict-of-law rules) of the

jurisdiction in which the Person creating a security interest is

located governs whether and how the security interest may be perfected

automatically or by filing a financing statement.

(d) If the jurisdiction specified in paragraph (b) of this section

is a State that has not adopted Revised Article 8 (incorporated by

reference, see Sec. 357.2), then the law for the matters specified in

paragraph (a) of this section shall be the law of that State as though

Revised Article 8 had been adopted by that State. For purposes of the

application of the matters specified in paragraph (a) of this section,

the Federal Reserve Bank maintaining the Securities Account is a

clearing corporation, and the

[[Page 43630]]

Participant's interest in a Book-entry Security is a Security

Entitlement.

Sec. 357.12 Creation of Participant's Security Entitlement; security

interests.

(a) A Participant's Security Entitlement is created when a Federal

Reserve Bank indicates by book entry that a Book-entry Security has

been credited to a Participant's Securities Account.

(b) A security interest in a Security Entitlement of a Participant

in favor of the United States to secure deposits of public money,

including without limitation deposits to the Treasury tax and loan

accounts, or other security interest in favor of the United States that

is required by Federal statute, regulation, or agreement, and that is

marked on the books of a Federal Reserve Bank is thereby effected and

perfected, and has priority over any other interest in the securities.

Where a security interest in favor of the United States in a Security

Entitlement of a Participant is marked on the books of a Federal

Reserve Bank, such Reserve Bank may rely, and is protected in relying,

exclusively on the order of an authorized representative of the United

States directing the transfer of the security. For purposes of this

paragraph, an ``authorized representative of the United States'' is the

official designated in the applicable regulations or agreement to which

a Federal Reserve Bank is a party, governing the security interest.

(c) (1) The United States and the Federal Reserve Banks have no

obligation to agree to act on behalf of any Person or to recognize the

interest of any transferee of a security interest or other limited

interest in favor of any Person except to the extent of any specific

requirement of Federal law or regulation or to the extent set forth in

any specific agreement with the Federal Reserve Bank on whose books the

interest of the Participant is recorded. To the extent required by such

law or regulation or set forth in an agreement with a Federal Reserve

Bank, or the Federal Reserve Bank Operating Circular, a security

interest in a Security Entitlement that is in favor of a Federal

Reserve Bank or a Person may be created and perfected by a Federal

Reserve Bank marking its books to record the security interest. Except

as provided in paragraph (b) of this section, a security interest in a

Security Entitlement marked on the books of a Federal Reserve Bank

shall have priority over any other interest in the securities.

(2) In addition to the method provided in paragraph (c)(1) of this

section, a security interest, including a security interest in favor of

a Federal Reserve Bank, may be perfected by any method by which a

security interest may be perfected under applicable law as described in

Sec. 357.10(b) or Sec. 357.11. The perfection, effect of perfection or

non-perfection and priority of a security interest are governed by that

applicable law. A security interest in favor of a Federal Reserve Bank

shall be treated as a security interest in favor of a clearing

corporation in all respects under that law, including with respect to

the effect of perfection and priority of the security interest. A

Federal Reserve Bank Operating Circular shall be treated as a rule

adopted by a clearing corporation for such purposes.

Sec. 357.13 Obligations of the United States; no Adverse Claims.

(a) Except in the case of a security interest in favor of the

United States or a Federal Reserve Bank or otherwise as provided in

Sec. 357.12(c)(1), for the purposes of this subpart B, the United

States and the Federal Reserve Banks shall treat the Participant to

whose Securities Account an interest in a Book-entry Security has been

credited as the person exclusively entitled to issue a Transfer

Message, to receive interest and other payments with respect thereof

and otherwise to exercise all the rights and powers with respect to the

Security, notwithstanding any information or notice to the contrary.

Neither the Federal Reserve Banks nor Treasury is liable to a Person

asserting or having an Adverse Claim to a Security Entitlement or to a

Book-entry Security in a Participant's Securities Account, including

any such claim arising as a result of the transfer or disposition of a

Book-entry Security by a Federal Reserve Bank pursuant to a Transfer

Message that the Federal Reserve Bank reasonably believes to be

genuine.

(b) The obligation of the United States to make payments of

interest and principal with respect to Book-entry Securities is

discharged at the time payment in the appropriate amount is made as

follows:

(1) Interest on Book-entry Securities is either credited by a

Federal Reserve Bank to a Funds Account maintained at the Bank or

otherwise paid as directed by the Participant.

(2) Book-entry Securities are redeemed in accordance with their

terms by a Federal Reserve Bank withdrawing the securities from the

Participant's Securities Account in which they are maintained and by

either crediting the amount of the redemption proceeds, including both

principal and interest, where applicable, to a Funds Account at the

Bank or otherwise paying such principal and interest as directed by the

Participant. No action by the Participant is required in connection

with the redemption of a Book-entry Security.

Sec. 357.14 Authority of Federal Reserve Banks.

(a) Each Federal Reserve Bank is hereby authorized as fiscal agent

of the United States to perform functions with respect to the issuance

of Book-entry Securities offered and sold by the Department to which

this Subpart applies, in accordance with the terms of the applicable

offering circular and with procedures established by the Department; to

service and maintain Book-entry Securities in accounts established for

such purposes; to make payments of principal and interest, as directed

by the Department; to effect transfer of Book-entry Securities between

Participants' Securities Accounts as directed by the Participants; and

to perform such other duties as fiscal agent as may be requested by the

Department.

(b) Each Federal Reserve Bank may issue Operating Circulars not

inconsistent with this Part, governing the details of its handling of

Book-entry Securities, Security Entitlements, and the operation of the

book-entry system under this Part.

5. In subpart D, Sec. 357.41 is revised and the text of

Secs. 357.42 and 357.44 are added, to read as follows:

Subpart D--Additional Provisions

Sec. 357.41 Waiver of regulations.

The Secretary reserves the right, in the Secretary's discretion, to

waive any provision(s) of these regulations in any case or class of

cases for the convenience of the United States or in order to relieve

any person(s) of unnecessary hardship, if such action is not

inconsistent with law, does not adversely affect any substantial

existing rights, and the Secretary is satisfied that such action will

not subject the United States to any substantial expense or liability.

Sec. 357.42 Liability of Department and Federal Reserve Banks.

The Department and the Federal Reserve Banks may rely on the

information provided in a tender, transaction request form, or Transfer

Message, and are not required to verify the information. The Department

and the Federal Reserve Banks shall not be liable for any action taken

in accordance with the information set out in a tender, transaction

request form, or Transfer

[[Page 43631]]

Message, or evidence submitted in support thereof.

Sec. 357.44 Notice of attachment for securities in TRADES.

The interest of a debtor in a Security Entitlement may be reached

by a creditor only by legal process upon the Securities Intermediary

with whom the debtor's securities account is maintained, except where a

Security Entitlement is maintained in the name of a secured party, in

which case the debtor's interest may be reached by legal process upon

the secured party. These regulations do not purport to establish

whether a Federal Reserve Bank is required to honor an order or other

notice of attachment in any particular case or class of cases.

6. Appendix B to part 357 is added to read as follows:

Appendix B to Part 357--TRADES Commentary

Introduction

The adoption of regulations for the Treasury/Reserve Automated

Debt Entry System (``TRADES'') is the culmination of a multi-year

Treasury process of moving from issuing securities only in

definitive (physical/certificated/paper) form to issuing securities

exclusively in book-entry form. The TRADES regulations provide the

legal framework for all commercially-maintained Treasury book-entry

securities. For a more detailed explanation of the procedural and

legal development of book-entry and the TRADES regulations, see the

preamble to the rule proposed March 4, 1996 (61 FR 8420), as well as

the earlier proposals cited therein 51 FR 8846 (March 14, 1986); 51

FR 43027 (November 28, 1986); 57 FR 12244 (April 9, 1992).

Comparison of TRADES and Treasury Direct

A person may hold interests in Treasury book-entry securities

either in TRADES 1 or TREASURY DIRECT. The following summarizes

the major differences between the two systems.

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\1\ In TRADES a Person's interest in a Treasury book-entry

security is a Security Entitlement, as described in TRADES. A

Participant's interest in a marketable Treasury book-entry security

also is a Security Entitlement. A Participant's Security Entitlement

is different than a Security Entitlement as described in Revised

Article 8, with respect to the Participant's rights against the

issuer. A non-Participant's Security Entitlement is described in

Revised Article 8.

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Persons holding Treasury book-entry securities in TRADES hold

their interests in such securities in a tiered system of ownership

accounts. In TRADES, Treasury, through its fiscal agents, the

Federal Reserve Banks, recognizes the identity only of Participants

(persons with a direct account relationship with a Federal Reserve

Bank). While Participants may be beneficial owners of interests in

Treasury book-entry securities, there are many beneficial owners of

such interests that are not Participants. Such beneficial owners

hold their interests through one or more Securities Intermediaries

such as banks, brokerage firms or securities clearing organizations.

In TRADES, the rights of non-Participant beneficial owners may

be exercised only through their Securities Intermediaries. Neither

Treasury nor the Federal Reserve Banks have any obligation to a non-

Participant beneficial owner of an interest in a Treasury book-entry

security. Two examples illustrate this principle. First, except

where a pledge has been recorded directly on the books of a Federal

Reserve Bank pursuant to Sec. 357.12(c)(1), Federal Reserve Banks,

as Treasury's fiscal agents, will act only on instructions of the

Participant in whose Securities Account the Treasury book-entry

security is maintained in recording transfers of an interest in a

Treasury book-entry security. A beneficial owner of the interest

that is a non-Participant has no ability to direct a transfer on the

books of a Federal Reserve Bank. Second, Treasury discharges its

payment obligation with respect to a Treasury book-entry security

when payment is credited to a Participant's account or paid in

accordance with the Participant's instructions. Neither Treasury nor

a Federal Reserve Bank has any payment obligation to a non-

Participant beneficial owner of an interest in a Treasury book-entry

security. A non-Participant beneficial owner receives its payment

when its Securities Intermediary credits the owner's account.

Persons holding Treasury book-entry securities in TREASURY

DIRECT, on the other hand, hold their securities accounts on records

maintained by Treasury through its fiscal agents, the Federal

Reserve Banks. The primary characteristic of TREASURY DIRECT is a

direct account relationship between the beneficial owner of a

Treasury book-entry security and Treasury. In TREASURY DIRECT,

Treasury discharges its payment obligation when payment is credited

to the depository institution specified by the beneficial owner of

the Treasury book-entry security, paid directly to the beneficial

owner by check, or paid in accordance with the beneficial owner's

instructions. Unlike TRADES, TREASURY DIRECT does not provide a

mechanism for the exchange of cash to settle a secondary market

transaction, nor are pledges of Treasury book-entry securities held

in TREASURY DIRECT generally recognized. Accordingly, TREASURY

DIRECT is suited for persons who plan to hold their Treasury

securities until maturity, and provides an alternative for investors

who are concerned about holding securities through intermediaries

and who do not wish to hold their interests in Treasury securities

indirectly in TRADES.

Scope of Regulation

Just as the scope of Revised Article 8 is limited,2 the

scope of this regulation is limited. It is not a comprehensive

codification of the law governing securities, transactions in

securities or the law of contracts for the purchase or sale of

securities. Similarly, it is not a codification of all laws that

could affect a person's interest in a Treasury book-entry security.

For example, state laws regarding divorce or intestate succession

could well affect which persons have rights in the interest in a

Treasury book-entry security. Moreover, the regulations deal with

certain aspects of transactions in Treasury securities, such as

perfection of a security interest and its effects and not other

aspects, such as the contractual relationship between a debtor and

its secured party, which are left to applicable law 3 See the

discussion under Sec. 357.10 of the Section-by-Section Analysis.

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\2\ U.C.C. Revised Article 8, Prefatory Note at 12.

\3\ The regulations in 31 CFR 306.118(b), which are being

supplanted by TRADES, state that ``applicable law'' covers how a

transfer or pledge is ``effected'' as well as perfected. Except with

respect to security interests marked on the books of a Federal

Reserve Bank, TRADES does not address how a security interest in a

Treasury book-entry security is created or what law governs the

creation of a security interest. Section 357.11(a) of TRADES, which

establishes the choice of law for interests other than those covered

by Sec. 357.10, addresses the choice of law with respect to the

perfection, effect of perfection or non-perfection, and priority of

security interests, but does not address the law governing creation

or attachment of a security interest. This is consistent with the

scope and choice of law provisions of Revised Article 8.

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Section-by-Section Analysis

Section 357.0 Dual Book-entry Systems

Section 357.0 sets forth that Treasury provides two systems for

maintaining Treasury book-entry securities--TRADES and TREASURY DIRECT.

Subpart A of part 357 of 31 CFR contains general information about

TRADES and TREASURY DIRECT. Subpart B contains the TRADES regulations.

Subpart C contains the TREASURY DIRECT regulations. Subpart D contains

miscellaneous provisions. Thus, in its totality, Part 357 sets forth in

one place the complete set of governing rules for Treasury securities

issued in book-entry form.

Section 357.1 Effective Date

Section 357.1 establishes the effective date for TRADES. TRADES

applies to outstanding securities formerly governed by 31 CFR part

306, subpart O. Conforming changes to parts 306, 356, and 358 are

being made to coincide with the publication of TRADES in final form.

Consistent with the approach set forth in Revised Article 8 (see

Sec. 8-603 and the official comment thereto), on and after the

effective date these regulations will apply to all transactions,

including transactions commenced prior to the effective date.

Revised Article 8, in Section 8-603, gave secured parties four

months after the effective date to take action to continue the

perfection of their security interests. TRADES, through its delayed

effectiveness, provides a similar period. In TRADES, January 1,

1997, becomes the date by which such actions must be completed.

The effective date for TRADES is January 1, 1997. While TRADES

is based in large part on Revised Article 8 that has received

widespread attention in the financial community and already has been

adopted in

[[Page 43632]]

28 states,\4\ Treasury has determined that TRADES will be effective

on January 1, 1997, to ensure a smooth transition to TRADES. In

making that determination, Treasury has taken into account the time

required by other Government-Sponsored Enterprises (GSEs) to

promulgate similar regulations for their securities. Such an

effective date, when combined with TRADES having been published in

proposed form with a 60-day comment period, should provide

sufficient time for an orderly transition to the new TRADES rules.

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\4\ As of August 1, 1996, those states are: Alabama, Alaska,

Arizona, Arkansas, Colorado, Idaho, Illinois, Indiana, Iowa, Kansas,

Kentucky, Louisiana, Maryland, Massachusetts, Minnesota,

Mississippi, Nebraska, New Mexico, Oklahoma, Oregon, Pennsylvania,

Texas, Utah, Vermont, Virginia, Washington, West Virginia and

Wyoming. See discussion accompanying footnote 11.

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Section 357.2 Definitions

Section 357.2 contains definitions for use in subparts B and C.

While most of the definitions are straightforward, four terms--

Participant, Entitlement Holder, Security Entitlement and Securities

Intermediary--are critical to an understanding of the proposed

TRADES regulations.

(a) Participant

A Participant is a person that has a securities account

relationship in its name with a Federal Reserve Bank. Accordingly,

the Federal Reserve Bank and Treasury know both the identity of the

persons maintaining these accounts and the Treasury book-entry

securities held in these accounts.

(b) Securities Intermediary

Securities Intermediaries are persons (other than individuals,

except as described below) that are in the business of holding

interests in Treasury book-entry securities for others. Participants

can be, and usually are, Securities Intermediaries.

In addition, entities such as clearing corporations, banks,

brokers and dealers can be Securities Intermediaries in a single

chain of ownership of a Treasury security. An individual, unless

registered as a broker or dealer under the federal securities laws,

cannot be a Securities Intermediary. As an illustration of a

possible chain of ownership, in the following chart, the Federal

Reserve Bank, Participant and Broker-Dealer are all Securities

Intermediaries.

Treasury

Federal Reserve Bank

|

Participant

|

Broker-Dealer

|

Individual Holder

(c) Entitlement Holder

An Entitlement Holder is any person for whom a Securities

Intermediary holds an interest in a Treasury book-entry security. In

the above example Individual Holder, Broker-Dealer and Participant

are all Entitlement Holders. Thus, a person can be both a Securities

Intermediary and an Entitlement Holder. See also the commentary on

``Security Entitlement.''

(d) Security Entitlement

A Security Entitlement is the interest that an Entitlement

Holder has in a Treasury book-entry security. In the example,

Participant, Broker-Dealer and Individual Holder all hold Security

Entitlements. The rights and property interests associated with a

Security Entitlement of a Participant held on the books of a Federal

Reserve Bank (``Participant's Security Entitlement'') are, however,

different from the rights and property interests associated with

other Security Entitlements. As provided in Sec. 357.10(a), Federal

law defines the scope and nature of a Participant's Security

Entitlement. While TRADES is based in large part on Revised Article

8, the meaning of Security Entitlement under federal law is

different than under Revised Article 8. For example, Participants

have a direct claim against the United States for interest and

principal even though, under state law, an Entitlement Holder would

only have a claim against its Securities Intermediary for such

payment. To the extent not inconsistent with this regulation, the

scope and nature of a Security Entitlement of an Entitlement Holder

below the level of a Participant, (Broker-dealer and Individual

Holder in the example above), is defined by applicable state law, as

determined pursuant to Sec. 357.11. It should also be noted that

while a Participant's rights have Federal law components under

Sec. 357.10(a), the nature of a Security Entitlement held by a lower

tier intermediary on the books of a Participant is determined

pursuant to applicable law as provided in Sec. 357.11.

Section 357.10 Law Governing the United States and Reserve Banks

Section 357.10(a) provides that the rights and obligations of

the United States and the Federal Reserve Banks (with one exception

detailed below), with respect to both the TRADES system and Treasury

book-entry securities maintained in TRADES are governed solely and

exclusively by Federal law. Thus, claims against the United States

and Federal Reserve Banks of both Participants and all other persons

with an interest (or claiming an interest) in a Treasury book-entry

security maintained in TRADES are governed by Federal law. Federal

law is defined to include TRADES, the offering circulars pursuant to

which the Treasury securities are sold, the offering announcements

and Federal Reserve Bank Operating Circulars.5 Prior to March

1, 1993, the terms of each offering of Treasury securities, except

for Treasury bills were set forth in an offering circular published

in the Federal Register.6 Since March 1, 1993, all Treasury

book-entry securities have been offered pursuant to a uniform

offering circular set forth at 31 CFR part 356.

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\5\ A ``Federal Reserve Bank Operating Circular'' is defined in

Sec. 357.2 as the publication issued by each Federal Reserve Bank

that sets forth the terms and conditions under which the Reserve

Bank maintains Book-entry Securities Accounts and transfers Book-

entry Securities.

\6\ Treasury bills were issued pursuant to one master offering

circular (31 CFR part 349, removed, and replaced by 31 CFR part 356)

effective March 1, 1993. (58 FR 412)

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While TRADES is based in large measure on Revised Article 8, a

fundamental principle of these regulations (and a divergence from

Revised Article 8) is that the obligations of the issuer (the United

States) and the Federal Reserve Banks, as well as all claims with

respect to TRADES or a Treasury book-entry security against Treasury

or a Federal Reserve Bank, are governed solely by Federal law. Thus,

for example, those parts of Revised Article 8 that detail

obligations of issuers (or their agents) of securities are not

applicable to either the United States or Federal Reserve

Banks.7 In addition, neither the United States nor Federal

Reserve Banks have any obligations to persons holding their

interests in a Treasury book-entry security at levels below the

level of a Participant or to any other person claiming an interest

in a Treasury book-entry security (with the limited exception set

out in Sec. 357.12(c)(1)). Thus, there are no derivative rights

against either the United States or the Federal Reserve Banks.

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\7\ The regulations in subpart C of this part set out other

obligations of the United States and the Federal Reserve Banks for

securities held in TREASURY DIRECT. These regulations preempt

applicable state law.

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In interpreting this section, it is important to note that the

scope of TRADES, like that of Revised Article 8, is limited.

Accordingly, the governing law set forth in Sec. 357.10(a) is

applicable only to the matters set forth in Sec. 357.10(a). Other

laws remain applicable and could affect the holders of book-entry

securities.

For example, the tax treatment of Securities Entitlements is

outside the scope of TRADES and other law (the Federal income tax

code) is applicable in determining such tax treatment. Similarly,

nothing in Sec. 357.10(a) limits the applicability of other laws to

matters such as whether the activities of Participants or Securities

Intermediaries with respect to interests in Treasury book-entry

securities are subject to banking or securities laws.

While TRADES in Sec. 357.10(a) defines what law governs the

contract between the United States, as issuer, and the holder of a

Security Entitlement, it is not a complete statement of the contract

law applicable to the United States or Federal Reserve Banks. For

example, if a Participant obtains a discount window loan from a

Federal Reserve Bank and agrees to pledge collateral, including

Treasury book-entry securities, to the Federal Reserve Bank as

security for the loan, Sec. 357.10(a) does not establish the law for

determining the validity or enforceability of the contract or the

law applicable to the creation and perfection of security interests

in property that is not a Treasury book-entry security. Section

357.10(a) does provide the law applicable for how a security

interest in Treasury book-entry securities is perfected, the

priority of such interest and, if Sec. 357.12(c)(1) is applicable,

how such security interest is created. Similarly, nothing in

Sec. 357.10(a) affects the continuing applicability or

enforceability of Federal Reserve Bank operating circulars such as

the circular setting forth provisions regarding

[[Page 43633]]

electronic access to services provided by Federal Reserve Banks and

agreements executed in connection with such circulars.

The law applicable with respect to interests granted to a

Federal Reserve Bank depends on the manner in which the security

interest is granted.

Where a security interest in favor of a Federal Reserve Bank is

marked on the books of the Federal Reserve Bank under Section

357.12(c)(1), Sec. 357.10(a) establishes the applicable law. A

security interest in favor of a Federal Reserve Bank would be

recorded on the Federal Reserve Bank's books where, for example, the

Federal Reserve Bank made a discount window loan to a depository

institution and any Treasury book-entry securities provided by the

depository institution as collateral have been deposited to a pledge

account on the books of the Federal Reserve Bank. For a borrowing

depository institution that is not a Participant, the book-entry

securities used as collateral generally would be deposited to the

Federal Reserve Bank pledge account by the borrowing institution's

Securities Intermediary. See Hypothetical 5.

Section 357.10(b) sets forth law applicable with respect to

security interests in favor of a Federal Reserve Bank that have not

been marked on the books of a Federal Reserve Bank. A security

interest in the Securities Entitlement of a Participant in favor of

a Federal Reserve Bank that is not marked on the books of the

Federal Reserve Bank is governed by the law of the state in which

the head office of the Federal Reserve Bank is located. Such a

security interest could arise, for example, where the delivery of

book-entry securities to the securities account of the Participant

results in an overdraft in the Participant's Funds Account. The

extent to which the Federal Reserve Bank has an interest in the

Participant's book-entry securities to secure the overdraft

therefore would be determined under the law of the state in which

the Reserve Bank's head office is located. If the State in which the

head office of the Federal Reserve Bank is located has not adopted

Revised Article 8, under Sec. 357.10(c) that State is deemed to have

adopted Revised Article 8.

In certain very limited circumstances, a Federal Reserve Bank

also may have a security interest in the book-entry securities of a

non-Participant that is not marked on the books of the Federal

Reserve Bank. Section 357.10(b) provides a separate rule for such a

security interest, which would be governed by the law of the non-

Participant's Securities Intermediary, as determined under

Sec. 357.11. Under Sec. 357.11, the perfection, effect of

perfection, and priority of a security interest created under such

an agreement would be governed by the law of the Securities

Intermediary's jurisdiction, as determined under Sec. 357.11(b).

Under Sec. 357.11(d), if the jurisdiction specified in

Sec. 357.11(b) has not adopted Revised Article 8, jurisdiction would

be deemed to have adopted Revised Article 8.\8\

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\8\ An interest in book-entry securities of a non-Participant

that is not marked on the books of the Federal Reserve Bank, while

uncommon, could arise where the Federal Reserve Bank lends to a non-

Participant depository institution and enters into a triparty

agreement with the depository institution and its Securities

Intermediary rather than requiring the deposit of the book-entry

securities in a pledge account on the books of the Federal Reserve

Bank through an instruction given by the non-Participant depository

institution to its Securities Intermediary.

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For purposes of applying the state law chosen under the rules of

Sec. 357.10(b), Federal Reserve Banks are treated as clearing

corporations. As a result, a security interest in a Securities

Entitlement of a Participant in favor of a Federal Reserve Bank

under Sec. 357.12(c)(2) has the same priority as security interests

granted to other clearing corporations under state law. This is

consistent with the treatment accorded to Federal Reserve Banks

generally under Revised Article 8.

Section 357.11 Law Governing Other Interests

(a) Law Governing the Rights and Obligation of Participants and Third

Parties

Section 357.11 is a choice of law rule. The substantive matters

subject to this choice of law rule are set forth in Sec. 357.11(a).

The matters set forth in Sec. 357.11(a) are meant to be coextensive

with those matters covered by Revised Article 8 with respect to a

person's interest in a Treasury book-entry security (other than

those related to a person's relationship to Treasury or a Federal

Reserve Bank which are governed solely by federal law). For purposes

of these choice of law rules Participants are Securities

Intermediaries.

Section 357.11(b) adopts Revised Article 8's general choice of

law rule. Section 357.11(c) sets forth a special choice of law rule

with respect to security interests perfected automatically or by

filing, which also is included in Revised Article 8. Generally, the

law applicable to the Securities Intermediary will govern matters

involving an interest in a book-entry security held through that

intermediary. This approach is not followed with respect to

perfection of security interests automatically or by filing. In

those cases, the law of the jurisdiction in which the debtor is

located is the governing law. Since filing systems are based on the

location of the debtor, this approach should reduce uncertainty and

preserve the normal practice of searching records based on the

debtor's location.\9\ The language ``person creating a security

interest'' is used in lieu of the term ``debtor'' in this provision

to avoid any confusion. The word ``debtor'' has two meanings in the

Uniform Commercial Code and the expression ``person creating a

security interest'' provides clarity with respect to who is covered

by this section. The term does not refer to a creditor. The language

``is located'' is intended to conform to its meaning under

applicable law, as it may be amended from time to time. See, e.g.,

U.C.C. section 9-103(3)(d). Section 357.11(d) provides for the

application of Revised Article 8 if the choice of law analysis

required by Sec. 357.11(b) results in the choice of the law of a

State that has not yet adopted Revised Article 8. As noted

elsewhere, in such a situation, the State's law is viewed as if it

had adopted Revised Article 8. This section also provides that, for

purposes of applying state law, the Federal Reserve Banks are

clearing corporations and Participants' interests in book-entry

securities are Security Entitlements.

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\9\ The substantive effect of filing is limited and applies only

in states which have adopted Revised Article 8. Since the effect of

filing is a unique state law matter, in this one area, Treasury has

determined that possible lack of uniformity does not justify

altering state law.

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(b) Limited Scope of Federal Preemption

In an earlier TRADES proposal Treasury contemplated adopting a

comprehensive regulation governing the rights of all persons in

Treasury book-entry securities held in TRADES. Such an approach was

proposed because Treasury believed that a uniform rule was necessary

to preserve the efficiency and liquidity of the market for Treasury

securities--the most liquid and efficient market in the world.

Treasury believed then, and believes now, that the material rights

of a holder in the United States of an interest in a Treasury

security should not vary solely by virtue of such holder's

geographic location or the location of the financial institution

through which it holds its interest in Treasury securities. In light

of Revised Article 8, Treasury has determined that it is possible to

achieve this uniformity without developing an independent system of

Federal commercial law.\9\ The questions inherent in a tiered system

of ownership have been analyzed, and, in Treasury's view,

satisfactorily addressed by Revised Article 8.

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\9\ As noted previously, the substantive scope of this

regulation is limited.

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As of August 1, 1996, 28 states have adopted Revised Article 8

and Treasury understands that it will soon be adopted in additional

states. As with all uniform laws, the adoption process takes several

years. In order to assure uniformity, in light of the unavoidable

delays in the state-by-state adoption process of Revised Article 8,

Treasury is promulgating regulations with a limited form of

preemption. As provided in both Secs. 357.10(c) and 357.11(d), if

the choice of law rules set forth in TRADES would lead to the

application of the law of a State that has not yet adopted Revised

Article 8, TRADES will apply Revised Article 8 (with conforming and

miscellaneous amendments to other Articles) in the form approved by

the ALI and NCCUSL. Treasury expects that these provisions will be

operative only during the state-by-state adoption process and would

plan to amend TRADES to delete reference to these provisions once

the adoption process has been completed.

While Revised Article 8 is defined to mean the official text of

Article 8 as approved by the ALI and NCCUSL, Treasury recognizes

that states may make minor changes in that text when adopting

Article 8. Treasury has concluded that minor changes should not

prevent Revised Article 8, as adopted by a state, from being the

appropriate law. In other words, if a state passes a version of

Article 8 that is substantially identical to Revised Article 8,

reference to Revised Article 8 (as defined) would no longer be

required. Treasury has determined that the

[[Page 43634]]

versions of Article 8 passed by 28 states \10\ that have enacted

Article 8 as of the date this rule is published in the Federal

Register meet this standard. Accordingly, Secs. 357.10(c) and

357.11(d) would not be applicable if the choice of law provisions of

TRADES directed a person to one of those states. As additional

states adopt Revised Article 8, Treasury will provide notice in the

Federal Register as to whether the enactments are ``substantially

identical'' to the uniform version for purposes of these regulations

and on an annual basis, the Commentary will be amended to reflect

subsequent enactments. This approach represents a significantly

reduced form of preemption of state law from former versions of

TRADES and preserves Treasury's preeminent interest in a uniform

system of rules applicable to all holders of interests in Treasury

book-entry securities.

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\10\ Alabama, Alaska, Arizona, Arkansas, Colorado, Idaho, Iowa,

Illinois, Indiana, Kansas, Kentucky, Louisiana, Maryland,

Massachusetts, Minnesota, Mississippi, Nebraska, New Mexico,

Oklahoma, Oregon, Pennsylvania, Texas, Utah, Vermont, Virginia,

Washington, West Virginia, Wyoming.

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Section 357.12 Obtaining an Interest in a Book-entry Security

(a) Creation of a Participant's Security Entitlement

A Participant's interest in a Treasury book-entry security is a

Securities Entitlement. Section 357.12(a) provides that a

Participant's Securities Entitlement is created when a Federal

Reserve Bank indicates by book entry that a Book-entry Security has

been credited to a Participant's Securities Account. Instead of the

concept of initial credit and transfer of a Treasury book-entry

security, as set forth in the existing regulations, this proposal

focuses on the creation of a Participant's Securities Entitlement

and, in this way, is similar to Section 8-501 of Revised Article 8.

The regulation focuses on the creation of a Participant's

Security Entitlement because Security Entitlement is the term used

to describe the Participant's interest in a Treasury book-entry

security. Once a Participant obtains that interest, the regulation

sets forth what that interest is. Thus, as provided in Sec. 357.10,

federal law describes a Participant's rights against the United

States and the Federal Reserve Bank where it maintains its

Securities Account. To the extent not inconsistent with Sec. 357.10,

Sec. 357.11 describes the applicable law to determine Participants'

rights and obligations with respect to all other persons. Under

these regulations, Participants can still transfer their interests

in a Treasury book-entry security as they did before--by issuing a

Transfer Message to the Federal Reserve Bank where they hold such

interest. Transfer of interests between Participants can occur by a

Participant holding such interest issuing a Transfer Message. As a

result of such message, the Federal Reserve Bank will make a book

entry in favor of the receiving Participant (thereby creating a

Security Entitlement in favor of such Participant) and also will

make a book entry deleting the initiator Participant's interest in

such Treasury book-entry security (thereby eliminating that

Participant's Security Entitlement). In addition, if authorized

under applicable state law, Participants may enter into agreements

with other Participants that, as to the Participants, constitute a

transfer. Such action is without effect to either the United States

or a Federal Reserve Bank.

(b) Creation and Priority of a Security Interest

(i) Security Interests of the United States. Section 357.12(b)

provides that a security interest in favor of the United States has

priority over the interests of any other person in a Treasury book-

entry security. The United States obtains security interests in

Treasury securities as collateral to secure funds in a variety of

situations such as Treasury Tax and Loan accounts; government agency

funds or funds under the control of the Federal Courts held at

financial institutions; and securities pledged in lieu of surety by

contractors and others. The priority provided the United States in

these situations is consistent with existing law.

In addition, Federal Reserve Banks do recognize on their books

and records security interests in favor of the United States. In

that situation, the Federal Reserve Bank will not transfer the

security without the permission of the United States. This section

provides that a Federal Reserve Bank may rely exclusively on the

directions of an authorized representative of the United States to

transfer a security and is protected in so relying. Ordinarily, an

authorized representative of the United States would take such

action under circumstances such as the default or insolvency of the

pledgor.

(ii) Security Interests on the Books of a Reserve Bank. Where

required by Federal law or regulation or pursuant to a specific

agreement with a Federal Reserve Bank, a security interest in favor

of a Federal Reserve Bank or other person may be created or

perfected by a Federal Reserve Bank marking its books to record the

security interest under Sec. 357.12(c)(1). An example of a security

interest that is marked on the books of a Federal Reserve Bank would

be the pledge in favor of a Federal Reserve Bank of a Participant's

book-entry securities as collateral for a discount window loan.\11\

For limited categories of pledges, Federal Reserve Banks may agree

to record a security interest in favor of a third party on their

books. For example, in some circumstances a Federal Reserve Bank may

permit the establishment of a pledge account to hold book-entry

securities pledged to governmental entities other than the United

States government. It is important to note that there is no

obligation for either Treasury or a Federal Reserve Bank to agree to

record a security interest on the books of a Federal Reserve Bank,

except as required by Federal law or regulation. If they do so, the

security interest is perfected when the Federal Reserve Bank records

a security interest on its books. In addition, the security interest

has priority over all other interests in the Treasury book-entry

security except an interest of the United States.

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\11\ Book-entry securities pledged by a non-Participant to a

Federal Reserve Bank generally would be deposited by the non-

Participant's Securities Intermediary to a pledge account at the

Federal Reserve Bank, and therefore also would be marked on the

books of the Federal Reserve Bank. See the discussion under D.

(Sec. 357.10).

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(iii) Other Security Interests. As provided in

Sec. 357.12(c)(2), a security interest in a book-entry security may

be perfected by any method available under applicable state law, as

determined under Sec. 357.10(b) or Sec. 357.11.\12\ The perfection

and priority of such interests shall be governed by applicable law.

Security interests under this section may include security interests

in favor of a Federal Reserve Bank, such as a clearing lien or

pledge by a non-participant of book-entry securities held through a

Securities Intermediary where the securities have not been deposited

to a Federal Reserve Bank pledge account. Consistent with Revised

Article 8, a Federal Reserve Bank would be treated as a clearing

corporation under the applicable state law.

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\12\ Under both of these sections, if the state has not yet

adopted Revised Article 8, the applicable law would be that state's

law as it would be amended by Revised Article 8.

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If a Person perfects a security interest pursuant to

Sec. 357.12(c)(2), obligations of the Treasury and the Federal

Reserve Banks with respect to that security interest are limited.

Specifically, unless special arrangements are agreed to by the

United States or a Federal Reserve Bank pursuant to

Sec. 357.12(c)(1), neither the Federal Reserve Bank nor the United

States will recognize the interests of any person other than the

person in whose securities account the interest in a Treasury book-

entry security is maintained. This does not mean that such a

security interest is invalid. Rather, it means that the creditor's

recourse will be solely against the debtor Participant or other

third party.

Section 357.13 Rights and Obligations of Treasury and the Reserve

Banks

(a) Adverse Claims

Section 357.13(a) sets forth the general rule that, with limited

exceptions, Treasury and the Federal Reserve Banks will recognize

only the interest of a Participant in a Treasury book-entry security

in whose Securities Account such interest is maintained.

As noted previously, Treasury book-entry securities maintained

in TRADES are held in a tiered system of ownership. The records of a

Federal Reserve Bank reflect only the ownership at the top tier.

Institutions maintaining a Securities Account with a Federal Reserve

Bank frequently will hold interests in Treasury book-entry

securities for their customers (which can include broker-dealers and

other Securities Intermediaries) and in certain cases those

customers will hold interests in securities for their customers.

Accordingly, neither Treasury nor a Federal Reserve Bank will know

the identity or recognize a claim of a Participant's customer if

that customer were to present it to Treasury or a Federal Reserve

Bank.

In addition, except in the limited case where a security

interest is marked on the books of a Federal Reserve Bank pursuant

to Sec. 357.12(c)(1), neither the Treasury nor a Federal Reserve

Bank will recognize the claims of any other person asserting a claim

[[Page 43635]]

in a Treasury book-entry security. Persons at levels below the

Participant level must present their claims to their Securities

Intermediary.

(b) Payment obligations

Section 357.13(b) contains a corollary to the rule set forth in

Sec. 357.13(a). This section provides that Treasury discharges its

payment responsibility with respect to a security that it has issued

when a Federal Reserve Bank credits the funds account of a

Participant with amounts due on that security or makes payment in

some other manner specified by the Participant. This is consistent

with existing law and the first TRADES proposal.13 In Revised

Article 8, the issuer discharges its obligations when it makes

payment to an owner registered on its books. Under common commercial

practice, the registered owner in the indirect system may be a

clearing corporation or the clearing corporation's nominee. Although

the Federal Reserve Banks are treated as clearing corporations under

both Revised Article 8 and TRADES, Treasury remains liable until

payment is made to, or in accordance with the instructions of, a

Participant. Section 357.13(b)(2) establishes the mechanism of how

Treasury book-entry securities are paid at maturity. It is intended

to cover a variety of procedures, including where the proceeds of

pledged securities are credited to a suspense account pending

substitution or release. This paragraph makes clear that the payment

takes place automatically and that, unlike with physical

certificates, there is no act of presentment required by the

Participant.

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\13\ 51 FR 8846, 8848 (March 14, 1986).

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Section 357.14 Authority of Reserve Banks

Section 357.14 provides that Federal Reserve Banks are

authorized, as fiscal agents of Treasury, to operate the commercial

book-entry system for Treasury.

Section 357.44 Notices

Section 357.44 contains a revised version of a provision that

appeared in earlier TRADES proposals. Similar to the rule in Revised

Article 8 (see section 8-112), it provides where certain legal

process should be directed. While providing instructions on where

notice should be directed, it makes clear that the regulations do

not establish whether a Federal Reserve Bank is required to honor

any such order or notice.

J. Hypotheticals

HYPOTHETICAL 1

TREASURY

FEDERAL RESERVE BANK

|

PARTICIPANT

|

DEALER

|

INVESTOR

The first hypothetical is designed to show what law applies at

different levels of the tiered book-entry system. TRADES provides

that federal law, and only federal law (defined in Sec. 357.10(a)),

governs the rights and obligations of the United States and the

Federal Reserve Banks (except for those matters involving Federal

Reserve Banks set forth in Sec. 357.10(b)). Thus, for example,

Treasury discharges its payment obligations with respect to a

security it has issued in the manner described in Sec. 357.13(b).

Federal law both defines the payment obligation and describes how

Treasury fulfills that obligation. Those portions of Revised Article

8 dealing with issuer obligations are not applicable to Treasury or

the Federal Reserve Banks.14 Similarly, with certain limited

exceptions as set forth in Sec. 357.12(c)(1), Treasury and the

Federal Reserve Banks will recognize only the interest of a

Participant in a Treasury book-entry security in whose Security

Account the interest is maintained. Accordingly, as a matter of

federal law, neither Treasury nor a Federal Reserve Bank will

recognize any claim by Dealer or Investor.15

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\14\ As provided in Sec. 357.14, Federal Reserve Banks, among

other things, effect transfers of book-entry securities between

Participants' Security Accounts.

\15\ One comment questioned whether similar language in the

March 4, 1996 release implied that, under Revised Article 8, in the

above example Investor could have a claim against Participant. No

such implication was intended. The only point of the language is to

make it clear that Federal, not state, law governs the rights and

obligations of Treasury and the Federal Reserve Banks.

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In the hypothetical above, as between Participant and Dealer,

Participant is the Securities Intermediary. With respect to the

matters set forth in Sec. 357.11(a), the law of the Securities

Intermediary's jurisdiction governs. Thus, with respect to the

matters in Sec. 357.11(a), the law of Participant's jurisdiction

applies as between Participant and Dealer.16 If Participant's

jurisdiction, as determined under Sec. 357.11(b), has not adopted

Revised Article 8, the law of Participant's jurisdiction, as it

would be amended by Revised Article 8, applies. Similarly, as

between Dealer and Investor, Dealer is a Securities Intermediary,

with respect to the matters in Sec. 357.11(a), the law of Dealer's

jurisdiction applies as between Dealer and Investor. If Dealer's

jurisdiction has not adopted Revised Article 8, the law of Dealer's

jurisdiction, as it would be amended by Article 8, applies.

HYPOTHETICAL 2

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\16\ As described in the March 4 Release, the scope of TRADES is

limited. As a general rule, if a matter is not covered in

Sec. 357.11(a), TRADES is not applicable. One comment questioned

whether TRADES covered the creation and attachment of a security

interest. The omission of creation and attachment in Sec. 357.11(a)

is intentional.

TREASURY

FEDERAL RESERVE BANK

| |

PARTICIPANT A PARTICIPANT B

| |

DEALER A DEALER B

Assume that Dealer A sells its interest in a Treasury book-entry

security to Dealer B. The transaction likely would take the

following form. Dealer A will instruct Participant A to transfer its

interest in a Treasury security to Participant B against cash

payment. Dealer B will instruct Participant B to transfer cash to

Participant A against delivery of an interest in the specified

securities. Participant A will instruct the Federal Reserve Bank to

transfer its interest in the Treasury security to Participant B

against simultaneous credit of cash. The Federal Reserve Bank will

debit Participant A's security account and credit Participant B's

security account and simultaneously credit Participant A's cash

account and debit Participant B's cash account. Participant A will

mark its books to show that it has debited Dealer A's securities

account and credited Dealer A's cash account. Participant B will

mark its books to show the Security Entitlement in the Treasury

security in favor of Dealer B and a debit against Dealer B's cash

account. Federal law, set forth in Sec. 357.12(a) provides that

Participant B acquires its interest in the Treasury book-entry

security when the Federal Reserve Bank indicates by book-entry that

the interest in the security has been credited to Participant B's

Securities Account. Pursuant to Sec. 357.11(a), but subject to

Sec. 357.11(d), Participant B's jurisdiction governs Dealer B's

acquisition of a Securities Entitlement from Participant B.

HYPOTHETICAL 3

TREASURY

FEDERAL RESERVE BANK

|

PARTICIPANT

Assume Participant wishes to obtain a loan from Federal Reserve

Bank and, as part of the transaction, will grant Federal Reserve

Bank a security interest in its Securities Entitlement with respect

to Treasury book-entry securities. The transaction can be

accomplished in one of two ways. Pursuant to Sec. 357.12(c)(1), the

Federal Reserve Bank can mark its books to reflect the security

interest. As a matter of federal law, that action creates and

perfects the Federal Reserve Bank's security interest and grants the

Federal Reserve Bank priority over all other claimants (other than

the United States pursuant to Sec. 357.12(b)).17 A second

method for completing the transaction, as set forth in

Sec. 357.12(c)(2), would be to take whatever actions are authorized

by applicable law. In that case, applicable law is the law of the

jurisdiction of the head office of the Federal Reserve Bank. If that

jurisdiction had adopted Revised Article 8, it would be the law of

that jurisdiction. If that jurisdiction had not adopted Revised

Article 8, it would

[[Page 43636]]

be the law of that jurisdiction as if the jurisdiction had adopted

Revised Article 8. Under Revised Article 8, the Federal Reserve

Bank's interest would be that of a clearing corporation.

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\17\ In certain limited circumstances, a Federal Reserve Bank

may enter into an agreement under which it agrees to record on its

books an interest in Participant's book-entry securities in favor of

a non-Participant, such as a governmental entity. Under these

circumstances, the non-Participant would have a perfected security

interest with priority over other claimants (other than the United

States under Sec. 357.12(b)). It should be noted that, as set forth

in Sec. 357.12(c)(1), there is no requirement that either the United

States or a Federal Reserve Bank agree to creation and perfection of

a security interest in this way, except as provided in

Sec. 357.12(c)(1).

HYPOTHETICAL 4

TREASURY

FEDERAL RESERVE BANK

| |

PARTICIPANT A PARTICIPANT B

Assume that Participant A wishes to borrow from Participant B

and grant Participant B a security interest in its Security

Entitlement in Treasury book-entry securities. As provided in

Sec. 357.12(c)(2), the transaction would be completed pursuant to

applicable law determined in accordance with 357.11. Although such

an interest could be recorded on the books of a Federal Reserve Bank

under Sec. 357.12(c)(1), Federal Reserve Banks generally do not mark

their books to record this type of security interest for

Participants.

HYPOTHETICAL 5

TREASURY

FEDERAL RESERVE BANK

|

PARTICIPANT A

|

DEALER A

|

BANK A

Assume that Bank A wishes to borrow from the Federal Reserve

Bank and will pledge its interest in Treasury book-entry securities

held at Dealer A to collateralize that loan. The transaction could

be accomplished in two ways. Pursuant to Sec. 357.12(c)(1), the

interest could be created and perfected on the books of a Federal

Reserve Bank. Such a transaction would take place in the following

fashion. Bank A could have Dealer A instruct Participant A to

deposit securities to a pledge account specified by the Federal

Reserve Bank. The Federal Reserve Bank likely would create an

account on its books and specify that account to Bank A as the

account to receive Bank A's interest in Treasury book-entry

securities. Participant A, upon receiving Dealer A's instructions,

would then instruct the Federal Reserve Bank to debit its account at

the Federal Reserve Bank and credit the account created by the

Federal Reserve Bank. The second way the transaction could take

place is by any method permitted by the law of Dealer A's (Bank A's

Securities Intermediary) jurisdiction. This could involve a tri-

party agreement among the Federal Reserve Bank, Dealer A, and Bank

A. As set forth in Sec. 357.11(b)(1), that agreement likely would

specify which jurisdiction's law is to govern the transaction and

could specify that such choice of law supersedes any other choice of

law agreement previously entered into by Dealer A and Bank A. If

Dealer A's jurisdiction has not adopted Revised Article 8, the

applicable law would be the law of Dealer A's jurisdiction as it

would be amended by Revised Article 8.

Dated: August 16, 1996.

Gerald Murphy,

Fiscal Assistant Secretary.

[FR Doc. 96-21469 Filed 8-20-96; 1:29 pm]

BILLING CODE 4810-39-P