Regulations Governing Book-Entry Treasury Bonds, Notes, and Bills

SUMMARY: Treasury is proposing regulations that will govern Treasury

bonds, notes, and bills (marketable Treasury securities) in book-entry

form held in the commercial book-entry system. The rules incorporate

recent and significant changes in commercial and property law

addressing the holdings of securities through financial intermediaries.

The proposed rules would replace existing Treasury regulations that

contain outdated legal concepts.

DATES: Comments must be submitted on or before May 3, 1996.

ADDRESSES: Send comments to the Office of the Chief Counsel, Bureau of

the Public Debt, Room 503, E Street Building, Washington, DC 20239-

0001. Comments received will be available for public inspection and

copying at the Treasury Department Library, Room 5030, Main Treasury

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

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

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

SUPPLEMENTARY INFORMATION:

I. Introduction

Treasury is reproposing rules for the Treasury/Reserve Automated

Debt Entry System (``TRADES''). The adoption of TRADES is the

culmination of a 27-year Treasury process of moving from issuing

securities only in definitive (physical/certificated/paper) form to

issuing marketable securities exclusively in book-entry form.

Some numbers help put the scope of this process in perspective. In

1967, the year before Treasury issued its first book-entry security,

there were $211 billion of marketable Treasury securities outstanding--

all in definitive form. As of December 31, 1995, there were

approximately $3.3 trillion of marketable Treasury securities

outstanding (not counting Treasury securities held by various

government trust funds), 99.7% of which were in book-entry form.

Treasury had considered the potential benefits of converting from

definitive securities to securities in book-entry form at various times

since as early as 1940. In 1964, following substantial losses of

definitive securities, Treasury and the Federal Reserve Banks began a

four-year study of the practical and legal aspects of initiating a

book-entry system.

As a culmination of this study, the first Treasury book-entry

securities regulations were issued effective January 1, 1968.1

Securities converted to book-entry form pursuant to these regulations

consisted of marketable Treasury securities held by Federal Reserve

Banks that were either held as collateral pledges to the United States

or represented proprietary holdings of member banks. The Federal

Reserve Banks, which already acted as Treasury's fiscal agent with

respect to transactions in definitive U.S. securities, began to act in

that capacity with respect to Treasury's book-entry securities as well.

\1\ 32 FR 15672 (November 14, 1967).

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During the following year, the then applicable regulations were

revised to extend the book-entry system to Treasury securities held by

the Federal Reserve Banks that were pledged to third parties, such as

courts or other public officials, for the performance of certain

obligations or to secure deposits of public funds. The book-entry

conversion authority initiated in 1968 and 1969 allowed the Federal

Reserve Banks to reduce both the increasing volume of definitive

securities stored in their vaults and the risk of loss. Studies were

undertaken at that time to determine the feasibility of expanding the

system to include other Treasury securities not initially eligible for

the Treasury book-entry system.

In 1971, Treasury regulations were further revised to allow for all

marketable Treasury securities to be held in book-entry form.2 The

regulations permitted member banks to place in book-entry form

securities held for customers, including those of dealers. Pursuant to

these regulations, holding marketable Treasury securities in book-entry

form was optional and book-entry securities could be converted to

definitive form.

\2\ 35 FR 20001 (December 31, 1970) and 36 FR 6749 (April 18,

1971).

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Issuance of these regulations was significant in several respects.

They were a key factor in averting a crisis in the government

securities market. At that time, banks, brokers and dealers were being

threatened with cancellation of insurance coverage because of large

losses resulting from the theft of definitive securities. The dramatic

increase in thefts and losses of government securities during the late

1960's ($30 million in 1969 and again in 1970) required Treasury to

obtain new legislation and implement new claims procedures to grant

relief to claimants through replacement of lost or stolen securities

prior to maturity.3 At the close of fiscal year 1971, about $230

billion of marketable Treasury securities were outstanding and about

$125 billion of that amount was in book-entry form.

\3\ Pub. L. No. 92-19, May 27, 1971, 85 Stat. 74.

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This initial success led to Treasury's decision to expand its

efforts to move toward a complete book-entry system. A Treasury and

Federal Reserve Bank task force was formed in 1976 to plan for the

expansion of the book-entry system for issuing Treasury securities. The

goal of the task force was to eliminate the issuance of definitive

securities in all new marketable Treasury offerings, with an overall

purpose of reducing paperwork, protecting against loss, theft, and

counterfeiting, and reducing printing costs. The task force planned for

a timed phase-out of the issuance of all definitive securities,

beginning in late 1976.

In December 1976, with the promulgation of new regulations,4

Treasury took the first step towards an exclusive book-entry

environment by offering Treasury bills only in that form, phasing in

this change for the various bill maturities. A 52-week bill issue in

December 1976 became the first offering of securities exclusively in

book-entry form. Use of book entry was expanded to include 26-week

bills in June 1977 and 13-week bills in September 1977.

\4\ 41 FR 5335 (December 6, 1976).

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Also, beginning in December 1976, Treasury, for the first time,

began to provide book-entry accounts for investors who did not choose

to hold their book-entry securities accounts at financial institutions

or dealers. As of September 30, 1977, Treasury maintained 6,690 book-

entry accounts holding a total $182 million of Treasury bills. These

accounts were the predecessor to the current TREASURY DIRECT

system,5 which was established in 1986. Treasury notes and bonds

were issued in book-entry only form beginning in August 1986, upon

implementation of the TREASURY

[[Page 8421]]

DIRECT system pursuant to new Treasury regulations.6

\5\ TREASURY DIRECT is a system in which persons purchasing or

already owning marketable Treasury securities may hold such

securities directly with the Treasury in book-entry accounts

maintained in their names. As of December 31, 1995, there were

922,397 accounts holding $85.3 billion of marketable Treasury book-

entry securities.

\6\ 31 CFR Part 357, Subpart C.

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With the issuance of these regulations, all original issues of

marketable Treasury securities (bills, notes, and bonds) were required

to be in book-entry form. Book-entry holdings in Treasury securities

have increased dramatically since that time. The following chart

illustrates this rapid increase.

Total Marketable Securities Outstanding 7

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Percent in

Year book-entry

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June 1965................................................... 0

August 1976................................................. 82

August 1982................................................. 95.6

August 1986................................................. 97.2

December 1995............................................... 99.7

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7 Exclusive of securities held in various government trust funds.

Adoption of the TRADES regulations, to govern the commercial book-

entry system counterpart to TREASURY DIRECT, will mark a major step in

the evolution of Treasury's full book-entry securities project by

providing a clearer legal framework for all commercially-maintained

marketable Treasury book-entry securities.

II. Legal Development

As Treasury began to issue securities in book-entry form, it

confronted a legal landscape that did not provide a framework for

describing how such securities should be treated. As described by

Professor James Rogers, the reporter for the drafting committee that

produced Revised Article 8, Investment Securities of the Uniform

Commercial Code (UCC), adopted by the American Law Institute (``ALI'')

and the National Conference of Commissioners on Uniform State Laws

(``NCCUSL'') in 1994 (``Revised Article 8''), the version of Article 8

in effect in the late 1960s and early 1970s ``* * * was based on the

assumption that possession and delivery of physical certificates are

the key elements in the securities holding system.'' 8 Those

assumptions, however, did not fit the commercial reality of marketable

Treasury book-entry securities.

\8\ James Steven Rogers, Boston College Law School, Reporter,

Drafting Committee to Revise U.C.C. Article 8 Investment Securities,

Prefatory Note, page 1, U.C.C. Article 8 (1994 official text with

comments), hereinafter ``Prefatory Note.''

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As noted above, beginning in 1968, Treasury began to promulgate

regulations for its marketable securities held in book-entry form.

These regulations provided, for the first time, a legal framework for

treating marketable book-entry securities issued by Treasury. These

regulations, particularly those adopted in 1971, contained several

important innovations. First, they described transfers of interests in

securities by means other than by moving paper certificates.9 As

currently set forth in the regulations,10 a transfer of a

marketable Treasury book-entry security occurs when a Federal Reserve

Bank makes an entry in its records. Second, the regulations implicitly

acknowledged that interests in marketable Treasury book-entry

securities held in the commercial book-entry system were held in a

tiered system.11

\9\ UCC Sec. 8-320, added in 1962, provided for transfers within

a central depository system by the making of appropriate entries on

the books of a clearing corporation. Unlike the Treasury regulatory

formulation, this UCC provision originally contemplated the deposit

of paper certificates with the depository.

\10\ 31 CFR 306.118(a).

\11\ The Federal Reserve Banks maintain book-entry security

accounts for depository institutions and other entities such as

government and international agencies and certain foreign central

banks. In their book-entry accounts at the Federal Reserve, the

depository institutions may maintain their own security holdings and

holdings for customers, which may include other depository

institutions, dealers, brokers, institutional investors and

individuals. In turn, the depository institutions' customers may

maintain accounts for their customers. This creates a tiered chain

of custodial relationships. Thus, there frequently are multiple

levels between the issuer of the security and the ultimate holder of

the beneficial interest in that security.

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Specifically, the regulations developed by Treasury had rules for

transfers both at the level of institutions having accounts at a

Federal Reserve Bank and rules for transfers at custodial levels below

that level. These were significant innovations.

The regulations developed by Treasury to describe the nature of a

book-entry security, however, also deemed such security to be the

equivalent of a bearer-definitive security. This bearer-definitive

security fiction, as it came to be known, had the advantage of

simplicity. It was also, at the time of its adoption, a useful concept

that allowed for the application of existing law at a time when holding

securities in book-entry form was a new development. Ultimately,

however, the bearer- definitive fiction proved to be unsatisfactory

because the attempt to graft the rules of certificated securities onto

book-entry securities left too many questions unanswered.12 This

uncertainty poses risks in the event of systemic failure.13 TRADES

is designed to ameliorate these risks.

\12\ These uncertainties are well described in Charles W.

Mooney, Jr., ``Beyond Negotiability: A New Model for Transfer and

Pledge of Interests in Securities Controlled by Intermediaries,'' 12

Cardozo L. Rev. 305 (1990) (hereinafter ``Beyond Negotiability'').

\13\ ``What led to the revision of Revised Article 8 is not

intermediary risk itself, that is, the risk that customers of a

failed intermediary might suffer loss, but systemic risk, that is,

the risk that a failure of one security firm might cause others to

fail.'' Rogers, supra, memorandum accompanying U.C.C. Revised

Article 8, (1994 official text with comments), ``Revised U.C.C.

Article 8--Why it's Needed--What it Does.''

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In 1978 the existing UCC Article 8 was amended and, as part of that

process, there was an attempt to provide some guidance on the treatment

of book-entry securities. That attempt did not provide sufficient

guidance for a tiered system of ownership such as the one that exists

for Treasury securities because the rules of that version of Article 8

``were based on the assumption that changes in ownership of securities

would be effected by delivery of physical certificates or by

registration of transfer on the books of the issuer.'' 14 In the

Treasury system that assumption was not correct. A second level of

confusion was created because the Treasury regulations continued to

rely on the bearer- definitive fiction but referenced state law (which

for most states included the 1978 revision to Article 8). Thus, there

was lack of clarity as to how the 1978 amendments to Article 8 and the

bearer-definitive fiction interacted and how interests at levels below

a Federal Reserve Bank were to be treated.15

\14\ Rogers, supra, U.C.C. Revised Article 8, Prefatory Note,

page 4.

\15\ Mooney, Beyond Negotiability, supra, pp. 345-350.

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By 1984 Treasury had concluded that it needed to change its

existing book-entry regulations. Several events buttressed that

conclusion. As described above, the outstanding amount of marketable

Treasury book-entry securities increased dramatically. In 1984

representatives of a number of financial institutions brought to

Treasury's attention the need for certainty in the market and raised a

number of questions about the existing regulations that they believed

undermined that certainty. With the growth of the size of the Treasury

market came an increase in the need for, and the use of, short-term

financing techniques, such as repurchase transactions, structured to be

low risk. In order to preserve the liquidity of this most liquid of

markets, it was critical that participants be able to settle their

transactions quickly with a high degree of certainty.

Disruptions in the market caused by the failure of some government

securities broker-dealers further

[[Page 8422]]

underscored the need for certainty in the minds of market participants.

Events post-1984, such as the 1987 market break and the failure of

Drexel Burnham, Lambert validated the concern that lack of certainty,

given the magnitude of the dollars involved, posed serious systemic

risks--both to the market for Treasury securities and all financial

markets.16 More recently, there has been reaffirmation of the

importance of certainty for transactions involving book-entry

securities. In a March 3, 1995 speech, Alan Greenspan, Chairman of the

Board of Governors of the Federal Reserve System, stated, ``* * * my

experience with financial crises has convinced me that the greatest

threat to the liquidity of our financial markets is the potential for

disturbance to the clearance and settlement process for financial

transactions.'' He went on to note, ``The most important set of

concerns relates to the legal and institutional foundations of book

entry settlement systems.'' 17

\16\ As set forth in the May 1988 Interim Report of the Working

Group on Financial Markets, ``the laws of the various states do not

have uniform requirements for * * * transfers and pledges of

certificated and uncertificated stocks * * * investors, market

professionals and their lenders should have a single, clear set of

rules for the transfer and pledge of securities similar to those

being developed by the United States Treasury.'' The working group

consisted of the chairpersons of the Board of Governors of the

Federal Reserve System, the Securities and Exchange Commission and

the Commodity Futures Trading Commission and the Department of the

Treasury Under Secretary for Finance.

\17\ Remarks by Alan Greenspan at the Financial Markets

Conference of the Federal Reserve Bank of Atlanta, Coral Gables,

Florida, March 3, 1995.

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III. Previous Trades Proposals

In 1985 Treasury began the process of revising its book-entry

security regulations. Treasury recognized early on that the process

would be quite complicated.

For reasons already explained, the first decision made in the

initial proposal of the TRADES regulations 18 was to eliminate the

bearer-definitive fiction. This proposed elimination, however,

presented two major difficulties in determining what should replace the

bearer-definitive fiction. First, state law was not uniform. In 1986

all states had not adopted the 1978 version of UCC Article 8. Because

of this lack of uniformity, Treasury determined that for purposes of

clarity and certainty, the basic mechanical rules for transfer and

pledge of marketable Treasury book-entry securities needed to be set

out in the Federal regulations.

\18\ 51 FR 8846 (March 14, 1986).

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The second difficulty was that the provisions in the 1978 version

of Article 8 could not be used as a model for the TRADES rules without

significant modifications to fit the Treasury book-entry system. As a

consequence, although this first proposal was based on provisions of

the 1978 version of Article 8, there were some significant

modifications. Treasury's goal was to clarify the rules for marketable

Treasury book-entry securities to the extent possible without causing

unnecessary changes in market practice.

The most problematic issue raised in the March 1986 proposal,

however, was the resolution of competing claims to interests in the

same securities when held through intermediaries (``book-entry

custodians,'' now referred to as ``Securities Intermediaries''). In

other words, under some circumstances (particularly in scenarios

involving failures of intermediaries), more than one person (e.g.,

owner or secured creditor) could claim entitlement to a Treasury

security. How should such disputes be sorted out? After considering

several different alternatives to deal with this issue, all of which

had some disadvantages, the initial proposal of TRADES left the

resolution of questions involving competing claims to state law.

Comments on the first TRADES proposal were wide-ranging in their

content and helpful. Most of the detailed comments dealt with the issue

of competing claims and urged some form of bona fide purchaser rule

(providing that an innocent purchaser would take a security free of

prior adverse claims) and some form of a priority clearing lien for

entities that perform the critical function of extending credit as a

part of a clearing function in the government securities market. These

and other new areas suggested by commenters were added to the second

regulatory proposal published in November 1986.19

\19\ 51 FR 43027 (November 28, 1986).

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Another difficult issue that was raised in the TRADES rulemaking

was the interaction between Federal and State law and the extent to

which the Federal regulations should preempt State law. The opinions of

the commentators on this point varied. The preamble to the second

TRADES proposal in November, 1986 noted that:

* * * With respect to book-entry securities, there is not an

accepted body of principles [uniform state laws] that operates to

provide predictable results * * * Even where such rules [the 1978

UCC Article 8] have been adopted, some of the litigation arising

from recent failures of government securities dealers suggests that

important legal issues are yet to be resolved that stem from some of

the concepts and relationships that arise where interests in

securities are transferred without the transfer of a

certificate.19a

\19a\ 51 FR 43029 (November 28, 1986).

Because of the difficulties in drawing lines between coverage of

Federal and State law, the November 1986 proposal adopted an approach

of complete preemption of State law. Like the first TRADES proposal,

the second proposal generated a large volume of detailed and helpful

comments.

Another significant development that had an impact on the TRADES

rulemaking was the passage, at about the time the November 1986

proposal was issued, of the Government Securities Act of 1986

(``GSA'').19b The GSA granted Treasury rulemaking authority over

the government securities market, including custodial holding of

government securities. It also required the registration of government

securities brokers and dealers for the first time and imposed a

regulatory framework that had not previously existed for those

entities. Treasury exercised its authority by promulgating rules in

July 1987 in the areas of financial responsibility, protection of

investor securities and balances, recordkeeping, and reporting and

audit. In addition, the GSA rules imposed, for the first time,

standards for the safeguarding and use of government securities by

depository institutions that hold such obligations in custody for the

account of customers. This new regulatory framework addressed many of

the practices that had been involved in dealer failures and increased

customer protection for securities held in the commercial book-entry

system. It also provided, for the first time, comprehensive Federal

regulation of the custody practices for government securities.

\19b\ Pub. L. No. 99-571, October 28, 1986, 100 Stat. 3208.

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In the next few years, other groups also explored many of the same

issues raised in the proposed TRADES regulations. In 1988, in response

to concerns raised about securities clearance and settlement as a

result of the stock market break of 1987, the American Bar Association

established an Advisory Committee on Settlement of Market Transactions.

In addition, the Market Transactions Advisory Committee was established

by the Securities and Exchange Commission under the Market Reform Act

of 1990. Finally, and most significantly, a major effort to revise

existing Article 8 commenced in 1991.

Under the aegis of the ALI and NCCUSL, a group of scholars and

[[Page 8423]]

practitioners began work on a multi-year process that by 1994 produced

Revised UCC Article 8. The importance of their work cannot be

overstated. Representatives of Treasury, the Federal Reserve Banks and

the Federal Reserve Board participated in virtually all of their

drafting sessions. It soon became obvious that the drafters of Revised

Article 8 were dealing with many of the issues that Treasury had

considered in its earlier versions of TRADES, including the difficult

questions involving the resolution of competing claims. While Treasury

continued to work on TRADES and produced a third draft in 1992,

Treasury ultimately concluded that it made sense to wait for work to be

completed on Revised Article 8 so that Treasury would have the benefit

of their final product.19c Treasury believes that decision was

prudent.

\19c\ The third TRADES proposal was published in April 1992 (57

FR 12244, April 9, 1992). In response to the comments on the second

proposal, Treasury reexamined and articulated the Federal interest

in the regulations. That interest was described as ``to provide that

degree of certainty in the law that is needed by participants in the

Government securities market to facilitate transactions in book-

entry securities and to assure the continued liquidity and

efficiency of the market.'' In that proposal, the extent of Federal

preemption was cut back from the prior proposal, and some areas that

had been included in prior proposals (e.g., warranties) were left to

state law. The 1992 proposal retained provisions dealing with

competing claims, while recognizing that the examination of legal

principles in this area was continuing. The overall content of the

rules, however, was not significantly different from the prior two

proposals. Commenters to this third proposal urged Treasury to

suspend its efforts and await the completion of the Revised Article

8 project. On November 12, 1993, Treasury agreed to that suggestion.

(58 FR 59972, November 12, 1993).

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The many difficult issues resolved by the drafters of Revised

Article 8 have been of significant benefit to Treasury as it has worked

on this proposal for TRADES. Based on its participation in the many

drafting sessions that produced Revised Article 8, and after a detailed

study, Treasury has concluded that Revised Article 8 represents a major

advance in commercial law. For the first time, there is a comprehensive

set of rules to govern the modern book-entry systems. Treasury agrees

with Professor Rogers when he notes that, ``The present version of

Article 8 [the 1978 version], which is based on legal concepts adopted

to the paper-based systems of the past, is not adequate to that task in

the modern world of computerized recordkeeping and global securities

trading.'' 20 Accordingly, as set forth in detail below, Treasury

has concluded that it is appropriate to rely on Revised Article 8 in a

significant way in this proposal for TRADES.21

\20\ Letter from James Rogers, Reporter, Drafting Committee to

Revise U.C.C. Article 8, to James Wong, Chief Consultant,

(California) Senate Judiciary Committee (April 10, 1995).

\21\ Copies of Article 8 are available upon request from the

Bureau of the Public Debt's Public Affairs Officer, (202) 219-3302.

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IV. Comparison of Trades and Treasury Direct

A person can hold interests in marketable Treasury book-entry

securities either in TRADES 22 or TREASURY DIRECT. The following

summarizes the major differences between the two systems.

\22\ In TRADES a person's interest in a marketable Treasury

book-entry security is a Security Entitlement. See the discussion at

VI.D.4. below.

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As previously described, persons holding marketable 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, knows 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 marketable 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.

The rights of non-Participant beneficial owners can be exercised

only through Securities Intermediaries. Neither Treasury nor the

Federal Reserve Banks have any obligations to a non-Participant

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

security. Two examples illustrate this principle. First, Federal

Reserve Banks, as Treasury's fiscal agents, will act only on

instructions of the Participant in whose Securities Account the

marketable Treasury book-entry security is maintained in recording

transfers of an interest in a marketable Treasury book-entry security.

A beneficial owner of such an 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

marketable Treasury book entry security when payment is credited to a

Participant's account or paid in accordance with such 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 marketable Treasury book-entry security. A non-Participant

beneficial owner receives its payment when its Securities Intermediary

credits such owner's account.

Persons holding marketable 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

marketable 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 marketable Treasury book-entry security. Unlike TRADES,

TREASURY DIRECT does not provide a mechanism for the exchange of cash

in a sales transaction, nor are pledges of marketable Treasury book-

entry securities 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.

V. Scope of Proposed Regulation

Just as the scope of Revised Article 8 is limited,23 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 marketable 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 marketable Treasury book-entry

security. This regulation does not displace such laws--with the sole

exception that such laws cannot affect either Treasury or the Federal

Reserve Banks.

\23\ Prefatory Note at 12.

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VI. Section by Section Analysis

A. Dual Book-Entry Systems

Section 357.0 sets forth that Treasury provides two systems for

maintaining marketable 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 will contain

the TRADES

[[Page 8424]]

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 marketable Treasury securities issued in book-entry form.

B. Effective Date

Section 357.1 establishes the effective date for TRADES. Treasury

contemplates that TRADES will apply to outstanding securities currently

governed by 31 CFR Part 306, Subpart O. Conforming changes to Part 306

will be made 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.

Treasury proposes that the effective date for TRADES will be 90

days following the publication of TRADES in final form in the Federal

Register. 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 13 states,24 Treasury is proposing

that TRADES will become effective 90 days following publication of the

final TRADES rule to ensure a smooth transition to TRADES. Such an

effective date, when combined with TRADES being published in proposed

form with a 60-day comment period, should provide sufficient time for

an orderly transition to the new TRADES rules. Treasury specifically

seeks comments on whether the proposed effective date of TRADES is

sufficient to permit an orderly transition.

\24\ As of January 1, 1996, those states are: Arizona,

Arkansas, Idaho, Illinois, Indiana, Louisiana, Minnesota, Nebraska,

Oklahoma, Oregon, Texas, Washington and West Virginia.

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C. 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.

1. Participant

A Participant is a person that has an 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 marketable Treasury book-entry securities held in

these accounts.

2. Securities Intermediary

Securities Intermediaries are persons (other than individuals,

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

interests in marketable 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

3. Entitlement Holder

An Entitlement Holder is any person for whom a Securities

Intermediary holds an interest in a marketable 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.

4. Security Entitlement

A Security Entitlement is the interest that an Entitlement Holder

has in a marketable 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 Section 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 Section 357.11.

D. 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 marketable

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 marketable 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. Prior to

March 1, 1993, the terms of each offering of marketable Treasury

securities, except for Treasury bills, were set forth in an offering

circular published in the Federal Register.25 Since March 1, 1993,

all marketable Treasury book-entry securities have been offered

pursuant to a uniform offering circular set forth at 31 CFR Part 356.

\25\ 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 marketable 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. In

addition, neither the United States nor Federal Reserve Banks have any

obligations to persons holding their interests in a marketable Treasury

book-entry security at levels below the level

[[Page 8425]]

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

marketable Treasury book-entry security (with the limited exception set

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

against either the United States or the Federal Reserve Banks.

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

security interests granted to Federal Reserve Banks. There are three

possible ways that such security interests are granted. First, security

interests granted to a Federal Reserve Bank by a Participant in which

such Bank does not mark its books are governed by the law of the state

in which the head office of the Federal Reserve Bank is located. If the

state in which the head office of a Federal Reserve Bank is located has

not adopted Revised Article 8, the law of such jurisdiction is deemed

to include Revised Article 8. (See discussion of federal pre-emption

below). Second, if a Federal Reserve Bank does not mark its books, a

security interest granted by a non-Participant is governed by the law

specified in the agreement with a Federal Reserve Bank. Third, if a

Participant or non-Participant grants a Federal Reserve Bank a security

interest and the Federal Reserve Bank marks its books, Section

357.12(c)(1) governs.

For purposes of applying the state law specified in Section

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

As a result, security interests granted under Section 357.12(c)(2) in

favor of a Federal Reserve Bank have the same priority as security

interests granted to other clearing corporations under state law.

E. Law Governing Other Interests

1. 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 Section 357.11(a).

The matters set forth in Section 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 marketable 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

this choice of law rules, both Participants and Federal Reserve Banks

are Securities Intermediaries.

Section 357.11(b) adopts Revised Article 8's choice of law rule.

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

to security interests perfected by filing. 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 security interests

created by filing. In those cases, the law applicable to the debtor 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.26

\26\ 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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Section 357.11(d) provides for the application of Revised Article 8

if the choice of law analysis required by Section 357.11(b) results in

the choice of the law of a jurisdiction that has not yet 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.

2. Limited Scope of Federal Preemption

As noted above, in an earlier TRADES proposal Treasury contemplated

adopting a comprehensive regulation governing the rights of all persons

in marketable 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.27 The questions inherent in a tiered system of ownership have

been analyzed, and, in Treasury's view, satisfactorily addressed by

Revised Article 8.

\27\ As noted previously, the substantive scope of this

regulation is limited.

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As of the date of this release, 13 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 proposing a limited form of preemption. As

provided in both Sections 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. 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

marketable Treasury book-entry securities.

F. Obtaining an Interest in a Book-Entry Security

1. Creation of a Participant's Security Entitlement

A Participant's interest in a marketable 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 marketable 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 marketable Treasury book-

[[Page 8426]]

entry security. Once a Participant obtains that interest, the

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

Section 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 Section 357.10,

Section 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

marketable Treasury book-entry security as they do today--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 marketable

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.

2. Creation and Priority of a Security Interest

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

marketable 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.

Security Interests on the Books of a Reserve Bank

In a limited number of situations, Federal Reserve Banks will agree

to record a security interest on their books. 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. 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 marketable Treasury book-entry security except an interest of

the United States.

Other Security Interests

As provided in Section 357.12(c)(2), Participants can create

security interests in any manner authorized by applicable state

law.\28\ The perfection and priority of such interests shall be

governed by such applicable law. In applying such law, when a

Participant grants a Federal Reserve Bank a security interest, the

Federal Reserve Bank is treated as a clearing corporation.

\28\ If the state has not yet adopted Revised Article 8,

applicable state law would be Revised Article 8.

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

If a person perfects a security interest pursuant to Section

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 Section 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 marketable 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.

G. Rights and Obligations of Treasury and the Reserve Banks

1. Adverse Claims

Section 357.13(a) sets forth the general rule that, except as

provided in Section 357.12(c)(1), Treasury and the Federal Reserve

Banks will recognize only the interest of a Participant in a marketable

Treasury book-entry security in whose Securities Account such interest

is maintained.

As noted previously, marketable 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 marketable 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 as provided in Section 357.12(c)(1), neither

the Treasury nor a Federal Reserve Bank will recognize the claims of

any other person asserting a claim in a marketable Treasury book-entry

security. Persons at levels below the Participant level must present

their claims to their Securities Intermediary.

2. Payment Obligations

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

Section 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 such other manner

specified by the Participant. This is consistent with existing law and

the first TRADES proposal.\29\ 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. Unlike Revised Article 8, even though Federal

Reserve Banks are deemed to be clearing corporations, Treasury remains

liable until payment is made to a Participant. Section 357.13(b)(2)

establishes the mechanism of how marketable Treasury book-entry

securities are paid at maturity. This paragraph makes clear that such

payment takes place automatically and that, unlike with physical

certificates, there is no act of presentment required by the

Participant.

\29\ 51 FR 8846, 8848 (March 14, 1986).

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H. Authority of Reserve Banks

Section 357.14 provides that Federal Reserve Banks are authorized,

as fiscal agents of Treasury, to operate the

[[Page 8427]]

commercial book-entry system for Treasury.

I. 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 Sec. 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.

VII. Procedural Requirements

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

regulatory action'' pursuant to Executive Order 12866.

Although this proposed rule is being issued in proposed form to

secure the benefit of public comment, 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 is required, the provisions of

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

There are no collections of information contained in this proposed

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, Securities.

For the reasons set forth in the preamble, Title 31, Chapter II,

Subchapter B, Part 357 is proposed to be 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.

2-3. 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 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 Section 357.20 of this

Part. Such accounts may be accessed by investors in accordance with

Subpart C through any Federal Reserve Bank or the Bureau of the Public

Debt. See Subpart C 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

Section 357.22(a).

Sec. 357.1 Effective date.

Subpart B of this Part, and other changes made to this Part with

the publication of Subpart B in final form, are effective on and after

[insert date 90 calendar days after the date of publication in final

form]. Subpart C and other provisions in this Part published in final

form on May 16, 1986, or as amended prior to [insert date 90 calendar

days after the date of publication in final form] (related to TREASURY

DIRECT) remain in effect.

Sec. 357.3 [Redesignated and Sec. 357.2; amended]

4. Section 357.3 is redesignated Sec. 357.2, the introductory text

of the section is designated as paragraph (a) introductory text, the

definition of security interest and pledge is removed, the definition

of TRADES is revised, the remaining definitions are added in

alphabetical order, and a new paragraph (b) is added to read as

follows:

Sec. 357.2 Definitions.

(a) * * *

* * * * *

Book-entry Security means, in Subpart B, a Treasury Security

maintained in TRADES and, in Subpart C, 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 uniform

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, 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, 4, 5, 9, and 10) 1994 Official Text, as set forth in

Appendix B of this part.

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 Separate Trading of Registered Interest

[[Page 8428]]

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.

* * * * *

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.

* * * * *

(b) Unless the context requires otherwise, terms not defined in

this section have the meanings as set forth in Revised Article 8.

5. Subpart B, consisting of Sections 357.10 through 357.14, is

added to read as follows:

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

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.

357.11 Law governing other interests.

157.12 Creation of Participant's Security Entitlement; security

interests.

357.13 Obligations of United States; no adverse claims.

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 granted to a Federal Reserve Bank, in the

manner described in Section 357.12(c)(2), 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. For purposes of the application of such

law, the Federal Reserve Bank shall be deemed a clearing corporation. A

security interest granted to a Federal Reserve Bank by a Person that is

not a Participant, is governed by the law specified in the agreement

between the Federal Reserve Bank and the non-Participant.

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

is a State or territory or possession of the United States that has not

adopted Revised Article 8, then the law specified in paragraph (b)

shall be Revised Article 8.

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), 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), 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), 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) and an account statement does not identify

an office serving the Entitlement Holder's account as provided in

paragraph (b)(3), 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 such security interest may be perfected by

filing a financing statement and the effect of perfection or

nonperfection and priority of such security interest.

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

is a State or territory or possession of the United States that has not

adopted Revised Article 8, then the law for the matters specified in

paragraph (a) of this section shall be Revised Article 8. For purposes

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

section, the Federal Reserve Bank maintaining the Securities Account

shall be deemed a clearing corporation, and the 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

[[Page 8429]]

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, the 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

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

perfection or non-perfection and priority of a security interest are

governed by such 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 such law, including

with respect to the effect of perfection and priority of such 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 United States; no adverse claims.

(a) Except as provided in Section 357.12(b) and (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 such 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 such 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 such

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.

6. In Subpart D, Section 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 Message, or evidence submitted in support

thereof.

* * * * *

[[Page 8430]]

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.

* * * * *

7. Appendix B and Appendix C to Part 357 are added and reserved as

follows:

Appendix B to Part 357--Revised Article 8 [Reserved]

Appendix C to Part 357--TRADES Commentary [Reserved]

Dated: February 22, 1996.

Gerald Murphy,

Fiscal Assistant Secretary.

[FR Doc. 96-4481 Filed 3-1-96; 8:45 am]

BILLING CODE 4810-39-W