Interpretive Letter to Ira Hammerman, The Securities Industry and Financial Markets Association
The buy-in requirements under FINRA Rules 11810 and 11870 do not apply for the specified time period to securities identified on the DTC Master List of Inaccessible Certificates, provided that the member firm maintains a detailed record indicating the fail to deliver items related to the physical certificates identified on the DTC Master List of Inaccessible Certificates.
December 21, 2012
The Securities Industry and Financial Markets Association
1101 New York Avenue, 8th Floor
Washington, DC 20005-4269
Re: Regulatory Issues Related to the Current Lack of Access to the Physical Securities Located at the Vault of the Depository Trust Corporation (“DTC”)
Dear Mr. Hammerman:
This letter responds to your letter dated December 21, 2012, addressed to the Financial Industry Regulatory Authority (“FINRA”) and the Securities and Exchange Commission (“SEC”), in which you request regulatory relief and interpretive guidance arising from the inability of customers and broker-dealers to access securities held in physical form in the name of the owner located in DTC’s vault at 55 Water Street (the “vault”). Until Hurricane Sandy struck the week of October 29, 2012, DTC operated the vault and custody service at this location designed to hold such securities (“physical certificates”). According to your letter, as a result of the hurricane and flooding of the building at 55 Water Street, the physical certificates located in the vault are inaccessible and may remain so for some period of time. DTC has announced that it maintains electronic records and images of all of the physical certificates in its vault and has commenced efforts to facilitate the issuance of replacement certificates.1
The inability to access the physical certificates in the vault, which include certificates registered to Cede & Co., as well as custody certificates held in customer/firm name (each as identified and listed on DTC’s master list, hereinafter referenced as the “DTC Master List of Inaccessible Certificates”), presents certain regulatory issues for broker-dealers with delivery obligations under FINRA Rules. In your letter, you seek interpretive guidance regarding, among other things, the buy-in obligations of broker-dealers under FINRA Rules 11810 (Buy-in Procedures and Requirements) and 11870 (Customer Account Transfer Contracts) with respect to certificates on the DTC Master List of Inaccessible Certificates.
Specifically, you state that you are seeking interpretative guidance with respect to securities transactions whose settlement is dependent on the delivery of the physical certificates that are located in the vault and therefore currently inaccessible. For the purposes of this request, in your letter you have defined the time at which a particular certificate becomes accessible as the earlier of (1) five business days after the date the particular physical certificate(s) in the vault or documentation with equivalent effect becomes available (when a member is notified through DTC’s systems that the security is in transfer to a requested destination) and (2) five business days after DTC has notified members that it has full access to all the physical certificates in the vault and has resumed standard processing operations (the “Recommencement Date”).
In addition, you state in your letter that broker-dealers seek relief from buy-in obligations under these rules because they believe it would be inappropriate to have buy-in proceedings initiated when the location of the physical certificates is known and when DTC has clear records evidencing it.
FINRA notes that the SEC is concurrently issuing a no-action letter to SIFMA in response to your letter dated December 21, 2012 regarding the application of requirements under Rules 15c3-3 and 15c3-1 under the Securities Exchange Act of 1934.
FINRA Rule 11810 (Buy-in Procedures and Requirements) generally sets forth the required steps that members must follow to effect the “buy-in” of securities including the procedures to be followed in issuing a “buy-in” notice, the contents of such notice, the expectations of the receiving party to respond to such notice, and the time frames in which a “buy-in” may be issued, retransmitted and effected. FINRA Rule 11810(a) provides that “[a] securities contract that has not been completed by the seller according to its terms may be closed by the buyer not sooner than the third business day following the date delivery was due.”
FINRA Rule 11870 (Customer Account Transfer Contracts) generally sets forth the required steps that members must follow when a customer whose securities account is carried by a member (the “carrying member”) wishes to transfer his or her account to another member (the “receiving member”) and gives authorized instructions to the receiving member. In general, both members must expedite and coordinate the transfer. The carrying member must indicate all securities positions, safekeeping positions, and money balances to be transferred as shown on its books. FINRA Rule 11870(d)(5)(B) defines a safekeeping position, for purposes of the rule, to mean “any security held by a carrying member in the name of the customer. Safekeeping positions shall also include securities that are unendorsed or have a stock/bond power attached thereto.” FINRA Rule 11870(f) requires members to establish fail files for any fail contracts that result from the securities transfer procedures, including safekeeping positions that are not transferred. The Rule further requires that not later than 10 business days following the date delivery was due (or 30 business days for certain identified types of securities), the member must take steps to obtain physical possession or control of the security subject to the fail contract by initiating a buy-in.
Based on the facts described in your letter, in FINRA staff’s view, the buy-in requirements under FINRA Rules 11810 and 11870 do not apply to securities identified on the DTC Master List of Inaccessible Certificates, provided that the member firm maintains a detailed record indicating the fail to deliver items related to the physical certificates identified on the DTC Master List of Inaccessible Certificates. Such records must be available for examination by FINRA and the SEC. In addition, broker-dealers that rely on the interpretative guidance set forth herein must notify their FINRA Regulatory Coordinator and provide any information requested. This interpretive guidance is effective for the period from October 29, 2012 to the Recommencement Date.
FINRA will continue to work in coordination with the SEC and DTC to monitor the situation.
We trust that this letter is responsive to your request. Please note that the opinions expressed herein are staff opinions only and have not been reviewed or endorsed by the FINRA Board of Governors. This letter responds only to the issues you have raised based on the facts as you have described them and does not address any other rule or interpretation of FINRA, or all the possible regulatory and legal issues involved. In addition, you should be aware that any changes in the facts as you have described them will require further consideration and may cause us to reach a different conclusion.
Kosha K. Dalal
Associate Vice President and Associate General Counsel
cc: Grace B. Vogel, Executive Vice President, Member Regulation, FINRA
John Ramsay, Associate Director, Division of Trading and Markets, SEC
Michael A. Macchiaroli, Associate Director, Division of Trading and Markets, SEC
1 See also DTC Statement on Condition of Securities Vault, dated November 14, 2012 and DTC Important Notice 1698-12, DTC Client Update on Superstorm Sandy – Physical Processing and Custody Services, dated November 1, 2012, at http://184.108.40.206/downloads/legal/imp_notices/2012/dtc/ope/1698-12.pdf. In your letter you state that “[o]n November 20th DTC announced that it had come to an agreement with representatives of the Securities Transfer Association (“STA”) on a protocol for the presentment of evidence of ownership in lieu of physical certificates which are inaccessible due to the impact of the storm on the Vault.[ ] For a description of DTC’s Custody Service, see generally: http://220.127.116.11/legal/imp_notices/hurricane_sandy.php.”