Notice To Members 83-41

SEC Staff Issues No-Action Letter Providing Temporary Relief from Certain Provisions of Rules 15c3-1 and 15c3-3 Dealing with Municipal Securities

Published Date:

TO: All NASD Members and Other Interested Persons

SUMMARY

Recently, in response to a request by the Association, the staff of the SEC's Division of Market Regulation issued a no-action letter concerning 17 C.F.R. 240.15c3-l (the "net capital rule") and 17 C.F.R. 240.15c3-3 (the "customer protection rule"). The letter provides, until December 31, 1983, a temporary extension of certain time periods specified in the rules before which capital deductions and/or other actions are required to be taken for transactions involving registered municipal securities.

The Association's request was prompted by a concern on the part of its Capital and Margin Committee, and others, that the issuance of municipal securities in registered form, as required by the provisions of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), would have a deleterious effect on the clearance and settlement of municipal securities transactions which, in turn, would subject broker-dealers to increased capital and reserve requirements in accordance with the provisions of the net capital and customer protection rules. A brief discussion of the background concerning the Association's request, and the sections of the rules affected as a result thereof, follows. Also, a copy of the letter issued by the Division of Market Regulation is reprinted as part of this Notice.

BACKGROUND

The Tax Equity and Fiscal Responsibility Act of 1982, which was signed into law on September 3, 1982, contains a number of provisions affecting the broker-dealer community. The Association has taken an active role in attempting to assess the impact of the new law by identifying various areas of concern to its members. One such area is the issuance of municipal securities in registered form.

Under the provisions of TEFRA, municipal securities issued after July 1, 1983, must be issued solely in registered form, both as to principal and interest, in order to preserve their tax-exempt status.1/ The registration requirement, however, does not change the status of municipal securities as exempt securities under the Securities Exchange Act of 1934 (the "1934 Act"). Therefore, issuing municipalities would not be required to use registered transfer agents who are subject to SEC rules regarding "turnaround" time for transfer items.

Municipal securities broker-dealers were concerned that the performance of the transfer function by issuers and unregistered transfer agents would increase the number of aged fails in the marketplace. The SEC's net capital and customer protection rules, which set forth methods of measuring the adequacy of a broker-dealer's capital and customer-related reserves, contain provisions, among others, which penalize the broker-dealer for: (1) transactions remaining uncompleted beyond specified dates after settlement; and, (2) transfer items which have not been returned from transfer after a specified time. If significant delays develop in the transfer process, causing clearance problems and an increase in the number of uncompleted transactions, broker-dealers would be subject to much higher capital penalties.

The Association believed that these were very real concerns on the part of municipal securities broker-dealers. In connection therewith, the NASD conducted a survey of selected municipal securities broker-dealers to gather data with respect to the aging of fails in municipal securities. Eight broker-dealers participated in the survey and supplied information regarding total aged fails and total mortgage revenue bond fails 2/ for the period September 1981 through January 1982 and correspondingly for the period September 1982 through January 1983. The findings of the survey supported the contention that the requirement to register previously unregistered securities results in an increase in total aged fails.

The Association was not alone in expressing concern over this situation. A number of industry groups including the Municipal Securities Rulemaking Board ("MSRB") and Public Securities Association ("PSA") have also undertaken actions with respect to the question of registration. On October 18, 1982, the PSA issued a white paper which, among other things, called for net capital relief for municipal securities in fail situations due to the action of transfer agents. Also, in October 1982, the MSRB conducted a two-day conference for all segments of the municipal industry on registered municipal securities in an effort to identify problems and to propose solutions. One of the many recommendations which came forth from the conference was the recommendation to liberalize certain of the provisions of the net capital and customer protection rules as they would apply to transactions in registered municipal securities.

In light of the above findings and discussions, the Association petitioned the Commission to extend by interpretation relevant time periods in the net capital and customer protection rules as applicable to registered municipal securities. The following is a summary of the Commission's no-action letter granting such relief.

SEC Rule 15c3-l

The no-action letter issued by the SEC's Division of Market Regulation provides relief in the following instances which would otherwise affect the capital requirements of a broker-dealer relative to its transactions in municipal securities in accordance with the provisions of SEC Rule 15c3-l.

  • Subparagraph (c)(2)(ix) provides for a deduction from net capital for those municipal fails to deliver which are outstanding for 21 business days or longer. This time period has been extended to 30 business days for transactions involving registered municipal securities.
  • Under subparagraph (c)(2)(iv)(B), an existing interpretation provides that broker-dealers must make appropriate deductions from net worth for deficits in cash accounts for C.O.D. transactions involving municipal securities 42 calendar days after trade date. This time period has been extended to 60 calendar days after trade date for such transactions involving registered municipal securities.
  • Subparagraph (a)(8) permits a municipal securities broker's broker to compute its capital requirements in accordance with specified guidelines. In this regard, subparagraph (a)(8)(iv) requires such a broker to make a deduction from net worth equal to 1% of the market value of the underlying security for municipal securities fails to deliver which are outstanding for 21 business days or longer. This time period has been extended to 30 business days for fails to deliver involving registered municipal securities.

SEC Rule 15c3-3

In its no-action letter, the staff of the Division of Market Regulation provides an extension of the time period applicable to municipal securities fails to deliver as specified in the Reserve Formula computed in accordance with SEC Rule 15c3-3.

  • In computing its reserve requirement, a broker-dealer is required to exclude from the debit side of the formula fails to deliver which are outstanding more than 30 calendar days. This time period has been extended to 45 calendar days for fails to deliver involving registered municipal securities.

Reporting Requirement

The SEC staff as a condition for granting relief in this area is requiring the designated examining authority to secure data from each broker-dealer who takes advantage of a temporary extension. A broker-dealer who determines to avail itself of such relief would be required to supply data concerning aged fail(s) on a monthly basis as of its FOCUS Part I filing date. The information would be submitted to the firm's designated examining authority which will then forward the information to the SEC.

In this regard, an Association member for whom the NASD is the designated examining authority is requested to complete the enclosed form and submit it to the Association along with its FOCUS Part I Report for each month in which the member relies on any of the extensions for aged fails permitted by the SEC's temporary no-action letter. This form must be submitted even if the member uses the interpretation in only one instance.

As you will note, the form has been designed to collect information on a cumulative basis; the member may use one form to record its data each month. In this regard, the member must furnish the following information for fails involving registered municipal securities when taking interpretive relief.

  • the number of such fails which exceed 21 business days;
  • the contract values of the fails;
  • the age of the fails;
  • the number of issuers and transfer agents responsible for the delays; and,
  • the number of broker-dealers who have failed to deliver to the reporting broker-dealer.

Members are reminded that the relief provided by the no-action letter is available only for fails involving registered municipal securities and is effective only through December 31, 1983.

* * *

Questions concerning this Notice may be directed to James M. Cangiano, Assistant Director, Department of Policy Research, at (202) 728-8273. Questions regarding the filing and the completion of the attached form should be referred to your local NASD District office.

Sincerely,

Gordon S. Macklin
President

Attachments

COPY

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Division of Market Regulation

July 7, 1983

Mr. Gordon S. Macklin
President
National Association of Securities Dealers, Inc.
1735 K Street, N.W.
Washington, D.C. 20006

Dear Mr. Macklin:

In your letter of June 15, 1983, you describe the problems which might arise from the required registration of municipal securities issued after July 1, 1983. You state that municipal broker-dealers will encounter delays in transferring the securities after sale or resale. These delays you believe may result in unwarranted deductions under the net capital rule and the customer protection rule. You recommend that provisions of the net capital rule and Rule 15c3-3 which require deductions for aged municipal securities failed to deliver be altered, for these registered securities. The NASD is requesting for its members temporary interpretative relief only and not a permanent rule change.

You believe that these further delays will be caused because neither issuers which do their own transferring nor unregistered transfer agents are subject to regulatory restraints comparable to those of Rule 17Ad-2 of the Securities Exchange Act. In connection with its concerns, the NASD conducted a survey of selected municipal securities broker-dealers to gather data with respect to the aging of fails in municipal securities. So that an adequate comparison could be made, the NASD requested information with respect to the impact that the registration of mortgage revenue bonds has had on the municipal marketplace. Mortgage revenue bonds were required to be issued in registered form as of January 31, 1982. Eight broker-dealers supplied information regarding total aged fails and total mortgage revenue bond fails for the period September 1981 through January 1982 and correspondingly for the period September 1982 through January 1983.

The findings of the survey support the contention that the requirement to register previously unregistered securities results in an increase in total aged fails. From one year to the next, total aged fail items showed an increase of 93%, and there was a corresponding increase of 246% in the dollar amount represented by these items. However, the statistics indicate even greater increases when mortgage revenue bond fails are considered separately. The total number of mortgage revenue bond fails showed an increase of 525%, with a corresponding increase in dollar amount of 2580%. In the period September 1981 through January 1982, mortgage revenue bond fails represented 3.1% of the total aged fails; for the period September 1982 through January 1983, they represented 10.0% of the total aged fails; however, they represented 17.4% of the total aged fails which constitute the increase from 1981/1982 to 1982/1983.

The Division shares your concerns that the present change in the form of registration should not result in unwarranted charges to broker-dealers in municipal securities. However, we are equally concerned that this change not be used as a mechanism to excuse delay in the completion of securities transactions. The Commission, as you are aware, in a recent release stressed the need for reduction in the aging period for fails in municipal securities.

In sum, we are sympathetic to the need for relief particularly as to the period for aging municipal securities fails to deliver. However, as a condition for granting relief in this area, the designated examining authority ("DEA") for each broker or dealer who takes advantage of any extension in the aging period must secure from that firm data on these fails which should be provided to the Commission in a report by the DEA. Specifically, we request data on the number of fails as to registered bonds which exceed 21 business days, their contract values, the age of the fails to deliver, the number of issuers and transfer agents responsible for the delays and the number of brokers who have failed to deliver to the reporting broker-dealer. This data should be obtained monthly as of the FOCUS filing date. It may be presented to the Commission in whatever form the DEA thinks most appropriate.

Based on the circumstances described above, the Division will raise no question nor recommend any action to the Commission until December 31, 1983 if (1) broker-dealers in computing net capital make required deductions under Rule 15c3-l(c)(2)(ix) from the contract value of fails to deliver of registered municipal securities only after the fails to deliver are outstanding 30 business days or longer; (2) broker-dealers in computing the reserve requirements under Rule 15c3-3 remove failed to deliver contracts of registered municipal securities only if older than 45 calendar days; and (3) broker-dealers in computing net capital make appropriate deductions from net worth under Rule 15c3-l(c)(2)(iv)(B) for C.O.D. transactions involving registered municipal securities only after 60 calendar days after trade date; and (4) those broker-dealers which have elected paragraph (a)(8) of the net capital rule make the required deduction as to fails to deliver contracts of registered municipal securities only after the fail is outstanding 30 business days or longer.

Sincerely,

/s/
Edward A. Kwalwasser
Associate Director

cc: Heather L. Ruth
Executive Director
Public Securities Association

1/ TEFRA exempts from this registration requirement securities with maturities of one year or less; securities which are not of a type offered to the public; and, securities which are sold to non-U.S. nationals and are payable outside the United States.

2/ So that an adequate comparison could be made, the Association requested information with respect to the impact that the registration of mortgage revenue bonds has had on the municipal marketplace. Mortgage revenue bonds were required to be issued in registered form as of January 31, 1982, a situation analogous to the overall registration requirement concerning municipal securities.