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8000 - Miscellaneous Statutes and Regulations


DEPARTMENT OF THE TREASURY STAFF INTERPRETATIONS OF GOVERNMENT SECURITIES REGULATIONS

Definition of "Associated Person" and "Fiduciary Capacity" in the Temporary Securities Regulations

DT-1

October 23, 1987

Charles O. Sethness

Assistant Secretary (Domestic Finance)

This is in response to your letter of July 3, 1987, concerning the definitions of the terms "associated person" and "fiduciary capacity" in section 400.3 of the temporary regulations promulgated by the Department of the Treasury implementing the Government Securities Act of 1986 (52 FR 19642, May 26, 1987).

You have asked for confirmation of the informal advice provided by Ellen Seidman, Special Assistant to the Under Secretary, that financial institution personnel responsible for providing investment advisory services not involving the exercise of sole or shared discretion would be deemed to be functioning in a fiduciary capacity, provided that, in the case of an institution that is a national bank, such persons are subject to supervision under policies of the bank pursuant to 12 CFR Part 9, and the customer accounts involved are subject to examination by the Office of the Comptroller of the Currency for compliance with fiduciary requirements. You have also asked whether the same criteria would apply with respect to the definition of "fiduciary capacity" set forth in section 450.2(d) of the temporary regulations.

Section 15C of the Securities and Exchange Act of 1934 ("the Act"), as amended by the Government Securities Act of 1986, Pub. L. 99--571, 100 Stat. 3208 (1986), requires a government securities broker or dealer that is a financial institution to file notice with its appropriate regulatory agency of its status as a government securities broker or government securities dealer. The notice shall be in such form and contain such information concerning any persons associated with the financial institution as the Board of Governors of the Federal Reserve System shall prescribe. Section 3(a) of the Act, as amended, generally defines a "person associated" with a government securities broker or dealer as (1) any partner, officer, director, or branch manager of the government securities broker or dealer, (2) any other employee of the government securities broker or dealer engaged in the management, direction, supervision, or performance of government securities activities, and (3) any person controlling, controlled by, or under common control with the government securities broker or dealer.

As you pointed out, section 400.3(c)(3) of the temporary regulations provided, in part, that in the case of a financial institution, persons who function solely in a fiduciary capacity shall not be considered "associated persons." The term "fiduciary capacity" was defined under section 400.3(i) to include "trustee, executor, administrator, registrar, transfer agent, guardian, assignee, receiver, managing agent, and any other similar capacity involving the sole or shared exercise of discretion by a financial institution having fiduciary powers that is supervised by a federal or state financial institution regulatory agency."

It is our opinion that under the temporary regulations, persons providing investment advisory services, who do not actually exercise investment discretion, would not be considered "associated persons" if all of their activities are subject to trust or fiduciary supervision and the related customer accounts are subject to fiduciary examination standards. In the case of national banks, the accounts must be subject to 12 CFR Part 9, "Fiduciary Powers of National Banks and Collective Investment Funds." We understand that the Office of the Comptroller of the Currency has taken the position that investment advisory accounts are subject to 12 CFR Part 9.

Under the final regulations, (52 FR 27910, July 24, 1987), the definition of the term "associated person" in section 400.3(c) has been clarified to provide, in part, that in the case of a financial institution, the term does not include "persons whose government securities functions (A) consist solely of carrying out the financial institution's activities in a fiduciary capacity and (B) are subject to examination by the appropriate regulatory agency for compliance with requirements applicable to activities by the financial institution in a fiduciary capacity." As noted in the explanation of this section in the preamble to the regulations, the definition of the term "fiduciary capacity" in section 400.3(i), which refers to the activity of the financial institution, was confusing when applied in the context of the definition of "associated person" in the temporary regulations. The change in the final regulations makes it clear that persons are excluded whose sole activities consist of carrying out the financial institution's fiduciary activities and are examined as such.

The rationale for exclusion of persons who perform fiduciary activities from the definition of "associated persons" is similar to the rationale for the exemption in section 450.3(a) from the requirements of Part 450 for holdings of government securities by depository institutions in a fiduciary capacity. In both cases, additional regulation was considered unnecessary because the standards and examination procedures applicable to the institution's fiduciary activities were deemed adequate. However, the purpose of the definition of "fiduciary capacity" in section 450.2(d), which is unchanged in the final regulations, relates to the exemption of the depository institution from the requirements of Part 450. Because Part 450 does not address the role of associated persons in the institution, the interpretation of the definition of "associated person" in section 400.3 is not directly relevant to sections 450.2(d) and 450.3.

As provided in section 400.2(c)(7), your incoming letter and this response will become available to the public thirty days from the date of this letter.

Custodial Holdings of Government Securities by Depository Institutions

DT-2

December 18, 1987

Charles O. Sethness

Assistant Secretary (Domestic Finance)

This is in response to your letter of September 15, 1987, concerning the Department of the Treasury regulations applicable to custodial holdings of government securities by depository institutions, 17 CFR Part 450 (52 FR 27957, July 24, 1987), which implement title II of the Government Securities Act of 1986.

You note that section 450.4(a)(2)(i)(A) of the regulations requires a depository institution maintaining customer securities at a custodian institution to notify the custodian institution that such securities are customer securities. You have asked whether similar notice is required in the case of securities maintained at a Federal Reserve bank.

Section 450.4(a)(1) of the regulations states that, except as otherwise provided in that section, a depository institution shall maintain possession or control of all government securities held for the account of customers by segregating such securities from the assets of the depository institution and keeping them free of any lien, charge or claim of any third party granted or created by such depository institution. In cases where customer securities are maintained by a depository institution at another depository institution ("custodian institution"), section 450.4(a)(2) also requires certain actions of the depository institution and its custodian institution to meet the requirements of section 450.4(a)(1). To ensure in such cases that liens, charges or claims of the custodian institution or any party claiming through it do not extend to securities held for customers of the depository institution, the custodian institution is required, based on notification and instructions from the depository institution, to maintain such customer securities in an account designated exclusively for customers of the depository institution.

Where a depository institution maintains customer securities at a Federal Reserve bank, there is no requirement in the current regulations that the depository institution notify the Federal Reserve bank which securities are customer securities or request segregation of such securities. (See the discussion in the temporary regulations at 52 FR 19666, May 26, 1987.) Section 450.4(a)(3) provides that the depository institution shall be in compliance with paragraph (a)(1) of that section if any lien, charge or other claim of such Federal Reserve bank or other person claiming through it against securities of the depository institution expressly excludes customer securities. Thus, a depository institution should ensure that any agreements that it enters into with a Federal Reserve bank that would grant a lien, charge or claim against securities held in an account at the Federal Reserve would exclude its customers' securities. Section 450.4(a)(3) does provide that a depository institution shall be deemed in compliance with the section if, as a result of extraordinary circumstances, a Federal Reserve bank retains a lien on securities received during the day that are subsequently determined to be customer securities under certain specified conditions set out in that section. As discussed in the preamble to the final regulations (52 FR 27925), such exception was provided to deal only with extraordinary circumstances and is not meant to allow a depository institution to enter into a standing agreement with a Federal Reserve bank that collateralizes daylight overdrafts or extensions of discount window credit with securities that are customer securities.

Your incoming letter and this response will become available to the public thirty days from the date of this letter.

Confirmation of Government Securities Transactions

DT-3

February 26, 1988

Charles Q. Sethness

Assistant Secretary (Domestic Finance)

This is in response to your letter of December 9, 1987, concerning the confirmation requirement of section 403.5(d) of the Treasury Department's implementing regulations for the Government Securities Act of 1986 (52 FR 27910; July 24, 1987).

You have asked whether the following practice by *** complies with section 403.5(d) of the regulations. You state that in some cases customers will instruct *** not to mail confirmation to them. You state that it is your position that the bank will not violate the regulations if it does not mail confirmations to these customers provided the bank retains evidence of each customer's instructions.

Section 403.5(d)(1)(ii) of the regulations states that a financial institution that retains custody of securities that are the subject of a repurchase transaction, as described in this section, shall confirm in writing the specific securities that are the subject of the repurchase transaction. The confirmation must be issued at the end of the day of initiation of the transaction and at the end of any other day during which other securities are substituted. Section 403.5(d)(2)(i) of the regulations specifies the information that must be included on the confirmation.

The regulations do not allow customers of financial institutions to waive the right to receive a confirmation except as authorized in section 403.5(d)(2)(ii). That section states that a non-United States citizen residing outside the United States or a foreign corporation, partnership, or trust may waive, but only in writing, the right to receive the confirmation required by section 405.3(d)(1)(ii). As discussed in the preamble to the implementing regulations (52 FR 27919), the confirmation required by section 403.5(d) may not be waived by any other customer.

Consistent with section 403.5(d), the same restriction applies to the confirmations that must be issued pursuant to section 403.4(e) by a registered government securities broker or dealer that retains custody of securities that are the subject of a repurchase agreement. In addition, only a foreign customer is permitted to waive the confirmation or safekeeping receipt that must be issued pursuant to section 450.4(b)(1) by a depository institution that holds government securities for the account of a customer.

Pursuant to 17 CFR 400.2(c)(7), your letter and this response will become available to the public thirty days from the date of this letter.

Application of the Government Securities Act to the Operations of a Trust Department

DT-4

June 6, 1988

Charles O. Sethness

Assistant Secretary (Domestic Finance)

This is in response to your letter of December 24, 1987, concerning the application of the Government Securities Act of 1986 (GSA) to the operations of a trust department. Specifically, you asked whether the trust department of *** must ratify special policies and procedures in order to comply with 17 CFR 450.3 of the regulations promulgated pursuant to the GSA. (17 CFR Chap. IV) Information regarding these matters was provided to you by a member of the Bureau of the Public Debt's Government Securities Regulations Staff in a telephone conversation on December 23, 1987.

Since all parts of your bank, including the trust department, that conduct government securities activities are affected by the regulations, it is important that the activities of all areas be reviewed for compliance. It is for this reason that we are providing a general overview of the regulations before responding to your specific question concerning trust department operations.

Generally, the regulations implementing the GSA are divided into two subchapters to regulate two types of activities. Subchapter A (17 CFR Parts 400--405, 449) of the regulations applies to the activities of government securities brokers and dealers, including financial institutions that are government securities brokers or dealers. It sets forth rules concerning the financial responsibility, protection of investor securities and funds, recordkeeping, reporting, and audit of brokers and dealers in government securities, Subchapter B (17 CFR Part 450) of the regulations deals with the custodial holdings of government securities by depository institutions, including those that are government securities brokers or dealers.

With respect to the regulations contained in subchapter A, it should be noted that the statutory definition of "government securities dealer" specifically excludes bank purchases and sales in a fiduciary capacity. (15 U.S.C. 78(c)(1)(44)) That exclusion is reiterated in the regulations at section 401.4, which exempts from subchapter A regulation, except for section 403.5(d), financial institutions whose dealer activities are limited to sales or purchases in a fiduciary capacity and repurchase transactions. These institutions would still be required to comply with Part 450 which concerns the custodial holdings of government securities for customers and, to the extent applicable, with the provisions of section 403.5(d) pertaining to hold-in-custody repurchase transactions.

In addition, section 401.2 exempts from regulation as a government securities broker depository institutions whose activities are limited to submitting tenders on behalf of customers for purchase on original issue of U.S. Treasury securities, and section 401.3 exempts financial institutions that effect a limited number of brokerage transactions or effect all such transactions on a fully disclosed basis pursuant to a "networking" arrangement. As is the case for institutions that are exempted from the regulations as government securities dealers, these exempt institutions would still be required to comply with Part 450 relating to custodial holdings of government securities by depository institutions.

In general, Part 450 (subchapter B) of the regulations applies to depository institutions that hold government securities as a fiduciary, custodian, or otherwise for customer accounts. Section 450.3 grants an exemption from Part 450 for a depository institution which holds government securities in a fiduciary capacity subject to examination by the appropriate regulatory agency under the agency's fiduciary standards.

Section 450.3 also exempts depository institutions that hold government securities in a custodial capacity provided the institutions have adopted policies and procedure that would apply to such custodial holdings all the requirements imposed by its appropriate regulatory agency on government securities held in a fiduciary capacity. As is the case for government securities held in a fiduciary capacity, the appropriate regulatory agency must, during examination of the institution, examine the custodial holdings under all of the agency's fiduciary standards in order for the institution to qualify for the exemption.

All of the information contained in this letter is offered as informal advice pursuant to 400.2(c)(6) of the regulations. If you require any additional assistance, please do not hesitate to call the Government Securities Regulations Staff at (202) 376-4632. If you would like a binding interpretation of a specific provision of the regulations, please submit a written request which includes all of the information required under section 400.2(c)(3) of the regulations.

As provided in section 400.2(c)(7), your letter and this response will become available to the public thirty days from the date of this letter.

Financial Institutions Performing Clearing and Custodial Services for Exempt Depository Institutions are Subject to "No Lien" Provision of Section 450.4

DT-5

May 11, 1989

Richard L. Gregg

Commissioner

The Department has received inquiries concerning situations in which a depository institution instructs another financial institution ("custodian institution") to receive securities for the account of the depository institution's customers. The circumstances involve depository institutions that, under the Government Securities Act regulations, 17 C.F.R. chap. IV, are eligible for exemption from the requirement to give notice of being a government securities broker or dealer ("exempt institution"). Such exempt institutions remain subject to 17 C.F.R. Part 450, including section 450.4(a)(2), which requires that fully paid customer securities be maintained free of lien. Section 450.4(a)(2) specifically requires an exempt institution, which is maintaining fully paid customer securities through a custodian institution, to instruct the custodian institution that the securities are fully paid customer securities to be maintained in a separate customer account free from lien, charge, or claim of the custodian institution. In the context of that prohibition, questions have been raised about the possibility of an exempt institution granting a lien on securities to a custodian institution until such time that the custodian institution receives payment for the securities from the exempt institution, even though the customer has paid the exempt institution for the securities.

It is our understanding that situations involving delays in receipt of payments by the custodian institution arise infrequently, but may occur, for example, if the exempt institution has misdirected the funds for payment of the securities or has missed the cut-off time for wire payments. As a result of these situations, the custodian institutions have raised questions concerning our rules with respect to securities for which they have not yet received payment, but which are fully paid customer securities from the perspective of the exemption institution. To obtain protection for an extension of credit in such situations, some custodian institutions have informally been seeking an interpretation of section 450.4(a)(2) that would permit the exempt institution to grant a temporary lien on its customers' fully paid securities until payment has been received by the custodian institution.

Although a custodian institution may be concerned that it is bearing the risk of exposure for clearing securities for other parties, the custodial rules, specifically, the "no lien" provision contained in section 450.4(a)(2) does not permit an exempt institution to grant a lien, even on a temporary basis, to the custodian institution, nor does it permit the custodian institution to take one. The Department views this treatment of fully paid customer securities to be an essential element of customer protection. It is the Department's view that the custodian institution must look toward the exempt institution to provide a remedy, and that alternative arrangements can be made, other than a lien on customer securities.

While the subject of this letter specifically addresses questions that are being raised about clearing for exempt institutions, it is noted that the requirements of section 450.4(a)(2) are applicable to all depository institutions, whether or not exempt. In discussions of these requirements, the provision of section 450.4(a)(4)(ii) was referenced to support arguments for permitting exempt institutions to grant liens on customer securities. This provision addresses situations of banks that are clearing for government securities broker-dealers, not exempt institutions, and states that the clearing bank is not required to segregate securities upon the instruction of the broker-dealer if the clearing bank determines that the securities continue to be required as collateral for the extension of clearing credit. The provision was expressly intended to be limited to situations involving financial institutions that are performing clearing functions for government securities broker-dealers.

Those clearing operations are conducted differently than the custody and clearing performed by the custodian institutions in the instant case. In the situation described in section 450.4(a)(4)(ii), on any given day, a clearing bank would be conducting a large number of transactions for a broker-dealer and would retain an intra-day lien until it could segregate customer securities at the end of the trading day. This is a different operation than custodial functions performed on behalf of exempt institutions. The exception was intended to be a narrow one of infrequent occurrence and limited application and it should not be interpreted as authorizing the broker-dealer to grant a lien on customers' securities. When a clearing bank invokes this provision, the broker-dealer is in violation of the possession or control requirements for customer securities. Further, the clearing bank is required to send notification of the violation to the broker-dealer's appropriate regulatory agency.

Therefore, pursuant to 15 U.S.C. 78o-5(b), it is our interpretation of 17 C.F.R. 450.4(a)(2) that financial institutions performing clearing and custody functions for exempt depository institutions may not take, nor may exempt depository institutions grant, a lien against fully paid customer securities.

This interpretation will be immediately available to the public and is being issued to each appropriate regulatory agency for depository institutions.

Interpretation of the Temporary Lag Provision in Section 403.5; Hold-in-Custody Repurchase Transactions

DT-6

July 24, 1989

Richard L. Gregg

Commissioner

The Department has received an inquiry from a noticed financial institution requesting a clarification of section 403.5(b) of the regulations promulgated by the Department of the Treasury under the Government Securities Act of 1986 (the "GSA", Pub. L. 99--571, 100 Stat. 3208, 15 U.S.C. 78o-5). The issue raised by the financial institution involves the temporary lag provision contained in section 403.5(b) as it relates to the hold-in-custody repurchase transaction provisions of section 403.5(d). The specific issue to be addressed is whether a security for which a financial institution has taken contractual title from a third party, and has a rightful expectation to hold at the end of a day, is an acceptable security for a hold-in-custody repurchase transaction, provided that a financial institution makes every good-faith effort to secure delivery from the third party on the contracted receipt date and to remedy any failure to receive within the required time.

It is suggested that sections 403.5(b), (c), and (d) of the GSA regulations would permit an overnight hold-in-custody repurchase transaction for which a financial institution is only contractually and not physically in control of the underlying security and that these provisions would not require a financial institution to break the hold-in-custody repurchase transaction after the fact if it failed to receive delivery of the security by the close of the trading day. It is represented that such one day lags, which may occur infrequently as a result of normal business operations, would fall within Treasury's definition of temporary lag.

It is also claimed that it is operationally impossible to assure that any security to be used for a new hold-in-custody repurchase transaction on a given day would be, at the start of the day, already in a financial institution's possession. Furthermore, holding securities already in a financial institution's possession at the start of the trading day, in anticipation of new hold-in-custody repurchase transactions that may or may not materialize, could hinder the flow of securities over the securities wire.

After consulting with the appropriate regulatory agencies for depository institutions, the Securities and Exchange Commission (SEC) and the National Association of Securities Dealers, and noting the representations made by the requesting financial institution, we are unable to concur with an interpretation of section 403.5 that would permit a fail on an overnight repurchase transaction resulting form normal business lags. A financial institution that does not have securities at the end of the business day to back an overnight repurchase transaction is in violation of the possession or control requirement of section 403.5(d)(1)(vi) of the GSA regulations. The concept of normal business lag as provided in section 403.5(d) may not be applied to allow a financial institution to avoid possession or control of securities for the entire term of an overnight repurchase transaction. Normal business lag is intended to refer to intra-day lags where a financial institution need not have possession or control of securities at every given moment during the business day.

In order to remain in compliance with section 403.5, it is not necessary for a financial institution to have in its possession or control at the beginning of the day the securities that would be used for all overnight hold-in-custody repurchase transactions. However, even though a repurchase transaction may have been initiated, final settlement of the transactions cannot take place if a financial institution does not have the securities in its possession or control at the close of the business day. It is suggested that it would be prudent for a financial institution to examine its procedures and take appropriate measures to ensure that sufficient securities are available at the end of the day to cover all overnight repurchase transactions that have been entered into with its customers.

In addition to the GSA regulations, financial institutions should be aware that a policy statement on due bills has been issued by the Office of the Comptroller of the Currency (OCC). Banking Circular 182 sets forth guidelines concerning the proper use of due bills by national banks and the principles enumerated in the circular are applicable to repurchase transaction. In particular, it discusses the requirement that the customer be advised of the inability of a financial institution dealer to consummate a transaction. It is our understanding that your agency as a general matter supports the guidelines contained in OCC Banking Circular 182.

Any enforcement action in response to a violation of the GSA rules would be determined by the appropriate regulatory agency, after taking into consideration the specific facts of the case.

This interpretation is being issued to each appropriate regulatory agency for depository institutions. Pursuant to 17 CFR 400.2(c)(7)(i), this letter will be immediately available to the public.

Distinctions Between "Tri-Party" and "Hold-in-Custody" Repurchase Agreement Transactions

DT-7

May 7, 1990

Richard L. Gregg

Commissioner

The Department has received a number of inquiries from government securities broker-dealers and financial institutions regarding whether the repurchase agreement transactions (repos) being conducted by their institutions are subject to the hold-in-custody repo requirements set out at 17 CFR 403.4(e) and 403.5(d) of the regulations promulgated pursuant to the Government Securities Act of 1986 (GSA). In many instances, the callers represented that the repos conducted by their institutions were in fact tri-party repos, and thus not subject to the hold-in-custody rules in sections 403.4(e) or 403.5(d) of the GSA regulations. Additionally, some callers requested guidance in determining whether the repos being effected by their institutions were hold-in-custody or tri-party transactions.

As a result of conversations with these callers, it became apparent that much uncertainty exists regarding whether or not certain transactions would be considered to be hold-in-custody repos. In light of the many uncertainties and questions still being raised concerning the distinction between hold-in-custody and tri-party repos, the Department is issuing this clarification of the GSA regulations to provide additional guidance to government securities broker-dealers, financial institutions and other participants in repo transactions and to make clear the Department's intent with respect to these transactions.

Specifically, some entities represented that they were conducting tri-party repos (i.e., a repurchase transaction involving a Repo Seller, a Repo Buyer, and a separate custodian with specific responsibilities to both parties) because they did not have possession of the repo securities which had been delivered to a third-party custodian institution, even though they (i.e., the Repo Seller) still retained control over the securities. This issue of possession or control of securities and the corresponding funds during the term of the repo transaction is a primary factor in determining whether a transaction will be considered a hold-in-custody or a tri-party repo. A common misunderstanding appears to be a belief that repo transactions that involve another custodian would not be considered "hold-in-custody" transactions and, therefore, not subject to the requirements of sections 403.4(e) or 403.5(d). However, the single factor of another custodian's involvement does not, by itself, determine whether a transaction is a tri-party or deliver-out repo, rather than a hold-in-custody transaction. What must be examined (and should be clearly stated in the governing written agreement) is the role of the third party custodian, the custodian's relationship to the Repo Buyer and Repo Seller, and the entity that ultimately exercises control over the securities or funds during the course of the transaction.

In a tri-party repo, an independent institution enters into a tripartite agreement with the two counterparties to the transaction. The third-party custodian assumes certain responsibilities with respect to safeguarding the interests of both counterparties and is involved in effecting the transfer of funds and securities between the two parties. In a deliver-out repo, the securities are actually delivered to the investor or its designated custodial agent who has no relationship with the Repo Seller. A hold-in-custody repo is characterized by the investor's counterparty (i.e., Repo Seller) retaining control of the securities and by serving simultaneously throughout the transaction not only as principal but also as the investor's custodial agent.

In the government securities market, and particularly with book-entry securities, it is not uncommon for a broker-dealer or financial institution to hold securities through another custodian institution. For example, this occurs in connection with a correspondent or clearing arrangement. Where an entity that is the Repo Seller is holding securities that are the subject of a repo through such a custodian institution, the Repo Seller would be considered to be engaging in hold-in-custody repos if the custodian institution is acting solely for the Repo Seller. The fact that the Repo Seller must request the custodian institution to maintain the repo securities in an account specifically designated for its Repo Buyers and may even provide the custodian institution with a listing of the names of the Repo Buyers does not change the hold-in-custody nature of the repo, since the Repo Seller is still viewed as retaining control over the repo securities. Additionally, repo transactions would also be considered hold-in-custody if the Repo Seller is in a position to control the funds of the Repo Buyer. For example, an arrangement where the Repo Buyer has funds on deposit with the Repo Seller which are invested in repos, without the funds either flowing through or the funds transfer being independently verified by an intermediary, would be considered a hold-in-custody repo. This is because the custodian of the repo securities is unable to determine whether the funds have been returned to the Repo Buyer when the custodian transfers the securities back to the Repo Seller.

On the other hand, a repo transaction would not be considered to be a hold-in-custody where the Repo Buyer instructs the Repo Seller to deliver the securities against payment to a custodian institution that is acting as custodian solely for the Repo Buyer and has no custodian relationship with the Repo Seller (i.e., deliver-out repo). The confusion arises in distinguishing among the various types of repo arrangements where the Repo Buyer and the Repo Seller may have or be represented as having a relationship with the same custodian institution.

In structuring a tri-party repo that would not be subject to the requirements of sections 403.4(e) or 403.5(d) of the GSA regulations, the Department believes that the parties to the written repurchase agreement must include the Repo Seller, Repo Buyer and the third-party custodian. Under this agreement, the custodian undertakes responsibilities to act on behalf of both the Repo Seller and the Repo Buyer. The custodian must be informed of the essential terms of the specific repo transaction being conducted (e.g., types of acceptable securities, purchase price, maturity, value of securities including margins to be transferred). The information should be in sufficient detail to enable the custodian to carry out its responsibilities to both parties for verifying that sufficient cash has been received by the Repo Seller and that eligible and proper securities of value have been received on behalf of the Repo Buyer. Upon verification, the funds should be transferred to the Repo Seller and the securities transferred to the account of the Repo Buyer on a simultaneous basis.

During the term of a tri-party repo, the custodian is responsible for maintaining specific repo securities (i.e., specific CUSIP or mortgage-backed security pool number and in an amount that is tradeable), directly in the name of the Repo Buyer, free of any third party lien, charge or claim. Therefore, pooling of securities is not permitted under a tri-party repo, just as it is prohibited for hold-in custody repos. In addition, these securities must also be segregated from the Repo Seller's own securities that may be held at the custodian. Thus, the custodian must be able to determine, on the basis of its own books and records, the specific securities that it is receiving and holding for an individual customer.

To accomplish this segregation, the custodian would normally be expected to maintain separate funds and securities accounts for the Repo Buyer and Repo Seller. The custodian is also responsible for determining, throughout the term of the transaction, that the valuation of all securities or cash in the Repo Buyer's account is sufficient. If the securities or cash collateral is less than the required amount for the transaction, the custodian should inform the Repo Buyer of the repo collateral deficiency and then follow the instructions of the Repo Buyer to satisfy the deficit.

In a tri-party repo, the custodian must exercise independent control over the exchange of securities between the Repo Buyer and Repo Seller. With regard to the funds, if the custodian is unable to independently control the transfer of funds between the two counterparties, it must, at a minimum, be able to independently verify the movement of the funds between the Repo Buyer and Repo Seller. The Department is aware of situations, particularly those involving sweep repos, in which some financial institutions are investing customer funds in repos and are attempting to structure the transactions as tri-party agreements by using another custodian to maintain the repurchase securities. Unless these transactions are structured in a manner whereby, at the unwinding of the transaction, either the custodian has independent control over the flow of funds, or alternatively it is able to independently verify the movement of funds back to the Repo Buyer, it is the Department's view that such arrangements cannot be considered tri-party repurchase transactions, but are hold-in-custody repos. This is because the custodian institution would not be involved in or be aware of the actual movement of funds between the Repo Buyer and Repo Seller.

Since the custodian represents both parties, neither the Repo Buyer nor the Repo Seller should be able to instruct the custodian to release the funds or securities that are being held for the benefit of its repo counterparty without first returning to the control of the custodian, for the benefit of the counterparty, the appropriate funds or securities. In those instances where the custodian does not have control over movement of the funds, it must be able to confirm the transfer of the funds back to the Repo Buyer before releasing securities to the Repo Seller.

In the event substitution of securities is permitted under the terms of the written agreement for a tri-party repo, the replacement securities or other acceptable collateral must be delivered to the custodian for the account of the Repo Buyer before, or simultaneous with, the release of the original repo securities from the Repo Buyer's account back to the account of the Repo Seller. Otherwise, the Department would consider the transaction to have reverted back in a hold-in-custody arrangement during the substitution process until such time as the replacement securities were credited to the Repo Buyer's account.

The third-party custodian maintaining customer securities on behalf of the Repo Buyer must, pursuant to 17 CFR 450.4(b)(1), issue a safekeeping receipt or a confirmation acknowledging receipt of all securities for the account of the Repo Buyer. The confirmation or safekeeping receipt must identify and list specific securities. This confirmation requirement applies to all depository institutions that hold government securities as custodian for the account of a customer, including securities held resulting from hold-in-custody, tri-party, or deliver-out repo transactions. In addition, since the confirmation or safekeeping receipt must list specific securities, pooling of securities (i.e., the failure to identify specific securities) for any type of repo transaction is not permitted.

Consistent with the view that the custodian should retain control over the repo securities in a tri-party arrangement, the Department believes that the written agreement should include a provision providing that, in the event of default of the Repo Seller, the Repo Buyer has the right, either directly or through instructions to the third-party custodian, to dispose of the securities and apply the proceeds in satisfaction of any Repo Seller liability.

This letter is intended to provide general guidance and direction regarding distinctions between tri-party and hold-in-custody repos; it is not meant to be an all inclusive list of criteria for reaching a final determination in every situation. The facts and circumstances of a particular transaction will dictate the ultimate conclusion regarding the type of repo being conducted.

This letter is being sent to the Securities and Exchange Commission, the appropriate regulatory agencies for depository institutions, the National Association of Securities Dealers, and the New York Stock Exchange. Pursuant to 17 CFR 400.2(c)(7)(i), this letter will be made immediately available to the public.

Clarification of the Purposes of Treasury Form PD 1832

DT-8

July 1, 1991

Kenneth R. Papaj

Director, Government

Securities Regulations Staff

The purpose of this letter is to request your assistance in advising your examiners and the institutions your agency supervises of the misuse of a Treasury form pertaining to transactions in government securities. We have recently received a number of calls regarding the misuse of Form PD 1832, "Special Securities."

Form PD 1832 is to be used only for Treasury notes and bonds in registered definitive form (i.e., certificated securities with the name of the registered owner inscribed on the security). The form is used to assign ownership of the security to another party, but is effective to transfer ownership on the books of the Treasury only if the registered definitive security accompanies the form. Form PD 1832 is reserved for exceptional circumstances such as correction of an erroneous assignment, obtaining the assignment of two or more geographically separated assignors, or when there are multiple securities involved in a transaction. Normally, assignments should be made by signing the registered definitive security itself. Upon receipt at Treasury of the Form PD 1832 and the accompanying security, the registered definitive security is retired and a new security is issued in accordance with the customer's instructions.

Form PD 1832 should not to be used to perfect or convey a security interest in book-entry Treasury securities or agency securities such as GNMAs or FNMAs. Over the last few months, Treasury has been advised of a number of transactions in which parties are attempting to use the Form PD 1832 to assign a security interest or transfer ownership rights in such instruments as book-entry Treasury notes and bonds, interest payment streams for book-entry Treasury securities, and GNMA and FNMA securities. In at least one of the proposed transactions, representations were apparently made to a broker-dealer that the Form PD 1832 was negotiable in the secondary market. We have also been informed that some broker-dealers have indicated that this form can be used to perfect a security interest in these securities.

To protect banks, broker-dealers, and customers from entering into transactions where this form may be misused, I am requesting your assistance in disseminating information on the proper use and intended purpose of Form PD 1832. I would appreciate your agency notifying the institutions it supervises and your examiners concerning this matter. Enclosed is suggested language that you may wish to consider using in order to alert the institutions and examiners to the possible misuse of Form PD 1832.

SUGGESTED NOTICE TO EXAMINERS, BROKER-DEALERS AND BANKS

We have recently been advised by the Department of the Treasury, Bureau of the Public Debt, of the reported misuse of Form PD 1832, "Special Form of Detached Assignment for United States Registered Securities."

Form PD 1832 is used to certify assignments of registered definitive Treasury securities. It is appropriately used only at the discretion of Public Debt or a Federal Reserve bank, acting as Treasury's fiscal agent, in the following circumstances.

• To correct a defective assignment already made on the back of a registered definitive security,

• To accomodate owners required to sign a large number of securities, or

• To obtain the assignment of two or more geographically separated assignors.

Several incidents have been reported to Public Debt whereby Form PD 1832 was erroneously being used to represent, convey interest in, or prove ownership of a security. The form is not intended for use without an accompanying registered definitive Treasury security. As such, it should not be used to assign or establish an interest in book-entry or agency securities. Form PD 1832 does not by itself convey any interest nor does it imply any ownership in securities described on its face. Even when properly certified and accompanied by registered definitive securities, this form is not to be used unless authorized by Public Debt or a Federal Reserve bank.

Report any attempted misuse of Form PD 1832 or direct any questions regarding the form to Walter Childs, Director, Division of Securities Accounts, Bureau of the Public Debt at (202) 874-1210.

DT-8A

April 27, 1993

Kenneth R. Papaj

Director, Government Securities Regulations Staff

This letter is intended to alert you to the continuing misuse of Form PD F 1832, "Special Form of Detached Assignment for United States Registered Securities." I wrote to you on July 1, 1991, concerning the improper use of this form and asked for your assistance in informing your examiners and the institutions that your agency supervises regarding its proper use.

Several recent incidents of attempted misuse of the form necessitates this follow-up letter. I am again asking for your cooperation in advising financial institutions, through whatever means are available to you, of the intended purpose of Form PD F 1832 as outlined below. This action will hopefully protect customers and financial institutions from entering into transactions in which Form PD F 1832 is used in an improper and potentially fraudulent manner. I would appreciate receiving a copy of any communication you issue concerning this matter.

Form PD F 1832 is used primarily to certify assignments of registered definitive Treasury securities. It is appropriately used only at the direction of Public Debt or a Federal Reserve bank, acting as Treasury's fiscal agent, in the following circumstances:

-- To correct a defective assignment already made on the back of a registered definitve security,

-- To accommodate owners required to sign a large number of securities, or

-- To obtain the assignment of two or more geographically separated assignors.

The form may also be used to certify assignments of registered agency securities for those agencies that have adopted the General Regulations Governing U.S. Securities (31 CFR 306) if authorized by Public Debt or a Federal Reserve bank.

Several incidents continue to be reported to Public Debt in which Form PD F 1832 was represented as conveying interest in, or transferring ownership of a security. In many of these cases, the security, which was not delivered with Form PD F 1832, was represented to be in bearer or book-entry form and held at a depository or in a special account at Treasury. The form is not intended for use without an accompanying United States registered definitive security. As such, it should never be used to assign or establish an interest in book-entry or bearer securities. Form PD F 1832 does not by itself convey any interest nor does it imply any ownership in securities described on its face. Even when properly certified and accompanied by registered definitive securities, this form is not to be used unless authorized by Public Debt or a Federal Reserve bank.

Public Debt is revising Form PD F 1832 so that it specifically and clearly states that the form has no monetary value, is not evidence of ownership of securities, and will not support a transaction unless accompanied by the securities, except for securities previously surrendered. This revision should serve to reduce the unauthorized use of the form. I have enclosed a copy of the draft revision of the form.

Please direct any questions regarding Form PD F 1832 or report any attempted misuse of the form to McKayla Braden, Director, Division of Customer Services, Bureau of the Public Debt, at (202) 874-1260. I appreciate your cooperation in this matter.

This letter is also being sent to each of the appropriate regulatory agencies and self-regulatory organizations (National Association of Securities Dealers and New York Stock Exchange) for government securities broker-dealers.

[The page following this is 8280.13.]


Interpretation Regarding the Proper Treatment of Government Securities in Certain Repurchase Transactions

DT-9

June 21, 1993

Richard L. Gregg

Commissioner

The Government Securities Regulations Staff has received several inquiries concerning the required timing of the allocation of securities to customer accounts (i.e., repurchase agreement collateral) in hold-in-custody repurchase transactions (hold-in-custody repos) pursuant to the requirements set out in the regulations promulgated pursuant to the Government Securities Act of 1986 (the "GSA," Pub. L. 99--571, 100 Stat. 3208, 15 U.S.C. 780--5). This interpretation is intended to clarify the requirements of the GSA regulations in this area.

Specifically, in accordance with 17 CFR 403.5(d)(1)(vi), any financial institution that retains custody of securities that are the subject of a repurchase agreement between the financial institution and a counterparty must maintain possession or control of the securities that are the subject of the repurchase agreement in accordance with section 450.4(a). Pursuant to 17 CFR 450.4(a)(1), a depository institution that holds government securities as custodian for the account of a customer must maintain possession or control of the government securities by segregating such securities from the assets of the depository institution and keeping them free of any lien, charge or claim of a third party.

There are also requirements under the GSA regulations (17 CFR Ch. IV) that specific records be made and kept relating to the custody of securities. Paragraph 404.4(a)(2) provides that government securities brokers and dealers that are financial institutions must comply with the recordkeeping requirements of sections 450.4(c), (d) and (f). Pursuant to 17 CFR 450.4(c), records of government securities held for customers shall be maintained and kept separate and distinct from other records of the depository institution. Such records shall provide a system for identifying each customer, and each government security (or the amount of each issue of a government security issued in book-entry form) held for the customer, and describe the customer's interest in the government security. Further, paragraph 404.4(a)(3)(i)(A) of the GSA regulations requires that government securities brokers and dealers that are financial institutions make and keep current a securities record or ledger reflecting separately for each government security as of the settlement dates all long or short positions (including government securities that are the subjects of repurchase or reverse repurchase agreements) carried by such financial institutions for its own account or for the account of its customers or others.

It is our understanding that the allocation (segregation) of securities to customer accounts for hold-in-custody repos often occurs as part of the end-of-the-day processing cycle. Recognizing the importance of ensuring customer protection, no unnecessary delay of the allocation process should occur. We also recognize that a certain amount of time is required, after trading is completed, to finish the normal processing of the day's transactions. However, to remain in compliance with 403.5(d)(1), 404.4 and 450.4 of the GSA regulations, a financial institution must complete the securities allocation process for hold-in-custody repos prior to opening the next business day. Further, for an allocation to be in compliance, the records of a financial institution must identify and list the specific securities that are allocated to each customer in authorized, transferrable denominations.

One of the fundamental objectives that gave rise to the enactment of the GSA, and the subsequent issuance of regulations thereunder, was to strengthen customer protection in hold-in-custody repo transactions. The requirement that financial institutions maintain and allocate specific securities to specific customers is aimed at protecting customer securities in the event of the failure of a financial institution. Without timely and proper allocation, it may not be clear if an interest in the securities has been conveyed to the counterparty. The allocation requirement focuses on eliminating duplicative use of securities as well as precluding pooling of securities (i.e., failing to identify and record specific securities on the books and records of the institution).

We have consulted with staffs of the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision. This letter is being sent to each of these agencies as guidance. I would appreciate your assistance in advising your examiners and the institutions that your organization supervises of this information.

Pursuant to 17 CFR 400.2(c)(7), this letter will be made immediately available to the public.


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