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Self Regulatory Organizations; Government Securities Clearing Corporation; Notice of Filing and Immediate Effectiveness of a Proposed Rule Change Relating to the Placement of Highly Leveraged Members on Surveillance Status

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Start Printed Page 55724 Start Preamble October 26, 2001.

Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) [1] notice is hereby given that on May 14, 2001, the Government Securities Clearing Corporation (“GSCC”) filed with the Securities and Exchange Commission (“Commission”) the proposed rule change as described in Items I, II, and III below, which Items have been prepared by GSCC. The Commission is published this notice to solicit comments on the proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change

GSCC proposes to add new definitions and procedures to its rules that relate to how GSCC will monitor its members' clearing fund status. In addition, GSCC proposes to add a rule that would permit GSCC to exchange information with other clearing organizations concerning a member that is on any surveillance status.

II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, GSCC included statements concerning the purpose of and basis for the proposed rules changes and discussed any comments it received on the proposed rules changes. The text of these statements may be examined at the places specified in Item IV below. GSCC has prepared summaries, set forth in sections A, B, C below of the most significant aspects of such statements.[2]

A. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change

Rule 4, section 3 of GSCC's rules states that a member whose clearing fund deposit obligation represents a significant portion of its net worth or net capital will be placed on a “class 1 (advisory list) surveillance status” and thus be subjected to a more thorough monitoring of its financial condition and activities. Until recently, GSCC has not routinely monitored its members' use of leverage. Now, due to factors such as the increasingly high level of members' clearing fund deposit requirements and the growing number of executing firms[3] for whose trades members are responsible, the amount of clearing fund deposit required of certain GSCC netting members can represent a significant proportion of their excess capital. Consequently, GSCC believes that it has become appropriate for risk management purposes to more closely monitor members' relative use of leverage.

Specifically, GSCC believes that it is important to compare the ratio of each member's clearing fund requirement to that member's level of excess regulatory capital [4] and to advise its membership of specific actions that it plans to take pursuant to Rule 4 with respect to any member that has a ratio in excess of certain defined parameters.[5]

To accomplish this, GSCC's approach under this proposed rule change would be analogous to the early warning concept applied by the Commission with respect to its net capital rule.[6] Examining authorities utilize parameters established within the net capital rule to provide an early warning of any broker-dealer that may be at risk of not having sufficient liquid capital to meet current obligations.[7] Deposits to GSCC's clearing fund are included in broker-dealers' net capital balances since such deposits are allowable assets.[8] Despite its liquidity, these amounts are deposited with and retained by GSCC to support GSCC-related trading and, therefore, are not available for other use. Therefore, GSCC believes that it is meaningful to measure the portion of a member's excess capital that is deposited to the clearing fund against its overall excess capital.

If a significant portion of the excess net capital of a netting member is committed to GSCC's clearing fund, it may be more likely than other members to have difficulty in meeting obligations in general and may therefore deemed to pose a greater likelihood of default with respect to its obligations to GSCC in particular.

To compensate for this potentially higher-than-ordinary risk of default, GSCC will place a member with a clearing fund requirement to excess net capital ratio of greater than .050 on Class 1 Surveillance Status.[9] Rule 4 permits GSCC to more thoroughly monitor such a highly leveraged member's financial condition and activities and to require the member to make more frequent financial disclosures. GSCC will require a highly leveraged member to provide GSCC with a satisfactory explanation of its leverage and it may seek to obtain information with respect to such member's margin requirements at other clearing organizations to better enable GSCC to assess whether the member will be able to meet its obligations to GSCC.

GSCC believes that the proposed rules change is consistent with the requirements of section 17A of the Act [10] and the rules and regulations thereunder because they serve to clarify rights that GSCC currently possesses with respect to highly leveraged participants.

B. Self-Regulatory Organization's Statement on Burden on Competition

GSCC does not believe that the proposed rules change will impact or impose a burden on competition.Start Printed Page 55725

C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants or Others

Written comments relating to the proposed rules changes have not yet been solicited or received. Members will be notified of the rule change filing and an Important Notice will solicit comments. GSCC will notify the Commission of any written comments received by GSCC.

III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action

The foregoing rule change has become effective pursuant to section 19(b)(3)(A) [11] of the Act and Rule 19b-4(f)(1) [12] thereunder because the proposed rule change constitutes a stated policy, practice, or interpretation with respect to the meaning, administration, or enforcement of an existing rule. At any time within sixty days of the filing of such proposed rule change, the Commission may summarily abrogate such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Act.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission's Public Reference Room in Washington, DC. Copies of such filing will also be available for inspection and copying at GSCC's principal office. All submissions should refer to File No. SR-GSCC-2001-06 and should be submitted by November 23, 2001.

Start Signature

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.[13]

Margaret H. McFarland,

Deputy Secretary.

End Signature End Preamble


2.  The Commission has modified the text of the summaries prepared by GSCC.

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3.  An executing firm is a non-GSCC member that contracts with a GSCC member to submit trades on its behalf to GSCC.

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4.  In this context, the term “excess regulatory capital” is used to include excess net capital, excess liquid capital, or excess adjusted net capital, all of which are measures of an organization's net worth after adjusting for the liquidity of its balance sheet.

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5.  Inter-dealer brokers (“IDBs”) and bank members are excluded from this analysis because IDBs, which have fixed clearing fund requirements and limited capital, are subject to different types of risk management considerations and because banks do not perform net capital computations.

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6.  17 CFR 240.15c3-1. The net capital rule is designed to ensure the liquidity of broker-dealers by requiring that they maintain minimum levels of liquid assets to support the volume and risk of the business in which they are engaged.

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7.  In order to derive net capital under the net capital rule, a firm's net worth is reduced to give effect to the elements of market, credit, or operational risk inherent in the business in which the firm is engaged. Net capital is the broker-dealer's net worth adjusted for illiquid (“nonallowable”) assets, certain operational capital charges, and potential adverse fluctuations in the value of securities inventory (known as “haircuts”). The purpose of the net capital computation is to determine that the broker-dealer's net liquid assets (minimum capital base) are adequate in the event of sudden adverse business conditions. Excess net capital is the amount by which the member's net capital exceeds its minimum capital requirement.

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8.  Letter from Richard L. Gregg, Commissioner of the Bureau of the Public Debt of the Department of the Treasury, to Jeffrey F. Ingber, General Counsel of the Government Securities Clearing Corporation (August 30, 1989) (permitting registered government securities brokers or dealers to treat clearing fund collateral as allowable assets for capital calculation purposes).

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9.  For purposes of this analysis, the separate clearing fund requirements of members with multiple accounts will be combined into a single aggregate number.

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[FR Doc. 01-27557 Filed 11-1-01; 8:45 am]