TO THE OFFICER IN CHARGE OF SUPERVISION AT EACH FEDERAL RESERVE BANK
Background
On December 17, 1993, the Government Securities Act
Amendments of 1993 was signed into law. The legislation amends
certain provisions of the Securities Exchange Act of 1934
("Securities Exchange Act") applicable to securities firms that act
solely as government securities brokers and dealers and to banking
institutions. The amendments vest additional regulatory authority
in the Department of the Treasury ("Treasury"), the banking
regulators, the Securities and Exchange Commission ("SEC"), and the
National Association of Securities Dealers ("NASD"). The
amendments will result in new requirements affecting the government
securities activities of banking organizations. These new
requirments also will affect the allocation of resources by Federal
Reserve Banks and the conduct of examinations of State member
banks, branches and agencies of foreign banks, and Edge
corporations. This supervisory letter highlights provisions of the
amendments that are of interest to those responsible for examining
the government securities activities of domestic and foreign
banking organizations under the Board's supervision.
Government securities brokers and dealers have been
regulated since 1987 when Treasury adopted regulations implementing
the Government Securities Act of 1986. Banks must notify their
banking regulators if they act as government securities brokers or
dealers, and the regulators are vested with examination and
enforcement authority for compliance with applicable requirements.1
Treasury was granted and has exercised rulemaking authority for
matters involving the financial responsibility of government
securities brokers and dealers, including capital adequacy, custody
and use of customer securities and funds, and the transfer and
control of government securities subject to repurchase agreements.
The Federal Reserve Banks examine the government securities
activities of State member banks, and, as discussed below, of
branches and agencies of foreign banks, and Edge corporations
located within their districts for compliance with these
requirements.
In August 1991, bidding scandals involving Treasury
securities came to light and the government securities markets were
subjected to additional scrutiny by the Congress and by federal
regulators. The amendments, which are summarized below, represent
the legislative response to certain problems identified in the
government securities markets over the past few years.
Prohibition Against Fraud, Manipulation, and Use of Fictitious Quotations in Connection
With the Distribution and Trading of Government Securities
An important purpose of the amendments is to make clear that the anti-fraud
provisions of the Securities Exchange Act and the SEC's enforcement authority thereunder
apply to all persons involved in the government securities markets. To this end, the
amendments expressly prohibit all government securities brokers and dealers, including
banking organizations engaged in these activities, from engaging in, or using, any fraudulent,
deceptive, or manipulative practice or device, and from making fictitious quotations in
connection with the purchase or sale of any government security. In addition, the
amendments expressly prohibit all government securities brokers and dealers from knowingly
or willfully making any false or misleading written statements in connection with any bid for
or purchase of newly-issued government securities.
Permanent Rulemaking Authority of Treasury and Large Position Reports
The amendments grant Treasury permanent rulemaking authority over
government securities brokers and dealers. Treasury's rulemaking authority had expired on
October 1, 1991, under the terms of the Government Securities Act of 1986. Although the
rules promulgated by Treasury remained in effect after that date, the agency was not able to
amend those rules or adopt additional requirements. A 1990 joint study by Treasury, SEC,
and the Board concluded that Treasury had exercised its rulemaking powers in an appropriate
and effective manner, and unanimously recommended that Treasury's authority be reinstated
on a permanent basis.
The amendments also grant Treasury authority to adopt large position reporting
rules if it concludes that such rules are necessary in order to monitor the impact on the
Treasury securities market of concentrations of positions and to assist the SEC in its
enforcement of the Securities Exchange Act. Treasury is authorized to adopt rules requiring
any person that holds, maintains or controls a large position in to-be-issued or recently-issued
Treasury securities to file a report of its position with the Federal Reserve Bank of New York
(unless specified otherwise) and to keep records of large positions. Such rules must specify
the minimum size of positions subject to reporting,2 the positions and securities covered, and
the form of reporting, which may include "machine readable form."
Treasury's authority over government securities brokers and dealers in
connection with the issuance of Treasury securities is given further definition by the
amendments. The amendments provide that no government securities broker or dealer may
receive any advantage, favorable treatment, or other benefit not generally available to other
government securities brokers and dealers in connection with the issuance of government
securities. Moreover, the amendments mandate that by 1995 any bidder that meets minimum
standards of creditworthiness should be permitted to submit a computer-generated tender to
any automated auction system established by Treasury for the sale of newly-issued Treasury
securities.
SEC Authority to Obtain Trading Records and Adopt Rules Applicable to all Government
Securities Brokers and Dealers
The SEC has been granted important new authority over all government
securities brokers and dealers, including banking organizations. This authority primarily is
related to the SEC's responsibility to prohibit fraudulent and manipulative practices in the
government securities market and to take enforcement actions when violations occur.
As noted earlier, the amendments expressly prohibit all government securities
brokers and dealers from engaging in any fraudulent, deceptive, or manipulative act or
practice, and from making fictitious quotations in connection with the purchase or sale of any
government security. The SEC is required to adopt rules that define and prevent any such
acts or practices. The SEC also is required to adopt rules requiring government securities
brokers and dealers that are not members of SIPC to advise customers that their accounts are
not covered by SIPC insurance.3 Once the SEC adopts rules in this area, Federal Reserve
examiners will be expected to examine for compliance by any State member bank, branch or
agency of a foreign bank, or Edge corporation that acts as a government securities broker or
dealer.
In addition, the SEC now has authority to obtain transaction records from any
government securities broker or dealer, including records of the date and time of execution of
trades. The SEC can only obtain trading records in the course of a particular inquiry or
investigation for enforcement or surveillance purposes and is prohibited from requiring any
government securities broker or dealer to furnish examination reports, or any supervisory
recommendation contained in an examination report, prepared by one of the banking
regulators. 4 The SEC also may require that information be furnished in machine readable
form, if it can minimize the burden this may place on small government securities broker and
dealers. To avoid requesting information that may be obtained from the other banking
regulators, the SEC is required to consult with the other regulators to determine what records
generally are available, and to develop an expeditious procedure for obtaining such
information.
Authority to Adopt Sales Practice Rules
The amendments authorize the banking regulators and the NASD to adopt sales
practice rules to prevent fraudulent and manipulative acts and practices and to promote just
and equitable principles of trade. In promulgating any such rules, the banking regulators must
consider the sufficiency of any existing requirements and consult with Treasury.
Sales practice rules typically address matters such as just and equitable
principles of trade, suitability, fair prices and commissions, disclosure, advertising,
supervision, and conflicts of interest. While adoption of sales practice rules is not required,
we understand that the NASD is seriously considering adopting sales practice rules for those
government securities brokers and dealers that are its members. Board staff is monitoring
developments in this area and discussing with the other banking regulators whether it is
necessary or appropriate to adopt sales practice rules for banking organizations that act as
government securities brokers or dealers. Any action by the Board will be coordinated with
the staffs of the Federal Reserve Banks.
Clarification of Appropriate Regulatory Authority
Last, we note that efforts are underway to coordinate implementation of the
amendments with the other regulators and with the NASD to ensure consistency in the
supervision of government securities brokers and dealers. Additional information and more
detailed examination material will be provided as the rules mandated by the amendments are
being considered or promulgated.
If you have questions regarding any of these matters, please contact Susan
Meyers or Angela Desmond at (202) 452-2781.
Deputy Director
Footnotes 1. Government securities firms that are separate subsidiaries of bank holding companies register with the SEC and must become members of a national securities exchange or the NASD. The SEC is the oversight agency for these firms and, under principles of functional regulation, the designated exchange or the NASD examines these nonbank subsidiaries for compliance with applicable requirements. Return to text 2. The amendments specify that the minimum size may be no less than the size that provides the potential for manipulation or control of the supply or price, or the cost of financing arrangements, of an issue or the portion thereof available for trading. Return to text 3. Banking organizations and firms that act solely as government securities brokers or dealers are not eligible for SIPC membership. Return to text 4. Information obtained by the SEC under this section and any large position reports required by Treasury may not be disclosed other than in connection with a Congressional inquiry or to a requesting regulatory agency for purposes within the scope of its jurisdiction. Return to text |
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