Notice To Members 86-60

Request for Comments on a Proposed Amendment to the Uniform Practice Code, Section 64, Acceptance and Settlement of COD Orders

Published Date:

TO: All NASD Members and Other Interested Persons

ATTN: Operations Principal, Cashier

EXECUTIVE SUMMARY

Last Date for Comments: October 1, 1986.

The NASD Board of Governors is circulating for comment a proposed amendment to Section 64 of the Uniform Practice Code, Acceptance and Settlement of COD Orders. The amendment would eliminate the exemption in subparagraph (a)(5)(ii), which provides that a COD/POD transaction may be settled physically if both parties to either side of the transaction (i.e., the customer and its agent or the member and its agent) are not participants in a registered securities depository.

This amendment would have the effect of requiring that all COD/POD transactions executed by a broker-dealer for a customer be processed through the confirmation and book-entry facilities of clearing agencies. If this method is not used, transactions would be completed on a regular-way settlement basis. The Board concluded that the effect of removing this exemption would be negligible while the benefits of book-entry settlement (reduced DKs, lower processing costs and timely transaction settlement) would be realized. The text of the proposed amendment is attached.

BACKGROUND

COD (Collect on Delivery) refers to a purchase by a customer and POD (Payment on Delivery) refers to a sale by a customer, wherein a broker-dealer receives or makes payment at the time the securities are delivered.

Regulation T of the Federal Reserve Board permits a broker-dealer and a customer to establish a special account whereby the broker-dealer purchases a security for a customer or sells a security to a customer with the understanding that the broker-dealer is to deliver the security promptly to the customer and full payment is to be made by the customer against the delivery (i.e., COD/POD). Regulation T states further that the period for payment in this type of account is not the usual seven business days, but rather 35 calendar days after the date of the purchase or sale.

COD/POD customers may be individual investors, but they are generally institutions, such as banks, insurance companies, registered investment companies and pension funds that request that securities purchased on a COD/POD basis be delivered to a clearing agent (generally a bank) that will receive the securities and make payment.

On January 1, 1983, the NASD adopted new Section 64 of the Uniform Practice Code, Acceptance and Settlement of COD Orders, which standardized the procedures for the acceptance and settlement of COD/POD transactions. This represented an industry-wide cooperative effort to modernize trade processing, to encourage the book-entry settlement of transactions through the use of the Institutional Delivery (ID) Systems available through registered securities depositories, and to help diminish the DK (Don't Know) problems attendant with physical deliveries.

Section 64, as originally adopted, prohibited NASD members of depositories and NASD members that cleared through depository members from accepting COD/POD orders from their customers who were or whose agents or correspondents were members of a depository. If the facilities of a depository, such as the ID System of the Depository Trust Company, were used for the confirmation, affirmation and book-entry settlement of depository-eligible transactions, the rule permitted COD/POD orders between these parties.

The rule applied only to transactions that involved NASD members and customers who were both participants or whose agents were participants in a depository. The rule did not affect the clearance of COD/POD business of NASD members that were not participants or whose agents, customers or customer's agents or correspondents were not participants in a depository. Nor did the rule require members, their COD/POD customers, clearing agents or correspondents to become participants in a registered securities depository. The rule also did not apply to transactions that were settled outside the United States. (As proposed, this exemption will remain.)

EXPLANATION OF THE PROPOSED AMENDMENT

Since the adoption of Section 64 in 1983, the industry has realized the benefits of book-entry settlement of COD/POD transactions in that it reduces DK rates, lowers processing costs and provides timely settlement of transactions. Additionally, industry-supported studies have confirmed that the majority of COD/POD transactions are processed through the ID System.

However, transactions that are settled outside the ID System by relying on the Section 64 exemptions are contributing to delays in processing, and increasing broker-dealer operational expenses and depository costs. This is a result of the need to maintain larger quantities of certificates to satisfy physical deliveries, which would not be required if these transactions were processed through the ID System or another book-entry type of delivery.

To resolve these problems, the ID Implementation Committee, a securities industry group, has proposed that the NASD amend Section 64 and that the New York Stock Exchange amend its Rule 387 to require that all COD/POD transactions executed by a broker-dealer for a customer be processed through the confirmation and book-entry delivery facilities that are available at several registered clearing agencies. If this processing method is not used, the committee feels that transactions executed for customers and institutional clients should be on a regular-way settlement basis.

The Uniform Practice Committee, a standing committee of the NASD Board of Governors, considered the ID Implementation Committee's request and concluded that the effect of removing the exemption would be negligible. The Uniform Practice Committee and the Board of Governors noted that it was not necessary for a broker-dealer to become a member of a securities depository, but only that it have access to a bank that is a member of a depository in order to extend the COD/POD privilege to customers.

Further, most banks, although not direct participants of a securities depository, are invariably associated on a correspondent basis with a bank that is a depository member. Therefore, the Committee recommended and the Board approved for member comments the proposal to eliminate the exemption in subparagraph (a)(5)(ii) of Section 64 of the Uniform Practice Code.

All members and other interested persons are invited to submit comments on the proposed amendment. Comments should be received no later than October 1, 1986, and should be directed to:

Mr. Lynn Nellius, Secretary
National Association of Securities Dealers, Inc.
1735 K Street, N.W.
Washington, D.C. 20006

Comments received will be considered by the Uniform Practice Committee and the NASD Board of Governors. If approved by the Board, the proposed amendment must be filed with and approved by the Securities and Exchange Commission before becoming effective.

Questions concerning this notice may be directed to Donald Catapano, Director, NASD Uniform Practice/TARS, at (212) 839-6255.

Sincerely,

John T. Wall
Executive Vice President
Member and Market Services

Attachment

PROPOSED AMENDMENT TO SECTION 64 OF THE NASD UNIFORM PRACTICE CODE*

Sec. 64. Acceptance and Settlement of COD Orders

(a)(l), (2), (3) and (4) are unchanged.

(a)
(5) The facilities of a securities depository shall be utilized for the confirmation, acknowledgment and book entry settlement of all depository eligible transactions covered by this rule except[:] transactions that are to be settled outside the United States.
[(i) transactions that are to be settled outside of the United States;]
[(ii) transactions wherein both a member and its agent are not participants in a security depository, or where both the customer and its agent are not participants in a securities depository.]

* New language is underlined; deleted language is bracketed.