SEC Requests Comments on Proposal To Establish Three-Business-Day Settlement For Securities Transactions

Executive Summary

In the March 1, 1993, edition of the Federal Register, the Securities and Exchange Commission (SEC) published notice of its intention to adopt Rule 15c6-1 under the Securities Exchange Act of 1934. This new rule would establish three, instead of five, business days as the standard settlement time-frame for broker/dealer transactions. The proposed rule is intended to reduce the risks associated with unsettled securities transactions. It is contemplated that shortening the settlement cycle will decrease the total number of unsettled trades at any given time, thereby benefiting broker/dealers, clearing corporations, and public investors. The SEC is requesting comments on the proposed rule as well as whether its proposed effective date of January 1, 1996 provides sufficient time to implement the necessary changes efficiently. Comments on the proposed rule are due on or before June 30, 1993.

Background

In the United States, the settlement cycle varies among markets. Settlement in the futures, options, and government securities markets occurs on the day after trade date using same-day funds. On the other hand, settlement of most trades in corporate and municipal securities takes place on the fifth business day after the trade date (T+5), with payment in next-day funds. Settling securities transactions on T+5 is largely a function of market custom and industry practice. Although the rules of the NASD and other self-regulatory organizations define "regular way" settlement as T+5, no federal rule mandates a specific settlement cycle for securities transactions.

Following the market break of October 1987, the clearance and settlement system came under close scrutiny as several government and industry groups sought to identify causes for the market decline and develop initiatives to protect market participants from the impact of such declines in the future.

The Group of Thirty conducted one of these studies. The Group is an independent, non-partisan, nonprofit organization composed of international financial leaders whose focus is on international economic and financial issues. In March 1989, the Group of Thirty issued a report with a number of proposals to improve clearance and settlement practices and standards. Among these proposals was the recommendation that settlement take place on the third day after trade date (T+3).

Following release of this report, the United States formed two subcommittees, the U.S. Steering Committee and a U.S. Working Committee of the Group of Thirty, to evaluate these recommendations. The subcommittees concluded that shortening the settlement cycle and converting to the use of same-day funds would be beneficial.

The SEC convened a round table to discuss the subcommittee's recommendations. Round table participants generally agreed that these recommendations should be adopted but expressed concern about the impact on broker/dealers conducting a predominantly retail business. Subsequently, at the request of SEC Chairman Richard Breeden, an industry task force, headed by John

W. Bachmann, the Managing Principal of Edward D. Jones & Co. of St. Louis, Missouri, undertook an independent evaluation of these issues.

In May 1992, the Bachmann Task Force presented its findings to the SEC. These findings supported T+3 settlement. The SEC published the Bachmann Task Force Report in the Federal Register on June 22, 1992, and requested public comment on the recommendations.

The SEC received 1,000 comment letters from banks, broker/dealers, investment advisers, trade associations, clearing agencies, exchanges, transfer agents, and individual investors. Although generally supportive, many commentators questioned how these changes would be implemented, expressing particular concern about the potential elimination of physical certificates. Many of the issues noted by the commentators were also identified by the Bachmann Task Force. Although the SEC's efforts to address them are nearing completion, the Commission will consider comments on the Bachmann Task Force Report recommendations in connection with this proposal.

Description of Proposed Rule 15c6-1

Proposed Rule 15c6-1 provides that, unless otherwise expressly agreed to by the parties at the time of the transaction, a broker or dealer is prohibited from entering into a contract for the purchase or sale of a security (other than an exempted security, government security, municipal security, commercial paper, bankers' acceptances, or commercial bills) that provides for payment of funds and delivery of securities later than the third business day after the date of the contract.

It should be noted that the proposed rule allows a broker or dealer to agree that settlement will occur in more or less than three business days, provided the agreement is explicit and reached at the time of the transaction. However, this is not intended to require broker/dealers to specify all contract terms before a trade is executed.

The proposed rule does not affect the ability of individual investors to obtain a physical certificate. The rule also does not specifically address settlement in same-day funds. However, various self-regulatory organizations currently are working on a number of initiatives to accomplish this goal.

The SEC is requesting comment on whether the scope of the proposed rule is appropriate and whether any particular characteristics of different types of securities (e.g., mutual fund shares and limited partnership interests) will create difficulties for broker/dealers and investors if included in or excluded from the rule. In particular, the SEC is seeking comment on the most appropriate way and a reasonable time frame for bringing municipal securities within the scope of the rule.

The SEC also is seeking comment on the proposed implementation date of January 1, 1996, which allows broker/dealers a three-year period in which to make necessary changes. Interested persons are also asked to comment on whether January 1, 1995, or July 5, 1995, would be appropriate alternative implementation dates.

NASD members that wish to comment on the proposed rule should do so by June 30, 1993. Comment letters should refer to File No. S7-5-93 and should be sent, in triplicate, to:

Jonathan G. Katz
Secretary
Securities and Exchange Commission
450 Fifth Street, NW
Mail Stop 6-1
Washington, DC 20549.

The Commission will make all comments available for public inspection and copying at its Public Reference Section, 450 Fifth Street, N.W., Washington, D.C. 20549.

Members are requested to send copies of their comment letters to:

Stephen D. Hickman
Corporate Secretary
National Association of Securities Dealers, Inc.
1735 K Street,
NW Washington, DC 20006-1500.

Questions concerning this Notice may be directed to Walter J. Robertson, Director, Compliance, at (202) 728-8236 or Samuel Luque, Associate Director, Compliance, at (202) 728-8472.