BOARD OF GOVERNORS
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 20551
DIVISION OF BANKING
SUPERVISION AND REGULATION
SR 94-5 (FIS)
January 25, 1994
TO THE OFFICER IN CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANK
SUBJECT: Government Securities Act Amendments of 1993
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
The amendments clear up jurisdictional inconsistencies that were inadvertently created by the 1986 definition of the appropriate regulatory agency for the various categories of government securities brokers and dealers. The amendments clarify that the Board now is the appropriate regulatory authority for branches and agencies of foreign banks that are not FDIC insured and for Edge corporations. The FDIC is now the designated regulatory agency for the government securities activities of insured branches of foreign banks.
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.
Stephen C. Schemering
Cross References: SR 87-37 (SA), November 6, 1987
SR 88-26 (SA), September 12, 1988
SR 90-1 (IB), January 2, 1990
AD 91-26 (SA), April 29, 1991
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
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
SR letters | 1994