UNITED STATES OF AMERICA
In the Matter of
THE CHASE MANHATTAN BANK
|ORDER INSTITUTING CEASE-AND-DESIST PROCEEDINGS, MAKING FINDINGS AND ORDERING RESPONDENT TO CEASE AND DESIST|
The Securities and Exchange Commission ("Commission") deems it appropriate that cease-and-desist proceedings be instituted against The Chase Manhattan Bank ("Chase") pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act").
In anticipation of this proceeding, Chase has submitted an Offer of Settlement ("Offer") which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceedings brought by or on behalf of the Commission or in which the Commission is a party, Chase consents, without admitting or denying the findings, except that it admits to the jurisdiction of the Commission over it and over the matters set forth in this Order, to the issuance of this Order Instituting Cease-and-Desist Proceedings, Making Findings and Ordering Respondent to Cease and Desist ("Order") pursuant to Section 21C of the Exchange Act.
Accordingly, IT IS HEREBY ORDERED that these cease-and-desist proceedings be, and hereby are, instituted.
On the basis of this Order and Chase's Offer of Settlement, the Commission finds that:
Chase, a New York banking corporation with its principal place of business in New York, New York, is a bank and a registered transfer agent wholly owned by J.P. Morgan Chase & Co. ("J.P. Morgan Chase"). Chase's primary regulator for compliance with the federal securities laws pertaining to transfer agents --the "appropriate regulatory agency" as defined in Section 3(a)(34) of the Exchange Act--is the Board of Governors of the Federal Reserve System. Throughout the period from January 1998 through June 2000, Chase conducted its transfer agent function for non-equities through various entities in its Capital Markets Fiduciary Services division ("CMFS"), or its predecessors. Over time, the transfer agent duties for most of its conventional debt issuers were consolidated at a former affiliate of Chase, Chase Bank of Texas, National Association ("CBT"), which on August 1, 2000, merged into Chase. CBT's primary regulator for compliance with the securities laws was the Office of the Comptroller of the Currency. CBT was formerly known as the Texas Commerce Bank, National Association ("TCB"). For purposes of the Order, "Chase" refers to Chase and each of its predecessors. The Commission and the Office of the Comptroller of the Currency disciplined Chase in 1994 for failing to destroy cancelled bond certificates properly and for failing to file timely Missing/Lost/Stolen/Counterfeit Securities Reports on form X-17f-1A with the proper agency. In the Matter of The Chase Manhattan Bank, N.A., Admin. Proc. File No. 3-8518, Exchange Act Rel. No. 34784, 57 SEC Docket 2195 (Oct. 4, 1994).
For several years , Chase had inaccurate records regarding the dollar amount of outstanding and/or unpresented bonds for which it acted as a transfer agent. By March 1998, Chase had identified inaccuracies in CBT's computerized bond recordkeeping system of over $46.8 billion for bond issues in which CMFS had a bond agency paying function. CBT did not fully reconcile these records until after June 2000. CBT filed false TA-2 reports (annual reports required of transfer agents), maintained inaccurate records, and did not notify issuers or the appropriate regulatory agency in the prescribed manner of discrepancies in its records.
Chase, through its subsidiaries and affiliates, has been, at all times relevant to the Order, a registered transfer agent that is subject to record keeping and reporting requirements established in the Exchange Act and by the Commission. In 1997, Chase acted as the transfer agent for approximately 40,000 bond issues, including both municipal and corporate debt. As a record keeping transfer agent, Chase was required to maintain a master securityholder file and a control book for each debt issue. A master securityholder file is the official list of individual securityholder accounts that includes, among other things, the principal amount of debt held by each account. A control book is the record or other document that shows the total number of shares (in the case of equity securities) or the principal dollar amount (in the case of debt securities) authorized and issued by the issuer. Chase was also required to report aged record differences which occur when the total principal dollar amount of securities in the master securityholder file does not equal the principal dollar amount in the control book, in the manner described by Rule 17Ad-11 under the Exchange Act.
After Chase began using a single automated system to maintain its master securityholder files in late 1997, it discovered a large discrepancy in its records. Historically, Chase had employed several different automated systems to maintain its master securityholder files and utilized certain desk files as control books. By late 1997, Chase consolidated all of its transfer agent functions to the BondMaster system, a commercially available automated bond processing system. Thereafter, Chase identified 6,569 bond issues (approximately 80% of which were bearer bonds) where there was an unpresented difference, defined as when the master securityholder files reflect an aggregate difference between the dollar value of unpresented items (matured, redeemed or called bonds and past-due bearer coupons which had not been presented for payment) and the cash available to pay such items (an "Unpresented Difference"). The aggregate value of the Unpresented Difference in early 1998 was approximately $46.8 billion. The Unpresented Difference, however, did not reflect an actual liability owed by Chase because Chase had cash management systems in place that, for the most part, were accurate.
The Unpresented Difference detected by Chase accumulated over several years, as Chase and its predecessors did not accurately reflect payments and exchanges in their required records. A large portion of the Unpresented Difference arose from bond issues in which the transfer agent was a bank that had merged with Chase prior to 1998. In particular, Chase Manhattan Bank, N.A., merged with and into Chemical Bank ("Chemical") on July 14, 1996. Historically, these entities, as well as Chase, did not accurately record all payments in their master securityholder files. Instead these entities processed payments on a separate system and failed to update their master securityholder files. In addition, when converting a bearer bond issue to a registered bond issue, Chase and its predecessors did not accurately update their master securityholder files. Sometime in 1997, before Chase converted to Bondmaster, CBT became aware of a significant Unpresented Difference.
By April 1998, Chase consolidated transfer agent responsibility for most of its conventional debt issues to CBT. At that time, Chase identified an Unpresented Difference of almost $17 billion arising from the bond issues where Chemical had been the transfer agent and an Unpresented Difference of almost $28 billion from bond issues where CBT had been the transfer agent.
By approximately April 1998, Chase was also aware that many of the records it was required to keep as a transfer agent were not accurate. While trying to resolve the Unpresented Difference, Chase concluded that the authorized outstanding bond position on BondMaster for many of these bond issues was not accurate. The outstanding bond position represented the number of bonds originally issued to bondholders less any reductions attributable to principal payments, partial or full calls. Chase relied on these records to maintain its master securityholder files. Chase also subsequently concluded that some of its desk files did not satisfy the requirement that it maintain accurate and readily accessible control books.
Chase could not reconcile its records in a timely manner. In late 1999 and early 2000, after an approximately two year project to reconcile the Unpresented Difference, Chase wrote off or reserved $45.8 million largely attributable to prior processing errors on historical systems. Approximately $28.8 million of that amount resulted from payment errors including situations where Chase had erroneously paid bondholders who were not entitled to the money and Chase has set aside a reserve of $17 million to pay additional claims that may be presented. These amounts were not material to any financial reports filed by J. P. Morgan Chase or its predecessors.
In addition to its failure to maintain accurate records, Chase failed to timely report aged record differences as required by Rule 17Ad-11 under the Exchange Act. Because the total principal amount of debt for many bond issues in Chase's master securityholder files was not equal to the total principal amount for the same debt issues in Chase's control books for at least the period between April 1998 and July 1999, Chase should have reported an aged record difference. Chase did not report in the prescribed manner any aged record differences to issuers or to the appropriate regulatory agency until October 1999.
Chase, through CBT, filed false TA-2 reports for the years ended June 30, 1998 and 1999. In August 1998, CBT filed a Form TA-2 for the year ended June 30, 1998. In response to question 6 of CBT's 1998 TA-2, CBT stated that there were no issues for which it was acting as transfer agent in which the aggregate value of securities record differences existed for 30 days. In fact, as of June 30, 1998, there were aged record differences at CBT. In August 1999, CBT filed a Form TA-2 for the period ending June 30, 1999. In response to question 6 of CBT's 1999 TA-2, CBT stated that there were no issues for which it was acting as transfer agent in which an aggregate value of securities record differences existed for 30 days. In fact, as of June 30, 1999, there were aged record differences at CBT. On October 18, 1999, CBT filed an amended Form TA-2 for the period ending June 30, 1999, that reported aged record differences of approximately $16 million and noted the ongoing reconciliation project. On June 1, 2000, CBT filed a second amended Form TA-2 for the period ended June 30, 1999 which stated that the aggregate value of securities record differences that existed for 30 days was over $25 million and that additional differences might be discovered.
Chase has recently implemented a number of measures, including: (1) an automated control book system, which is reconciled regularly against the master securityholder file, which allows Chase to identify aged record differences in a timely manner; (2) the appointment of a senior compliance officer and the augmentation of its compliance staff; and (3) the reorganization and augmentation of the reconciliation function.
Section 17A(d)(1) of the Exchange Act prohibits transfer agents from, directly or indirectly, engaging in activity as a transfer agent in contravention of the Commission's rules. Pursuant to such authority, the Commission promulgated Rules 17Ac2-2, 17Ad-10(a), (b) and (e), 17Ad-11(b) and (c). Rule 17Ac2-2 requires a transfer agent to file annual reports. Rule17Ad-10(a) requires transfer agents to promptly and accurately post to the master securityholder file debits and credits containing minimum and appropriate certificate detail representing every security transferred, purchased, redeemed or issued, to post appropriate debits to a subsidiary file where certificate detail was different from the master securityholder file, and to exercise diligent and continuous attention to resolve record differences. Rule17Ad-10(b) requires transfer agents to maintain and keep current an accurate master securityholder file and subsidiary files for each security for which they act as transfer agent and to accurately reflect all debits and credits in their master securityholder files until any record differences are resolved. Rule17Ad-10(e) requires a transfer agent to maintain and keep current an accurate control book for each securities issue for which the entity acts as transfer agent. Rule17Ad-11(b) requires a transfer agent to report to issuers when the aged record difference exceeded the relevant thresholds, within ten business days of the end of each month, (i) the principal dollar amount and related market value of debt securities comprising the aged record difference; (ii) the reasons for the aged record difference; and (iii) the steps being taken or to be taken to resolve the aged record difference. Rule17Ad-11(c) requires transfer agents to report to the appropriate regulatory agency when the aged record difference exceeded the relevant thresholds, within ten business days of the end of each calendar quarter, (i) the principal dollar amount and related market value of debt securities comprising the aged record difference; (ii) the reasons for the aged record difference; and (iii) the steps being taken or to be taken to resolve the aged record difference. Finally, Rule17Ad-11(c) requires transfer agents to report to the appropriate regulatory agency debits or credits for securities transferred, purchased, redeemed or issued that were unposted to the master securityholder and/or subsidiary files for more than five business days after such debits or credits were required to be posted pursuant to Rule 17Ad-10.
Chase violated both the recordkeeping and reporting requirements of the rules described above because at the times indicated above relevant to the Order, Chase in its capacity as a transfer agent, had a discrepancy between its master securityholder files and its control books for certain issues of debt securities. Despite these aged record differences, Chase did not submit the necessary reports to the appropriate regulators and did not file accurate Form TA-2 reports, as described above.
Based on the foregoing, Chase committed or caused violations of Section 17A(d)(1) of the Exchange Act and Rules 17Ac2-2, 17Ad-10(a),(b) and (e), and 17Ad-11(b) and (c) promulgated thereunder.
In view of the foregoing, the Commission deems it appropriate to accept the Offer submitted by Chase and to impose the order to cease and desist specified therein.
Accordingly, IT IS ORDERED that:
Chase shall cease and desist from committing or causing any violation, and any future violation, of Section 17A(d)(1) of the Exchange Act, and Rules 17Ac2-2, 17Ad-10(a), (b) and (e), and 17Ad-11(b) and (c) of the Exchange Act.
By the Commission
Jonathan G. Katz
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