FILE NO. S7-13-04From: Desimone, Judy [JDesimone@williamblair.com] Sent: Monday, June 14, 2004 2:08 PM To: rule-comments@sec.gov Cc: Sargant, Tom Subject: FILE NO. S7-13-04 RMOA Regional Municipal Operations Association June 14, 2004 Jonathan G. Katz Secretary Securities & Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549-0609 Re: File No. S7-13-04 Dear Mr. Katz, The membership of the Regional Municipal Operations Association is pleased to respond to the Securities and Exchange Commissions Request for Comment of the “Concept Release: Securities Transactions Settlement”. The RMOA is a trade organization comprised of operations professionals representing regional broker/dealers, industry utilities and regulatory agencies. Our primary focus is the efficient and compliant processing of fixed income products in both the primary and secondary markets. On occasion we expand our horizon to include topics that will impact our membership. We believe that the SEC Request for Comment is one of those occasions. Therefore our comments will not be limited to debt securities. We thank the SEC for reviving the necessary conversation on topics that could potentially have a dramatic effect on the future of timely, effective and cost efficient securities settlement. Trade Confirmation and Affirmation The membership of the RMOA strongly supports the concept of same-day affirmation/confirmation of delivery vs. payment trades. We already enjoy the numerous benefits of same day comparison in the dealer-to-dealer arena and look forward to sharing that comfort level with the market participants on the buy-side. In order to achieve this worthwhile goal we believe that all parties to a trade need to accept both the responsibility and benefits of creating a matching condition. We need common standards and possibly even a common regulator to ensure that both the broker/dealer community and the buy-side are motivated to participate at the same level of intensity. Broker/Dealers cannot be put in the dual role of abider and enforcer. This is an opportunity to break new ground. We already know that current procedures have proven ineffective. We must concentrate on policies that create a new and level playing field. The unimpressive percentage of affirmed transactions on trade date tells us that we have a problem that needs to be solved. Whether improvement is a result of systemic, procedural or cultural changes is a question best answered by each participant in the process. Both the buy-side and the broker dealers will need to determine what is preventing a higher success rate. We encourage and anticipate a productive dialogue that includes both sides of the trade. Page Two June 14, 2004 Our responses to your specific questions will be from the vantage point of the regional broker/dealer. What are the benefits and costs of same-day trade confirmation/affirmation? o It is a necessary part of the foundation for the future of progressive clearance and settlement in the U.S. Securities Markets. o A more accurate picture of borrowing/lending needs on settlement date. o Early determination of problem trades. All too often we are made aware of discrepancies on settlement date. o More cost efficient settlement methods are available on affirmed transactions. What are the relative burdens of trade date confirmation/affirmation on the different market participants involved? The broker/dealer community is already matching dealer-to-dealer equity trades at the time of execution. As noted in the Request for Comment, broker/dealers are submitting trades to OMGEO for confirmation on trade date 85.8% of the time. Substantial portions of the remaining trades are awaiting submission pending the receipt of new account information or allocations. We would expect no additional burden. What effect would trade date confirmation/affirmation have on the relationship between a broker-dealer and its customer? If the requirement to match a transaction were shared equally by the broker/dealer and the buy-side, the result could be beneficial. There is little or no communication now between the Operations of the two entities. A joint responsibility in which both parties were to benefit could conceivably create a more productive relationship. If the broker/dealer were to continue to unilaterally be required to achieve a matched condition and were subject to regulatory criticism, the atmosphere could very easily turn negative. We would not want to be put in a position of evaluating the performance of our customers. Do the benefits of trade date confirmation/affirmation accrue to all participants – brokers, institutional customers, custodians or matching utilities? Do they accrue to large, medium and small entities? Regardless of the size of the participant, all parties would benefit from a scenario in which the buyer and seller and their agents agree to the terms of a trade on the day the transaction occurs. This is true in any business venture and especially when the commodity that is being traded is subject to constant price changes. Does trade date confirmation/affirmation introduce any new risks? If so, can they be quantified? There would be no additional risk in the matching of trades on trade date. Quite the contrary, risk would be substantially reduced. We have been successful in the matching of broker-to-broker trades without experiencing risk and are confident that expanding this practice to include the buy-side could only produce a positive result. Page Three June 14, 2004 Would the modification of the existing SRO confirmation rules or the adoption of a new Commission rule be feasible approaches to having trades confirmed/affirmed by T+0? Are there alternative rule changes? The rules that would govern this procedure would need to require equal responsibility from all parties involved. Rules are needed and must be enforced. The practice of “best efforts” has produced a 23% success rate. If we are to improve, we must all be equally motivated. Eventually the benefits of same day comparison will produce enough incentive to negate the need for regulatory scrutiny. If rules mandating trade date confirmation/affirmation are adopted, what should be the time frame for implementing them? What factors should the Commission consider in determining the implementation period? Should all participants in institutional trades be required to use a matching service if the Commission were to require confirmation/affirmation on T+0? The proposed rules should mandate participation in a central matching facility in order to grant or be granted delivery vs. payment privileges and also to be capable of same day confirmation/affirmation of trades. This might require firms to use a third party for these capabilities. Representatives of the buy-side would be best qualified to address the time frame necessary to assess the need and the solution. Would same-day confirmation/affirmation affect cross-border trading? If so, how would it do so? Should any confirmation/affirmation rule apply to all types of non-exempt securities? We believe that confirmation/affirmation rules should apply to all non-exempt securities and to all DVP clients. Cross border trades would require a liberal interpretation of “same day” but we feel that if the trade is affirmed by the morning of T+1, we will achieve the same benefits. Obviously if the trades are not affirmed by T+1, there must be a mechanism that allows enforcement of domestic regulations on overseas customers. A variation on the extension request similar to Regulation T could be a starting point. What, if anything, should the Commission do to facilitate the standardization of reference data and use of standardized industry protocols by broker-dealers, asset managers and custodians? If it is determined that conflicting protocols are part of the reason for an unimpressive affirmation rate on trade date, this should be brought to the attention of the common matching facility. They are in the best position to determine the alternatives. Immobilization and Dematerialization of Securities Certificates We have only to look back into recent history for proof that the immobilization/dematerialization of physical certificates has had a positive impact on the investment community. Dramatic increases in trading volume would not have been possible were it not for the combined efforts of the trade associations, DTCC and the regulatory agencies that promoted the use of book-entry only processing and alternative methods of Page Four June 14, 2004 demonstrating ownership. While it is easy to see the benefits that we have experienced it is difficult to see any negatives. There appears to be little advantage to holding a physical certificate other than habit and tradition. The retail investor has already been weaned off of the need for certificates by the myriad of products that have removed the obstacle of choice. It is difficult to imagine an investor changing their investment philosophy because of the need for a certificate. The effort to reduce, and in some cases, eliminate, the physical certificate in investment vehicles such as U.S. Treasury’s, Mutual Funds, Municipal Bonds, Money Market Instruments, Options and Futures contracts clearly demonstrates how little was lost and how much was gained. As the frequency of re-registration of physical certificates lessens we experience how lengthy, cumbersome and costly this archaic process has become. The retail investor that currently has physical certificates, places himself at a market disadvantage when his intent to sell conflicts with the timely access to the certificate. This problem gets worse if the industry moves ahead with an effort to reduce the settlement cycle to less than the current three days. Under any settlement time frame the risk of theft and loss continues to pose a problem. Replacement procedures are costly and time consuming. We see the Direct Registration System as a temporary reprieve since it offers the capability of providing registration on the books of the issuer without producing a certificate. The practice of replacing a physical certificate with a physical receipt does not go far enough in streamlining the process neither at the time of purchase nor the time of sale. DRS also relies on the retail salesman at the broker/dealer to advise the customer of the availability of this service. It is not in the best interest of the salesman to lose control of the asset. Removing the position from the books of the broker/dealer could detract from the ability of the salesman to evaluate investment objectives and portfolio performance along with the possible loss of the subsequent sell order. If DRS are to grow in popularity it will need a marketing effort that is not reliant on an uninterested participant. The membership of the RMOA believes that the elimination of the physical certificate is a necessary step on the path to a faster and more progressive settlement system. We hope that the Commission joins the industry in this effort. Securities Settlement Cycles The possibility of reducing the settlement cycle to less than the current three days is contingent upon the removal of many obstacles, not the least of which are the confirmation/affirmation of customer DVP trades and the elimination/immobilization of physical certificates. We must also consider the potential negative affect of: o Cross border trading and different or conflicting delivery rules. o New Issue concerns including CUSIP assignment, pricing/timing and distribution of official statements/prospectus’. o The overall cost and who bears the responsibility. o The required system enhancements-are they manageable for all participants. o Money market sweep timing and liquidation. Batch vs. real-time. o Mutual funds and their idiosyncrasies. o Education for the industry participants and investors. o ACATS o New concerns will surface as we begin solving the obvious. Page Five June 14, 2004 The broker/dealer community has been on a path to Straight Through Processing and has already addressed issues that effect street-side trades. All enhancements to current systems and procedures are conceived with an eye towards real-time. We have much to be proud of and much more yet to do. Unfortunately our efforts to prepare for T+1 settlement may have the negative effect of actually creating risk if we attempt a change as dramatic as a shortened settlement cycle without considering the potential impact of an unprepared buy-side. Our industry has correctly used the philosophy of Time=Risk when we debated the move from Trade date +5 to Trade date +3. Our prior successful reduction in the settlement cycle was based on the assumption that if we reduce the number of trades in the pipeline between trade date and settlement date we reduce the risk. That was excellent logic and created an excellent result. As we consider the move from Trade date +3 to Trade date +1, we must accept the possibility that final settlement of the trade and settlement date might not be the same. Therefore trades are not automatically removed from the pipeline on settlement date but must wait until trade settlement. We must also consider that risk is more than just market risk, it is also financing risk. If the street side is capable of same day comparison and next day settlement of trades, but the customer side is not prepared to accept deliveries vs. payment, our well intentioned move to Trade date +1 will add risk to the process. This should not deter us from continuing to make progressive moves to a safer and more efficient settlement system but should encourage us to use caution and move at a pace that will assure success. The starting point needs to be the dramatic improvement of matched DVP trades on trade date. We must determine what needs to be done and make it happen. If given a choice between a carrot and a stick when devising our method of gauging success, we strongly prefer the carrot. Our resources will be better spent on bringing all relevant parties to parity rather than trying to assign blame. We can begin by blending the pro-active members of our communities into a joint task force. Our trade associations need to encourage productive dialogue with the contra side of our trades. Our regulatory agencies must also participate. We will be setting a tone for all future enhancements to the clearance and settlement system. Please accept these thoughts of the membership of the RMOA, not as criticisms of the efforts of others, but more as positive recommendations and realistic assessments of what needs to be done to achieve a common goal. On behalf of the membership of the RMOA, I remain very truly yours, Thomas Sargant President Regional Municipal Operations Association 222 West Adams Street, / Suite 14 Chicago, Illinois 60606 312/364-8360