Goodwin Procter LLP
Counsellors at Law
Exchange Place
Boston, MA 02109
T: 617.570.1000
F: 617.523.1231

Elizabeth Shea Fries, P.C.

October 16, 2002

Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 5th Street, N.W.
Washington, D.C. 20549

RE: Comment File S7-12-01

Dear Mr. Katz:

Our firm represents RMA -The Risk Management Association ("RMA"), an association founded in 1914 that specializes in promoting effective and prudent risk management practices for financial institutions. RMA promotes risk management for securities lending activities conducted by its members and has previously worked with the staff of the Securities and Exchange Commission (the "Commission") to promote the understanding of securities lending transactions and operations. RMA membership consists of more than 3,000 financial service providers, which are represented in the association by more than 18,000 professionals in 50 states, Puerto Rico, Canada and numerous foreign cities, including Hong Kong and Singapore.

On behalf of RMA and its Committee on Securities Lending, we would like to submit formally our written comments regarding the regulation of certain securities lending activities following the effectiveness of amendments to the Securities Exchange Act of 1934, as amended (the "Exchange Act"), pursuant to the Gramm-Leach-Bliley Act (the "GLB Act").1 RMA commends the significant efforts of the staff in addressing these issues. As a general matter, it is the view of RMA that in light of the existing extensive regulatory framework applicable to the participants in typical institutional securities lending transactions, it is not necessary at this time to create additional regulatory oversight with respect to securities lending activity by non-custodial parties.

Securities Lending Background

In a securities lending transaction, an owner of an equity or fixed-income security (the "Lender") transfers title temporarily to another party (the "Borrower"). The Lender retains the economic rights of an owner of the securities that are the subject of the loan and has the power to terminate a loan at any time and to recall loaned securities. The Borrower secures its obligation to the Lender with collateral of equal or greater value than the loaned security. While the loan is outstanding, the Borrower agrees to remit to the Lender payments in lieu of any dividends, interest or other distributions that the Lender would have been entitled to had the security not been lent. The Borrower typically uses the loaned security to satisfy its settlement obligations (in connection with short sales or otherwise) and the Lender is compensated for the use of its security. The Lender is responsible for returning to the Borrower the principal amount of the collateral, assuming no default on the part of the Borrower.

In the 1970s US institutional investors began to lend securities to broker-dealers. These loans were most often effected through the facilities of the custodian bank, with the bank acting as agent to negotiate with Borrowers and administer loans, all for an agreed fee. Since then, the profile of the typical Lender has expanded to include all types of US and non-US institutional investment portfolios, including pension funds, mutual funds, insurance companies and others. The universe of potential Borrowers has also expanded to include both US and non-US brokers, banks and other institutions. Certain Lenders participate in "direct" transactions without the use of an agent, and the pool of potential agents has expanded beyond the traditional custodian bank of the Lender to include non-custodian banks, asset managers and other regulated institutions (collectively, "Agents"), which may render services with or without a custodial component. As a result, throughout the 1980s and 1990s the industry has expanded globally and today securities lending plays a substantial role in the liquidity of many world securities markets.2

Agency Lending Programs. In an Agent-sponsored securities lending program (an "Agency Program"), the Agent generally enters into a securities lending agreement with each Lender, which agreement authorizes the Agent, on behalf of the Lender, to lend portfolio securities of the Lender to one or more Borrowers. The securities lending agreement also typically authorizes the Agent to lend pursuant to a borrowing agreement with each Borrower on behalf of each Lender. The Agent maintains a list of creditworthy Borrowers that are eligible to participate in the Agency Program, which may be modified from time to time by the Agent. Each Lender has the ability to select Borrowers from the pre-approved list and also has the right to add Borrowers to the list, subject to the Agent's approval. Each Lender typically provides the Agent with guidelines with respect to the maximum dollar amount or percentage of its assets that may be subject to loans.

Securities loans generally are collateralized by cash ("Cash Collateral"), securities or letters of credit issued by acceptable banks. At the commencement of a lending transaction, the Borrower posts collateral at a predetermined margin, typically of at least 100% of the aggregate market value of the loaned securities, plus any accrued but unpaid interest or similar distributions thereon. The Borrower must maintain collateral at a designated margin level during the term of an outstanding loan, which level is monitored by the Agent. On a daily basis, the Agent determines the market value of the loaned securities and the market value of the collateral in accordance with its valuation policies (a process commonly referred to as "marking to market"), and, subject in certain cases to de minimis marking criteria, if the value of the collateral is insufficient, either (i) notifies the Borrower that it must deliver additional collateral to meet the designated margin level, or (ii) causes excess collateral to be returned to the Borrower.

When the collateral is Cash Collateral, typically the Agent on behalf of the Lender invests the Cash Collateral during the loan period in investments approved by the Lender. The Agent uses proceeds from the Cash Collateral investments to pay the Borrower an agreed-upon interest rate (commonly known as a "rebate"). The Agent retains a percentage of the fee or the proceeds from the Cash Collateral investments net of rebate, as compensation for its services, and returns the remainder to the Lender. If the collateral is non-Cash Collateral, the Borrower pays a lending fee. The Agent typically is responsible for the administration of the loans, including identifying Borrowers (including conducting due diligence and assessments of credit-worthiness), negotiating loan transactions to be effected between approved Borrowers and the Lender, maintaining the books and records of securities loans made by the Lender, marking to market each day all outstanding loans, ensuring that the value of collateral received in connection with such loans is equal to a specified percentage of the value of securities loaned, monitoring the delivery and maintaining control of the collateral, processing investments of cash collateral and monitoring delivery to the Lender of any distributions (or payments in lieu of distributions) on loaned securities. In many Agency Programs, the Agent provides indemnification to the Lender in the event of the default of the Borrower or in other circumstances where the Lender might bear a loss in connection with its securities lending activities.

Custodial and Non-Custodial Agents. As noted above, securities lending developed largely out of the activities of institutional investors and their custodian banks. In general, custodian banks provide safekeeping services and facilitate the transfer of funds and securities in connection with the clearance and settlement of transactions. Because custodian banks generally hold large portfolios of securities for numerous clients, they can easily identify securities that a Borrower may be seeking to borrow. Securities lending developed as an outgrowth of custodial services, with custodians effecting and settling transactions in both securities and collateral on their custodial systems, and subject to the same regulatory review and oversight as their custody and safekeeping activities. A custodial Agent therefore provides the additional services of holding the collateral and settling securities lending transactions.

The growth of the securities lending business, including the desire of Lenders to increase revenues through lending activities, and the needs of Borrowers to obtain securities for the smooth operation of the global securities markets, led to the development of non-custodial securities lending programs whereby Agents offer securities lending services to institutional clients for whom they may not act as custodian with respect to the applicable securities. The growth of lending by non-custodial Agents increases competition in the securities lending marketplace, resulting in greater efficiencies and decreasing costs for Lenders and Borrowers. There are some Agents who act solely as non-custodial Agents, and others who combine the activities of custodial Agents and non-custodial Agents in the same or different parts of their business.

Non-custodial Agents coordinate with the Lender's custodian so that securities lending service may be provided by the Agent, while the custodian provides the primary safekeeping service. Furthermore, many custodial Agents also provide securities lending services to certain non-custodial clients. Whether or not an Agent provides safekeeping services together with its securities lending services to a particular client, its role and compensation is largely the same. The major distinction between custodial and non-custodial Agents is that a custodial Agent carries out the actual settlement and safekeeping function for securities lending transactions, while a non-custodial Agent issues instructions to the custodian regarding movements of cash and securities in connection with its lending activities. With respect to securities which are out on loan, non-custodial Agents may carry out many of the same operational functions as custodial agents, including: marking to market of loan positions; collection of substitute income payments; monitoring corporate actions; and reporting. Moreover, custodial and non-custodial Agents use similar systems, processes and personnel to render these services.

Lenders and Borrowers. Despite the growth of the securities lending business and its role in the global securities markets, securities lending is an institutional transaction generally unavailable to retail investors. Typical Lenders include governmental employee benefit plans, benefit plans subject to the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), central banks, insurance companies, bank-maintained common and collective trust funds, and investment companies ("Mutual Funds") registered under the Investment Company Act of 1940, as amended (the "1940 Act"). These institutional Lenders are generally subject to limitations on their securities lending activities under their investment guidelines and many are subject to additional substantive regulation. For example, benefit plans subject to Title I of ERISA typically must conduct their lending activity in accordance with the conditions set forth in Prohibited Transaction Class Exemption 81-63 to avoid prohibited transactions. Similarly, securities lending activity by Mutual Funds is limited by, among other things, a series of interpretive and no-action letters issued by the staff of the Commission's Division of Investment Management.4 Typical Borrowers are registered broker-dealers and banks, each of which is subject to extensive regulatory requirements and oversight,5 as well as limitations under Regulation T promulgated by the FRB.

Regulation of Agency Programs

As described above, the institutions involved in securities lending activities are typically highly regulated institutions. The Agents that initially developed Agency Programs were custodian banks. These Agents were "banks" within the meaning of Section 3(a)(6) of the Exchange Act and therefore excluded from the definition of "broker" in Section 3(a)(4) of the Exchange Act.6 Accordingly, whether or not the activities of a securities lending Agent involved effecting transactions in securities as contemplated in Section 3(a)(4) of the Exchange Act, these activities did not subject the Agent to regulation by the Commission as a broker.

Under the GLB Act, as of the effective date of the applicable provisions of the GLB Act (the "Effective Date"), the definition of a "broker" is amended such that banks will no longer benefit from the blanket definitional exemption but rather will need to rely upon one of the enumerated exemptions found in the GLB Act. One of these enumerated exemptions applies to a bank that is engaged in securities lending activities as part of certain custody, safekeeping, transfer or custodial clearing services7 (hereinafter, the "Custodial Exemption"). Accordingly, following the Effective Date most Agent banks will continue to conduct their Agency Programs without registration as a broker under the Exchange Act.

The Custodial Exemption applies to securities lending transactions effected by a bank "as part of" custodian and safekeeping services. If the Custodial Exemption were narrowly interpreted, an Agent may need to have registered as a broker in order to provide services to certain non-custodial clients and, yet, may be in a position to render identical services to custodial clients pursuant to the Custodial Exemption. Under these circumstances, the same Agent may be subject to regulation and examination by Federal Banking Authorities with respect to its activities for its custodial clients and by the Commission with respect to activities for its non-custodial clients.

RMA believes that, regardless of any authority of the Commission to impose regulation on certain Agents, there is presently no need to require registration of Agents as brokers in connection with non-custodial securities lending activity because the securities lending industry is well regulated within the existing framework of functional regulation applied to the institutional participants in the securities lending markets. Accordingly, RMA believes that an Agent should not be required to register as a broker if it seeks to provide securities lending services (including identifying Borrowers, negotiating loans, maintaining books and records, marking to market loans, managing and investing collateral, providing indemnification in the event of borrower default, and monitoring distributions (or payments in lieu of distributions) and corporate actions) to institutional clients for which the Agent does not render any custodial or safekeeping services.

We believe there is both a functional basis and a regulatory basis for the position that an Agent not be regulated as a "broker" in connection with securities lending services provided to institutional clients for which the Agent does not render any custodial or safekeeping services. From a functional perspective, as described above, custodial and non-custodial Agents rendering securities lending services render effectively the same services and use the same custodial-based systems and processes regardless of their capacity. These systems are generally separate from the systems of any affiliated broker-dealer (including any Borrower), and Agents generally believe it is appropriate to segregate their agency activities from their borrowing activities. Causing certain non-custodial agency activities to be conducted through a registered broker-dealer could jeopardize this segregation.

As defined within the scope of this letter, non-custodial Agents are (i) banks within the meaning of the Exchange Act, (ii) banks within the meaning of the 1940 Act, (iii) asset managers and (iv) other regulated institutions, each of which is subject to independent regulation by its primary functional regulator. In particular, most banks are subject to examination and oversight by the network of Federal Banking Agencies, which have extensive experience regulating securities lending activities and, particularly, Agency Programs.8 Other Agents may be regulated by state banking authorities or other regulators. From a regulatory perspective, to the extent that an Agent would be required to register as a broker, the efficiency of having an experienced regulator for the securities lending marketplace would be reduced as conceivably the Federal Banking Agencies would regulate custodial securities lending and the Commission would regulate non-custodial securities lending with different outcomes possible or, at a minimum, a need to coordinate policy to ensure regulatory standards and consistency within the securities lending marketplace. In the context of the securities lending marketplace in which Lenders, Borrowers and Agents are institutions and are generally highly regulated institutions, we believe such additional regulation is unnecessary and potentially detrimental to the operation of the markets.


On behalf of RMA and its Committee on Securities Lending we request that the Commission consider interpretive or exemptive rulemaking to provide that regulated institutions may serve as non-custodial Agents and carry out securities lending activities without registration with the Commission as brokers or dealers. Should you have any questions or require additional information, please contact the undersigned at the above address and phone number. We appreciate the opportunity to provide these comments.


Elizabeth Shea Fries, P.C.

cc: Catherine McGuire
RMA Securities Lending Executive Committee


1Pub. L. No. 106-102, 113 Stat. 1338 (1999).
2See generally, Securities Lending Transactions: Market Development and Implications, report prepared by the Technical Committee of the International Organization of Securities Commissions and the Committee on Payment and Settlement Systems, July, 1999.
3These conditions include the following: (1) neither the Borrower nor an affiliate of the Borrower may have discretionary authority or control with respect to the investment of ERISA plan assets; (2) collateral consisting of cash or securities with a market value equal to not less than 100% of the market value of the securities lent must be maintained for the plan at all times; (3) prior to the making of a loan the Borrower must provide to the plan the Borrower's most recent available audited financial statement, the most recent available unaudited financial statement (if more recent than the audited financial statement) and representation that, at the time the loan is negotiated, there has been no material adverse change in its financial condition since the date of the most recent financial statement disclosed; (4) the loan must be made pursuant to a written agreement the terms of which are arm's length; (5) the plan must receive a reasonable fee related to the value of the borrowed securities and the duration of the loan and must have the opportunity to derive compensation through the investment of cash collateral; (6) the plan must receive the equivalent of all distributions made to holders of the borrowed securities (including dividends, interest payments, shares of stock); (6) there must be a daily mark to market; and (7) the plan may terminate the loan at anytime.
4E.g., State Street Bank and Trust Company, SEC No-Action Letter (available January 29, 1972 and September 29, 1972).
5Securities borrowing activity by broker-dealers is subject to certain specific provisions of the Exchange Act providing, among other things: (1) the borrowing of securities is done pursuant to an written agreement; (2) the broker-dealer must provide to the lender collateral having a value, based on a daily mark to the market, of not less than 100% of the market value of the securities loaned; and (3) the collateral must be in the form of cash, U.S. Treasury and Treasury notes or a specific type of irrevocable letter of credit. See, Exchange Act Rule 15c3-3. Banks, on the other hand, typically operate within the regulatory framework and safeguards developed by the Comptroller of the Currency (the "OCC"), the Board of Governors of the Federal Reserve System (the "FRB"), the Office of Thrift Supervision (the "OTS") and the Federal Deposit Insurance Corporation (the "FDIC") (collectively, the "Federal Banking Agencies") and/or the regulation and oversight of state bank regulators.
6"[T]he term "broker" means any person engaged in the business of effecting transactions in securities for the account of others, but does not include a bank." (Emphasis added).
7Section 3(a)(4)(B) (viii): "EXCEPTION FOR CERTAIN BANK ACTIVITIES- A bank shall not be considered to be a broker because the bank engages in any one or more of the following activities under the conditions described:
. . .


    (I) IN GENERAL- The bank, as part of customary banking activities--

      (aa) provides safekeeping or custody services with respect to securities, including the exercise of warrants and other rights on behalf of customers;

      (bb) facilitates the transfer of funds or securities, as a custodian or a clearing agency, in connection with the clearance and settlement of its customers' transactions in securities;

      (cc) effects securities lending or borrowing transactions with or on behalf of customers as part of services provided to customers pursuant to division (aa) or (bb) or invests cash collateral pledged in connection with such transactions [emphasis added]...."

    8See, e.g., Federal Financial Institutions Examination Council Policy Statement on Securities Lending, 62 Fed. Reg. 38991 (July 21, 1997).