[Code of Federal Regulations]
[Title 31, Volume 2]
[Revised as of July 1, 2002]
From the U.S. Government Printing Office via GPO Access
[CITE: 31CFR357.45]
[Page 412-427]
TITLE 31--MONEY AND FINANCE: TREASURY
CHAPTER II--FISCAL SERVICE, DEPARTMENT OF THE TREASURY
PART 357--REGULATIONS GOVERNING BOOK-ENTRY TREASURY BONDS, NOTES AND BILLS (DEPARTMENT OF THE TREASURY CIRCULAR, PUBLIC DEBT SERIES NO. 2-86)--Table of Contents
Subpart D--Additional Provisions
Sec. 357.45 Supplements, amendments, or revisions.
The Secretary may, at any time, prescribe additional supplemental,
amendatory or revised regulations with respect to securities, including
charges and fees for the maintenance and servicing of securities in
book-entry form.
Appendix A to Part 357--Discussion of Final Rule
Background
Twenty-four written comments were received to the notice of proposed
rulemaking from various sources, including Federal agencies, trade
associations, as well as financial and commercial investment
institutions. With the exception of one bank, all commentators endorsed
the concept of a certificateless security.
The grouping and identification of the comments received have been
made on a section-by-section basis, with an explanation of the action
taken with respect thereto. As circumstances necessitated the
publication of the rule in two segments, in order to make each part more
understandable, certain definitions, such as those for ``Department''
and ``securities'', have appeared in the proposed rule for both TREASURY
DIRECT and TRADES, and were slightly modified in the proposed rules on
TRADES. Because these modifications represent non-substantive
clarifications, and to avoid confusion as between the two portions of
the rules, the definitions as used in TRADES have been adopted.
Section-By-Section Analysis
Section 357.21 Registration.
The forms of registrations provided for securities to be held in
TREASURY DIRECT have different legal effect from those currently
provided for in the case of definitive Treasury securities and for the
Treasury's book-entry Treasury bill system. A comment was received that,
as a result, this could lead to some confusion, and that the Treasury
bill forms of recordation currently offered should be changed,
particularly since Treasury bills will be phased into TREASURY DIRECT
gradually. The Bureau believes that the benefits of uniformity of rights
and interests that TREASURY DIRECT investors will derive far outweigh
any possible confusion. As for confusion with the current Treasury bill
book-entry system, given the fact that Treasury bills have a term of not
more than a year, it is believed that the problem, if any, will be
short-lived.
Given the importance of the change that TREASURY DIRECT provides as
to registration, the discussion thereof that accompanied the Notice of
Proposed Rulemaking is re-published below.
``Forms of Registration. The proposed rule provides the investor
with a variety of registration options. They are essentially similar to
those provided for registered, definitive marketable Treasury
securities. Investors should be particularly aware that,
[[Page 413]]
where the security is held in the names of two individuals, the
registration chosen may establish rights of survivorship.
``The reason for establishing the rights of ownership for securities
held in TREASURY DIRECT is that it will give investors the assurance
that the forms of registration they select will establish conclusively
the rights to their book-entry securities. It will also serve to
eliminate some of the uncertainties, as well as possible conflicts,
between the varying laws of the several States.
``A Federal rule of ownership is being adopted by the Treasury for
TREASURY DIRECT securities. This regulatory approach is consistent with
the one previously taken in the case of United States Savings Bonds. It
will have the effect of overriding inconsistent State laws. See, Free v.
Bland, 369 U.S. 663 (1962).
``In the case of individuals (who are likely to be by far the
majority of holders of securities in TREASURY DIRECT), the options
offered will permit virtually all the preferred forms of ownership. At
the investor's option, it will be possible to provide for the
disposition of the securities upon death through rights of survivorship.
``Coownership registration. One option is the coownership form of
registration, i.e., ``A or B.'' Unlike the current Treasury bill book-
entry system being administered by the Bureau of the Public Debt, a
security held in TREASURY DIRECT registered in this form will be
transferable upon the written request of either coowner. Other changes
in the account may also be made upon the request of either party. While
this form of registration will facilitate the receipt of payments and
provide ease in conducting transactions, care should obviously be
exercised in designating a coowner.
``Joint ownership. For those who would prefer to have the
transferability of a security held in two names contingent upon the
request of both, the joint form of registration will be appropriate.
This form of registration, i.e., ``A and B, with [without] the right of
survivorship,'' will require the agreement of both parties to conduct
any authorized transaction.
``Beneficiary form. The beneficiary form, i.e., ``A payable on death
to (POD) B,'' will permit the owner to have sole control of the account
during his/her lifetime, but in the event of death, the account will
pass by right of survivorship to the beneficiary.''
One commentator questioned the ``natural guardian'' and ``voluntary
guardian'' forms of registration provided in the regulations, pointing
out that financial institutions are reluctant to establish an account in
the name of a natural guardian of a minor because of the uncertainties
as to who might be entitled to the funds on the death of the natural
guardian or minor, or when the minor reached majority. It was mentioned
that a bank would be reluctant to open an account in the name of a
voluntary guardian, or to release funds from an existing account to a
voluntary guardian because of the potential risk in the event of a claim
from a court-appointed guardian. It seems apparent that the comment was
prompted by the provision that appeared in the proposed rule that the
account held in TREASURY DIRECT and the deposit account to which
payments are to be directed should be in the same form. As hereafter
pointed out in the discussion under the payment section, this is not a
requirement.
While parents are universally recognized as the natural guardians of
the person of minors, they have generally not been recognized as
entitled to control the estates of these minors, except perhaps in the
case of small amounts. Traditionally, the guardian of the estate of a
minor involves judicial appointment and supervision. In order to provide
a means of dealing with the problem of disposing of securities
inadvertently registered in the name of minors without requiring the
appointment of a legal guardian and to provide a means for investing
funds of a minor, which did not technically qualify for investment under
the Uniform Gifts to Minors Act, the Department decided to provide
recognition for natural guardians.
The voluntary guardianship procedure is wholly a creature of the
Department's regulations. It was established in recognition of the
burden placed on an incompetent's estate and his/her family by requiring
the appointment of a legal guardian to receive the interest on, or to
redeem securities for, the account of an individual who has become
incompetent, at least where the incompetent's estate is relatively
modest. This form of registration is not available on original issue and
is limited to an aggregate of $20,000 (par amount) of TREASURY DIRECT
securities. The $20,000 limit in connection with the use of the
voluntary guardianship procedure is in keeping with the limits used in
connection with the summary administration of decedents' estates under
the laws of many States.
Section 357.23 Judicial proceedings.
No comments were received regarding the provisions on judicial
proceedings. Given their importance, the discussion that accompanied the
publication thereof in proposed form is included here.
Judicial proceedings. Under the principle of sovereign immunity,
neither the Department nor a Federal Reserve Bank, acting as fiscal
agent of the United States, will recognize a court order that attempts
to restrain or enjoin the Department or a Federal Reserve Bank from
making payment on a security or from disposing of a security in
accordance with instructions of the owner as shown on the Department's
records.
[[Page 414]]
``The Department will recognize a final court order affecting
ownership rights in TREASURY DIRECT securities provided that the order
is consistent with the provisions of subpart C and the terms and
conditions of the security, and the appropriate evidence, as described
in Sec. 357.23(c), is supplied to the Department. For example, the
Department may recognize final orders arising from divorce or
dissolution of marriage, creditor or probate proceedings, or cases
involving application of a State slayer's act. The Department will also
recognize a transaction request submitted by a person appointed by a
court and having authority under an order of a court to dispose of the
security or payment with respect thereto, provided conditions similar to
those above are met.''
Section 357.25 Security interests.
TREASURY DIRECT is not designed to reflect or handle the various
types of security interests that may arise in connection with a Treasury
bond, note or bill. However, the Treasury has from time to time and to a
limited extent held in safekeeping, for such agencies as the Customs
Service and Immigration and Naturalization Service, Treasury securities
submitted in lieu of surety bonds in accordance with 31 U.S.C. 9303.
While the Federal Reserve Banks handle the majority of such pledges and
will continue to do so, as this statute requires the Treasury to accept
these Government obligations so pledged, a provision has been added for
accepting and holding book-entry securities submitted for such purposes.
Section 357.26 Payments.
(a) General. Most comments focused on the provisions on payments. A
key feature of TREASURY DIRECT will be the making of payments by the
direct deposit method (also known as the electronic funds transfer or
ACH method). Checks will be issued only under extraordinary
circumstances. A number of comments endorsed the concept of payment by
direct deposit as an improvement given the difficulties associated with
checks.
One comment expressed concern as to who would have the burden of
resolving errors in cases where a receiving financial institution fails
to properly credit a payment. The Department has concluded that while
the direct deposit payment method is not without risks, it is far
superior to the use of checks, in terms of the risks, potential losses,
and costs. In a case where a receiving institution fails to act in
accordance with the instructions given it, the Bureau intends to use its
best efforts to assist investors in rectifying the error.
(b) Direct deposit. A number of comments expressed the view that the
TREASURY DIRECT payment system should adopt either the rules governing
the direct deposit of Government payments (31 CFR part 210), or the
rules of the National Automated Clearing House Association (``NACHA
Rules''), but not separate rules. The final rules have adopted some of
the existing practices applicable to commercial ACH payments, but it is
not possible for the Department of the Treasury to conform to all of
these rules. For example, the Treasury has no authority to indemnify
recipients of direct deposit payments, although such indemnification by
a sender is contemplated in the NACHA rules and was advocated in several
comments. It should also be noted that the rules applicable to TREASURY
DIRECT payments are modeled, to some extent, on the rules for Government
direct deposit payments in order to take advantage of the large number
of entities that are a part of the Government direct deposit network.
See the discussion under paragraph (b)(2). Where there are unique rules
applicable to TREASURY DIRECT, however, they are explained here.
Given the variance between the procedures set out in the proposed
rules and existing practice, and the increased burdens resulting
therefrom, several clearing house associations and financial
institutions requested that the implementation of TREASURY DIRECT be
delayed from July 1986 to July 1987. The Treasury is satisfied that the
added burdens that would have been imposed on financial institutions to
receive TREASURY DIRECT payments under the proposed rules have been
effectively eliminated in the final rule. Thus, Treasury plans to
implement the system on or about the original target date. The final
rules are being published, however, in advance of actual implementation
so as to give financial institutions an opportunity to make whatever
remaining, minor procedural changes as may be necessary.
(b)(1) Information on deposit account at financial institution. The
proposed regulations provided that the owner of a security in TREASURY
DIRECT, or in the case of ownership by two individuals, the first-named
owner, must be an owner of, and so designated, on the account at the
receiving financial institution. The regulations also provided that in
any case in which a security is held jointly or with right of
survivorship, the account at the financial institution should be
established in a form that assures that the rights of each joint owner
or survivor will be preserved.
The rule requiring the naming of the first-named owner on the
receiving financial institution account was based on tax reporting
considerations. It has now been determined that the first-named security
owner need not be named on the receiving deposit account.
The rule relating to establishment of the receiving account in joint
ownership cases in
[[Page 415]]
the same form as the registration of the security was intended to be a
notice to investors of a potential problem, rather than a requirement.
In cases where an investor intends a beneficiary, joint owner or coowner
to receive securities after the investor's death, this intention may be
defeated if the recipient is not also named on the receiving deposit
account. It is up to the investor to examine his or her particular
circumstances and determine whether the form in which the deposit
account will be held is satisfactory. This matter has been clarified in
paragraph (b)(1)(v) of the final rule. Except for the restriction
described in paragraph (b)(1)(ii) (see below), the Treasury does not
intend to establish any limitations on how the receiving deposit account
is held.
Several comments addressed the issue of the registration of the
security versus the title of the deposit account. Two comments pointed
out that if the deposit account must be in the same form as the
registration of the security, then existing traditional forms of
ownership for bank accounts, which do not include all the forms of
registration for securities held in TREASURY DIRECT, would not suffice.
Concerns were also expressed that with multiple forms of ownership,
financial institutions could become involved in disputes with investors.
As noted above, there is no requirement that the TREASURY DIRECT account
and the deposit account be identical. The responsibility to choose the
title of the deposit account rests with the investor.
Another comment objected to the rule that the first-named security
owner be named on the receiving deposit account because the rule would
eliminate the possibility of payment to an account at a financial
institution in the name of a mutual fund, security dealer, or insurance
company. Although the change in the tax reporting rule described above
permits payment to such accounts, as well as to trust accounts, since it
appears that there is a question as to the capability of some receiving
institutions to handle such payments, investors are strongly urged to
consult their financial institution before requesting such payment
arrangements. See paragraph (b)(1)(iii).
It should be emphasized that any payments that must be made by check
will be made in the form in which the TREASURY DIRECT account is held,
which may be different than the form of the deposit account. Investors
should be aware that this may result in checks being issued, and thus
payment being made, in a form different than they intended the direct
deposit payments to be made. For example, if Investor A purchases a
security in his or her name alone with instructions that payments be
directed to a financial institution for the account of a money market
fund, any checks that must be issued will be drawn in the name of
Investor A. This could happen if Investor A furnishes erroneous payment
instructions and the problem cannot be resolved before a payment date,
in which case a check would be issued.
The one restriction on the form of the deposit account that appears
in paragraph (b)(1)(ii) of the final regulations is a rule that where
the TREASURY DIRECT account is in the name of individual(s), and the
receiving deposit account is also in the name of individual(s), one of
the individuals on the TREASURY DIRECT account must be named on the
deposit account. This rule is intended to provide a means to determine
the disposition of the payment, if necessary. The Treasury does not
expect financial institutions to monitor this rule.
Provision has been made in paragraph (b)(1)(vii) to permit financial
institutions to request ``mass changes'' of deposit account numbers
without the submission of individual requests from investors to TREASURY
DIRECT. This procedure is intended for use where an institution changes
all or an entire group of its account numbers, typically as a result of
an organizational change. TREASURY DIRECT will honor requests from a
financial institution to change deposit account numbers under such
circumstances, with the understanding that the institution agrees to
indemnify the Treasury and the security owners for any losses resulting
from errors made by the institution. If the institutions does not wish
to use the ``mass change'' procedure, then the change in account number
must be requested by the investor, using the authorized transaction
request form. See Sec. 357.28.
Some institutions voiced concern in general about investor errors in
furnishing the TREASURY DIRECT a deposit account number and the
financial institution's routing number. Although the Treasury plans to
provide as much assistance to investors as possible, the investor must
bear the responsibility for securing accurate payment information.
Investors are urged to consult with their receiving institution to
verify the accuracy of the payment information, since neither the
Treasury nor the receiving financial institution would be responsible
for payment errors resulting from erroneous information provided by
investors.
The proposed rule provided in Sec. 357.26(b)(1)(iii) that the
designation of a financial institution by a security owner to receive
payments from TREASURY DIRECT would constitute the appointment of the
financial institution as agent for the owner for the receipt of
payments. The crediting of a payment to the financial institution for
deposit to the owner's account, in accordance with the owner's
instructions, would discharge the United States of any further
responsibility for the payment. One comment noted that, in contrast, the
rule in 31 CFR 210.13 for Federal recurring payments is that
[[Page 416]]
the United States is not acquitted until the payment is credited to the
account of the recipient on the books of a financial institution.
Although, in principle, the same rules should apply to all
Government payments, the proposed TREASURY DIRECT rule has been retained
in the final regulations on the basis of the major differences in the
procedures to be used in TREASURY DIRECT. Most significantly, the
Treasury will not be securing any written verification (i.e., an
enrollment form) from a financial institution as to the accuracy of the
deposit account number and other payment information, as is now the
practice in the case of payments under 31 CFR part 210. Under these
circumstances, the Treasury cannot, in effect, guarantee that a payment
will be credited by a financial institution to the correct account. It
should also be noted that this rule on acquittance of the United States
is consistent with the provision in Sec. 357.10(c) of the proposed
regulations on TRADES. In practice, however, the Treasury plans to
participate actively in seeking to locate and recover any payments that
have been misdirected.
(b)(2) Agreement of financial institution. The proposed rule
provided, in Sec. 357.26(b)(2), that a financial institution which has
agreed to accept payments under 31 CFR part 210 shall be deemed to have
agreed to accept payments from TREASURY DIRECT. The rule further
provided that an institution could not be designated to receive TREASURY
DIRECT payments unless it had agreed to accept direct deposit payments
under 31 CFR part 210.
One financial institution commented that a receiving institution
that has already agreed to accept part 210 payments should have the
choice as to whether to accept payments from TREASURY DIRECT. The basis
for this comment was the perception that the receipt of TREASURY DIRECT
payments would require the implementation of special procedures by the
financial institution and expose it to additional risks. As explained
earlier, the Treasury has significantly modified the procedures and
reduced the requirements imposed upon a financial institution in order
to receive TREASURY DIRECT payments, and decreased as well the risks an
institution will incur in the receipt of such payments. Thus, the
proposed rule on eligibility of receiving institutions has been retained
in the final rule in essentially the same form.
Two other comments were made to the effect that the category of
institutions receiving payments should be broadened. In deciding to
authorize payments to all institutions receiving part 210 payments, the
Treasury considered the fact that many more institutions are designated
endpoints for Government (direct deposit) payments than for commercial
ACH payments. In order to afford investors the widest choice of
recipient institutions, all institutions that had agreed to accept part
210 payments were designated as authorized recipients. Treasury has now
broadened the rule further to also authorize those financial
institutions that are willing to agree to accept part 210 payments in
the future. This rule will permit investors to designate institutions
that are not now receiving Government direct deposit payments as the
recipients of their TREASURY DIRECT payments if the institutions make
appropriate arrangements with the Federal Reserve Bank of their
District.
(b)(3) Pre-notification. A significant feature of the TREASURY
DIRECT payment procedure will be the use of a pre-notification message
sent to the receiving financial institution in advance of the first
payment. This procedure, already in use for commercial ACH payments,
alerts the institution that a payment will be made and provides an
opportunity for verification of the accuracy of the account information.
The proposed regulations provided that the financial institution
would be required to reject the pre-notification message within four
calendar days after the date of receipt if the information contained in
the message did not agree with the records of the institution or if for
any other reason the institution would not be able to credit the
payment. The rules also stated that a failure to reject the message
within the specified time period would be deemed an acceptance of the
pre-notification and a warranty that the information in the message was
accurate.
Because there was some confusion over when the pre-notification
message woud be sent, the final rules clarify, in paragraph (b)(3)(i),
that in most cases, this will occur shortly after establishment of a
TREASURY DIRECT account. The Treasury has under consideration a system
change that would permit a second pre-notification to be sent closer to
the time of the payment if the first payment is to occur a substantial
length of time after account establishment.
One of the items of information contained in a pre-notification
message is the name the investor has indicated appears on the deposit
account. Comments were received that existing procedures and software do
not permit automatic verification of the account name. Although there is
apparently some variation in practice, and some institutions undertake
to verify the account name information manually, the Treasury has
decided to drop the account name verification requirement in the final
rules. This means that under paragraph (b)(3)(ii), a financial
institution need only verify the account number and type designations on
the pre-notification message. However, the Treasury urges institutions
which are able to verify account
[[Page 417]]
names to do so and encourages the development of software that would
have this capability.
A number of comments urged that the four-day period provided for an
institution to reject a pre-notification message be lengthened. After
consideration of the various alternatives proposed, the Treasury has
concluded that an eight-day period will meet the needs of most
institutions. See paragraph (b)(3)(ii) of the final rule. In responding
to a pre-notification message, an institution may use the NACHA's
``notification of change'' procedure, standardized automated rejection
codes, or any other similar standard procedure. Upon receipt of such
notification, the Treasury will either make the necessary changes in the
TREASURY DIRECT account or contact the investor, depending on the
circumstances.
One commentator objected to the warranty by the receiving
institution as to the accuracy of the pre-notification information,
particularly in view of the manual verification or changes in procedures
that would be required, and the resulting possibility of error. As
previously noted, the requirement to verify an account name has been
eliminated. In addition, language has been added to make it clear that
the verification is limited to the time of pre-notification. The
Treasury is of the view that the warranty is a useful concept in
encouraging institutions to respond to pre-notification messages and
will benefit all concerned by increasing the likelihood that payments
will be made accurately and to the appropriate party.
(b)(5) Responsibility of financial institution. The proposed
regulations provided, in Sec. 357.26(b)(5)(ii), that a financial
institution that receives a TREASURY DIRECT payment on behalf of a
customer would be required to promptly notify the Treasury when it has
made a change in the status or ownership of the customer's deposit
account, such as the deletion of the first-named owner of the security
from the title of the account, or when the institution is on notice of
the death or incompetency of the owner of the deposit account.
Several financial institutions objected to this requirement on the
grounds that it would be burdensome and would require the development of
new procedures to monitor the changes in deposit accounts. Specifically,
several institutions indicated they would be unable to relate the
receipt of TREASURY DIRECT payments, which would be handled in a
centralized area of the institution, to the changes being made in a
deposit account, which are handled in another operational area of the
institution. These institutions said they would not necessarily be aware
of who is the first-named owner of the security in TREASURY DIRECT, and
that more responsibility should be placed on the security owner in
reporting changes.
In response to these comments, the Treasury has narrowed the
notification rule, in paragraph (b)(5)(ii) of the final rule, to require
a financial institution to notify TREASURY DIRECT only in cases where it
is on notice of the death or legal incapacity of an individual named on
the deposit account, or where it is on notice of the dissolution of a
corporation named in the deposit account. Upon receipt of notice by the
area of the institution that receives credit payments, the institution
will be required to return any TREASURY DIRECT payments received
thereafter.
(b)(6) Payments in error/duplicate payments. The proposed
regulations, in Sec. 357.26(b)(6), set out rules describing the
procedure that would be followed in cases where the Treasury or a
Federal Reserve Bank has made a duplicate payment or a payment in error.
First, the financial institution to which the payment was directed would
be provided with a notice asking for the return of the amount of the
payment remaining in the deposit account. If the financial institution
were unable to return any part of the payment, it would be required to
notify the Treasury or its Federal Reserve Bank, and provide the names
and addresses of the persons who withdrew funds from the deposit account
after the date of the duplicate payment or the payment in error. If the
financial institution did not respond to the notice within 30 days, the
financial institution's account at its Federal Reserve Bank could be
debited in the amount of the duplicate or improper payment.
Several institutions raised objections about various aspects of the
above procedures. One stated that 30 days was an insufficient time to
respond and urged conformity with the rules in 31 CFR part 210
permitting a 60-day response time. Some objected to furnishing
information about the persons who withdrew money from an account.
Several objected in principle to the provision authorizing the debiting
of their accounts. Several comments indicated that if a payment is
returned by a financial institution using an automated payment reversal
procedure, then only the full amount of the payment (not a partial
amount) can be reversed.
In the final rule, the Treasury has clarified the procedures. The
requirement to provide the names of persons who withdrew funds from an
account has been changed. In paragraph (b)(6)(i), financial institutions
are asked to provide only such information as they have about the
matter. The debiting of an institution's account at a Federal Reserve
Bank is intended to be simply a last resort if the institution fails
totally to respond to the notice of a duplicate payment or payment made
in error. See paragraph (b)(6)(iii). The time provided for response to
this notice has been lengthened to 60 days.
[[Page 418]]
The final rule has also been clarified in paragraph (b)(6)(i) to
provide that the amount that should be returned is an amount equal to
the payment. The Treasury reserves the right, however, to request the
return by other than automated means of a partial amount of a payment
made in error. It is anticipated that such a procedure would occur only
if the notice of a payment made in error is not issued immediately after
the payment was made.
(d) Handling of payments by Federal Reserve Banks. Some of the
comments raised a question about the liability of the Federal Reserve
Banks in making payments. The proposed rule, in Sec. 357.26(d)(2),
provided that each Federal Reserve Bank would be responsible only to the
Department and would not be liable to any other party for any loss
resulting from its handling of payments. This rule was taken from the
existing regulations in 31 CFR part 210 (see Sec. 210.3(f)), and is
simply a restatement of existing law.
In making payments, the Federal Reserve Banks are acting in the
capacity as fiscal agents of the United States, pursuant to 12 U.S.C.
391. They are not acting in an individual (banking) capacity. If a
Federal Reserve Bank misdirects a payment contrary to instructions
provided by the investor, the United States, as principal, may remain
liable to the investor for the payment. The United States could seek to
recover any loss from its agent, the Fedeal Reserve Bank. However,
because the proposed rule simply stated a legal conclusion and tended to
create the impression that the rule was broader than intended, it has
been omitted from the final regulations.
Section 357.31 Certifying individuals.
For clarity, the warranties which accompany the use of a ``Signature
guaranteed'' stamp have been set out.
Section 357.42 Preservation of existing rights.
This section has been deleted. The same subject-matter will be
covered in Sec. 357.1, as finally adopted.
Section 357.43 Liability of Department and Federal Reserve Banks.
This section was published as Sec. 357.42 in the notice of proposed
rulemaking for TRADES. The final version will be published after all the
comments on the rulemaking for TRADES have been reviewed and considered.
Section 357.46 Supplements, amendments, or revisions.
Provision for ``charges and fees for services and maintenance of
book-entry Treasury securities'' has been added in the event
circumstances should dictate their imposition.
[51 FR 18260, May 16, 1986; 51 FR 18884, May 23, 1986]
Appendix B to Part 357--TRADES Commentary
Introduction
The adoption of regulations for the Treasury/Reserve Automated Debt
Entry System (``TRADES'') is the culmination of a multi-year Treasury
process of moving from issuing securities only in definitive (physical/
certificated/paper) form to issuing securities exclusively in book-entry
form. The TRADES regulations provide the legal framework for all
commercially-maintained Treasury book-entry securities. For a more
detailed explanation of the procedural and legal development of book-
entry and the TRADES regulations, see the preamble to the rule proposed
March 4, 1996 (61 FR 8420), as well as the earlier proposals cited
therein 51 FR 8846 (March 14, 1986); 51 FR 43027 (November 28, 1986); 57
FR 12244 (April 9, 1992).
Comparison of TRADES and Treasury Direct
A person may hold interests in Treasury book-entry securities either
in TRADES \1\ or TREASURY DIRECT. The following summarizes the major
differences between the two systems.
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\1\ In TRADES a Person's interest in a Treasury book-entry security
is a Security Entitlement, as described in TRADES. A Participant's
interest in a marketable Treasury book-entry security also is a Security
Entitlement. A Participant's Security Entitlement is different than a
Security Entitlement as described in Revised Article 8, with respect to
the Participant's rights against the issuer. A non-Participant's
Security Entitlement is described in Revised Article 8.
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Persons holding Treasury book-entry securities in TRADES hold their
interests in such securities in a tiered system of ownership accounts.
In TRADES, Treasury, through its fiscal agents, the Federal Reserve
Banks, recognizes the identity only of Participants (persons with a
direct account relationship with a Federal Reserve Bank). While
Participants may be beneficial owners of interests in Treasury book-
entry securities, there are many beneficial owners of such interests
that are not Participants. Such beneficial owners hold their interests
through one or more Securities Intermediaries such as banks, brokerage
firms or securities clearing organizations.
In TRADES, the rights of non-Participant beneficial owners may be
exercised only
[[Page 419]]
through their Securities Intermediaries. Neither Treasury nor the
Federal Reserve Banks have any obligation to a non-Participant
beneficial owner of an interest in a Treasury book-entry security. Two
examples illustrate this principle. First, except where a pledge has
been recorded directly on the books of a Federal Reserve Bank pursuant
to Sec. 357.12(c)(1), Federal Reserve Banks, as Treasury's fiscal
agents, will act only on instructions of the Participant in whose
Securities Account the Treasury book-entry security is maintained in
recording transfers of an interest in a Treasury book-entry security. A
beneficial owner of the interest that is a non-Participant has no
ability to direct a transfer on the books of a Federal Reserve Bank.
Second, Treasury discharges its payment obligation with respect to a
Treasury book-entry security when payment is credited to a Participant's
account or paid in accordance with the Participant's instructions.
Neither Treasury nor a Federal Reserve Bank has any payment obligation
to a non-Participant beneficial owner of an interest in a Treasury book-
entry security. A non-Participant beneficial owner receives its payment
when its Securities Intermediary credits the owner's account.
Persons holding Treasury book-entry securities in TREASURY DIRECT,
on the other hand, hold their securities accounts on records maintained
by Treasury through its fiscal agents, the Federal Reserve Banks. The
primary characteristic of TREASURY DIRECT is a direct account
relationship between the beneficial owner of a Treasury book-entry
security and Treasury. In TREASURY DIRECT, Treasury discharges its
payment obligation when payment is credited to the depository
institution specified by the beneficial owner of the Treasury book-entry
security, paid directly to the beneficial owner by check, or paid in
accordance with the beneficial owner's instructions. Unlike TRADES,
TREASURY DIRECT does not provide a mechanism for the exchange of cash to
settle a secondary market transaction, nor are pledges of Treasury book-
entry securities held in TREASURY DIRECT generally recognized.
Accordingly, TREASURY DIRECT is suited for persons who plan to hold
their Treasury securities until maturity, and provides an alternative
for investors who are concerned about holding securities through
intermediaries and who do not wish to hold their interests in Treasury
securities indirectly in TRADES.
Scope of Regulation
Just as the scope of Revised Article 8 is limited,\2\ the scope of
this regulation is limited. It is not a comprehensive codification of
the law governing securities, transactions in securities or the law of
contracts for the purchase or sale of securities. Similarly, it is not a
codification of all laws that could affect a person's interest in a
Treasury book-entry security. For example, state laws regarding divorce
or intestate succession could well affect which persons have rights in
the interest in a Treasury book-entry security. Moreover, the
regulations deal with certain aspects of transactions in Treasury
securities, such as perfection of a security interest and its effects
and not other aspects, such as the contractual relationship between a
debtor and its secured party, which are left to applicable law \3\. See
the discussion under Sec. 357.10 of the Section-by-Section Analysis.
---------------------------------------------------------------------------
\2\ U.C.C. Revised Article 8, Prefatory Note at 12.
\3\ The regulations in 31 CFR 306.118(b), which are being supplanted
by TRADES, state that ``applicable law'' covers how a transfer or pledge
is ``effected'' as well as perfected. Except with respect to security
interests marked on the books of a Federal Reserve Bank, TRADES does not
address how a security interest in a Treasury book-entry security is
created or what law governs the creation of a security interest. Section
357.11(a) of TRADES, which establishes the choice of law for interests
other than those covered by Sec. 357.10, addresses the choice of law
with respect to the perfection, effect of perfection or non-perfection,
and priority of security interests, but does not address the law
governing creation or attachment of a security interest. This is
consistent with the scope and choice of law provisions of Revised
Article 8.
---------------------------------------------------------------------------
Section-by-Section Analysis
Section 357.0 Dual book-entry systems.
Section 357.0 sets forth that Treasury provides two systems for
maintaining Treasury book-entry securities--TRADES and TREASURY DIRECT.
Subpart A of part 357 of 31 CFR contains general information about
TRADES and TREASURY DIRECT. Subpart B contains the TRADES regulations.
Subpart C contains the TREASURY DIRECT regulations. Subpart D contains
miscellaneous provisions. Thus, in its totality, part 357 sets forth in
one place the complete set of governing rules for Treasury securities
issued in book-entry form.
Section 357.1 Effective date.
Section 357.1 establishes the effective date for TRADES. TRADES
applies to outstanding securities formerly governed by 31 CFR part 306,
subpart O. Conforming changes to parts 306, 356, and 358 are being made
to coincide with the publication of TRADES in final form. Consistent
with the approach set forth in Revised Article 8 (see Sec. 8-603 and the
official comment thereto), on and after the
[[Page 420]]
effective date these regulations will apply to all transactions,
including transactions commenced prior to the effective date. Revised
Article 8, in Section 8-603, gave secured parties four months after the
effective date to take action to continue the perfection of their
security interests. TRADES, through its delayed effectiveness, provides
a similar period. In TRADES, January 1, 1997, becomes the date by which
such actions must be completed.
The effective date for TRADES is January 1, 1997. While TRADES is
based in large part on Revised Article 8 that has received widespread
attention in the financial community and already has been adopted in 28
states,\4\ Treasury has determined that TRADES will be effective on
January 1, 1997, to ensure a smooth transition to TRADES. In making that
determination, Treasury has taken into account the time required by
other Government-Sponsored Enterprises (GSEs) to promulgate similar
regulations for their securities. Such an effective date, when combined
with TRADES having been published in proposed form with a 60-day comment
period, should provide sufficient time for an orderly transition to the
new TRADES rules.
---------------------------------------------------------------------------
\4\ As of August 1, 1996, those states are: Alabama, Alaska,
Arizona, Arkansas, Colorado, Idaho, Illinois, Indiana, Iowa, Kansas,
Kentucky, Louisiana, Maryland, Massachusetts, Minnesota, Mississippi,
Nebraska, New Mexico, Oklahoma, Oregon, Pennsylvania, Texas, Utah,
Vermont, Virginia, Washington, West Virginia and Wyoming. See discussion
accompanying footnote 11.
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Section 357.2 Definitions.
Section 357.2 contains definitions for use in subparts B and C.
While most of the definitions are straightforward, four terms--
Participant, Entitlement Holder, Security Entitlement and Securities
Intermediary--are critical to an understanding of the proposed TRADES
regulations.
(a) Participant. A Participant is a person that has a securities
account relationship in its name with a Federal Reserve Bank.
Accordingly, the Federal Reserve Bank and Treasury know both the
identity of the persons maintaining these accounts and the Treasury
book-entry securities held in these accounts.
(b) Securities Intermediary. Securities Intermediaries are persons
(other than individuals, except as described below) that are in the
business of holding interests in Treasury book-entry securities for
others. Participants can be, and usually are, Securities Intermediaries.
In addition, entities such as clearing corporations, banks, brokers
and dealers can be Securities Intermediaries in a single chain of
ownership of a Treasury security. An individual, unless registered as a
broker or dealer under the federal securities laws, cannot be a
Securities Intermediary. As an illustration of a possible chain of
ownership, in the following chart, the Federal Reserve Bank, Participant
and Broker-Dealer are all Securities Intermediaries.
Treasury
Federal Reserve Bank
<3-ln [><3-root>||||<3-ln ]>
Participant
<3-ln [><3-root>||||<3-ln ]>
Broker-Dealer
<3-ln [><3-root>||||<3-ln ]>
Individual Holder
(c) Entitlement Holder. An Entitlement Holder is any person for whom
a Securities Intermediary holds an interest in a Treasury book-entry
security. In the above example Individual Holder, Broker-Dealer and
Participant are all Entitlement Holders. Thus, a person can be both a
Securities Intermediary and an Entitlement Holder. See also the
commentary on ``Security Entitlement.''
(d) Security Entitlement. A Security Entitlement is the interest
that an Entitlement Holder has in a Treasury book-entry security. In the
example, Participant, Broker-Dealer and Individual Holder all hold
Security Entitlements. The rights and property interests associated with
a Security Entitlement of a Participant held on the books of a Federal
Reserve Bank (``Participant's Security Entitlement'') are, however,
different from the rights and property interests associated with other
Security Entitlements. As provided in Sec. 357.10(a), Federal law
defines the scope and nature of a Participant's Security Entitlement.
While TRADES is based in large part on Revised Article 8, the meaning of
Security Entitlement under federal law is different than under Revised
Article 8. For example, Participants have a direct claim against the
United States for interest and principal even though, under state law,
an Entitlement Holder would only have a claim against its Securities
Intermediary for such payment. To the extent not inconsistent with this
regulation, the scope and nature of a Security Entitlement of an
Entitlement Holder below the level of a Participant, (Broker-dealer and
Individual Holder in the example above), is defined by applicable state
law, as determined pursuant to Sec. 357.11. It should also be noted that
while a Participant's rights have Federal law components under
Sec. 357.10(a), the nature of a Security Entitlement held by a lower
tier intermediary on the books of a Participant is determined pursuant
to applicable law as provided in Sec. 357.11.
[[Page 421]]
Section 357.10 Law governing the United States and Reserve Banks.
Section 357.10(a) provides that the rights and obligations of the
United States and the Federal Reserve Banks (with one exception detailed
below), with respect to both the TRADES system and Treasury book-entry
securities maintained in TRADES are governed solely and exclusively by
Federal law. Thus, claims against the United States and Federal Reserve
Banks of both Participants and all other persons with an interest (or
claiming an interest) in a Treasury book-entry security maintained in
TRADES are governed by Federal law. Federal law is defined to include
TRADES, the offering circulars pursuant to which the Treasury securities
are sold, the offering announcements and Federal Reserve Bank Operating
Circulars.\5\ Prior to March 1, 1993, the terms of each offering of
Treasury securities, except for Treasury bills were set forth in an
offering circular published in the Federal Register\6\ Since March 1,
1993, all Treasury book-entry securities have been offered pursuant to a
uniform offering circular set forth at 31 CFR part 356.
---------------------------------------------------------------------------
\5\ A ``Federal Reserve Bank Operating Circular'' is defined in
Sec. 357.2 as the publication issued by each Federal Reserve Bank that
sets forth the terms and conditions under which the Reserve Bank
maintains Book-entry Securities Accounts and transfers Book-entry
Securities.
\6\ Treasury bills were issued pursuant to one master offering
circular (31 CFR part 349, removed, and replaced by 31 CFR part 356)
effective March 1, 1993. (58 FR 412)
---------------------------------------------------------------------------
While TRADES is based in large measure on Revised Article 8, a
fundamental principle of these regulations (and a divergence from
Revised Article 8) is that the obligations of the issuer (the United
States) and the Federal Reserve Banks, as well as all claims with
respect to TRADES or a Treasury book-entry security against Treasury or
a Federal Reserve Bank, are governed solely by Federal law. Thus, for
example, those parts of Revised Article 8 that detail obligations of
issuers (or their agents) of securities are not applicable to either the
United States or Federal Reserve Banks.\7\ In addition, neither the
United States nor Federal Reserve Banks have any obligations to persons
holding their interests in a Treasury book-entry security at levels
below the level of a Participant or to any other person claiming an
interest in a Treasury book-entry security (with the limited exception
set out in Sec. 357.12(c)(1)). Thus, there are no derivative rights
against either the United States or the Federal Reserve Banks.
---------------------------------------------------------------------------
\7\ The regulations in subpart C of this part set out other
obligations of the United States and the Federal Reserve Banks for
securities held in TREASURY DIRECT. These regulations preempt applicable
state law.
---------------------------------------------------------------------------
In interpreting this section, it is important to note that the scope
of TRADES, like that of Revised Article 8, is limited. Accordingly, the
governing law set forth in Sec. 357.10(a) is applicable only to the
matters set forth in Sec. 357.10(a). Other laws remain applicable and
could affect the holders of book-entry securities.
For example, the tax treatment of Securities Entitlements is outside
the scope of TRADES and other law (the Federal income tax code) is
applicable in determining such tax treatment. Similarly, nothing in
Sec. 357.10(a) limits the applicability of other laws to matters such as
whether the activities of Participants or Securities Intermediaries with
respect to interests in Treasury book-entry securities are subject to
banking or securities laws.
While TRADES in Sec. 357.10(a) defines what law governs the contract
between the United States, as issuer, and the holder of a Security
Entitlement, it is not a complete statement of the contract law
applicable to the United States or Federal Reserve Banks. For example,
if a Participant obtains a discount window loan from a Federal Reserve
Bank and agrees to pledge collateral, including Treasury book-entry
securities, to the Federal Reserve Bank as security for the loan,
Sec. 357.10(a) does not establish the law for determining the validity
or enforceability of the contract or the law applicable to the creation
and perfection of security interests in property that is not a Treasury
book-entry security. Section 357.10(a) does provide the law applicable
for how a security interest in Treasury book-entry securities is
perfected, the priority of such interest and, if Sec. 357.12(c)(1) is
applicable, how such security interest is created. Similarly, nothing in
Sec. 357.10(a) affects the continuing applicability or enforceability of
Federal Reserve Bank operating circulars such as the circular setting
forth provisions regarding electronic access to services provided by
Federal Reserve Banks and agreements executed in connection with such
circulars.
The law applicable with respect to interests granted to a Federal
Reserve Bank depends on the manner in which the security interest is
granted.
Where a security interest in favor of a Federal Reserve Bank is
marked on the books of the Federal Reserve Bank under Section
357.12(c)(1), Sec. 357.10(a) establishes the applicable law. A security
interest in favor of a Federal Reserve Bank would be recorded on the
Federal Reserve Bank's books where, for example, the Federal Reserve
Bank made a discount window loan to a depository institution and any
Treasury book-entry securities provided by the depository institution as
collateral have been deposited to a pledge account on the books of the
Federal Reserve
[[Page 422]]
Bank. For a borrowing depository institution that is not a Participant,
the book-entry securities used as collateral generally would be
deposited to the Federal Reserve Bank pledge account by the borrowing
institution's Securities Intermediary. See Hypothetical 5.
Section 357.10(b) sets forth law applicable with respect to security
interests in favor of a Federal Reserve Bank that have not been marked
on the books of a Federal Reserve Bank. A security interest in the
Securities Entitlement of a Participant in favor of a Federal Reserve
Bank that is not marked on the books of the Federal Reserve Bank is
governed by the law of the state in which the head office of the Federal
Reserve Bank is located. Such a security interest could arise, for
example, where the delivery of book-entry securities to the securities
account of the Participant results in an overdraft in the Participant's
Funds Account. The extent to which the Federal Reserve Bank has an
interest in the Participant's book-entry securities to secure the
overdraft therefore would be determined under the law of the state in
which the Reserve Bank's head office is located. If the State in which
the head office of the Federal Reserve Bank is located has not adopted
Revised Article 8, under Sec. 357.10(c) that State is deemed to have
adopted Revised Article 8.
In certain very limited circumstances, a Federal Reserve Bank also
may have a security interest in the book-entry securities of a non-
Participant that is not marked on the books of the Federal Reserve Bank.
Section 357.10(b) provides a separate rule for such a security interest,
which would be governed by the law of the non-Participant's Securities
Intermediary, as determined under Sec. 357.11. Under Sec. 357.11, the
perfection, effect of perfection, and priority of a security interest
created under such an agreement would be governed by the law of the
Securities Intermediary's jurisdiction, as determined under
Sec. 357.11(b). Under Sec. 357.11(d), if the jurisdiction specified in
Sec. 357.11(b) has not adopted Revised Article 8, jurisdiction would be
deemed to have adopted Revised Article 8.\8\
---------------------------------------------------------------------------
\8\ An interest in book-entry securities of a non-Participant that
is not marked on the books of the Federal Reserve Bank, while uncommon,
could arise where the Federal Reserve Bank lends to a non-Participant
depository institution and enters into a triparty agreement with the
depository institution and its Securities Intermediary rather than
requiring the deposit of the book-entry securities in a pledge account
on the books of the Federal Reserve Bank through an instruction given by
the non-Participant depository institution to its Securities
Intermediary.
---------------------------------------------------------------------------
For purposes of applying the state law chosen under the rules of
Sec. 357.10(b), Federal Reserve Banks are treated as clearing
corporations. As a result, a security interest in a Securities
Entitlement of a Participant in favor of a Federal Reserve Bank under
Sec. 357.12(c)(2) has the same priority as security interests granted to
other clearing corporations under state law. This is consistent with the
treatment accorded to Federal Reserve Banks generally under Revised
Article 8.
Section 357.11 Law governing other interests.
(a) Law governing the rights and obligation of Participants and third
parties. Section 357.11 is a choice of law rule. The substantive matters
subject to this choice of law rule are set forth in Sec. 357.11(a). The
matters set forth in Sec. 357.11(a) are meant to be coextensive with
those matters covered by Revised Article 8 with respect to a person's
interest in a Treasury book-entry security (other than those related to
a person's relationship to Treasury or a Federal Reserve Bank which are
governed solely by federal law). For purposes of these choice of law
rules Participants are Securities Intermediaries.
Section 357.11(b) adopts Revised Article 8's general choice of law
rule. Section 357.11(c) sets forth a special choice of law rule with
respect to security interests perfected automatically or by filing,
which also is included in Revised Article 8. Generally, the law
applicable to the Securities Intermediary will govern matters involving
an interest in a book-entry security held through that intermediary.
This approach is not followed with respect to perfection of security
interests automatically or by filing. In those cases, the law of the
jurisdiction in which the debtor is located is the governing law. Since
filing systems are based on the location of the debtor, this approach
should reduce uncertainty and preserve the normal practice of searching
records based on the debtor's location.\9\ The language ``person
creating a security interest'' is used in lieu of the term ``debtor'' in
this provision to avoid any confusion. The word ``debtor'' has two
meanings in the Uniform Commercial Code and the expression ``person
creating a security interest'' provides clarity with respect to who is
covered by this section. The term does not refer to a creditor. The
language ``is located'' is intended to conform to its meaning under
applicable law, as it may be amended from
[[Page 423]]
time to time. See, e.g., U.C.C. section 9-103(3)(d). Section 357.11(d)
provides for the application of Revised Article 8 if the choice of law
analysis required by Sec. 357.11(b) results in the choice of the law of
a State that has not yet adopted Revised Article 8. As noted elsewhere,
in such a situation, the State's law is viewed as if it had adopted
Revised Article 8. This section also provides that, for purposes of
applying state law, the Federal Reserve Banks are clearing corporations
and Participants' interests in book-entry securities are Security
Entitlements.
---------------------------------------------------------------------------
\9\ The substantive effect of filing is limited and applies only in
states which have adopted Revised Article 8. Since the effect of filing
is a unique state law matter, in this one area, Treasury has determined
that possible lack of uniformity does not justify altering state law.
---------------------------------------------------------------------------
(b) Limited scope of Federal preemption. In an earlier TRADES proposal
Treasury contemplated adopting a comprehensive regulation governing the
rights of all persons in Treasury book-entry securities held in TRADES.
Such an approach was proposed because Treasury believed that a uniform
rule was necessary to preserve the efficiency and liquidity of the
market for Treasury securities--the most liquid and efficient market in
the world. Treasury believed then, and believes now, that the material
rights of a holder in the United States of an interest in a Treasury
security should not vary solely by virtue of such holder's geographic
location or the location of the financial institution through which it
holds its interest in Treasury securities. In light of Revised Article
8, Treasury has determined that it is possible to achieve this
uniformity without developing an independent system of Federal
commercial law.\10\ The questions inherent in a tiered system of
ownership have been analyzed, and, in Treasury's view, satisfactorily
addressed by Revised Article 8.
---------------------------------------------------------------------------
\10\ As noted previously, the substantive scope of this regulation
is limited.
---------------------------------------------------------------------------
As of August 1, 1996, 28 states have adopted Revised Article 8 and
Treasury understands that it will soon be adopted in additional states.
As with all uniform laws, the adoption process takes several years. In
order to assure uniformity, in light of the unavoidable delays in the
state-by-state adoption process of Revised Article 8, Treasury is
promulgating regulations with a limited form of preemption. As provided
in both Secs. 357.10(c) and 357.11(d), if the choice of law rules set
forth in TRADES would lead to the application of the law of a State that
has not yet adopted Revised Article 8, TRADES will apply Revised Article
8 (with conforming and miscellaneous amendments to other Articles) in
the form approved by the ALI and NCCUSL. Treasury expects that these
provisions will be operative only during the state-by-state adoption
process and would plan to amend TRADES to delete reference to these
provisions once the adoption process has been completed.
While Revised Article 8 is defined to mean the official text of
Article 8 as approved by the ALI and NCCUSL, Treasury recognizes that
states may make minor changes in that text when adopting Article 8.
Treasury has concluded that minor changes should not prevent Revised
Article 8, as adopted by a state, from being the appropriate law. In
other words, if a state passes a version of Article 8 that is
substantially identical to Revised Article 8, reference to Revised
Article 8 (as defined) would no longer be required. Treasury has
determined that the versions of Article 8 passed by 50\11\ states that
have enacted Article 8 meet this standard. Accordingly, Secs. 357.10(c)
and 357.11(d) would not be applicable if the choice of law provisions of
TRADES directed a person to one of those states. As additional states
adopt Revised Article 8, Treasury will provide notice in the Federal
Register as to whether the enactments are ``substantially identical'' to
the uniform version for purposes of these regulations and on an annual
basis, the Commentary will be amended to reflect subsequent enactments.
This approach represents a significantly reduced form of preemption of
state law from former versions of TRADES and preserves Treasury's
preeminent interest in a uniform system of rules applicable to all
holders of interests in Treasury book-entry securities.
---------------------------------------------------------------------------
\11\ Alabama, Alaska, Arizona, Arkansas, California, Colorado,
Connecticut, Delaware, District of Columbia, Florida, Georgia, Hawaii,
Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine,
Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri,
Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, New
York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon,
Pennsylvania, Puerto Rico, South Dakota, Tennessee, Texas, Utah,
Vermont, Virginia, Washington, West Virginia, Wisconsin and Wyoming.
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[[Page 424]]
Section 357.12 Obtaining an interest in a book-entry security.
(a) Creation of a Participant's Security Entitlement. A Participant's
interest in a Treasury book-entry security is a Securities Entitlement.
Section 357.12(a) provides that a Participant's Securities Entitlement
is created when a Federal Reserve Bank indicates by book entry that a
Book-entry Security has been credited to a Participant's Securities
Account. Instead of the concept of initial credit and transfer of a
Treasury book-entry security, as set forth in the existing regulations,
this proposal focuses on the creation of a Participant's Securities
Entitlement and, in this way, is similar to Section 8-501 of Revised
Article 8.
The regulation focuses on the creation of a Participant's Security
Entitlement because Security Entitlement is the term used to describe
the Participant's interest in a Treasury book-entry security. Once a
Participant obtains that interest, the regulation sets forth what that
interest is. Thus, as provided in Sec. 357.10, federal law describes a
Participant's rights against the United States and the Federal Reserve
Bank where it maintains its Securities Account. To the extent not
inconsistent with Sec. 357.10, Sec. 357.11 describes the applicable law
to determine Participants' rights and obligations with respect to all
other persons. Under these regulations, Participants can still transfer
their interests in a Treasury book-entry security as they did before--by
issuing a Transfer Message to the Federal Reserve Bank where they hold
such interest. Transfer of interests between Participants can occur by a
Participant holding such interest issuing a Transfer Message. As a
result of such message, the Federal Reserve Bank will make a book entry
in favor of the receiving Participant (thereby creating a Security
Entitlement in favor of such Participant) and also will make a book
entry deleting the initiator Participant's interest in such Treasury
book-entry security (thereby eliminating that Participant's Security
Entitlement). In addition, if authorized under applicable state law,
Participants may enter into agreements with other Participants that, as
to the Participants, constitute a transfer. Such action is without
effect to either the United States or a Federal Reserve Bank.
(b) Creation and priority of a Security Interest. (i) Security Interests
of the United States. Section 357.12(b) provides that a security
interest in favor of the United States has priority over the interests
of any other person in a Treasury book-entry security. The United States
obtains security interests in Treasury securities as collateral to
secure funds in a variety of situations such as Treasury Tax and Loan
accounts; government agency funds or funds under the control of the
Federal Courts held at financial institutions; and securities pledged in
lieu of surety by contractors and others. The priority provided the
United States in these situations is consistent with existing law.
In addition, Federal Reserve Banks do recognize on their books and
records security interests in favor of the United States. In that
situation, the Federal Reserve Bank will not transfer the security
without the permission of the United States. This section provides that
a Federal Reserve Bank may rely exclusively on the directions of an
authorized representative of the United States to transfer a security
and is protected in so relying. Ordinarily, an authorized representative
of the United States would take such action under circumstances such as
the default or insolvency of the pledgor.
(ii) Security Interests on the books of a Reserve Bank. Where
required by Federal law or regulation or pursuant to a specific
agreement with a Federal Reserve Bank, a security interest in favor of a
Federal Reserve Bank or other person may be created or perfected by a
Federal Reserve Bank marking its books to record the security interest
under Sec. 357.12(c)(1). An example of a security interest that is
marked on the books of a Federal Reserve Bank would be the pledge in
favor of a Federal Reserve Bank of a Participant's book-entry securities
as collateral for a discount window loan.\12\ For limited categories of
pledges, Federal Reserve Banks may agree to record a security interest
in favor of a third party on their books. For example, in some
circumstances a Federal Reserve Bank may permit the establishment of
[[Page 425]]
a pledge account to hold book-entry securities pledged to governmental
entities other than the United States government. It is important to
note that there is no obligation for either Treasury or a Federal
Reserve Bank to agree to record a security interest on the books of a
Federal Reserve Bank, except as required by Federal law or regulation.
If they do so, the security interest is perfected when the Federal
Reserve Bank records a security interest on its books. In addition, the
security interest has priority over all other interests in the Treasury
book-entry security except an interest of the United States.
---------------------------------------------------------------------------
\12\ Book-entry securities pledged by a non-Participant to a Federal
Reserve Bank generally would be deposited by the non-Participant's
Securities Intermediary to a pledge account at the Federal Reserve Bank,
and therefore also would be marked on the books of the Federal Reserve
Bank. See the discussion under D. (Sec. 357.10).
---------------------------------------------------------------------------
(iii) Other Security Interests. As provided in Sec. 357.12(c)(2), a
security interest in a book-entry security may be perfected by any
method available under applicable state law, as determined under
Sec. 357.10(b) or Sec. 357.11.\13\ The perfection and priority of such
interests shall be governed by applicable law. Security interests under
this section may include security interests in favor of a Federal
Reserve Bank, such as a clearing lien or pledge by a non-participant of
book-entry securities held through a Securities Intermediary where the
securities have not been deposited to a Federal Reserve Bank pledge
account. Consistent with Revised Article 8, a Federal Reserve Bank would
be treated as a clearing corporation under the applicable state law.
---------------------------------------------------------------------------
\13\ Under both of these sections, if the state has not yet adopted
Revised Article 8, the applicable law would be that state's law as it
would be amended by Revised Article 8.
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If a Person perfects a security interest pursuant to
Sec. 357.12(c)(2), obligations of the Treasury and the Federal Reserve
Banks with respect to that security interest are limited. Specifically,
unless special arrangements are agreed to by the United States or a
Federal Reserve Bank pursuant to Sec. 357.12(c)(1), neither the Federal
Reserve Bank nor the United States will recognize the interests of any
person other than the person in whose securities account the interest in
a Treasury book-entry security is maintained. This does not mean that
such a security interest is invalid. Rather, it means that the
creditor's recourse will be solely against the debtor Participant or
other third party.
Section 357.13 Rights and obligations of Treasury and the Reserve
Banks.
(a) Adverse claims. Section 357.13(a) sets forth the general rule
that, with limited exceptions, Treasury and the Federal Reserve Banks
will recognize only the interest of a Participant in a Treasury book-
entry security in whose Securities Account such interest is maintained.
As noted previously, Treasury book-entry securities maintained in
TRADES are held in a tiered system of ownership. The records of a
Federal Reserve Bank reflect only the ownership at the top tier.
Institutions maintaining a Securities Account with a Federal Reserve
Bank frequently will hold interests in Treasury book-entry securities
for their customers (which can include broker-dealers and other
Securities Intermediaries) and in certain cases those customers will
hold interests in securities for their customers. Accordingly, neither
Treasury nor a Federal Reserve Bank will know the identity or recognize
a claim of a Participant's customer if that customer were to present it
to Treasury or a Federal Reserve Bank.
In addition, except in the limited case where a security interest is
marked on the books of a Federal Reserve Bank pursuant to
Sec. 357.12(c)(1), neither the Treasury nor a Federal Reserve Bank will
recognize the claims of any other person asserting a claim in a Treasury
book-entry security. Persons at levels below the Participant level must
present their claims to their Securities Intermediary.
(b) Payment obligations. Section 357.13(b) contains a corollary to
the rule set forth in Sec. 357.13(a). This section provides that
Treasury discharges its payment responsibility with respect to a
security that it has issued when a Federal Reserve Bank credits the
funds account of a Participant with amounts due on that security or
makes payment in some other manner specified by the Participant. This is
consistent with existing law and the first TRADES
proposal.\14\ In Revised Article 8, the issuer discharges its
obligations when it makes payment to an owner registered on its books.
Under common commercial practice, the registered owner in the indirect
system may be a clearing corporation or the clearing corporation's
nominee. Although the Federal Reserve Banks are treated as clearing
corporations under both Revised Article 8 and TRADES, Treasury remains
liable until payment is made to, or in accordance with the instructions
of, a Participant. Section 357.13(b)(2) establishes the mechanism of how
Treasury book-entry securities are paid at maturity. It is intended to
cover a variety of procedures, including where the proceeds of pledged
securities are credited to a suspense account pending substitution or
release. This paragraph makes clear that the payment takes place
automatically and that, unlike with physical certificates, there is no
act of presentment required by the Participant.
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\14\ 51 FR 8846, 8848 (March 14, 1986).
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Section 357.14 Authority of Reserve Banks.
Section 357.14 provides that Federal Reserve Banks are authorized,
as fiscal agents of Treasury, to operate the commercial book-entry
system for Treasury.
[[Page 426]]
Section 357.44 Notices.
Section 357.44 contains a revised version of a provision that
appeared in earlier TRADES proposals. Similar to the rule in Revised
Article 8 (see section 8-112), it provides where certain legal process
should be directed. While providing instructions on where notice should
be directed, it makes clear that the regulations do not establish
whether a Federal Reserve Bank is required to honor any such order or
notice.
J. Hypotheticals
HYPOTHETICAL 1
TREASURY
FEDERAL RESERVE BANK
<3-ln [><3-root>||||<3-ln ]>
PARTICIPANT
<3-ln [><3-root>||||<3-ln ]>
DEALER
<3-ln [><3-root>||||<3-ln ]>
INVESTOR
The first hypothetical is designed to show what law applies at
different levels of the tiered book-entry system. TRADES provides that
federal law, and only federal law (defined in Sec. 357.10(a)), governs
the rights and obligations of the United States and the Federal Reserve
Banks (except for those matters involving Federal Reserve Banks set
forth in Sec. 357.10(b)). Thus, for example, Treasury discharges its
payment obligations with respect to a security it has issued in the
manner described in Sec. 357.13(b). Federal law both defines the payment
obligation and describes how Treasury fulfills that obligation. Those
portions of Revised Article 8 dealing with issuer obligations are not
applicable to Treasury or the Federal Reserve Banks.\15\ Similarly, with
certain limited exceptions as set forth in Sec. 357.12(c)(1), Treasury
and the Federal Reserve Banks will recognize only the interest of a
Participant in a Treasury book-entry security in whose Security Account
the interest is maintained. Accordingly, as a matter of federal law,
neither Treasury nor a Federal Reserve Bank will recognize any claim by
Dealer or Investor.\16\
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\15\ As provided in Sec. 357.14, Federal Reserve Banks, among other
things, effect transfers of book-entry securities between Participants'
Security Accounts.
\16\ One comment questioned whether similar language in the March 4,
1996 release implied that, under Revised Article 8, in the above example
Investor could have a claim against Participant. No such implication was
intended. The only point of the language is to make it clear that
Federal, not state, law governs the rights and obligations of Treasury
and the Federal Reserve Banks.
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In the hypothetical above, as between Participant and Dealer,
Participant is the Securities Intermediary. With respect to the matters
set forth in Sec. 357.11(a), the law of the Securities Intermediary's
jurisdiction governs. Thus, with respect to the matters in
Sec. 357.11(a), the law of Participant's jurisdiction applies as between
Participant and Dealer.\17\ If Participant's jurisdiction, as determined
under Sec. 357.11(b), has not adopted Revised Article 8, the law of
Participant's jurisdiction, as it would be amended by Revised Article 8,
applies. Similarly, as between Dealer and Investor, Dealer is a
Securities Intermediary, with respect to the matters in Sec. 357.11(a),
the law of Dealer's jurisdiction applies as between Dealer and Investor.
If Dealer's jurisdiction has not adopted Revised Article 8, the law of
Dealer's jurisdiction, as it would be amended by Article 8, applies.
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\17\ As described in the March 4 Release, the scope of TRADES is
limited. As a general rule, if a matter is not covered in
Sec. 357.11(a), TRADES is not applicable. One comment questioned whether
TRADES covered the creation and attachment of a security interest. The
omission of creation and attachment in Sec. 357.11(a) is intentional.
---------------------------------------------------------------------------
HYPOTHETICAL 2
Assume that Dealer A sells its interest in a Treasury book-entry
security to Dealer B. The transaction likely would take the following
form. Dealer A will instruct Participant A to transfer its interest in a
Treasury security to Participant B against cash payment. Dealer B will
instruct Participant B to transfer cash to Participant A against
delivery of an interest in the specified securities. Participant A will
instruct the Federal Reserve Bank to transfer its interest in the
Treasury security to Participant B against simultaneous credit of cash.
The Federal Reserve Bank will debit Participant A's security account and
credit Participant B's security account and simultaneously credit
Participant A's cash account and debit Participant B's cash account.
Participant A will mark its books to show that it has debited Dealer A's
securities account and credited Dealer A's cash account. Participant B
will mark its books to show the Security Entitlement in the Treasury
security in favor of Dealer B and a debit against Dealer B's cash
account. Federal law, set forth in Sec. 357.12(a) provides that
Participant B acquires its interest in the Treasury book-entry security
when the Federal Reserve Bank indicates by book-entry that the interest
in the security has been credited to Participant B's Securities Account.
Pursuant to Sec. 357.11(a), but subject to Sec. 357.11(d), Participant
B's jurisdiction governs Dealer B's acquisition of a Securities
Entitlement from Participant B.
HYPOTHETICAL 3
[[Page 427]]
TREASURY
FEDERAL RESERVE BANK
<3-ln [><3-root>||||<3-ln ]>
PARTICIPANT
Assume Participant wishes to obtain a loan from Federal Reserve Bank
and, as part of the transaction, will grant Federal Reserve Bank a
security interest in its Securities Entitlement with respect to Treasury
book-entry securities. The transaction can be accomplished in one of two
ways. Pursuant to Sec. 357.12(c)(1), the Federal Reserve Bank can mark
its books to reflect the security interest. As a matter of federal law,
that action creates and perfects the Federal Reserve Bank's security
interest and grants the Federal Reserve Bank priority over all other
claimants (other than the United States pursuant to Sec. 357.12(b)).\18\
A second method for completing the transaction, as set forth in
Sec. 357.12(c)(2), would be to take whatever actions are authorized by
applicable law. In that case, applicable law is the law of the
jurisdiction of the head office of the Federal Reserve Bank. If that
jurisdiction had adopted Revised Article 8, it would be the law of that
jurisdiction. If that jurisdiction had not adopted Revised Article 8, it
would be the law of that jurisdiction as if the jurisdiction had adopted
Revised Article 8. Under Revised Article 8, the Federal Reserve Bank's
interest would be that of a clearing corporation.
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\18\ In certain limited circumstances, a Federal Reserve Bank may
enter into an agreement under which it agrees to record on its books an
interest in Participant's book-entry securities in favor of a non-
Participant, such as a governmental entity. Under these circumstances,
the non-Participant would have a perfected security interest with
priority over other claimants (other than the United States under
Sec. 357.12(b)). It should be noted that, as set forth in
Sec. 357.12(c)(1), there is no requirement that either the United States
or a Federal Reserve Bank agree to creation and perfection of a security
interest in this way, except as provided in Sec. 357.12(c)(1).
HYPOTHETICAL 4
TREASURY
FEDERAL RESERVE BANK
<3-ln [><3-root><3-root>| -|| S||<3-ln ]>
PARTICIPANT A PARTICIPANT B
Assume that Participant A wishes to borrow from Participant B and
grant Participant B a security interest in its Security Entitlement in
Treasury book-entry securities. As provided in Sec. 357.12(c)(2), the
transaction would be completed pursuant to applicable law determined in
accordance with 357.11. Although such an interest could be recorded on
the books of a Federal Reserve Bank under Sec. 357.12(c)(1), Federal
Reserve Banks generally do not mark their books to record this type of
security interest for Participants.
HYPOTHETICAL 5
TREASURY
FEDERAL RESERVE BANK
<3-ln [><3-root>||||<3-ln ]>
PARTICIPANT A
<3-ln [><3-root>||||<3-ln ]>
DEALER A
<3-ln [><3-root>||||<3-ln ]>
BANK A
Assume that Bank A wishes to borrow from the Federal Reserve Bank
and will pledge its interest in Treasury book-entry securities held at
Dealer A to collateralize that loan. The transaction could be
accomplished in two ways. Pursuant to Sec. 357.12(c)(1), the interest
could be created and perfected on the books of a Federal Reserve Bank.
Such a transaction would take place in the following fashion. Bank A
could have Dealer A instruct Participant A to deposit securities to a
pledge account specified by the Federal Reserve Bank. The Federal
Reserve Bank likely would create an account on its books and specify
that account to Bank A as the account to receive Bank A's interest in
Treasury book-entry securities. Participant A, upon receiving Dealer A's
instructions, would then instruct the Federal Reserve Bank to debit its
account at the Federal Reserve Bank and credit the account created by
the Federal Reserve Bank. The second way the transaction could take
place is by any method permitted by the law of Dealer A's (Bank A's
Securities Intermediary) jurisdiction. This could involve a tri-party
agreement among the Federal Reserve Bank, Dealer A, and Bank A. As set
forth in Sec. 357.11(b)(1), that agreement likely would specify which
jurisdiction's law is to govern the transaction and could specify that
such choice of law supersedes any other choice of law agreement
previously entered into by Dealer A and Bank A. If Dealer A's
jurisdiction has not adopted Revised Article 8, the applicable law would
be the law of Dealer A's jurisdiction as it would be amended by Revised
Article 8.
[61 FR 43631, Aug. 23, 1996, as amended at 62 FR 43284, Aug. 13, 1997;
63 FR 69191, Dec. 16, 1998]
[[Page 428]]