Self-Regulatory Organizations; The Depository Trust Company; Order Granting Approval of a Proposed Rule Change, as Modified by Amendment No. 1, To Impose Deposit Chills and Global Locks and Provide Fair Procedures to Issuers, 89533-89543 [2016-29668]

Download as PDF Federal Register / Vol. 81, No. 238 / Monday, December 12, 2016 / Notices is consistent with the protection of investors and the public interest. The Exchange has requested that the Commission waive the 30-day operative delay so that the proposed rule change will become operative on filing. The Exchange stated that the proposed rule change promotes the protection of investors and the public interest by clarifying and harmonizing the terminology used in the Exchange’s rules. Waiver of the operative delay would allow the Exchange, without delay, to rename the rules to make clear what the rules cover, therefore, the Commission believes that waiver of the 30-day operative delay is consistent with the protection of investors and the public interest. Therefore, the Commission designates the proposed rule change to be operative upon filing.10 At any time within 60 days of the filing of the proposed rule change, the Commission summarily may temporarily suspend such rule change if it appears to the Commission that such action is: (i) Necessary or appropriate in the public interest; (ii) for the protection of investors; or (iii) otherwise in furtherance of the purposes of the Act. If the Commission takes such action, the Commission shall institute proceedings to determine whether the proposed rule should be approved or disapproved. IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: mstockstill on DSK3G9T082PROD with NOTICES Electronic Comments • Use the Commission’s Internet comment form (http://www.sec.gov/ rules/sro.shtml); or • Send an email to rule-comments@ sec.gov. Please include File Number SR– BX–2016–066 on the subject line. Paper Comments • Send paper comments in triplicate to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–BX–2016–066. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use 10 For purposes only of waiving the 30-day operative delay, the Commission also has considered the proposed rule’s impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). VerDate Sep<11>2014 18:59 Dec 09, 2016 Jkt 241001 only one method. The Commission will post all comments on the Commission’s Internet Web site (http://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for Web site viewing and printing in the Commission’s Public Reference Room, 100 F Street NE., Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–BX– 2016–066 and should be submitted on or before January 3, 2017. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.11 Eduardo A. Aleman, Assistant Secretary. [FR Doc. 2016–29658 Filed 12–9–16; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–79488; File No. SR–DTC– 2016–003] Self-Regulatory Organizations; The Depository Trust Company; Order Granting Approval of a Proposed Rule Change, as Modified by Amendment No. 1, To Impose Deposit Chills and Global Locks and Provide Fair Procedures to Issuers December 6, 2016. I. Introduction On May 27, 2016, The Depository Trust Company (‘‘DTC’’) filed with the Securities and Exchange Commission (‘‘Commission’’) proposed rule change SR–DTC–2016–003 pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’),1 and Rule 19b–4 11 17 1 15 PO 00000 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). Frm 00109 Fmt 4703 Sfmt 4703 89533 thereunder.2 The proposed rule change was published in the Federal Register on June 9, 2016.3 The Commission received 10 comment letters to the proposed rule change from five commenters, including three response letters from DTC.4 Pursuant to Section 19(b)(2) of the Act,5 on July 21, 2016, the Commission designated a longer period within which to approve the proposed rule change, disapprove the proposed rule change, or institute proceedings to determine whether to disapprove the proposed rule change.6 On July 29, 2016, DTC filed Amendment No. 1 to the proposed rule change. On September 6, 2016, the Commission published notice of Amendment No. 1 and instituted proceedings under Section 19(b)(2)(B) of the Act 7 to determine whether to approve or disapprove the proposed rule change.8 Section II below provides an overview and brief description of both DTC and the proposed rule change. Section III provides a summary of the comments received and DTC’s response to those comments. Section IV provides a discussion of the proposed rule change, 2 17 CFR 240.19b–4. Securities Exchange Act Release No. 77991 (June 3, 2016), 81 FR 37232 (June 9, 2016) (SR– DTC–2016–003) (‘‘Notice’’). 4 See letter from Charles V. Rossi, Chairman, The Securities Transfer Association (‘‘STA’’), Inc. Board Advisory Committee, dated June 30, 2016, to Brent J. Fields, Secretary, Commission (‘‘STA Letter I’’); letter from Dorian Deyet, dated June 30, 2016 (‘‘Deyet Letter’’); letter from Ann K. Shuman, Managing Director and Deputy General Counsel, DTC, dated July 21, 2016, to Brent J. Fields, Secretary, Commission (‘‘DTC Letter I’’); letter from Harvey Kesner (‘‘Kesner’’), Sichenzia, Ross, Friedman, Ference, dated August 11, 2016, to Brent J. Fields, Secretary, Commission (‘‘Kesner Letter I’’); letter from Isaac Montal, Managing Director and Deputy General Counsel, DTC, dated August 22, 2016, to Brent J. Fields, Secretary, Commission (‘‘DTC Letter II’’); letter from Charles V. Rossi, Chairman, STA Board Advisory Committee, dated August 29, 2016, to Brent J. Fields, Secretary, Commission (‘‘STA Letter II’’); letter from Kesner, Sichenzia, Ross, Friedman, Ference, dated August 30, 2016, to Brent J. Fields, Secretary, Commission (‘‘Kesner Letter II’’); letter from Norman B. Arnoff (‘‘Arnoff’’), dated September 4, 2016 to Secretary Fields (‘‘Arnoff Letter’’); letter from Charles V. Rossi, Chairman, STA Board Advisory Committee, dated October 3, 2016, to Brent J. Fields, Secretary, Commission (‘‘STA Letter III’’); and letter from Ann K. Shuman, Managing Director and Deputy General Counsel, DTC, dated October 17, 2016, to Brent J. Fields, Secretary, Commission (‘‘DTC Letter III’’). See comments on the proposed rule change (SR– DTC–2016–003), https://www.sec.gov/comments/srdtc-2016-003/dtc2016003.shtml. 5 15 U.S.C. 78s(b)(2). 6 See Securities Exchange Act Release No. 78379 (July 21, 2016), 81 FR 49309 (July 27, 2016). The Commission designated September 7, 2016, as the date by which it should approve, disapprove, or institute proceedings to determine whether to disapprove the proposed rule change. 7 15 U.S.C. 78s(b)(2)(B). 8 See Securities Exchange Act Release No. 78774 (September 6, 2016), 81 FR 62775 (September 12, 2016). 3 See E:\FR\FM\12DEN1.SGM 12DEN1 89534 Federal Register / Vol. 81, No. 238 / Monday, December 12, 2016 / Notices the comments received, and details the Commission’s findings with respect to the proposed rule change. Finally, Section V concludes that, for the reasons discussed below in Sections II through IV, the Commission is granting approval of the proposed rule change, as modified by Amendment No.1. II. Description of the Proposed Rule Change A. Background 1. DTC mstockstill on DSK3G9T082PROD with NOTICES DTC plays a critical function in the national clearance and settlement system. It is the nation’s central securities depository, registered as a clearing agency under Section 17A of the Act,9 and its deposit and book-entry transfer services help facilitate the operation of the nation’s securities markets. As a registered holder of trillions of dollars of securities, DTC processes enormous volumes of securities transactions facilitated by book-entry movement of interests, without transferring physical certificates. The Financial Stability Oversight Council, pursuant to Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act,10 designated DTC as a Systemically Important Financial Market Utility.11 DTC’s participants (‘‘Participants’’) are primarily broker-dealers and banks, but as the nation’s central securities depository, its role and actions also affect issuers and investors.12 Participants agree to be bound by the Rules, By-Laws, and Organization Certificate of DTC, and other rules and procedures (collectively, ‘‘Rules’’).13 DTC performs various services for Participants, including maintaining accounts that list Participants’ securities holdings and allowing Participants to present securities to be made eligible for DTC’s depository and book-entry services. If a security is accepted by DTC as meeting DTC’s eligibility 9 See Securities Exchange Act Release No. 20221 (September 23, 1983), 48 FR 45167 (October 3, 1983) (600–1). 10 Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111–203, 124 Stat. 1376 (2010). 11 See Financial Stability Oversight Council, 2012 Annual Report, Appendix A, available at https:// www.treasury.gov/initiatives/fsoc/Documents/2012 %20Appendix%20A%20Designation%20of%20 Systemically%20Important%20Market%20 Utilities.pdf. 12 See In re International Power Group, Ltd. (‘‘IPWG’’), Securities Exchange Act Release No. 66611 (March 15, 2012), 2012 SEC LEXIS 844 at *24 (March 15, 2012) (Admin. Proc. File No. 3–13687). 13 Available at http://www.dtcc.com/legal/rulesand-procedures.aspx. VerDate Sep<11>2014 18:59 Dec 09, 2016 Jkt 241001 requirements for services 14 and is deposited with DTC for credit to the securities account of a Participant, it becomes an ‘‘Eligible Security.’’ Thereafter, Participants may deposit shares of that Eligible Security (‘‘Deposited Securities’’) into their respective DTC accounts. To facilitate book-entry transfers and other services that DTC provides for its Participants, Deposited Securities are generally registered on the books of the issuer of the Eligible Security (typically, in a register maintained by a transfer agent) in DTC’s nominee name, Cede & Co. DTC maintains Deposited Securities that are eligible for book-entry services in ‘‘fungible bulk,’’ meaning that each Participant whose securities of an issue have been credited to its securities account has a pro rata (proportionate) interest in DTC’s entire inventory of that issue, but none of the securities on deposit are identifiable to or ‘‘owned’’ by any particular Participant.15 2. Overview of DTC’s Prior Practice With Respect to Service Restrictions As detailed in a proposed rule change previously filed by DTC on December 5, 2013,16 DTC currently imposes two types of service restrictions: (i) A ‘‘Deposit Chill’’ whereby DTC refuses to accept further deposits of an Eligible Security but continues to provide bookentry services for existing shares of that Eligible Security already on deposit with DTC; or (ii) a more stringent ‘‘Global Lock’’ whereby DTC not only refuses to accept further deposits of an Eligible Security, but also ceases to provide all book-entry services for existing shares of that Eligible Security already on deposit with DTC.17 Prior to filing the current proposed rule change, DTC’s practice was to impose a Deposit Chill upon detecting suspiciously large deposits of a thinly14 See Rule 5, supra note 13; DTC Operational Arrangements (Necessary for Securities to Become and Remain Eligible for DTC Services), January 2012 (the ‘‘Operational Arrangements’’), Section 1, available at http://www.dtcc.com/∼/media/Files/ Downloads/legal/issue-eligibility/eligibility/ operational-arrangements.pdf. 15 See Securities Exchange Act Release No. 19678 (April 15, 1983), 48 FR 17603, 17605, n.5 (April 25, 1983) (describing fungible bulk); see also ≤N.Y. Uniform Commercial Code, § 8–503, Off. Cmt 1 (‘‘. . . all entitlement holders have a pro rata interest in whatever positions in that financial asset the [financial] intermediary holds’’). 16 See Securities Exchange Act Release No. 71132 (December 18, 2013); 78 FR 77755 (December 24, 2013) (SR–DTC–2013–11). The filing was in response to the Commission’s opinion and order in IPWG, which directed DTC to ‘‘adopt procedures that accord with the fairness requirements of Section 17A(b)(3)(H)’’ of the Act. 17 See Notice, 81 FR at 37232; see also SEC Investor Bulletin: DTC Chills and Freezes, https:// www.sec.gov/investor/alerts/dtcfreezes.pdf. PO 00000 Frm 00110 Fmt 4703 Sfmt 4703 traded Eligible Security.18 According to DTC, such large deposits often were a red flag that could indicate a ‘‘pump and dump’’ scheme or other illegal distribution related to that security, and a Deposit Chill was necessary to maintain the status quo and avoid allowing DTC’s services to be used in furtherance of improper activity.19 An issuer could obtain the release of a Deposit Chill by providing to DTC a satisfactory legal opinion from independent counsel establishing that the Eligible Security fulfilled DTC’s requirements for eligibility.20 If an issuer were non-responsive to DTC’s requests for information or otherwise refused or was unable to provide the required legal opinion, a Deposit Chill could remain in effect for years.21 Similarly, DTC’s former practice was to impose a Global Lock if it became aware of a judicial or administrative proceeding alleging a violation of Section 5 of the Securities Act of 1933 (‘‘Securities Act’’) with respect to an Eligible Security on deposit with DTC.22 According to DTC, such allegations in a formal legal proceeding provided a concrete indication that Eligible Securities could have been involved in an illegal distribution, making a Global Lock necessary to maintain the status quo and avoid allowing DTC’s services to be used in furtherance of improper activity. Because of the gravity of the allegations and the risk to DTC and its Participants of potentially allowing DTC’s services to be used in furtherance of improper activity, a Global Lock would be released only when (i) the underlying action was withdrawn, (ii) dismissed on the merits with prejudice, or (iii) otherwise resolved in a final, non-appealable judgment in favor of the defendants allegedly responsible for the violations of federal securities laws. Because many actions are only resolved after several years,23 a Global Lock also could be maintained for years. B. Proposed Rule Change DTC withdrew its prior proposed rule change regarding Deposit Chill and Global Lock procedures, as described 18 See Notice, 81 FR at 37233. DTC Service Restrictions on Certain BookEntry Securities—Procedures for Affected Issuers (September 2013), http://www.stai.org/pdfs/dtcwhitepaperresericesrestrictionsandissuerfair process.pdf. 20 See Operational Arrangements, Section I.A, supra note 14. 21 Notice, 81 FR at 37233. 22 Id. 23 See, e.g., SEC v. Kahlon,12–CV–517 (E.D. Tex., filed August 14, 2012); SEC v. Bronson, 12–cv– 06421–KMK (S.D.N.Y., filed August 22, 2012). As of the date of this filing, neither case has been resolved. 19 See E:\FR\FM\12DEN1.SGM 12DEN1 mstockstill on DSK3G9T082PROD with NOTICES Federal Register / Vol. 81, No. 238 / Monday, December 12, 2016 / Notices above, on August 18, 2014.24 Since that time, according to DTC, its prior practice of imposing Deposit Chills and Global Locks is no longer effective at preventing the harms those restrictions were originally intended to prevent, including, maintaining the status quo and preventing DTC’s book-entry services from being used in furtherance of improper activity.25 In May 2016, DTC filed the current proposed rule change. Based in part on DTC’s determination that the prior process for imposing Deposit Chills and Global Locks (together, ‘‘Restrictions’’) is no longer effective at preventing or affecting the violative behavior the Restrictions were originally designed to combat, DTC now proposes to make significant changes to its processes and procedures for imposing Restrictions. As discussed more fully below, DTC now proposes, with certain limited exceptions as provided in Section 1(d) of the proposed rule change, to limit the circumstances in which it would impose a Restriction to the occurrence of a Financial Industry Regulatory Authority, Inc. (‘‘FINRA’’) halt, Commission suspension, or if DTC is ordered to impose the Restriction by a court of competent jurisdiction.26 According to DTC, limiting Restrictions primarily to these three occurrences would be more effective in preventing DTC’s services from being used in furtherance of improper activities. Accordingly, as modified by Amendment 1, DTC’s proposal would add Rule 33 to DTC’s Rules to establish the limited circumstances under which DTC would impose a Restriction, as well as the fair procedures for the issuer to receive notice and an opportunity to challenge the Restriction and the standards DTC would apply to determine when to release a Restriction. Section 1 of the proposed rule would establish the four specific circumstances in which DTC may impose either a Deposit Chill or a Global Lock. Section 2 would require DTC to send written notice of the Restriction to the issuer of the Eligible Security detailing the basis for the Restriction and the specific procedures for the issuer to follow to challenge the Restriction. If an issuer chooses to challenge a Restriction under Section 2, Section 3 of the proposed rule establishes DTC’s obligations with respect to providing a written decision from an independent Review Officer in response to that challenge. Section 4 24 See Securities Exchange Act Release No. 72860 (August 18, 2014), 79 FR 49825 (August 22, 2014) (SR–DTC–2013–11). 25 Notice, 81 FR at 37233. 26 Id. VerDate Sep<11>2014 18:59 Dec 09, 2016 Jkt 241001 identifies the specific bases upon which DTC would release a Restriction, even in the absence of a challenge by an issuer. Finally, Section 5 would clarify and limit the scope and applicability of the proposed rule. Each section of the proposed rule change is discussed in more detail below. 1. Section 1: The Specific Conditions Under Which DTC Could Impose a Restriction Section 1 of the proposed rule establishes the conditions and the type of Restriction that DTC would impose under various circumstances. Under Section 1(a), DTC would impose a Global Lock if an Eligible Security is the subject of a trading halt imposed by the FINRA. Under Section 1(b), DTC would impose a Global Lock if an Eligible Security is the subject of a trading suspension imposed by the Commission. The proposed rule provides, however, that DTC would be permitted to decline to impose a Global Lock under Sections 1(a) and (b) of the proposed rule change if DTC reasonably determines that the Global Lock would not further the regulatory purpose of the trading halt or suspension.27 For example, DTC could decline to impose a Global Lock if the reason for a FINRA halt is to pause the market to give market participants time to assess news of a pending event that may affect the security’s price,28 or the sole reason for a Commission suspension is the lack of current and accurate information about the company because it failed to file certain periodic reports with the Commission.29 Under Section 1(c) of the proposed rule change, DTC would impose a Restriction if ordered to do so by a court of competent jurisdiction. DTC would impose the particular Restriction imposed by court, or if no Restriction is specified, DTC would impose a Global Lock. According to DTC, Restrictions would be necessary in the circumstances described in Sections 1(a)–(c) to prevent settlement of trades that continue despite the halt or suspension, and prevent the liquidation of a halted or suspended position through DTC,30 and because DTC’s facilities should not be available to settle transactions otherwise prohibited by the Commission, FINRA, or a court of competent jurisdiction.31 27 Id. at 37233–34. Commission notes that imposing a halt on this basis is, in most instances, outside the scope of FINRA’s trading halt authority for unlisted securities. See FINRA Rule 6440. 29 DTC Letter III at 3. 30 Id. 31 Id. 89535 Lastly, under Section 1(d) of the proposed rule change, DTC would be permitted to impose a Restriction, either Deposit Chill or Global Lock, if it identifies or otherwise becomes aware of a need for immediate action to avert an imminent harm, injury, or other such material adverse consequence to DTC or its Participants that could arise from further deposits of, or continued bookentry services with respect to, an Eligible Security. This provision would provide DTC with flexibility to address unforeseen risks to DTC and its Participants, which would not be addressed by the more narrow conditions enumerated in Sections 1(a)– (c). DTC asserts that Section 1(d) would be invoked rarely, and only if such a Restriction would be necessary to avoid a significant material harm to DTC or one or more of its Participants.32 2. Section 2: Timing and Procedural Requirements for Written Notice of Restrictions and Opportunity To Object to Restrictions Section 2 of the proposed rule would establish the timing and procedural requirements for DTC to provide an issuer with notice of a Restriction and for the issuer to object to that Restriction. First, DTC would be required to send a written ‘‘Restriction Notice’’ to the issuer of the Eligible Security within three business days of the imposition of the Restriction.33 Section 2(a) would require DTC to include the following information in the Restriction Notice: (i) A statement of the basis for the Restriction under Section 1, which would be required to be set forth with reasonable specificity; (ii) the date the Restriction was imposed; and (iii) that within 20 days of receiving the Restriction Notice, the issuer may submit a written ‘‘Restriction Response’’ setting forth its objection to the Restriction and the basis for that objection under Section 4 of the proposed rule (discussed below). If an issuer submits a Restriction Response, Section 2(b) would permit DTC to request reasonable additional information or documentation from the issuer. Section 2(c) specifies that an issuer who fails to comply with a deadline required under Section 2 would waive its right to make the submission required by the deadline. 28 The PO 00000 Frm 00111 Fmt 4703 Sfmt 4703 32 Id.; see also Notice, 81 FR at 37234. Restriction Notice would be send by overnight courier to (i) the issuer’s last known business address, and (ii) the last known business address of the issuer’s transfer agent, if any, on record with DTC. 33 The E:\FR\FM\12DEN1.SGM 12DEN1 89536 Federal Register / Vol. 81, No. 238 / Monday, December 12, 2016 / Notices 3. Section 3: Timing and Procedural Requirements for DTC’s Review of and Written Response to an Issuer’s Objection to a Restriction Section 3 of the proposed rule change establishes the process for DTC to issue a Restriction Decision when, under Section 2, it receives a Restriction Response. Specifically, Section 3 provides that DTC shall provide the issuer with a written ‘‘Restriction Decision’’ within 10 business days of receipt of the Restriction Response.34 Under Section 3(a), the Restriction Decision would be required to be made by a ‘‘Review Officer’’ who did not have responsibility for the imposition of the Restriction, or his delegate. The Review Officer would be required to be an officer of DTC as defined in DTC’s ByLaws.35 In conducting his or her review, the Review Officer would be required to look to the standards of review set forth in Section 4 of the proposed rule (discussed below) to determine whether reasonable adequate cause to release the Restriction exists. After receiving the Restriction Decision, an issuer would have 10 business days to submit a supplemental written response (‘‘Supplement’’). However, a Supplement could only be submitted for the purpose of establishing that DTC made a clerical mistake or mistake arising from an oversight or omission in reviewing the Restriction Response. If the issuer submits a Supplement, the Review Officer would provide a Supplement Decision within 10 business days after the Supplement was delivered. Section 3(d) of the proposed rule specifies that, taken together, the Restriction Notice, the Restriction Response, the Restriction Decision, the Supplement, the Supplement Decision, and any other documents submitted in connection with the proposed procedures would constitute the record for purposes of any appeal to the Commission. 4. Section 4: Standards For Determining Whether Adequate Cause Exists for Release of a Restriction Section 4 of the proposed rule establishes the specific grounds upon mstockstill on DSK3G9T082PROD with NOTICES 34 The deadline may be extended for a reasonable period if DTC has requested additional information or documentation from the issuer pursuant to Section 2(b) of the proposed rule change, or by consent of the issuer, the issuer’s transfer agent, if any, or the issuer’s authorized representatives, if any. 35 An officer is defined under the DTC By-Laws to be the Executive Chairman of the Board, Chief Executive Officer, Chief Operating Officer, or a Managing Director or other senior officers or employees of DTC elected or appointed by the DTC Board pursuant to the DTC By-Laws. See supra, note 13. VerDate Sep<11>2014 18:59 Dec 09, 2016 Jkt 241001 which DTC would be required to release a Restriction imposed pursuant to Section 1 of the proposed rule, even in the absence of a Restriction Response from an issuer, by establishing when adequate cause for the release of the Restriction would be deemed to exist. For Global Locks imposed pursuant to Sections 1(a) or (b) of the proposed rule change (i.e., when FINRA issues a trading halt or the Commission issues a trading suspension), adequate cause to release the Global Lock would exist when the halt or suspension was lifted. According to DTC, because trading would no longer be prohibited by FINRA or the Commission, there should not be any settlement restrictions at DTC, other than operational restrictions imposed in the ordinary course of business as otherwise provided for in DTC’s Rules. Similarly, under Section 4(c) of the proposed rule change, for a Restriction imposed pursuant to Section 1(c) of the proposed rule change (i.e., an order from a court of competent jurisdiction), adequate cause would exist to release the Restriction when a court of competent jurisdiction orders DTC to release the Restriction. DTC explains that if the court no longer required the Restriction, there would be no reason for DTC to continue to impose it. As noted above, Section 1(d) of the proposed rule change is intended to provide DTC with necessary flexibility to address unforeseen risks to it and its Participants, and thus DTC notes it is impossible to outline with specificity all of the scenarios that could give rise to a release of a Restriction under Section 1(d). However, to provide a workable standard for evaluating when the release of a Restriction imposed under Section 1(d), DTC provides that ‘‘adequate cause’’ for the release of the Restriction would exist when DTC reasonably determines that the release of the Restriction would not pose a threat of imminent adverse consequences to DTC or its Participants—typically meaning that the conditions underlying original basis for the Restriction have abated. For example, a Section 1(d) Restriction would be released when DTC determines that the perceived harm has passed or is significantly remote, or when the basis for the Restriction no longer exists.36 DTC also notes that, for Global Locks in effect today that were originally imposed based on a judicial or administrative proceeding under the prior procedures described above in Section II.A.2, Section 4(d) of the proposed rule change would require DTC to release the Global Lock, 36 Notice, PO 00000 81 FR at 37234. Frm 00112 Fmt 4703 Sfmt 4703 provided there currently is no indication that illegally distributed securities are about to be deposited.37 Lastly, Section 4(e) of the proposed rule change would require DTC to release a Restriction if DTC reasonably determined that its imposition of the Restriction was based on a clerical mistake. 5. Section 5: Clarification and Limitation of Scope and Applicability of Proposed Rule 33 Section 5 of the proposed rule change clarifies the scope and applicability of the proposed rule change. Section 5(a) specifies that the proposed rules would not affect DTC’s ability to lift or modify a Restriction, thus preserving DTC’s flexibility to release or modify a Restriction based on the needs of DTC and its Participants. Section 5(b) clarifies that the proposed rules do not affect DTC’s ability to operationally restrict book-entry services, Deposits, or other services in the ordinary course of business pursuant to other provisions of the DTC Rules, as such restrictions would not constitute Restrictions under the proposed rule change. Sections 5(c) and (d) would permit DTC to communicate with the issuer or its transfer agent or representative, if any, provided that substantive communications are memorialized in writing to be included in the record for purposes of any appeal to the Commission, and to send out a Restriction Notice prior to the imposition of a Restriction (thus giving the issuer or its transfer agent advance notice of the Restriction), respectively. III. Summary of Comments Received The Commission received 10 comment letters in response to the proposed rule change.38 One comment letter generally supports the proposed rule change.39 Five comment letters by two commenters, STA and Kesner, object to the proposed rule change.40 Three comment letters from DTC respond to the objections raised by STA and Kesner,41 and one comment letter does not specifically comment on any aspect of the proposed rule change.42 A. Supporting Comment One commenter generally endorses the proposed rule change, stating that the proposed procedures for fair notice and opportunity to challenge would 37 Id. 38 See supra note 4. Arnoff Letter. 40 See STA Letters I, II, and III and Kesner Letters I and II. 41 See DTC Letters I and II. 42 See Deyet Letter. 39 See E:\FR\FM\12DEN1.SGM 12DEN1 Federal Register / Vol. 81, No. 238 / Monday, December 12, 2016 / Notices prevent and mitigate harm to both issuers and innocent shareholders.43 B. Objecting Comments STA and Kesner express general concerns with DTC, which STA and Kesner claim functions as a monopoly in the clearance and settlement of securities, exercising discretion to deny access to its services.44 More specifically, STA and Kesner argue that the proposed rule change is inconsistent with Section 17A(b)(3)(F) of the Act because it is not designed to protect investors and the public interest, and that it is inconsistent with Section 17A(b)(3)(H) of the Act because the procedures for notice of and opportunity to challenge restrictions imposed by DTC are not fair.45 1. The Proposed Rule Change is Not Designed To Protect Investors and Public Interest as Required by Section 17A(b)(3)(F) of the Act STA and Kesner argue that the proposed rule change is inconsistent with the Act for the following reasons: (i) The proposed basis for the imposition of Restrictions is vague and discretionary and inconsistent with the intent of Section 19 of the Exchange Act; (ii) the proposed basis for imposition of Restrictions would hurt issuers and shareholders; and (iii) Congress did not intend for DTC to be a fraud regulator. Each argument is discussed below. (i) Proposed Basis for Imposition of Restrictions Is Vague and Discretionary and Inconsistent With the Intent of Sections 17A and 19 of the Act and Rule 19b–4 Thereunder Commenters were generally supportive of the proposed basis for imposing Restrictions under Sections 1(a), (b), and (c) of the proposed rule change,46 but some commenters raise objections to Section 1(d) of the proposed rule change. Specifically, STA asserts that the authority to impose Restrictions under Section 1(d) of the proposed rule change is overly broad, arbitrary, permits DTC to exercise unfettered discretion, and would allow DTC to take action without any real evidence of the likelihood of actual harm or violation of objective 43 See mstockstill on DSK3G9T082PROD with NOTICES Arnoff Letter. 44 STA Letter I at 1; Kesner Letter I at 1. 45 See id. 46 See, e.g., Kesner states that the basis for imposing Restrictions under Sections 1(a), (b), and (c) of the proposed rule change is consistent with the approach of DTC being directed by a regulator or court. Kesner Letter I at 6. Meanwhile, STA states that it applauds the certainty afforded by the Sections 1(a), (b), and (c) of the proposed rule change. See STA Letter I at 3. standards.47 STA further claims that the authority to impose Restrictions under Section 1(d) is so vague that the Commission has no way of knowing whether DTC is attempting to regulate matters not related to (i) the purposes of Section 17A of the Act, (ii) the administration of the clearing agency, or (iii) consistent with the requirements of the Act, as required by Sections 17A(b)(3)(F) and 19(b)(2)(C) of the Act.48 Likewise, STA states that the authority to impose Restrictions under Section 1(d) of the proposed rule change is inconsistent with the intent of Section 19 of the Act and Rule 19b–4 thereunder, which encourages transparency by requiring a clearing agency to seek approval of a stated policy, practice, or interpretation.49 Therefore, STA argues that the proposal is contrary to the openness envisioned by Congress.50 Similar to STA, Kesner expresses concern that Section 1(d) of the proposed rule change would give authority to DTC to impose Restrictions merely upon the initiation of an investigation or enforcement proceeding where it concludes a threat is imminent requiring immediate action.51 Kesner states that the Commission has not directed DTC to adopt rules to protect DTC or DTC’s financial institution owners and DTC has not articulated how exercising discretionary authority satisfies its obligation for a fair process.52 According to Kesner, DTC’s previous imposition of Restrictions, in many cases, were only based upon ‘‘flimsy legal footing, notice of commencement of an investigation or inquiry, anecdotal observations or even unproven news stories.’’ 53 Kesner states that the proposed rule change does not address the ‘‘unfortunate results that befall innocents caught up by a [Restriction], nor the immensity of the costs and burdens placed on issuers and investors seeking to clear a [Restriction].’’ 54 Kesner states that small issuers do not have the resources to defend themselves and even with the potential of an appeal Restrictions cause irreparable damage.55 Rather, the imposition of Restrictions would best be left to exchanges and other ‘‘regulatory bodies’’ that have sufficient resources and could direct VerDate Sep<11>2014 18:59 Dec 09, 2016 Jkt 241001 47 STA Letter I at 1–3; see also STA Letter II at 48 STA Letter III at 2. 2. 49 Id. 50 Id. 51 Kesner Letter I at 6. Letter I at 2, 3; Kesner Letter II at 1. 53 Kesner Letter I at 2. 54 Id. at 2, 3; Kesner Letter II at 1. 55 Kesner Letter I at 2. 52 Kesner PO 00000 Frm 00113 Fmt 4703 Sfmt 4703 89537 DTC to impose a service restriction when warranted.56 (ii) Proposed Basis for Imposition of Restrictions Would Hurt Issuers and Shareholders STA contends that the proposed rule change was not a ‘‘good faith attempt’’ by DTC to comply with the Commission’s order in IPWG and is inconsistent with Section 17A(b)(3)(F) of the Act 57 because imposition of Restrictions would hurt issuers and innocent investors.58 Specifically, STA asserts that the authority to impose Restrictions under Section 1(d) of the proposed rule change should balance the effect of DTC’s actions on innocent shareholders because a Restriction could have a devastating effect on investors and could cause trading in the shares of an issuer to come to a virtual stop.59 Therefore, innocent investors may find that their shares are virtually valueless during the period the Restriction is in place.60 (iii) Congress Did Not Intend DTC To Be a Fraud Regulator STA states that the proposed rule change is inconsistent with Section 17A(b)(3)(F) of the Act 61 because Congress did not intend DTC to act as a fraud regulator or to enforce laws unrelated to clearance and settlement.62 Specifically, STA asserts that the authority to impose Restrictions under Section 1(d) of the proposed rule change is inconsistent with Section 17A(b)(3)(F) of the Act,63 which requires, among other things, that the rules of the clearing agency are not designed to regulate by virtue of any authority conferred by the Act matters not related to the purposes of Section 17A of the Act or the administration of the clearing agency.64 STA states that the authority for fraud regulation is conferred under other sections of the Act on the Commission and different selfregulatory organizations with respect to their members.65 Thus, STA contends that DTC does not have the authority to implement the proposed rule change.66 56 Id. at 6. U.S.C. 78q–1(b)(3)(F). 58 STA Letter I at 3. STA Letter III at 2. 59 STA Letter III at 2. 60 Id. 61 15 U.S.C. 78q–1(b)(3)(F). 62 STA Letter III at 2. 63 15 U.S.C. 78q–1(b)(3)(F). 64 STA Letter III at 2. 65 Id. 66 Id. 57 15 E:\FR\FM\12DEN1.SGM 12DEN1 89538 Federal Register / Vol. 81, No. 238 / Monday, December 12, 2016 / Notices 2. The Proposed Rule Change Does Not Provide Fair Procedure With Respect to Restrictions Imposed by DTC as Required by Section 17A(b)(3)(H) of the Act Commenters object to the proposed rule change on the basis that they do not believe that it is consistent with either Section 17A(b)(3)(H) of the Act 67 or the Commission’s order in IPWG. First, Kesner argues that DTC cannot be ‘‘fair’’ and cannot satisfy the requirements set forth in IPWG if DTC sets its own standards and acts on its own accord to impose a Restriction not directed by a traditional regulator or court because DTC does not have the resources, technical expertise, or ‘‘commitment to fairness’’ to undertake such an expansive role in the substantive regulation of securities issuers or to become a ‘‘super-gatekeeper.’’ 68 Second, Kesner states that DTC’s imposition of Restrictions under Section 1(d) of the proposed rule change, if approved, should include specific methods by which an issuer can successfully appeal and require DTC to remove the Restriction (or provide for automatic removal after a short period) that are fair and reasonable and that do not burden smaller issuers with excessive costs or delays during the denial of the DTC’s essential services.69 Kesner argues that to do otherwise would hurt innocent investors and shareholders.70 Third, STA contends that Section 3 of the proposed rule change as originally proposed (i.e., before DTC filed Amendment 1) was procedurally deficient because there were no time periods specified in the proposed rule change for the DTC Review Officer’s review to be completed. Thus, in some cases issuers and investors could be harmed for an indefinite period while waiting for DTC to reach a decision.71 Specifically, STA asserts that DTC should limit its Restriction, under Section 1(d) of the proposed rule change, to only a single 10-day period, with any ‘‘fair process’’ occurring during that 10-day Restriction.72 DTC could resolve concerns based on a ‘‘misunderstanding’’ or inform the Commission or FINRA of its concerns, 67 15 U.S.C. 78q–1(b)(3)(H). Letter I at 2, 4–5; Kesner also stated that the Commission has not ‘‘direct[ed] DTC to adopt[ ] rules to protect DTC or DTC’s financial institution owners and DTC has not articulated how exercising discretionary authority satisfies its obligation for a fair process.’’ Kesner Letter II at 1; see also STA Letter II at 3; STA Letter III at 2. 69 Kesner Letter I at 6. 70 Id. 71 STA Letter I at 4. 72 Id. mstockstill on DSK3G9T082PROD with NOTICES 68 Kesner VerDate Sep<11>2014 18:59 Dec 09, 2016 Jkt 241001 allowing either organization to take further action to protect DTC, its Participants, or investors from the imminent harm.73 STA also asserts that notice of a Restriction should occur prior to or, at least, contemporaneously with imposition of the Restriction, particularly in the case of a Restriction imposed based on DTC’s assessment of imminent harm, under Section 1(d) of the proposed rule change, not three days after the Restriction is imposed.74 Fourth, STA expresses concern that the Review Officer tasked with reviewing a Restriction Response could be located in an office near the person that imposed the Restriction, could have been involved in imposing the Restriction, and could be charged with overturning the decision made by a colleague.75 Similarly, Kesner questions the independence of the Review Officer and asserts that IWPG requires that appeals should be heard by parties independent of DTC and suggests that ‘‘representatives of the securities bar, [STA], transfer agents, clearing and settlement firms, auditors, and business people, under the guidance of the DTC General Counsel, should constitute the panel of hearing officers making recommendations for imposition and removal of [Restrictions], continuations and appeals whenever DTC acts.’’ 76 Finally, commenters raise other points that either did not pertain to the proposed rule change, or did not suggest how such issues would make the proposed rule change inconsistent with the Act.77 As such, those points are 73 Id. at 4. Letter I at 4. 74 STA 75 Id. 76 Kesner Letter II at 2. of points raised by the commenters about the proposed rule change that did not address whether the proposed rule change is or is not consistent with the Act include STA stating that the proposal should also apply to transfer agents seeking initial access to DTC’s facilities (STA Letter I at 4), and Kesner stating that (i) the Commission should not act on the proposal without specific comments from major exchanges and OTCLink regarding coordination with DTC and the Commission concluding that DTC’s actions under the proposal would not interfere with the objectives of exchanges and other regulators and not hamper the functioning of the markets; (ii) DTC would need to give up its immunity from lawsuits in order for there to be a potentially fair process in the imposition and appeal of Restrictions; (iii) investors should have standing to appeal a Restriction; and (iv) the Commission should require DTC to undertake a study and submit all of its statistics surrounding Restrictions. Kesner Letter I at 4, 6; Kesner Letter II at 3. Similarly, Arnoff asserted that the proposal should clarify that DTC should not be immune from civil liability, particularly if DTC cannot establish that it acted in good faith and with reasonable judgment, because DTC is not acting in a governmental capacity in the settlement and clearance process. Arnoff Letter. Moreover, Arnoff stated that because DTC is not infallible and the risk of error always exists, DTC should be required to 77 Examples PO 00000 Frm 00114 Fmt 4703 Sfmt 4703 beyond the scope of the proposed rule change and, therefore, are not further summarized or discussed in this order. C. DTC’s Response As discussed more fully below, DTC argues that the proposed rule change is consistent with the Act in that it is consistent with Section 17A(b)(3)(F) of the Act because it is designed to protect investors and the public interest, and it provides fair procedures as required by Section 17A(b)(3)(H) of the Act. 1. The Proposed Rule Change Is Designed To Protect Investors and the Public Interest as Required by Section 17A(b)(3)(F) of the Act (i) Response to Comments That the Proposed Basis for Imposition of Restrictions Is Vague and Discretionary and Inconsistent With the Intent of Sections 17A and 19 of the Act and Rule 19b–4 Thereunder In response to STA’s comment that the basis for imposition of Restrictions under the proposed rule change is vague, DTC asserts that Sections 1(a)–(c) of the proposed rule change provide specific, objective trigger events for imposing Restrictions and would be the primary focus of the Restriction program going forward.78 Further, while DTC acknowledges that it cannot anticipate each circumstance under which immediate action could be needed under Section 1(d) to prevent harm to DTC or its Participants,79 it provides specific examples of such circumstances, including: (i) If DTC receives information from an authorized officer of the issuer that another company has usurped the identity of the company and issued unauthorized shares; (ii) if DTC has corroborated and plausible information that forged securities are being deposited at DTC; (iii) a foreign regulatory authority raises credible concerns about an Eligible Security; or (iv) there is a material recordkeeping issue that raises questions about the Eligibility of a specific security.80 DTC also asserts that STA’s position that the Commission should not approve the proposed rule change if it includes Section 1(d) would deny DTC the flexibility to impose Restrictions that could be necessary to avoid imminent harm to DTC or its Participants,81 thereby subjecting DTC and its Participants to significant purchase ‘‘errors and omissions insurance’’ to protect innocent issuers and investors and to add an ‘‘additional dimension of loss prevention.’’ Arnoff Letter. 78 DTC Letter I at 2. 79 DTC Letter I at 3; DTC Letter III at 3. 80 DTC Letter III at 3. 81 Id. at 2; DTC Letter III at 3. E:\FR\FM\12DEN1.SGM 12DEN1 Federal Register / Vol. 81, No. 238 / Monday, December 12, 2016 / Notices potential harm. DTC states that it needs such flexibility to protect itself and its Participants from an imminent harm that may not warrant or be covered by a trading halt or suspension.82 In response to Kesner’s comment that Section 1(d) of the proposed rule change would give authority to DTC to impose Restrictions merely upon the initiation of an investigation or enforcement proceeding where DTC concludes a threat is imminent and requires immediate action, DTC asserts that the Commission recognized in In re Atlantis Internet Group (‘‘Atlantis’’) 83 and IPWG that DTC has such authority and that it is critical to the self-regulatory function of DTC to retain discretion to avert imminent harm, including the discretion to take action before providing notice to the issuer, if necessary.84 DTC states that Section 1(d) of the proposed rule change would be used only for urgent situations and exercised rarely, such as in the example scenarios listed above.85 (ii) Response to Comments That the Proposed Basis for Imposition of Restrictions Would Hurt Issuers and Shareholders DTC states, generally, that the proposed rule change would assure the safeguarding of securities by providing a mechanism for DTC to act quickly and efficiently to screen out prior to deposit, or restrict after deposit, securities that pose an imminent harm to DTC or its Participants, or for which trading has been prohibited by a court or applicable regulator.86 Specifically, DTC states that Sections 1(a) and (b) of the proposed rule change provide objective trigger events for imposing Restrictions when the Commission imposes a trading suspension or FINRA impose a trading halt.87 DTC explains that, although trading activity takes place outside of DTC, DTC provides a settlement location for market traders or other transfers of interests in securities.88 Thus, absent a DTC Restriction, other book-entry transfers might continue (e.g., pledges, repos, or securities lending), notwithstanding a Commission suspension or FINRA halt.89 A Restriction would freeze these Participant activities, which DTC believes would further the regulatory mstockstill on DSK3G9T082PROD with NOTICES 82 DTC Letter I at 3; DTC Letter III at 3. 83 Atlantis, Securities Exchange Act Release. No. 75168 at 7–8, 2015 SEC LEXIS 2394 (June 12, 2015) (Admin. Proc. File No. 3–15432). 84 DTC Letter I at 3; DTC Letter II at 2. 85 DTC Letter III at 3. 86 See Notice, 81 FR 37235. 87 DTC Letter III at 2. 88 Id. 89 Id. VerDate Sep<11>2014 18:59 Dec 09, 2016 Jkt 241001 purpose of the Commission suspension or FINRA halt.90 Further, DTC emphasizes that it would not impose a Restriction if DTC believes that the suspension or halt does not implicate concerns that DTC believes should lead to a Restriction.91 For example, under Section 1 of the proposed rule change, DTC could decline to impose a Global Lock if (i) in the case of a FINRA halt, if the reason for the halt is to pause the market to give market participants time to assess news of a pending event that may affect the security’s price; or (ii) in the case of a Commission suspension, if the sole reason for the suspension is the lack of current and accurate information about the company because it failed to file certain periodic reports with the Commission.92 With respect to Section 1(d) of the proposed rule change, DTC asserts that it believes that Section 1(d) is consistent with the Act because it would provide DTC with the flexibility it needs to protect its fungible bulk, which it holds on behalf of its Participants, from imminent harm that could arise from circumstances that would neither justify nor be affected by a trading halt or suspension,93 while still providing sufficient notice of the types of circumstances that could trigger a Restriction under Section 1(d). DTC also reiterates that it does not anticipate imposing Restrictions pursuant to Section 1(d) of the proposed rule change frequently,94 and has provided specific examples of circumstances under which imminent harm could arise in the future, as described above.95 (iii) Response to Comments That DTC Would Be Acting as a Fraud Regulator In response to comments that Congress did not intend DTC to act as a fraud regulator or to enforce laws unrelated to clearance and settlement, DTC asserts that Sections 1(a)–(c) of the proposed rule change would further the regulatory purpose behind a Commission, FINRA, or court action by stopping the flow of questionable securities in other book-entry transfers that may continue despite other regulatory action.96 With respect to Section 1(d), DTC states that there are situations that would require DTC to impose a Restriction that might not require a 90 Id. 91 Id. at 2, 3. at 3. 93 DTC Letter I at 2; DTC Letter III at 3. 94 DTC Letter III at 3. 95 Id. 96 Id. at 2, 3. 92 Id. PO 00000 Frm 00115 Fmt 4703 Sfmt 4703 89539 Commission suspension or FINRA halt.97 For instance, DTC could impose a Restriction (i) if DTC receives information from an authorized officer of the issuer that another company has usurped the identity of the company and issued unauthorized shares; (ii) if DTC has corroborated and plausible information that forged securities are being deposited at DTC; (iii) a foreign regulatory authority raises credible concerns about an eligible security; or (iv) there is a material recordkeeping issue that raises questions about the eligibility of a specific security. The Commission also notes that, as discussed below, a Restriction could be necessary to prevent DTC’s services from being used to facilitate an unregistered distribution or other violation of the securities laws. 2. The Proposed Rule Change Does Provide Fair Procedure With Respect to Restrictions Imposed by DTC on Access to Its Book-Entry Services by Issuers and Shareholders as Required by Section 17A(b)(3)(H) of the Act DTC states that the proposed rule change is consistent with Section 17A(b)(3)(H) of the Act 98 and IPWG. Specifically, in response to STA’s and Kesner’s comments that the proposed rule change does not provide for fair procedures nor satisfy the requirements of IPWG, DTC highlights that the Commission’s decisions in both Atlantis and IPWG 99 recognize that DTC must retain discretion to avert imminent harm, including the discretion to take action before providing notice to the issuer, if necessary.100 In response to STA’s specific claim that the proposal is procedurally deficient because it lacks a stated time period for the Review Officer to complete the review, DTC submitted Amendment No.1 to Section 3 of the proposed rule change, which, as described above, establishes a 10 business-day deadline, with limited extension, for the Review Officer to complete its review of the Restriction Response and for DTC to provide a Restriction Decision.101 Similarly, in response to both STA’s and Kesner’s comments that Restrictions imposed under Section 1(d) of the 97 Id. at 3. U.S.C. 78q–1(b)(3)(H). 99 Atlantis, 2015 SEC LEXIS 2394 at *7, 8. 100 DTC Letter I at 3. 101 Prior to filing Amendment No. 1, DTC also contended in its first response letter that a reasonable review by the Review Officer in a timely manner is implicit in the proposed process, recognizing that DTC is bound to perform a prompt review, and to do otherwise may conflict with its obligations under Section 17A of the Act. DTC Letter I at 4; 15 U.S.C. 78q–1. 98 15 E:\FR\FM\12DEN1.SGM 12DEN1 89540 Federal Register / Vol. 81, No. 238 / Monday, December 12, 2016 / Notices proposed rule change should be automatically removed after a short period or expire after 10 days, DTC states that it would not be effective, reasonable, or practical for DTC to premise its proposed rule change on the assumption that the Commission or FINRA would or could take action quickly enough to protect DTC, its Participants, or investors.102 DTC explains further that imminent harm to DTC or its Participants could arise from circumstances that may not be addressed by or may not justify a trading halt or suspension, such as the impending deposit of illegally distributed securities at DTC.103 DTC also reiterates that it does not anticipate imposing Restrictions pursuant to Section 1(d) of the proposed rule change frequently.104 In response to STA’s and Kesner’s comments on the independence of the Review Officer, and STA’s comment that notice of a Restriction should be at least contemporaneously with the imposition of the Restriction, DTC states that it believes the proposed rule change is sufficiently clear to require that the Review Officer not be conflicted and that the Review Officer’s decision would be unbiased and independent,105 and that both Atlantis and IPWG recognize that DTC must retain discretion to take action before providing notice to the issuer, if necessary.106 mstockstill on DSK3G9T082PROD with NOTICES IV. Discussion and Commission Findings Section 19(b)(2)(C) of the Act directs the Commission to approve a proposed rule change of a self-regulatory organization if it finds that such proposed rule change is consistent with the requirements of the Act and rules and regulations thereunder applicable to such organization.107 After carefully considering the proposed rule change, the comments received, and DTC’s responses thereto, the Commission finds that the proposed rule change, as modified by Amendment No. 1, is consistent with the requirements of the Act and the rules and regulations thereunder applicable to DTC. In particular, the Commission finds that the proposed rule change is consistent with Sections 17A(b)(3)(F) and 17A(b)(3)(H) of the Act, as discussed in detail below. 102 DTC Letter I at 3; see also DTC Letter II at 2. 103 Id. 104 Id. Letter I at 4. at 3. 107 15 U.S.C. 78s(b)(2)(C). A. Consistency With Section 17A(b)(3)(F) of the Act Section 17A(b)(3)(F) of the Act requires, among other things, that the rules of the clearing agency are designed to assure the safeguarding of securities in the custody or control of the clearing agency and, in general, protect investors and the public interest.108 Sections 1(a) and (b) of the proposed rule change, respectively, would authorize DTC to impose a Global Lock where FINRA has issued an order for the halt of trading of an Eligible Security or the Commission has issued an order for the suspension of trading of an Eligible Security. Section 1(c) of the proposed rule change would authorize DTC to impose a Restriction when ordered to do so by a court of competent jurisdiction. In such a situation, DTC would impose the Restriction specified by the court, or a Global Lock if no Restriction was specified. As noted above, commenters are generally supportive of the proposed basis for imposing Restrictions under Sections 1(a), (b), and (c) of the proposed rule change.109 A halt, suspension, or court order would raise questions as to whether the security at issue would continue to meet the eligibility criteria set forth in DTC’s Rules. The Commission therefore agrees that DTC should have the authority under its Rules to place a Restriction on such securities if doing so will help prevent potentially ineligible securities from tainting DTC’s fungible bulk, thereby protecting DTC and DTC’s Participants from facilitating wrongful activities, and investors from having Eligible Securities tainted by securities of the same issue that do not meet DTC’s eligibility criteria. The Commission also agrees that providing DTC with authority to impose a Restriction on securities that are the subject of a FINRA halt or Commission suspension would help protect investors and possibly stop further wrongdoing, because the Restriction would stop deliveries, redemptions, pledges, lending, deposits, and other types of transfers and settlements made via DTC’s book-entry services that may not be addressed by the trading halt or suspension. The proposed rule change would provide DTC the discretion to not impose a Global Lock, even if FINRA or the Commission issued a halt or suspension of trading of an Eligible Security, if such a Restriction would not further the regulatory purpose of the halt or suspension. For example, if a 105 DTC 106 Id. VerDate Sep<11>2014 18:59 Dec 09, 2016 108 15 U.S.C. 78q–1(b)(3)(F). supra Section III.B.1.i at note 46. 109 See Jkt 241001 PO 00000 Frm 00116 Fmt 4703 Sfmt 4703 halt or suspension was imposed for a reason unrelated to the eligibility of the security for DTC’s book-entry services,110 DTC would not be required to impose a Restriction. This provision protects issuers and investors from the burdens of unnecessary Restrictions by providing DTC with flexibility to avoid imposing a Global Lock if doing so would not be in the interest of protecting DTC, DTC’s Participants, issuers, or investors. Section 1(d) of the proposed rule change would authorize DTC to impose a Restriction upon identifying or becoming aware of a need to take such action to avoid imminent harm, injury, or other such material adverse consequence to DTC or its Participants that could arise from further deposits of, or continued book-entry services to, a particular Eligible Security. As described above, commenters generally raise three objections to Section 1(d): (i) Section 1(d) is impermissibly vague, thereby granting DTC unfettered discretion to impose Restrictions under it; (ii) issuers and investors would be harmed by Restrictions imposed under this provision, including because it would stop all book-entry services for that security, possibly affecting the value of the security; 111 and (iii) by exercising its discretion under Section 1(d), DTC would be improperly acting as a fraud regulator. With respect to the first objection, one commenter also states that the need to impose a Restriction under Section 1(d) of the proposed rule change should be balanced with the interests of shareholders of the security.112 The Commission does not find that Section 1(d) of the proposed rule change is impermissibly vague, or that it would grant DTC unfettered discretion to impose Restrictions without a proper basis or adequate protections for issuers. First, Section 1(d) is not impermissibly vague because it establishes specific criteria for imposing a Restriction and would require DTC to meet a high standard before it would be permitted to do so under that provision. Specifically, DTC would be required to identify (i) a need for immediate action (ii) to avert an imminent, (iii) harm, injury, or other such material adverse consequence, (iv) to DTC or its Participants, (v) that could arise from further deposits of, or 110 For example, DTC states that it would not impose a Restriction where an alleged improper issuance of shares were deposited at DTC several years earlier, or the chief executive officer of a company was convicted of a corporate crime that had no apparent effect on the eligibility of the company’s securities at DTC. DTC Letter III at 4. 111 STA Letter III at 2. 112 Id. E:\FR\FM\12DEN1.SGM 12DEN1 Federal Register / Vol. 81, No. 238 / Monday, December 12, 2016 / Notices continued book-entry services to, an Eligible Security. As such, DTC’s discretion to impose restrictions under Section 1(d) would be constrained. Indeed, in light of the standards set forth in Section 1(d), DTC acknowledges that Restrictions under this section would only be imposed in rare and exigent circumstances,113 where imminent harm is present.114 DTC’s discretion would also be limited by Section 19(g) of the Act, which requires DTC, as a registered clearing agency and self-regulatory organization, to administer all of its rules in a manner consistent with its obligations of compliance with the federal securities laws and other applicable laws.115 Regarding DTC’s discretion under proposed Section 1(d), the Commission agrees that it would be impossible for DTC to predict and codify every possible circumstance that could taint DTC’s fungible bulk, and thus harm DTC, its Participants, issuers, and investors. Without Section 1(d) of the proposed rule change, DTC would not have the authority or discretion to impose a Restriction when a significant concern arises that would not fall under Sections 1(a)–(c) because it is not related to a halt, suspension, or court order.116 The Commission finds that such discretion is necessary to allow DTC to protect not only itself and its Participants, but also investors and issuers who, but for a Restriction imposed by DTC, could be unwilling participants in fraudulent activity, or victims of improper conduct.117 For example, in the event that DTC becomes aware that all or some portion of the fungible bulk of an Eligible Security may have been sold or distributed in violation of Section 5 of the Securities Act, it could be necessary for DTC to limit further deposits and/or book-entry services for that security to prevent DTC and its Participants from participating in or otherwise facilitating an ongoing Section 5 violation. Without the authority and discretion granted by proposed Section 1(d), DTC might not have the authority under its Rules to take such action. Likewise, the 113 See DTC Letter I at 2. Notice, 81 FR at 37234. 115 15 U.S.C. 78s(g). 116 For example, DTC could have a concern about a foreign issuance, but FINRA or the Commission may not share that same concern and may not impose a trading halt or suspension; yet, DTC may believe it necessary to impose a Restriction to protect DTC and its Participants. See DTC Letter III at 3. 117 For example, as DTC suggests, if DTC became aware of a current corporate hijacking, it would be able to impose a Restriction immediately, under Section 1(d) of the proposed rule. See DTC Letter III at 3. mstockstill on DSK3G9T082PROD with NOTICES 114 See VerDate Sep<11>2014 18:59 Dec 09, 2016 Jkt 241001 discretion provided by proposed Section 1(d) would enable DTC to protect current shareholders from potential fraudulent deposits of securities that could compromise the value of their securities of the same issue. The Commission also does not find that the potential harm that could be caused to issuers and investors by Restrictions imposed under Section 1(d) outweighs the benefits to DTC, DTC’s Participants, issuers, and investors gained by permitting DTC to impose Restrictions in the limited circumstances, and subject to the processes and procedures, that would be established by the proposed rule change. Any such potential harm would be mitigated not only by the issuer’s ability under the proposed rule change to challenge a Restriction with DTC, but also by the issuer’s ability to then appeal DTC’s Restriction Decision to the Commission. Further, DTC, DTC’s Participants, issuers, and investors could all be harmed if DTC did not have the authority to impose a Restriction in the circumstances described in Sections 1(a)–(d). Rather, the Commission finds that Section 1(d) of the proposed rule change is necessary to provide DTC with adequate flexibility and authority to prevent and avoid imminent harm to DTC and its Participants, as well as issuers and investors, that could arise as a result of unforeseen and unpredictable events outside DTC’s ability to predict or control. In addition, the Commission believes that DTC’s flexibility to impose a Restriction under Section 1(d) is appropriately balanced with the interests of issuers and shareholders of the security by Section 4(d) of the proposed rule change, which would require DTC to release the Restriction when it reasonably determines that the original basis for the Restriction has abated, and release of the Restriction would no longer pose a threat of imminent harm, injury, or other such material adverse consequent to DTC or its Participants.118 Finally, with respect to commenters’ third objection, that Section 1(d) of the proposed rule change is inconsistent with Section 17A(b)(3)(F) of the Act because Congress did not intend DTC to act as a fraud regulator or to enforce laws unrelated to clearance and settlement,119 the Commission finds that the proposed rule change is directly related to DTC’s administration of its book-entry clearing and settlement services, which are directly related to the purposes of Section 17A of the Act, 118 See Notice, 81 FR 37234. Letter III at 3. 119 STA PO 00000 Frm 00117 Fmt 4703 Sfmt 4703 89541 including the establishment of the national system for clearance and settlement of securities transactions.120 As the Commission noted in both Atlantis and IPWG, one of the reasons DTC’s book-entry clearing and settlement services are fundamentally important services is because any suspension by DTC of its clearance and settlement services with respect to an issuer’s securities means that all trades in that issuer’s stock would then require physical transfer of the stock certificates.121 As the central depository of securities in the United States, DTC has an obligation to ensure that by allowing book-entry services on deposited shares, it is not facilitating the illegal distribution of unregistered shares or helping to perpetrate a fraud, in violation of Section 5 of the Securities Act. Such actions are necessary to help assure the safeguarding of securities in the custody or control of DTC, and, in general, protect investors and the public interest. Further, DTC is a registered clearing agency and self-regulatory organization under Section 19 of the Act. As such, the Commission previously concluded in Atlantis and IPWG that DTC has the authority to impose restrictions on its book-entry services.122 Based on the above, the Commission finds that the proposed rule change, is designed to help assure the safeguarding of securities in the custody or control of DTC, and, in general, protect investors and the public interest, as required by Section 17A(b)(3)(F) of the Act. B. Consistency With Section 17A(b)(3)(H) of the Act Section 17A(b)(3)(H) of the Act requires, among other things, that the rules of a clearing agency are in accordance with the provisions of Section 17A(b)(5)(B) of the Act, and, in general, provide a fair procedure with respect to the prohibition or limitation by the clearing agency of any person with respect to access to services offered by the clearing agency.123 Section 17A(b)(5)(B) of the Act 124 requires that, in any proceeding by a registered clearing agency to determine whether a person shall be denied participation or prohibited or limited with respect to access to services offered by the clearing agency, the clearing agency shall notify such person of, and give that person an opportunity to be heard, the specific 120 15 U.S.C. 78q–1. 2015 SEC LEXIS 2394 at *7–8 n.4; IPWG, 2012 SEC LEXIS 844 at *24. 122 Atlantis, 2015 SEC LEXIS 2394 at *7–8 n.4; IPWG, 2012 SEC LEXIS 844 at *24. 123 15 U.S.C. 78q–1(b)(3)(H). 124 15 U.S.C. 78q–1(b)(5)(B). 121 Atlantis, E:\FR\FM\12DEN1.SGM 12DEN1 89542 Federal Register / Vol. 81, No. 238 / Monday, December 12, 2016 / Notices grounds for denial or prohibition or limitation under consideration and keep a record.125 A determination by the clearing agency to deny participation or prohibit or limit a person with respect to access to services offered by the clearing agency shall be supported by a statement setting forth the specific grounds on which the denial or prohibition or limitation is based.126 In Atlantis and IPWG, the Commission concluded that issuers are ‘‘persons’’ under Section 17A(b)(3)(H) of the Act, and, thus, are entitled to Commission review of DTC’s actions that deny or limit issuers access to DTC services.127 The Commission further found that, to comply with Section 17A(b)(3)(H) of the Act,128 DTC must provide the issuer with notice of DTC’s determination to impose a Restriction, specifying the basis for DTC’s action, and that DTC must also provide an issuer with an opportunity to be heard,129 but that a formal hearing is not required.130 The Commission stated that DTC may design fair procedures in accordance with its own internal needs and circumstances.131 The Commission also held in Atlantis and IPWG that if DTC believes that circumstances exist that justify imposing a suspension of services with respect to an issuer’s securities, in advance of being able to provide the issuer with notice and an opportunity to be heard on the suspension, it may do so,132 provided that, in such circumstances, the process to impose such a suspension should balance the identifiable need for emergency action with the issuer’s right to fair procedures under Section 17A(b)(3)(H) of the Act.133 Under such procedures, DTC would be authorized to act to avert an imminent harm, but it could not maintain such a suspension indefinitely without providing expedited fair process to the affected issuer.134 The Commission finds that the proposed rule change appropriately addresses the Commission’s findings in 125 Id. mstockstill on DSK3G9T082PROD with NOTICES 126 Id. 127 Atlantis, 2015 SEC LEXIS 2394 at *7, 8 n.4; IPWG, 2012 SEC LEXIS 844 at *24. 128 15 U.S.C. 78q–1(b)(3)(H). 129 Atlantis, 2015 SEC LEXIS 2394 at *7, 8 n.4; IPWG, 2012 SEC LEXIS 844 at *24. 130 Atlantis, 2015 SEC LEXIS 2394 at *19; IPWG, 2012 SEC LEXIS 844 at *30 n.36. 131 Atlantis, 2015 SEC LEXIS 2394 at *19; IPWG, 2012 SEC LEXIS 844 at *24. 132 Atlantis, 2015 SEC LEXIS 2394 at *18 n.9; IPWG, 2012 SEC LEXIS 844 at *29. 133 15 U.S.C. 78q–1(b)(3)(H); Atlantis, 2015 SEC LEXIS 2394 at *18 n.9; IPWG, 2012 SEC LEXIS 844 at *29. 134 Atlantis, 2015 SEC LEXIS 2394 at *18 n.9; IPWG, 2012 SEC LEXIS 844 at *29. VerDate Sep<11>2014 18:59 Dec 09, 2016 Jkt 241001 IPWG and Atlantis by, among other things, limiting Restrictions primarily to circumstances in which there would be objective external criteria for the Restriction of which the issuer would clearly be on notice (i.e., a FINRA halt, Commission suspension, or Court order under Sections 1(a)–(c)), or where the Restriction would be necessary to avoid a specific imminent harm to DTC or one or more of DTC’s Participants. Sections 2 and 3 of the proposed rule change would establish a clear, unambiguous framework for providing issuers with notice of a Restriction and an opportunity to be heard and object to the Restriction, as well as DTC’s obligations to review and provide a response to any such objection. Under Section 2(a) of the proposed rule change, DTC would be required to provide the issuer with notice of a Restriction within three business days after imposition of the Restrictions. The Restriction Notice would be required to set forth with reasonable specificity (i) the basis for the Restriction; (ii) the date the Restriction was imposed; and (iii) the timing and procedural requirements for the issuer to object to the Restriction. The issuer would be permitted to submit a Restriction Response to DTC within 20 business days of receiving the Restriction Notice, setting forth its objection to the Restriction and detailing the reasons that the Restriction should be released pursuant to Section 4(d). Under Section 3 of the proposed rule change, DTC would then have 10 business days to provide the issuer with a Restriction Decision, which would be required to be made by an independent Review Officer, defined as an officer of DTC under DTC’s By-Laws. Under Section 3(b) of the proposed rule change, in response to the Restriction Decision, the issuer would be permitted to submit a Supplement within 10 business days to establish that DTC made a clerical mistake or an oversight in reviewing the Restriction Response. Finally, DTC would be required to provide the issuer with a Supplement Decision within 10 business days of receiving the Supplement. As described above, commenters’ concerns with the notice and objection procedures that would be established by the proposed rule change were as follows: (i) The proposed rule change could not be fair and could not satisfy the requirements set forth in IPWG if DTC is permitted to set its own standards and act on its own accord to impose a Restriction under Section 1(d) of the proposed rule change; 135 (ii) DTC should limit any Restriction under 135 Kesner PO 00000 Letter at 6. Frm 00118 Fmt 4703 Sfmt 4703 Section 1(d) of the proposed rule change to only a single 10 day period with any fair process occurring during that 10 day period; 136 and (iii) questions regarding whether the Review Officer would be sufficiently independent,137 including an assertion by one commenter that IPWG requires that appeals should be heard by parties independent of DTC.138 In addition, one commenter asserted that the proposed rule change fails to establish fair procedures as required by Section 17A(b)(3)(H) of the Act and the Commission’s decision in IPWG because there is no stated time period for the Review Officer to complete its review of the issuer’s Restriction Response and issue a Restriction Decision.139 This comment is obviated by DTC’s Amendment No. 1 to the proposed rule change,140 which modified the initial proposed rule change to add a 10 business-day time period for the Review Officer to complete the review and issue a Restriction Decision. The Commission believes that the limited discretion provided to DTC under Section 1(d) of the proposed rule change does not render the proposed rule change unfair or unable to satisfy the requirements of Section 17A(b)(3)(H) of the Act and the Commission’s decision in IPWG. As the Commission previously articulated in IPWG, DTC may design fair procedures in accordance with its own internal needs and circumstances.141 Similarly, if DTC believes that circumstances exist that justify imposing a Restriction, even in advance of notifying the issuer of the Restriction, it may do so, as long as DTC’s process for imposing the emergency Restriction balances the identifiable need with the issuer’s right to fair procedures under the Act.142 Here, as discussed above, Section 1(d) strikes the appropriate balance between providing DTC with sufficient flexibility to address unforeseen harms and issuers and investors rights with respect to their securities. It also establishes a high standard for imposing a Restriction, and DTC’s discretion under that provision is limited. Further, although Section 1(d) of the proposed rule change would authorize DTC to impose a Restriction to avert an imminent harm, DTC could not maintain the Restriction indefinitely without providing expedited fair 136 STA Letter I at 3. e.g., STA Letter I at 4 138 Kesner Letter II at 2. 139 STA Letter I at 3. 140 See Securities Exchange Act Release No. 78774 (September 6, 2016), 81 FR 62775 (September 12, 2016). 141 2012 SEC LEXIS 844 at *30 n.36. 142 Id. at *32. 137 See, E:\FR\FM\12DEN1.SGM 12DEN1 mstockstill on DSK3G9T082PROD with NOTICES Federal Register / Vol. 81, No. 238 / Monday, December 12, 2016 / Notices process to the affected issuer under Sections 2 and 3 of the proposed rule change. Further, to impose a Restriction under Section 1(d) of the proposed rule change, DTC would be required to identify or become aware of the need to avoid an imminent harm that could arise from further deposits or book-entry services, and would be required to provide the issuer notice and opportunity to appeal the Restriction pursuant to the specific procedures set forth in Sections 2 and 3 of the proposed rule change. As described above, these procedures establish a process to require DTC to promptly notify the issuer of a Restriction and give the issuer an opportunity to be heard upon the specific grounds for the Restriction, all within specified periods of time. With respect to the independence of the Review Officer, Section 3 of the proposed rule change requires an officer of DTC, as defined in DTC’s By-Laws, who did not have responsibility for the initial imposition of the Restriction, to review the Restriction Response and provide the Restriction Decision to the issuer. As the Commission previously articulated in IPWG, DTC may comply with the Act by designing fair procedures in accordance with its own internal needs and circumstances.143 The Commission finds that having a DTC officer who was not involved in imposing the Restriction review a Restriction Response is a fair procedure. This is consistent with similar procedures by other clearing agencies supervised by the Commission. For instance, the Commission has approved as a fair procedure the Options Clearing Corporation’s (‘‘OCC’s’’) use of a panel of OCC officers and a director of OCC in the review of suspension decisions.144 The Commission believes that the proposed rule change establishes clear, consistent, and fair procedures for the imposition of Restrictions and for providing issuers with notice of Restrictions and opportunity to be heard. Section 1 identifies the specific circumstances under which a Restriction will be imposed, Sections 2 and 3 would establish clear, policies, procedures, and specific requirements for providing issuers with notice of Restrictions and an opportunity to be heard, and Section 4 of the proposed rule change would establish clear standards for determining when adequate exists to release a Restriction. 143 2012 SEC LEXIS 844 at *30 n.36. Rule 1110, OCC Rules, available at http:// www.optionsclearing.com/components/docs/legal/ rules_and_bylaws/occ_rules.pdf. 144 See VerDate Sep<11>2014 18:59 Dec 09, 2016 Jkt 241001 The Commission therefore finds that the proposed rule change, as modified by Amendment No. 1, provides for fair procedures with respect to the prohibition or limitation by the clearing agency of any person with respect to access to services offered by the clearing agency, as required by Section 17A(b)(3)(H) of the Act. V. Conclusion On the basis of the foregoing, the Commission finds that the proposal, as modified by Amendment No. 1, is consistent with the requirements of the Act and in particular with the requirements of Section 17A of the Act 145 and the rules and regulations thereunder. It is therefore ordered, pursuant to Section 19(b)(2) of the Act, that proposed rule change SR–DTC–2016– 003, as modified by Amendment No. 1, be, and hereby is, Approved.146 For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.147 Robert W. Errett, Deputy Secretary. [FR Doc. 2016–29668 Filed 12–9–16; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–79474; File No. SR–CHX– 2016–20] Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; Notice of Filing of Proposed Rule Change in Connection With the Proposed Transaction Involving CHX Holdings, Inc. and North America Casin Holdings, Inc. December 6, 2016. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’) 1 and Rule 19b–4 thereunder,2 notice is hereby given that on December 2, 2016, the Chicago Stock Exchange, Inc. (‘‘CHX’’ or ‘‘Exchange’’) filed with the Securities and Exchange Commission (the ‘‘Commission’’) the proposed rule change as described in Items I, II and III below, which Items have been prepared by the selfregulatory organization. The Commission is publishing this notice to 145 15 U.S.C. 78q–1. approving the proposed rule change, the Commission considered the proposal’s impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f). 147 17 CFR 200.30–3(a)(12). 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 146 In PO 00000 Frm 00119 Fmt 4703 Sfmt 4703 89543 solicit comments on the proposed rule change from interested persons. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The Exchange is filing this proposed rule change in connection with a Transaction (‘‘Transaction’’) whereby Exchange Acquisition Corporation (‘‘Merger Sub’’), a corporation organized under the laws of the State of Delaware and wholly-owned subsidiary of North America Casin Holdings, Inc. (‘‘NA Casin Holdings’’), a corporation organized under the laws of the State of Delaware,3 would merge with and into CHX Holdings, Inc. (‘‘CHX Holdings’’), a corporation organized under the laws of the State of Delaware,4 with CHX Holdings continuing as the surviving corporation. Pursuant to the Transaction, the Exchange will remain a wholly-owned subsidiary of CHX Holdings and CHX Holdings will become a wholly-owned subsidiary of NA Casin Holdings. The text of the proposed Third Amended and Restated Certificate of Incorporation of CHX Holdings (‘‘CHX Holdings Certificate’’) is attached as Exhibit 5A.5 The text of the proposed amended Bylaws of CHX Holdings (‘‘CHX Holdings Bylaws’’) 6 is attached as Exhibit 5B.7 The text of the proposed Amended and Restated Certificate of Incorporation for CHX (‘‘CHX Certificate’’) is attached as Exhibit 5C.8 3 NA Casin Holdings was incorporated in the State of Delaware on January 4, 2016. 4 CHX Holdings was incorporated in the State of Delaware on January 26, 2005. 5 The original CHX Holdings Certificate was filed with the Delaware Secretary of State on January 26, 2005 and was last amended on July 26, 2006 to modify the ownership limitations applicable to Participants and other persons or entities and increased the number of shares of common stock that CHX Holdings is authorized to issue. See Securities Exchange Act Release No. 54213 (June 26, 2006), 71 FR 43547 (August 1, 2006) (order approving SR–CHX–2006–22); see also CHX Article 1, Rule 1(s) defining ‘‘Participant.’’ 6 Reference to a ‘‘current’’ governing document (e.g., ‘‘current CHX Holdings Bylaws’’) is to the version of the governing document that is currently operative, whereas reference to a ‘‘proposed’’ governing document (e.g., ‘‘proposed CHX Holdings Bylaws’’) is to the version of the governing document that would be in effect pursuant to this proposed rule change. 7 The CHX Holdings Bylaws were last amended on November 23, 2009 to eliminate an age restriction for CHX Holdings Directors. See Securities Exchange Act Release No. 61053 (November 23, 2009), 74 FR 62861 (December 1, 2009). 8 The original Certificate of Incorporation for CHX was filed with the Delaware Secretary of State on March 15, 1972 and was last amended on February 9, 2005 in connection with the demutualization of the CHX. See Securities Exchange Act Release No. 51149 (February 8, 2005), 70 FR 7531 (February 14, 2005). E:\FR\FM\12DEN1.SGM 12DEN1

Agencies

[Federal Register Volume 81, Number 238 (Monday, December 12, 2016)]
[Notices]
[Pages 89533-89543]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-29668]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-79488; File No. SR-DTC-2016-003]


Self-Regulatory Organizations; The Depository Trust Company; 
Order Granting Approval of a Proposed Rule Change, as Modified by 
Amendment No. 1, To Impose Deposit Chills and Global Locks and Provide 
Fair Procedures to Issuers

December 6, 2016.

I. Introduction

    On May 27, 2016, The Depository Trust Company (``DTC'') filed with 
the Securities and Exchange Commission (``Commission'') proposed rule 
change SR-DTC-2016-003 pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 thereunder.\2\ The 
proposed rule change was published in the Federal Register on June 9, 
2016.\3\ The Commission received 10 comment letters to the proposed 
rule change from five commenters, including three response letters from 
DTC.\4\ Pursuant to Section 19(b)(2) of the Act,\5\ on July 21, 2016, 
the Commission designated a longer period within which to approve the 
proposed rule change, disapprove the proposed rule change, or institute 
proceedings to determine whether to disapprove the proposed rule 
change.\6\ On July 29, 2016, DTC filed Amendment No. 1 to the proposed 
rule change. On September 6, 2016, the Commission published notice of 
Amendment No. 1 and instituted proceedings under Section 19(b)(2)(B) of 
the Act \7\ to determine whether to approve or disapprove the proposed 
rule change.\8\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 77991 (June 3, 
2016), 81 FR 37232 (June 9, 2016) (SR-DTC-2016-003) (``Notice'').
    \4\ See letter from Charles V. Rossi, Chairman, The Securities 
Transfer Association (``STA''), Inc. Board Advisory Committee, dated 
June 30, 2016, to Brent J. Fields, Secretary, Commission (``STA 
Letter I''); letter from Dorian Deyet, dated June 30, 2016 (``Deyet 
Letter''); letter from Ann K. Shuman, Managing Director and Deputy 
General Counsel, DTC, dated July 21, 2016, to Brent J. Fields, 
Secretary, Commission (``DTC Letter I''); letter from Harvey Kesner 
(``Kesner''), Sichenzia, Ross, Friedman, Ference, dated August 11, 
2016, to Brent J. Fields, Secretary, Commission (``Kesner Letter 
I''); letter from Isaac Montal, Managing Director and Deputy General 
Counsel, DTC, dated August 22, 2016, to Brent J. Fields, Secretary, 
Commission (``DTC Letter II''); letter from Charles V. Rossi, 
Chairman, STA Board Advisory Committee, dated August 29, 2016, to 
Brent J. Fields, Secretary, Commission (``STA Letter II''); letter 
from Kesner, Sichenzia, Ross, Friedman, Ference, dated August 30, 
2016, to Brent J. Fields, Secretary, Commission (``Kesner Letter 
II''); letter from Norman B. Arnoff (``Arnoff''), dated September 4, 
2016 to Secretary Fields (``Arnoff Letter''); letter from Charles V. 
Rossi, Chairman, STA Board Advisory Committee, dated October 3, 
2016, to Brent J. Fields, Secretary, Commission (``STA Letter 
III''); and letter from Ann K. Shuman, Managing Director and Deputy 
General Counsel, DTC, dated October 17, 2016, to Brent J. Fields, 
Secretary, Commission (``DTC Letter III''). See comments on the 
proposed rule change (SR-DTC-2016-003), https://www.sec.gov/comments/sr-dtc-2016-003/dtc2016003.shtml.
    \5\ 15 U.S.C. 78s(b)(2).
    \6\ See Securities Exchange Act Release No. 78379 (July 21, 
2016), 81 FR 49309 (July 27, 2016). The Commission designated 
September 7, 2016, as the date by which it should approve, 
disapprove, or institute proceedings to determine whether to 
disapprove the proposed rule change.
    \7\ 15 U.S.C. 78s(b)(2)(B).
    \8\ See Securities Exchange Act Release No. 78774 (September 6, 
2016), 81 FR 62775 (September 12, 2016).
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    Section II below provides an overview and brief description of both 
DTC and the proposed rule change. Section III provides a summary of the 
comments received and DTC's response to those comments. Section IV 
provides a discussion of the proposed rule change,

[[Page 89534]]

the comments received, and details the Commission's findings with 
respect to the proposed rule change. Finally, Section V concludes that, 
for the reasons discussed below in Sections II through IV, the 
Commission is granting approval of the proposed rule change, as 
modified by Amendment No.1.

II. Description of the Proposed Rule Change

A. Background

1. DTC
    DTC plays a critical function in the national clearance and 
settlement system. It is the nation's central securities depository, 
registered as a clearing agency under Section 17A of the Act,\9\ and 
its deposit and book-entry transfer services help facilitate the 
operation of the nation's securities markets. As a registered holder of 
trillions of dollars of securities, DTC processes enormous volumes of 
securities transactions facilitated by book-entry movement of 
interests, without transferring physical certificates. The Financial 
Stability Oversight Council, pursuant to Title VIII of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act,\10\ designated DTC as a 
Systemically Important Financial Market Utility.\11\
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    \9\ See Securities Exchange Act Release No. 20221 (September 23, 
1983), 48 FR 45167 (October 3, 1983) (600-1).
    \10\ Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Public Law 111-203, 124 Stat. 1376 (2010).
    \11\ See Financial Stability Oversight Council, 2012 Annual 
Report, Appendix A, available at https://www.treasury.gov/initiatives/fsoc/Documents/2012%20Appendix%20A%20Designation%20of%20Systemically%20Important%20Market%20Utilities.pdf.
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    DTC's participants (``Participants'') are primarily broker-dealers 
and banks, but as the nation's central securities depository, its role 
and actions also affect issuers and investors.\12\ Participants agree 
to be bound by the Rules, By-Laws, and Organization Certificate of DTC, 
and other rules and procedures (collectively, ``Rules'').\13\ DTC 
performs various services for Participants, including maintaining 
accounts that list Participants' securities holdings and allowing 
Participants to present securities to be made eligible for DTC's 
depository and book-entry services. If a security is accepted by DTC as 
meeting DTC's eligibility requirements for services \14\ and is 
deposited with DTC for credit to the securities account of a 
Participant, it becomes an ``Eligible Security.'' Thereafter, 
Participants may deposit shares of that Eligible Security (``Deposited 
Securities'') into their respective DTC accounts.
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    \12\ See In re International Power Group, Ltd. (``IPWG''), 
Securities Exchange Act Release No. 66611 (March 15, 2012), 2012 SEC 
LEXIS 844 at *24 (March 15, 2012) (Admin. Proc. File No. 3-13687).
    \13\ Available at http://www.dtcc.com/legal/rules-and-procedures.aspx.
    \14\ See Rule 5, supra note 13; DTC Operational Arrangements 
(Necessary for Securities to Become and Remain Eligible for DTC 
Services), January 2012 (the ``Operational Arrangements''), Section 
1, available at http://www.dtcc.com/~/media/Files/Downloads/legal/
issue-eligibility/eligibility/operational-arrangements.pdf.
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    To facilitate book-entry transfers and other services that DTC 
provides for its Participants, Deposited Securities are generally 
registered on the books of the issuer of the Eligible Security 
(typically, in a register maintained by a transfer agent) in DTC's 
nominee name, Cede & Co. DTC maintains Deposited Securities that are 
eligible for book-entry services in ``fungible bulk,'' meaning that 
each Participant whose securities of an issue have been credited to its 
securities account has a pro rata (proportionate) interest in DTC's 
entire inventory of that issue, but none of the securities on deposit 
are identifiable to or ``owned'' by any particular Participant.\15\
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    \15\ See Securities Exchange Act Release No. 19678 (April 15, 
1983), 48 FR 17603, 17605, n.5 (April 25, 1983) (describing fungible 
bulk); see also >N.Y. Uniform Commercial Code, Sec.  8-503, Off. Cmt 
1 (``. . . all entitlement holders have a pro rata interest in 
whatever positions in that financial asset the [financial] 
intermediary holds'').
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2. Overview of DTC's Prior Practice With Respect to Service 
Restrictions
    As detailed in a proposed rule change previously filed by DTC on 
December 5, 2013,\16\ DTC currently imposes two types of service 
restrictions: (i) A ``Deposit Chill'' whereby DTC refuses to accept 
further deposits of an Eligible Security but continues to provide book-
entry services for existing shares of that Eligible Security already on 
deposit with DTC; or (ii) a more stringent ``Global Lock'' whereby DTC 
not only refuses to accept further deposits of an Eligible Security, 
but also ceases to provide all book-entry services for existing shares 
of that Eligible Security already on deposit with DTC.\17\
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    \16\ See Securities Exchange Act Release No. 71132 (December 18, 
2013); 78 FR 77755 (December 24, 2013) (SR-DTC-2013-11). The filing 
was in response to the Commission's opinion and order in IPWG, which 
directed DTC to ``adopt procedures that accord with the fairness 
requirements of Section 17A(b)(3)(H)'' of the Act.
    \17\ See Notice, 81 FR at 37232; see also SEC Investor Bulletin: 
DTC Chills and Freezes, https://www.sec.gov/investor/alerts/dtcfreezes.pdf.
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    Prior to filing the current proposed rule change, DTC's practice 
was to impose a Deposit Chill upon detecting suspiciously large 
deposits of a thinly-traded Eligible Security.\18\ According to DTC, 
such large deposits often were a red flag that could indicate a ``pump 
and dump'' scheme or other illegal distribution related to that 
security, and a Deposit Chill was necessary to maintain the status quo 
and avoid allowing DTC's services to be used in furtherance of improper 
activity.\19\ An issuer could obtain the release of a Deposit Chill by 
providing to DTC a satisfactory legal opinion from independent counsel 
establishing that the Eligible Security fulfilled DTC's requirements 
for eligibility.\20\ If an issuer were non-responsive to DTC's requests 
for information or otherwise refused or was unable to provide the 
required legal opinion, a Deposit Chill could remain in effect for 
years.\21\
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    \18\ See Notice, 81 FR at 37233.
    \19\ See DTC Service Restrictions on Certain Book-Entry 
Securities--Procedures for Affected Issuers (September 2013), http://www.stai.org/pdfs/dtc-whitepaperresericesrestrictionsandissuerfairprocess.pdf.
    \20\ See Operational Arrangements, Section I.A, supra note 14.
    \21\ Notice, 81 FR at 37233.
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    Similarly, DTC's former practice was to impose a Global Lock if it 
became aware of a judicial or administrative proceeding alleging a 
violation of Section 5 of the Securities Act of 1933 (``Securities 
Act'') with respect to an Eligible Security on deposit with DTC.\22\ 
According to DTC, such allegations in a formal legal proceeding 
provided a concrete indication that Eligible Securities could have been 
involved in an illegal distribution, making a Global Lock necessary to 
maintain the status quo and avoid allowing DTC's services to be used in 
furtherance of improper activity. Because of the gravity of the 
allegations and the risk to DTC and its Participants of potentially 
allowing DTC's services to be used in furtherance of improper activity, 
a Global Lock would be released only when (i) the underlying action was 
withdrawn, (ii) dismissed on the merits with prejudice, or (iii) 
otherwise resolved in a final, non-appealable judgment in favor of the 
defendants allegedly responsible for the violations of federal 
securities laws. Because many actions are only resolved after several 
years,\23\ a Global Lock also could be maintained for years.
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    \22\ Id.
    \23\ See, e.g., SEC v. Kahlon,12-CV-517 (E.D. Tex., filed August 
14, 2012); SEC v. Bronson, 12-cv-06421-KMK (S.D.N.Y., filed August 
22, 2012). As of the date of this filing, neither case has been 
resolved.
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B. Proposed Rule Change

    DTC withdrew its prior proposed rule change regarding Deposit Chill 
and Global Lock procedures, as described

[[Page 89535]]

above, on August 18, 2014.\24\ Since that time, according to DTC, its 
prior practice of imposing Deposit Chills and Global Locks is no longer 
effective at preventing the harms those restrictions were originally 
intended to prevent, including, maintaining the status quo and 
preventing DTC's book-entry services from being used in furtherance of 
improper activity.\25\ In May 2016, DTC filed the current proposed rule 
change. Based in part on DTC's determination that the prior process for 
imposing Deposit Chills and Global Locks (together, ``Restrictions'') 
is no longer effective at preventing or affecting the violative 
behavior the Restrictions were originally designed to combat, DTC now 
proposes to make significant changes to its processes and procedures 
for imposing Restrictions. As discussed more fully below, DTC now 
proposes, with certain limited exceptions as provided in Section 1(d) 
of the proposed rule change, to limit the circumstances in which it 
would impose a Restriction to the occurrence of a Financial Industry 
Regulatory Authority, Inc. (``FINRA'') halt, Commission suspension, or 
if DTC is ordered to impose the Restriction by a court of competent 
jurisdiction.\26\ According to DTC, limiting Restrictions primarily to 
these three occurrences would be more effective in preventing DTC's 
services from being used in furtherance of improper activities.
---------------------------------------------------------------------------

    \24\ See Securities Exchange Act Release No. 72860 (August 18, 
2014), 79 FR 49825 (August 22, 2014) (SR-DTC-2013-11).
    \25\ Notice, 81 FR at 37233.
    \26\ Id.
---------------------------------------------------------------------------

    Accordingly, as modified by Amendment 1, DTC's proposal would add 
Rule 33 to DTC's Rules to establish the limited circumstances under 
which DTC would impose a Restriction, as well as the fair procedures 
for the issuer to receive notice and an opportunity to challenge the 
Restriction and the standards DTC would apply to determine when to 
release a Restriction. Section 1 of the proposed rule would establish 
the four specific circumstances in which DTC may impose either a 
Deposit Chill or a Global Lock. Section 2 would require DTC to send 
written notice of the Restriction to the issuer of the Eligible 
Security detailing the basis for the Restriction and the specific 
procedures for the issuer to follow to challenge the Restriction. If an 
issuer chooses to challenge a Restriction under Section 2, Section 3 of 
the proposed rule establishes DTC's obligations with respect to 
providing a written decision from an independent Review Officer in 
response to that challenge. Section 4 identifies the specific bases 
upon which DTC would release a Restriction, even in the absence of a 
challenge by an issuer. Finally, Section 5 would clarify and limit the 
scope and applicability of the proposed rule. Each section of the 
proposed rule change is discussed in more detail below.
1. Section 1: The Specific Conditions Under Which DTC Could Impose a 
Restriction
    Section 1 of the proposed rule establishes the conditions and the 
type of Restriction that DTC would impose under various circumstances. 
Under Section 1(a), DTC would impose a Global Lock if an Eligible 
Security is the subject of a trading halt imposed by the FINRA. Under 
Section 1(b), DTC would impose a Global Lock if an Eligible Security is 
the subject of a trading suspension imposed by the Commission. The 
proposed rule provides, however, that DTC would be permitted to decline 
to impose a Global Lock under Sections 1(a) and (b) of the proposed 
rule change if DTC reasonably determines that the Global Lock would not 
further the regulatory purpose of the trading halt or suspension.\27\ 
For example, DTC could decline to impose a Global Lock if the reason 
for a FINRA halt is to pause the market to give market participants 
time to assess news of a pending event that may affect the security's 
price,\28\ or the sole reason for a Commission suspension is the lack 
of current and accurate information about the company because it failed 
to file certain periodic reports with the Commission.\29\
---------------------------------------------------------------------------

    \27\ Id. at 37233-34.
    \28\ The Commission notes that imposing a halt on this basis is, 
in most instances, outside the scope of FINRA's trading halt 
authority for unlisted securities. See FINRA Rule 6440.
    \29\ DTC Letter III at 3.
---------------------------------------------------------------------------

    Under Section 1(c) of the proposed rule change, DTC would impose a 
Restriction if ordered to do so by a court of competent jurisdiction. 
DTC would impose the particular Restriction imposed by court, or if no 
Restriction is specified, DTC would impose a Global Lock. According to 
DTC, Restrictions would be necessary in the circumstances described in 
Sections 1(a)-(c) to prevent settlement of trades that continue despite 
the halt or suspension, and prevent the liquidation of a halted or 
suspended position through DTC,\30\ and because DTC's facilities should 
not be available to settle transactions otherwise prohibited by the 
Commission, FINRA, or a court of competent jurisdiction.\31\
---------------------------------------------------------------------------

    \30\ Id.
    \31\ Id.
---------------------------------------------------------------------------

    Lastly, under Section 1(d) of the proposed rule change, DTC would 
be permitted to impose a Restriction, either Deposit Chill or Global 
Lock, if it identifies or otherwise becomes aware of a need for 
immediate action to avert an imminent harm, injury, or other such 
material adverse consequence to DTC or its Participants that could 
arise from further deposits of, or continued book-entry services with 
respect to, an Eligible Security. This provision would provide DTC with 
flexibility to address unforeseen risks to DTC and its Participants, 
which would not be addressed by the more narrow conditions enumerated 
in Sections 1(a)-(c). DTC asserts that Section 1(d) would be invoked 
rarely, and only if such a Restriction would be necessary to avoid a 
significant material harm to DTC or one or more of its 
Participants.\32\
---------------------------------------------------------------------------

    \32\ Id.; see also Notice, 81 FR at 37234.
---------------------------------------------------------------------------

2. Section 2: Timing and Procedural Requirements for Written Notice of 
Restrictions and Opportunity To Object to Restrictions
    Section 2 of the proposed rule would establish the timing and 
procedural requirements for DTC to provide an issuer with notice of a 
Restriction and for the issuer to object to that Restriction. First, 
DTC would be required to send a written ``Restriction Notice'' to the 
issuer of the Eligible Security within three business days of the 
imposition of the Restriction.\33\ Section 2(a) would require DTC to 
include the following information in the Restriction Notice: (i) A 
statement of the basis for the Restriction under Section 1, which would 
be required to be set forth with reasonable specificity; (ii) the date 
the Restriction was imposed; and (iii) that within 20 days of receiving 
the Restriction Notice, the issuer may submit a written ``Restriction 
Response'' setting forth its objection to the Restriction and the basis 
for that objection under Section 4 of the proposed rule (discussed 
below). If an issuer submits a Restriction Response, Section 2(b) would 
permit DTC to request reasonable additional information or 
documentation from the issuer. Section 2(c) specifies that an issuer 
who fails to comply with a deadline required under Section 2 would 
waive its right to make the submission required by the deadline.
---------------------------------------------------------------------------

    \33\ The Restriction Notice would be send by overnight courier 
to (i) the issuer's last known business address, and (ii) the last 
known business address of the issuer's transfer agent, if any, on 
record with DTC.

---------------------------------------------------------------------------

[[Page 89536]]

3. Section 3: Timing and Procedural Requirements for DTC's Review of 
and Written Response to an Issuer's Objection to a Restriction
    Section 3 of the proposed rule change establishes the process for 
DTC to issue a Restriction Decision when, under Section 2, it receives 
a Restriction Response. Specifically, Section 3 provides that DTC shall 
provide the issuer with a written ``Restriction Decision'' within 10 
business days of receipt of the Restriction Response.\34\ Under Section 
3(a), the Restriction Decision would be required to be made by a 
``Review Officer'' who did not have responsibility for the imposition 
of the Restriction, or his delegate. The Review Officer would be 
required to be an officer of DTC as defined in DTC's By-Laws.\35\ In 
conducting his or her review, the Review Officer would be required to 
look to the standards of review set forth in Section 4 of the proposed 
rule (discussed below) to determine whether reasonable adequate cause 
to release the Restriction exists.
---------------------------------------------------------------------------

    \34\ The deadline may be extended for a reasonable period if DTC 
has requested additional information or documentation from the 
issuer pursuant to Section 2(b) of the proposed rule change, or by 
consent of the issuer, the issuer's transfer agent, if any, or the 
issuer's authorized representatives, if any.
    \35\ An officer is defined under the DTC By-Laws to be the 
Executive Chairman of the Board, Chief Executive Officer, Chief 
Operating Officer, or a Managing Director or other senior officers 
or employees of DTC elected or appointed by the DTC Board pursuant 
to the DTC By-Laws. See supra, note 13.
---------------------------------------------------------------------------

    After receiving the Restriction Decision, an issuer would have 10 
business days to submit a supplemental written response 
(``Supplement''). However, a Supplement could only be submitted for the 
purpose of establishing that DTC made a clerical mistake or mistake 
arising from an oversight or omission in reviewing the Restriction 
Response. If the issuer submits a Supplement, the Review Officer would 
provide a Supplement Decision within 10 business days after the 
Supplement was delivered. Section 3(d) of the proposed rule specifies 
that, taken together, the Restriction Notice, the Restriction Response, 
the Restriction Decision, the Supplement, the Supplement Decision, and 
any other documents submitted in connection with the proposed 
procedures would constitute the record for purposes of any appeal to 
the Commission.
4. Section 4: Standards For Determining Whether Adequate Cause Exists 
for Release of a Restriction
    Section 4 of the proposed rule establishes the specific grounds 
upon which DTC would be required to release a Restriction imposed 
pursuant to Section 1 of the proposed rule, even in the absence of a 
Restriction Response from an issuer, by establishing when adequate 
cause for the release of the Restriction would be deemed to exist. For 
Global Locks imposed pursuant to Sections 1(a) or (b) of the proposed 
rule change (i.e., when FINRA issues a trading halt or the Commission 
issues a trading suspension), adequate cause to release the Global Lock 
would exist when the halt or suspension was lifted. According to DTC, 
because trading would no longer be prohibited by FINRA or the 
Commission, there should not be any settlement restrictions at DTC, 
other than operational restrictions imposed in the ordinary course of 
business as otherwise provided for in DTC's Rules. Similarly, under 
Section 4(c) of the proposed rule change, for a Restriction imposed 
pursuant to Section 1(c) of the proposed rule change (i.e., an order 
from a court of competent jurisdiction), adequate cause would exist to 
release the Restriction when a court of competent jurisdiction orders 
DTC to release the Restriction. DTC explains that if the court no 
longer required the Restriction, there would be no reason for DTC to 
continue to impose it.
    As noted above, Section 1(d) of the proposed rule change is 
intended to provide DTC with necessary flexibility to address 
unforeseen risks to it and its Participants, and thus DTC notes it is 
impossible to outline with specificity all of the scenarios that could 
give rise to a release of a Restriction under Section 1(d). However, to 
provide a workable standard for evaluating when the release of a 
Restriction imposed under Section 1(d), DTC provides that ``adequate 
cause'' for the release of the Restriction would exist when DTC 
reasonably determines that the release of the Restriction would not 
pose a threat of imminent adverse consequences to DTC or its 
Participants--typically meaning that the conditions underlying original 
basis for the Restriction have abated. For example, a Section 1(d) 
Restriction would be released when DTC determines that the perceived 
harm has passed or is significantly remote, or when the basis for the 
Restriction no longer exists.\36\ DTC also notes that, for Global Locks 
in effect today that were originally imposed based on a judicial or 
administrative proceeding under the prior procedures described above in 
Section II.A.2, Section 4(d) of the proposed rule change would require 
DTC to release the Global Lock, provided there currently is no 
indication that illegally distributed securities are about to be 
deposited.\37\
---------------------------------------------------------------------------

    \36\ Notice, 81 FR at 37234.
    \37\ Id.
---------------------------------------------------------------------------

    Lastly, Section 4(e) of the proposed rule change would require DTC 
to release a Restriction if DTC reasonably determined that its 
imposition of the Restriction was based on a clerical mistake.
5. Section 5: Clarification and Limitation of Scope and Applicability 
of Proposed Rule 33
    Section 5 of the proposed rule change clarifies the scope and 
applicability of the proposed rule change. Section 5(a) specifies that 
the proposed rules would not affect DTC's ability to lift or modify a 
Restriction, thus preserving DTC's flexibility to release or modify a 
Restriction based on the needs of DTC and its Participants. Section 
5(b) clarifies that the proposed rules do not affect DTC's ability to 
operationally restrict book-entry services, Deposits, or other services 
in the ordinary course of business pursuant to other provisions of the 
DTC Rules, as such restrictions would not constitute Restrictions under 
the proposed rule change. Sections 5(c) and (d) would permit DTC to 
communicate with the issuer or its transfer agent or representative, if 
any, provided that substantive communications are memorialized in 
writing to be included in the record for purposes of any appeal to the 
Commission, and to send out a Restriction Notice prior to the 
imposition of a Restriction (thus giving the issuer or its transfer 
agent advance notice of the Restriction), respectively.

III. Summary of Comments Received

    The Commission received 10 comment letters in response to the 
proposed rule change.\38\ One comment letter generally supports the 
proposed rule change.\39\ Five comment letters by two commenters, STA 
and Kesner, object to the proposed rule change.\40\ Three comment 
letters from DTC respond to the objections raised by STA and 
Kesner,\41\ and one comment letter does not specifically comment on any 
aspect of the proposed rule change.\42\
---------------------------------------------------------------------------

    \38\ See supra note 4.
    \39\ See Arnoff Letter.
    \40\ See STA Letters I, II, and III and Kesner Letters I and II.
    \41\ See DTC Letters I and II.
    \42\ See Deyet Letter.
---------------------------------------------------------------------------

A. Supporting Comment

    One commenter generally endorses the proposed rule change, stating 
that the proposed procedures for fair notice and opportunity to 
challenge would

[[Page 89537]]

prevent and mitigate harm to both issuers and innocent 
shareholders.\43\
---------------------------------------------------------------------------

    \43\ See Arnoff Letter.
---------------------------------------------------------------------------

B. Objecting Comments

    STA and Kesner express general concerns with DTC, which STA and 
Kesner claim functions as a monopoly in the clearance and settlement of 
securities, exercising discretion to deny access to its services.\44\ 
More specifically, STA and Kesner argue that the proposed rule change 
is inconsistent with Section 17A(b)(3)(F) of the Act because it is not 
designed to protect investors and the public interest, and that it is 
inconsistent with Section 17A(b)(3)(H) of the Act because the 
procedures for notice of and opportunity to challenge restrictions 
imposed by DTC are not fair.\45\
---------------------------------------------------------------------------

    \44\ STA Letter I at 1; Kesner Letter I at 1.
    \45\ See id.
---------------------------------------------------------------------------

1. The Proposed Rule Change is Not Designed To Protect Investors and 
Public Interest as Required by Section 17A(b)(3)(F) of the Act
    STA and Kesner argue that the proposed rule change is inconsistent 
with the Act for the following reasons: (i) The proposed basis for the 
imposition of Restrictions is vague and discretionary and inconsistent 
with the intent of Section 19 of the Exchange Act; (ii) the proposed 
basis for imposition of Restrictions would hurt issuers and 
shareholders; and (iii) Congress did not intend for DTC to be a fraud 
regulator. Each argument is discussed below.
(i) Proposed Basis for Imposition of Restrictions Is Vague and 
Discretionary and Inconsistent With the Intent of Sections 17A and 19 
of the Act and Rule 19b-4 Thereunder
    Commenters were generally supportive of the proposed basis for 
imposing Restrictions under Sections 1(a), (b), and (c) of the proposed 
rule change,\46\ but some commenters raise objections to Section 1(d) 
of the proposed rule change. Specifically, STA asserts that the 
authority to impose Restrictions under Section 1(d) of the proposed 
rule change is overly broad, arbitrary, permits DTC to exercise 
unfettered discretion, and would allow DTC to take action without any 
real evidence of the likelihood of actual harm or violation of 
objective standards.\47\ STA further claims that the authority to 
impose Restrictions under Section 1(d) is so vague that the Commission 
has no way of knowing whether DTC is attempting to regulate matters not 
related to (i) the purposes of Section 17A of the Act, (ii) the 
administration of the clearing agency, or (iii) consistent with the 
requirements of the Act, as required by Sections 17A(b)(3)(F) and 
19(b)(2)(C) of the Act.\48\ Likewise, STA states that the authority to 
impose Restrictions under Section 1(d) of the proposed rule change is 
inconsistent with the intent of Section 19 of the Act and Rule 19b-4 
thereunder, which encourages transparency by requiring a clearing 
agency to seek approval of a stated policy, practice, or 
interpretation.\49\ Therefore, STA argues that the proposal is contrary 
to the openness envisioned by Congress.\50\
---------------------------------------------------------------------------

    \46\ See, e.g., Kesner states that the basis for imposing 
Restrictions under Sections 1(a), (b), and (c) of the proposed rule 
change is consistent with the approach of DTC being directed by a 
regulator or court. Kesner Letter I at 6. Meanwhile, STA states that 
it applauds the certainty afforded by the Sections 1(a), (b), and 
(c) of the proposed rule change. See STA Letter I at 3.
    \47\ STA Letter I at 1-3; see also STA Letter II at 2.
    \48\ STA Letter III at 2.
    \49\ Id.
    \50\ Id.
---------------------------------------------------------------------------

    Similar to STA, Kesner expresses concern that Section 1(d) of the 
proposed rule change would give authority to DTC to impose Restrictions 
merely upon the initiation of an investigation or enforcement 
proceeding where it concludes a threat is imminent requiring immediate 
action.\51\ Kesner states that the Commission has not directed DTC to 
adopt rules to protect DTC or DTC's financial institution owners and 
DTC has not articulated how exercising discretionary authority 
satisfies its obligation for a fair process.\52\
---------------------------------------------------------------------------

    \51\ Kesner Letter I at 6.
    \52\ Kesner Letter I at 2, 3; Kesner Letter II at 1.
---------------------------------------------------------------------------

    According to Kesner, DTC's previous imposition of Restrictions, in 
many cases, were only based upon ``flimsy legal footing, notice of 
commencement of an investigation or inquiry, anecdotal observations or 
even unproven news stories.'' \53\ Kesner states that the proposed rule 
change does not address the ``unfortunate results that befall innocents 
caught up by a [Restriction], nor the immensity of the costs and 
burdens placed on issuers and investors seeking to clear a 
[Restriction].'' \54\ Kesner states that small issuers do not have the 
resources to defend themselves and even with the potential of an appeal 
Restrictions cause irreparable damage.\55\ Rather, the imposition of 
Restrictions would best be left to exchanges and other ``regulatory 
bodies'' that have sufficient resources and could direct DTC to impose 
a service restriction when warranted.\56\
---------------------------------------------------------------------------

    \53\ Kesner Letter I at 2.
    \54\ Id. at 2, 3; Kesner Letter II at 1.
    \55\ Kesner Letter I at 2.
    \56\ Id. at 6.
---------------------------------------------------------------------------

(ii) Proposed Basis for Imposition of Restrictions Would Hurt Issuers 
and Shareholders
    STA contends that the proposed rule change was not a ``good faith 
attempt'' by DTC to comply with the Commission's order in IPWG and is 
inconsistent with Section 17A(b)(3)(F) of the Act \57\ because 
imposition of Restrictions would hurt issuers and innocent 
investors.\58\ Specifically, STA asserts that the authority to impose 
Restrictions under Section 1(d) of the proposed rule change should 
balance the effect of DTC's actions on innocent shareholders because a 
Restriction could have a devastating effect on investors and could 
cause trading in the shares of an issuer to come to a virtual stop.\59\ 
Therefore, innocent investors may find that their shares are virtually 
valueless during the period the Restriction is in place.\60\
---------------------------------------------------------------------------

    \57\ 15 U.S.C. 78q-1(b)(3)(F).
    \58\ STA Letter I at 3. STA Letter III at 2.
    \59\ STA Letter III at 2.
    \60\ Id.
---------------------------------------------------------------------------

(iii) Congress Did Not Intend DTC To Be a Fraud Regulator
    STA states that the proposed rule change is inconsistent with 
Section 17A(b)(3)(F) of the Act \61\ because Congress did not intend 
DTC to act as a fraud regulator or to enforce laws unrelated to 
clearance and settlement.\62\ Specifically, STA asserts that the 
authority to impose Restrictions under Section 1(d) of the proposed 
rule change is inconsistent with Section 17A(b)(3)(F) of the Act,\63\ 
which requires, among other things, that the rules of the clearing 
agency are not designed to regulate by virtue of any authority 
conferred by the Act matters not related to the purposes of Section 17A 
of the Act or the administration of the clearing agency.\64\ STA states 
that the authority for fraud regulation is conferred under other 
sections of the Act on the Commission and different self-regulatory 
organizations with respect to their members.\65\ Thus, STA contends 
that DTC does not have the authority to implement the proposed rule 
change.\66\
---------------------------------------------------------------------------

    \61\ 15 U.S.C. 78q-1(b)(3)(F).
    \62\ STA Letter III at 2.
    \63\ 15 U.S.C. 78q-1(b)(3)(F).
    \64\ STA Letter III at 2.
    \65\ Id.
    \66\ Id.

---------------------------------------------------------------------------

[[Page 89538]]

2. The Proposed Rule Change Does Not Provide Fair Procedure With 
Respect to Restrictions Imposed by DTC as Required by Section 
17A(b)(3)(H) of the Act
    Commenters object to the proposed rule change on the basis that 
they do not believe that it is consistent with either Section 
17A(b)(3)(H) of the Act \67\ or the Commission's order in IPWG. First, 
Kesner argues that DTC cannot be ``fair'' and cannot satisfy the 
requirements set forth in IPWG if DTC sets its own standards and acts 
on its own accord to impose a Restriction not directed by a traditional 
regulator or court because DTC does not have the resources, technical 
expertise, or ``commitment to fairness'' to undertake such an expansive 
role in the substantive regulation of securities issuers or to become a 
``super-gatekeeper.'' \68\
---------------------------------------------------------------------------

    \67\ 15 U.S.C. 78q-1(b)(3)(H).
    \68\ Kesner Letter I at 2, 4-5; Kesner also stated that the 
Commission has not ``direct[ed] DTC to adopt[ ] rules to protect DTC 
or DTC's financial institution owners and DTC has not articulated 
how exercising discretionary authority satisfies its obligation for 
a fair process.'' Kesner Letter II at 1; see also STA Letter II at 
3; STA Letter III at 2.
---------------------------------------------------------------------------

    Second, Kesner states that DTC's imposition of Restrictions under 
Section 1(d) of the proposed rule change, if approved, should include 
specific methods by which an issuer can successfully appeal and require 
DTC to remove the Restriction (or provide for automatic removal after a 
short period) that are fair and reasonable and that do not burden 
smaller issuers with excessive costs or delays during the denial of the 
DTC's essential services.\69\ Kesner argues that to do otherwise would 
hurt innocent investors and shareholders.\70\
---------------------------------------------------------------------------

    \69\ Kesner Letter I at 6.
    \70\ Id.
---------------------------------------------------------------------------

    Third, STA contends that Section 3 of the proposed rule change as 
originally proposed (i.e., before DTC filed Amendment 1) was 
procedurally deficient because there were no time periods specified in 
the proposed rule change for the DTC Review Officer's review to be 
completed. Thus, in some cases issuers and investors could be harmed 
for an indefinite period while waiting for DTC to reach a decision.\71\ 
Specifically, STA asserts that DTC should limit its Restriction, under 
Section 1(d) of the proposed rule change, to only a single 10-day 
period, with any ``fair process'' occurring during that 10-day 
Restriction.\72\ DTC could resolve concerns based on a 
``misunderstanding'' or inform the Commission or FINRA of its concerns, 
allowing either organization to take further action to protect DTC, its 
Participants, or investors from the imminent harm.\73\ STA also asserts 
that notice of a Restriction should occur prior to or, at least, 
contemporaneously with imposition of the Restriction, particularly in 
the case of a Restriction imposed based on DTC's assessment of imminent 
harm, under Section 1(d) of the proposed rule change, not three days 
after the Restriction is imposed.\74\
---------------------------------------------------------------------------

    \71\ STA Letter I at 4.
    \72\ Id.
    \73\ Id. at 4.
    \74\ STA Letter I at 4.
---------------------------------------------------------------------------

    Fourth, STA expresses concern that the Review Officer tasked with 
reviewing a Restriction Response could be located in an office near the 
person that imposed the Restriction, could have been involved in 
imposing the Restriction, and could be charged with overturning the 
decision made by a colleague.\75\ Similarly, Kesner questions the 
independence of the Review Officer and asserts that IWPG requires that 
appeals should be heard by parties independent of DTC and suggests that 
``representatives of the securities bar, [STA], transfer agents, 
clearing and settlement firms, auditors, and business people, under the 
guidance of the DTC General Counsel, should constitute the panel of 
hearing officers making recommendations for imposition and removal of 
[Restrictions], continuations and appeals whenever DTC acts.'' \76\
---------------------------------------------------------------------------

    \75\ Id.
    \76\ Kesner Letter II at 2.
---------------------------------------------------------------------------

    Finally, commenters raise other points that either did not pertain 
to the proposed rule change, or did not suggest how such issues would 
make the proposed rule change inconsistent with the Act.\77\ As such, 
those points are beyond the scope of the proposed rule change and, 
therefore, are not further summarized or discussed in this order.
---------------------------------------------------------------------------

    \77\ Examples of points raised by the commenters about the 
proposed rule change that did not address whether the proposed rule 
change is or is not consistent with the Act include STA stating that 
the proposal should also apply to transfer agents seeking initial 
access to DTC's facilities (STA Letter I at 4), and Kesner stating 
that (i) the Commission should not act on the proposal without 
specific comments from major exchanges and OTCLink regarding 
coordination with DTC and the Commission concluding that DTC's 
actions under the proposal would not interfere with the objectives 
of exchanges and other regulators and not hamper the functioning of 
the markets; (ii) DTC would need to give up its immunity from 
lawsuits in order for there to be a potentially fair process in the 
imposition and appeal of Restrictions; (iii) investors should have 
standing to appeal a Restriction; and (iv) the Commission should 
require DTC to undertake a study and submit all of its statistics 
surrounding Restrictions. Kesner Letter I at 4, 6; Kesner Letter II 
at 3. Similarly, Arnoff asserted that the proposal should clarify 
that DTC should not be immune from civil liability, particularly if 
DTC cannot establish that it acted in good faith and with reasonable 
judgment, because DTC is not acting in a governmental capacity in 
the settlement and clearance process. Arnoff Letter. Moreover, 
Arnoff stated that because DTC is not infallible and the risk of 
error always exists, DTC should be required to purchase ``errors and 
omissions insurance'' to protect innocent issuers and investors and 
to add an ``additional dimension of loss prevention.'' Arnoff 
Letter.
---------------------------------------------------------------------------

C. DTC's Response

    As discussed more fully below, DTC argues that the proposed rule 
change is consistent with the Act in that it is consistent with Section 
17A(b)(3)(F) of the Act because it is designed to protect investors and 
the public interest, and it provides fair procedures as required by 
Section 17A(b)(3)(H) of the Act.
1. The Proposed Rule Change Is Designed To Protect Investors and the 
Public Interest as Required by Section 17A(b)(3)(F) of the Act
(i) Response to Comments That the Proposed Basis for Imposition of 
Restrictions Is Vague and Discretionary and Inconsistent With the 
Intent of Sections 17A and 19 of the Act and Rule 19b-4 Thereunder
    In response to STA's comment that the basis for imposition of 
Restrictions under the proposed rule change is vague, DTC asserts that 
Sections 1(a)-(c) of the proposed rule change provide specific, 
objective trigger events for imposing Restrictions and would be the 
primary focus of the Restriction program going forward.\78\ Further, 
while DTC acknowledges that it cannot anticipate each circumstance 
under which immediate action could be needed under Section 1(d) to 
prevent harm to DTC or its Participants,\79\ it provides specific 
examples of such circumstances, including: (i) If DTC receives 
information from an authorized officer of the issuer that another 
company has usurped the identity of the company and issued unauthorized 
shares; (ii) if DTC has corroborated and plausible information that 
forged securities are being deposited at DTC; (iii) a foreign 
regulatory authority raises credible concerns about an Eligible 
Security; or (iv) there is a material recordkeeping issue that raises 
questions about the Eligibility of a specific security.\80\ DTC also 
asserts that STA's position that the Commission should not approve the 
proposed rule change if it includes Section 1(d) would deny DTC the 
flexibility to impose Restrictions that could be necessary to avoid 
imminent harm to DTC or its Participants,\81\ thereby subjecting DTC 
and its Participants to significant

[[Page 89539]]

potential harm. DTC states that it needs such flexibility to protect 
itself and its Participants from an imminent harm that may not warrant 
or be covered by a trading halt or suspension.\82\
---------------------------------------------------------------------------

    \78\ DTC Letter I at 2.
    \79\ DTC Letter I at 3; DTC Letter III at 3.
    \80\ DTC Letter III at 3.
    \81\ Id. at 2; DTC Letter III at 3.
    \82\ DTC Letter I at 3; DTC Letter III at 3.
---------------------------------------------------------------------------

    In response to Kesner's comment that Section 1(d) of the proposed 
rule change would give authority to DTC to impose Restrictions merely 
upon the initiation of an investigation or enforcement proceeding where 
DTC concludes a threat is imminent and requires immediate action, DTC 
asserts that the Commission recognized in In re Atlantis Internet Group 
(``Atlantis'') \83\ and IPWG that DTC has such authority and that it is 
critical to the self-regulatory function of DTC to retain discretion to 
avert imminent harm, including the discretion to take action before 
providing notice to the issuer, if necessary.\84\ DTC states that 
Section 1(d) of the proposed rule change would be used only for urgent 
situations and exercised rarely, such as in the example scenarios 
listed above.\85\
---------------------------------------------------------------------------

    \83\ Atlantis, Securities Exchange Act Release. No. 75168 at 7-
8, 2015 SEC LEXIS 2394 (June 12, 2015) (Admin. Proc. File No. 3-
15432).
    \84\ DTC Letter I at 3; DTC Letter II at 2.
    \85\ DTC Letter III at 3.
---------------------------------------------------------------------------

(ii) Response to Comments That the Proposed Basis for Imposition of 
Restrictions Would Hurt Issuers and Shareholders
    DTC states, generally, that the proposed rule change would assure 
the safeguarding of securities by providing a mechanism for DTC to act 
quickly and efficiently to screen out prior to deposit, or restrict 
after deposit, securities that pose an imminent harm to DTC or its 
Participants, or for which trading has been prohibited by a court or 
applicable regulator.\86\ Specifically, DTC states that Sections 1(a) 
and (b) of the proposed rule change provide objective trigger events 
for imposing Restrictions when the Commission imposes a trading 
suspension or FINRA impose a trading halt.\87\ DTC explains that, 
although trading activity takes place outside of DTC, DTC provides a 
settlement location for market traders or other transfers of interests 
in securities.\88\ Thus, absent a DTC Restriction, other book-entry 
transfers might continue (e.g., pledges, repos, or securities lending), 
notwithstanding a Commission suspension or FINRA halt.\89\ A 
Restriction would freeze these Participant activities, which DTC 
believes would further the regulatory purpose of the Commission 
suspension or FINRA halt.\90\
---------------------------------------------------------------------------

    \86\ See Notice, 81 FR 37235.
    \87\ DTC Letter III at 2.
    \88\ Id.
    \89\ Id.
    \90\ Id.
---------------------------------------------------------------------------

    Further, DTC emphasizes that it would not impose a Restriction if 
DTC believes that the suspension or halt does not implicate concerns 
that DTC believes should lead to a Restriction.\91\ For example, under 
Section 1 of the proposed rule change, DTC could decline to impose a 
Global Lock if (i) in the case of a FINRA halt, if the reason for the 
halt is to pause the market to give market participants time to assess 
news of a pending event that may affect the security's price; or (ii) 
in the case of a Commission suspension, if the sole reason for the 
suspension is the lack of current and accurate information about the 
company because it failed to file certain periodic reports with the 
Commission.\92\
---------------------------------------------------------------------------

    \91\ Id. at 2, 3.
    \92\ Id. at 3.
---------------------------------------------------------------------------

    With respect to Section 1(d) of the proposed rule change, DTC 
asserts that it believes that Section 1(d) is consistent with the Act 
because it would provide DTC with the flexibility it needs to protect 
its fungible bulk, which it holds on behalf of its Participants, from 
imminent harm that could arise from circumstances that would neither 
justify nor be affected by a trading halt or suspension,\93\ while 
still providing sufficient notice of the types of circumstances that 
could trigger a Restriction under Section 1(d). DTC also reiterates 
that it does not anticipate imposing Restrictions pursuant to Section 
1(d) of the proposed rule change frequently,\94\ and has provided 
specific examples of circumstances under which imminent harm could 
arise in the future, as described above.\95\
---------------------------------------------------------------------------

    \93\ DTC Letter I at 2; DTC Letter III at 3.
    \94\ DTC Letter III at 3.
    \95\ Id.
---------------------------------------------------------------------------

(iii) Response to Comments That DTC Would Be Acting as a Fraud 
Regulator
    In response to comments that Congress did not intend DTC to act as 
a fraud regulator or to enforce laws unrelated to clearance and 
settlement, DTC asserts that Sections 1(a)-(c) of the proposed rule 
change would further the regulatory purpose behind a Commission, FINRA, 
or court action by stopping the flow of questionable securities in 
other book-entry transfers that may continue despite other regulatory 
action.\96\
---------------------------------------------------------------------------

    \96\ Id. at 2, 3.
---------------------------------------------------------------------------

    With respect to Section 1(d), DTC states that there are situations 
that would require DTC to impose a Restriction that might not require a 
Commission suspension or FINRA halt.\97\ For instance, DTC could impose 
a Restriction (i) if DTC receives information from an authorized 
officer of the issuer that another company has usurped the identity of 
the company and issued unauthorized shares; (ii) if DTC has 
corroborated and plausible information that forged securities are being 
deposited at DTC; (iii) a foreign regulatory authority raises credible 
concerns about an eligible security; or (iv) there is a material 
recordkeeping issue that raises questions about the eligibility of a 
specific security. The Commission also notes that, as discussed below, 
a Restriction could be necessary to prevent DTC's services from being 
used to facilitate an unregistered distribution or other violation of 
the securities laws.
---------------------------------------------------------------------------

    \97\ Id. at 3.
---------------------------------------------------------------------------

2. The Proposed Rule Change Does Provide Fair Procedure With Respect to 
Restrictions Imposed by DTC on Access to Its Book-Entry Services by 
Issuers and Shareholders as Required by Section 17A(b)(3)(H) of the Act
    DTC states that the proposed rule change is consistent with Section 
17A(b)(3)(H) of the Act \98\ and IPWG. Specifically, in response to 
STA's and Kesner's comments that the proposed rule change does not 
provide for fair procedures nor satisfy the requirements of IPWG, DTC 
highlights that the Commission's decisions in both Atlantis and IPWG 
\99\ recognize that DTC must retain discretion to avert imminent harm, 
including the discretion to take action before providing notice to the 
issuer, if necessary.\100\
---------------------------------------------------------------------------

    \98\ 15 U.S.C. 78q-1(b)(3)(H).
    \99\ Atlantis, 2015 SEC LEXIS 2394 at *7, 8.
    \100\ DTC Letter I at 3.
---------------------------------------------------------------------------

    In response to STA's specific claim that the proposal is 
procedurally deficient because it lacks a stated time period for the 
Review Officer to complete the review, DTC submitted Amendment No.1 to 
Section 3 of the proposed rule change, which, as described above, 
establishes a 10 business-day deadline, with limited extension, for the 
Review Officer to complete its review of the Restriction Response and 
for DTC to provide a Restriction Decision.\101\
---------------------------------------------------------------------------

    \101\ Prior to filing Amendment No. 1, DTC also contended in its 
first response letter that a reasonable review by the Review Officer 
in a timely manner is implicit in the proposed process, recognizing 
that DTC is bound to perform a prompt review, and to do otherwise 
may conflict with its obligations under Section 17A of the Act. DTC 
Letter I at 4; 15 U.S.C. 78q-1.
---------------------------------------------------------------------------

    Similarly, in response to both STA's and Kesner's comments that 
Restrictions imposed under Section 1(d) of the

[[Page 89540]]

proposed rule change should be automatically removed after a short 
period or expire after 10 days, DTC states that it would not be 
effective, reasonable, or practical for DTC to premise its proposed 
rule change on the assumption that the Commission or FINRA would or 
could take action quickly enough to protect DTC, its Participants, or 
investors.\102\ DTC explains further that imminent harm to DTC or its 
Participants could arise from circumstances that may not be addressed 
by or may not justify a trading halt or suspension, such as the 
impending deposit of illegally distributed securities at DTC.\103\ DTC 
also reiterates that it does not anticipate imposing Restrictions 
pursuant to Section 1(d) of the proposed rule change frequently.\104\
---------------------------------------------------------------------------

    \102\ DTC Letter I at 3; see also DTC Letter II at 2.
    \103\ Id.
    \104\ Id.
---------------------------------------------------------------------------

    In response to STA's and Kesner's comments on the independence of 
the Review Officer, and STA's comment that notice of a Restriction 
should be at least contemporaneously with the imposition of the 
Restriction, DTC states that it believes the proposed rule change is 
sufficiently clear to require that the Review Officer not be conflicted 
and that the Review Officer's decision would be unbiased and 
independent,\105\ and that both Atlantis and IPWG recognize that DTC 
must retain discretion to take action before providing notice to the 
issuer, if necessary.\106\
---------------------------------------------------------------------------

    \105\ DTC Letter I at 4.
    \106\ Id. at 3.
---------------------------------------------------------------------------

IV. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
such proposed rule change is consistent with the requirements of the 
Act and rules and regulations thereunder applicable to such 
organization.\107\ After carefully considering the proposed rule 
change, the comments received, and DTC's responses thereto, the 
Commission finds that the proposed rule change, as modified by 
Amendment No. 1, is consistent with the requirements of the Act and the 
rules and regulations thereunder applicable to DTC. In particular, the 
Commission finds that the proposed rule change is consistent with 
Sections 17A(b)(3)(F) and 17A(b)(3)(H) of the Act, as discussed in 
detail below.
---------------------------------------------------------------------------

    \107\ 15 U.S.C. 78s(b)(2)(C).
---------------------------------------------------------------------------

A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of the Act requires, among other things, that 
the rules of the clearing agency are designed to assure the 
safeguarding of securities in the custody or control of the clearing 
agency and, in general, protect investors and the public interest.\108\
---------------------------------------------------------------------------

    \108\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    Sections 1(a) and (b) of the proposed rule change, respectively, 
would authorize DTC to impose a Global Lock where FINRA has issued an 
order for the halt of trading of an Eligible Security or the Commission 
has issued an order for the suspension of trading of an Eligible 
Security. Section 1(c) of the proposed rule change would authorize DTC 
to impose a Restriction when ordered to do so by a court of competent 
jurisdiction. In such a situation, DTC would impose the Restriction 
specified by the court, or a Global Lock if no Restriction was 
specified. As noted above, commenters are generally supportive of the 
proposed basis for imposing Restrictions under Sections 1(a), (b), and 
(c) of the proposed rule change.\109\ A halt, suspension, or court 
order would raise questions as to whether the security at issue would 
continue to meet the eligibility criteria set forth in DTC's Rules. The 
Commission therefore agrees that DTC should have the authority under 
its Rules to place a Restriction on such securities if doing so will 
help prevent potentially ineligible securities from tainting DTC's 
fungible bulk, thereby protecting DTC and DTC's Participants from 
facilitating wrongful activities, and investors from having Eligible 
Securities tainted by securities of the same issue that do not meet 
DTC's eligibility criteria. The Commission also agrees that providing 
DTC with authority to impose a Restriction on securities that are the 
subject of a FINRA halt or Commission suspension would help protect 
investors and possibly stop further wrongdoing, because the Restriction 
would stop deliveries, redemptions, pledges, lending, deposits, and 
other types of transfers and settlements made via DTC's book-entry 
services that may not be addressed by the trading halt or suspension.
---------------------------------------------------------------------------

    \109\ See supra Section III.B.1.i at note 46.
---------------------------------------------------------------------------

    The proposed rule change would provide DTC the discretion to not 
impose a Global Lock, even if FINRA or the Commission issued a halt or 
suspension of trading of an Eligible Security, if such a Restriction 
would not further the regulatory purpose of the halt or suspension. For 
example, if a halt or suspension was imposed for a reason unrelated to 
the eligibility of the security for DTC's book-entry services,\110\ DTC 
would not be required to impose a Restriction. This provision protects 
issuers and investors from the burdens of unnecessary Restrictions by 
providing DTC with flexibility to avoid imposing a Global Lock if doing 
so would not be in the interest of protecting DTC, DTC's Participants, 
issuers, or investors.
---------------------------------------------------------------------------

    \110\ For example, DTC states that it would not impose a 
Restriction where an alleged improper issuance of shares were 
deposited at DTC several years earlier, or the chief executive 
officer of a company was convicted of a corporate crime that had no 
apparent effect on the eligibility of the company's securities at 
DTC. DTC Letter III at 4.
---------------------------------------------------------------------------

    Section 1(d) of the proposed rule change would authorize DTC to 
impose a Restriction upon identifying or becoming aware of a need to 
take such action to avoid imminent harm, injury, or other such material 
adverse consequence to DTC or its Participants that could arise from 
further deposits of, or continued book-entry services to, a particular 
Eligible Security. As described above, commenters generally raise three 
objections to Section 1(d): (i) Section 1(d) is impermissibly vague, 
thereby granting DTC unfettered discretion to impose Restrictions under 
it; (ii) issuers and investors would be harmed by Restrictions imposed 
under this provision, including because it would stop all book-entry 
services for that security, possibly affecting the value of the 
security; \111\ and (iii) by exercising its discretion under Section 
1(d), DTC would be improperly acting as a fraud regulator. With respect 
to the first objection, one commenter also states that the need to 
impose a Restriction under Section 1(d) of the proposed rule change 
should be balanced with the interests of shareholders of the 
security.\112\
---------------------------------------------------------------------------

    \111\ STA Letter III at 2.
    \112\ Id.
---------------------------------------------------------------------------

    The Commission does not find that Section 1(d) of the proposed rule 
change is impermissibly vague, or that it would grant DTC unfettered 
discretion to impose Restrictions without a proper basis or adequate 
protections for issuers. First, Section 1(d) is not impermissibly vague 
because it establishes specific criteria for imposing a Restriction and 
would require DTC to meet a high standard before it would be permitted 
to do so under that provision. Specifically, DTC would be required to 
identify (i) a need for immediate action (ii) to avert an imminent, 
(iii) harm, injury, or other such material adverse consequence, (iv) to 
DTC or its Participants, (v) that could arise from further deposits of, 
or

[[Page 89541]]

continued book-entry services to, an Eligible Security. As such, DTC's 
discretion to impose restrictions under Section 1(d) would be 
constrained. Indeed, in light of the standards set forth in Section 
1(d), DTC acknowledges that Restrictions under this section would only 
be imposed in rare and exigent circumstances,\113\ where imminent harm 
is present.\114\ DTC's discretion would also be limited by Section 
19(g) of the Act, which requires DTC, as a registered clearing agency 
and self-regulatory organization, to administer all of its rules in a 
manner consistent with its obligations of compliance with the federal 
securities laws and other applicable laws.\115\
---------------------------------------------------------------------------

    \113\ See DTC Letter I at 2.
    \114\ See Notice, 81 FR at 37234.
    \115\ 15 U.S.C. 78s(g).
---------------------------------------------------------------------------

    Regarding DTC's discretion under proposed Section 1(d), the 
Commission agrees that it would be impossible for DTC to predict and 
codify every possible circumstance that could taint DTC's fungible 
bulk, and thus harm DTC, its Participants, issuers, and investors. 
Without Section 1(d) of the proposed rule change, DTC would not have 
the authority or discretion to impose a Restriction when a significant 
concern arises that would not fall under Sections 1(a)-(c) because it 
is not related to a halt, suspension, or court order.\116\ The 
Commission finds that such discretion is necessary to allow DTC to 
protect not only itself and its Participants, but also investors and 
issuers who, but for a Restriction imposed by DTC, could be unwilling 
participants in fraudulent activity, or victims of improper 
conduct.\117\ For example, in the event that DTC becomes aware that all 
or some portion of the fungible bulk of an Eligible Security may have 
been sold or distributed in violation of Section 5 of the Securities 
Act, it could be necessary for DTC to limit further deposits and/or 
book-entry services for that security to prevent DTC and its 
Participants from participating in or otherwise facilitating an ongoing 
Section 5 violation. Without the authority and discretion granted by 
proposed Section 1(d), DTC might not have the authority under its Rules 
to take such action. Likewise, the discretion provided by proposed 
Section 1(d) would enable DTC to protect current shareholders from 
potential fraudulent deposits of securities that could compromise the 
value of their securities of the same issue.
---------------------------------------------------------------------------

    \116\ For example, DTC could have a concern about a foreign 
issuance, but FINRA or the Commission may not share that same 
concern and may not impose a trading halt or suspension; yet, DTC 
may believe it necessary to impose a Restriction to protect DTC and 
its Participants. See DTC Letter III at 3.
    \117\ For example, as DTC suggests, if DTC became aware of a 
current corporate hijacking, it would be able to impose a 
Restriction immediately, under Section 1(d) of the proposed rule. 
See DTC Letter III at 3.
---------------------------------------------------------------------------

    The Commission also does not find that the potential harm that 
could be caused to issuers and investors by Restrictions imposed under 
Section 1(d) outweighs the benefits to DTC, DTC's Participants, 
issuers, and investors gained by permitting DTC to impose Restrictions 
in the limited circumstances, and subject to the processes and 
procedures, that would be established by the proposed rule change. Any 
such potential harm would be mitigated not only by the issuer's ability 
under the proposed rule change to challenge a Restriction with DTC, but 
also by the issuer's ability to then appeal DTC's Restriction Decision 
to the Commission. Further, DTC, DTC's Participants, issuers, and 
investors could all be harmed if DTC did not have the authority to 
impose a Restriction in the circumstances described in Sections 1(a)-
(d). Rather, the Commission finds that Section 1(d) of the proposed 
rule change is necessary to provide DTC with adequate flexibility and 
authority to prevent and avoid imminent harm to DTC and its 
Participants, as well as issuers and investors, that could arise as a 
result of unforeseen and unpredictable events outside DTC's ability to 
predict or control. In addition, the Commission believes that DTC's 
flexibility to impose a Restriction under Section 1(d) is appropriately 
balanced with the interests of issuers and shareholders of the security 
by Section 4(d) of the proposed rule change, which would require DTC to 
release the Restriction when it reasonably determines that the original 
basis for the Restriction has abated, and release of the Restriction 
would no longer pose a threat of imminent harm, injury, or other such 
material adverse consequent to DTC or its Participants.\118\
---------------------------------------------------------------------------

    \118\ See Notice, 81 FR 37234.
---------------------------------------------------------------------------

    Finally, with respect to commenters' third objection, that Section 
1(d) of the proposed rule change is inconsistent with Section 
17A(b)(3)(F) of the Act because Congress did not intend DTC to act as a 
fraud regulator or to enforce laws unrelated to clearance and 
settlement,\119\ the Commission finds that the proposed rule change is 
directly related to DTC's administration of its book-entry clearing and 
settlement services, which are directly related to the purposes of 
Section 17A of the Act, including the establishment of the national 
system for clearance and settlement of securities transactions.\120\ As 
the Commission noted in both Atlantis and IPWG, one of the reasons 
DTC's book-entry clearing and settlement services are fundamentally 
important services is because any suspension by DTC of its clearance 
and settlement services with respect to an issuer's securities means 
that all trades in that issuer's stock would then require physical 
transfer of the stock certificates.\121\ As the central depository of 
securities in the United States, DTC has an obligation to ensure that 
by allowing book-entry services on deposited shares, it is not 
facilitating the illegal distribution of unregistered shares or helping 
to perpetrate a fraud, in violation of Section 5 of the Securities Act. 
Such actions are necessary to help assure the safeguarding of 
securities in the custody or control of DTC, and, in general, protect 
investors and the public interest. Further, DTC is a registered 
clearing agency and self-regulatory organization under Section 19 of 
the Act. As such, the Commission previously concluded in Atlantis and 
IPWG that DTC has the authority to impose restrictions on its book-
entry services.\122\
---------------------------------------------------------------------------

    \119\ STA Letter III at 3.
    \120\ 15 U.S.C. 78q-1.
    \121\ Atlantis, 2015 SEC LEXIS 2394 at *7-8 n.4; IPWG, 2012 SEC 
LEXIS 844 at *24.
    \122\ Atlantis, 2015 SEC LEXIS 2394 at *7-8 n.4; IPWG, 2012 SEC 
LEXIS 844 at *24.
---------------------------------------------------------------------------

    Based on the above, the Commission finds that the proposed rule 
change, is designed to help assure the safeguarding of securities in 
the custody or control of DTC, and, in general, protect investors and 
the public interest, as required by Section 17A(b)(3)(F) of the Act.

B. Consistency With Section 17A(b)(3)(H) of the Act

    Section 17A(b)(3)(H) of the Act requires, among other things, that 
the rules of a clearing agency are in accordance with the provisions of 
Section 17A(b)(5)(B) of the Act, and, in general, provide a fair 
procedure with respect to the prohibition or limitation by the clearing 
agency of any person with respect to access to services offered by the 
clearing agency.\123\ Section 17A(b)(5)(B) of the Act \124\ requires 
that, in any proceeding by a registered clearing agency to determine 
whether a person shall be denied participation or prohibited or limited 
with respect to access to services offered by the clearing agency, the 
clearing agency shall notify such person of, and give that person an 
opportunity to be heard, the specific

[[Page 89542]]

grounds for denial or prohibition or limitation under consideration and 
keep a record.\125\ A determination by the clearing agency to deny 
participation or prohibit or limit a person with respect to access to 
services offered by the clearing agency shall be supported by a 
statement setting forth the specific grounds on which the denial or 
prohibition or limitation is based.\126\
---------------------------------------------------------------------------

    \123\ 15 U.S.C. 78q-1(b)(3)(H).
    \124\ 15 U.S.C. 78q-1(b)(5)(B).
    \125\ Id.
    \126\ Id.
---------------------------------------------------------------------------

    In Atlantis and IPWG, the Commission concluded that issuers are 
``persons'' under Section 17A(b)(3)(H) of the Act, and, thus, are 
entitled to Commission review of DTC's actions that deny or limit 
issuers access to DTC services.\127\ The Commission further found that, 
to comply with Section 17A(b)(3)(H) of the Act,\128\ DTC must provide 
the issuer with notice of DTC's determination to impose a Restriction, 
specifying the basis for DTC's action, and that DTC must also provide 
an issuer with an opportunity to be heard,\129\ but that a formal 
hearing is not required.\130\ The Commission stated that DTC may design 
fair procedures in accordance with its own internal needs and 
circumstances.\131\
---------------------------------------------------------------------------

    \127\ Atlantis, 2015 SEC LEXIS 2394 at *7, 8 n.4; IPWG, 2012 SEC 
LEXIS 844 at *24.
    \128\ 15 U.S.C. 78q-1(b)(3)(H).
    \129\ Atlantis, 2015 SEC LEXIS 2394 at *7, 8 n.4; IPWG, 2012 SEC 
LEXIS 844 at *24.
    \130\ Atlantis, 2015 SEC LEXIS 2394 at *19; IPWG, 2012 SEC LEXIS 
844 at *30 n.36.
    \131\ Atlantis, 2015 SEC LEXIS 2394 at *19; IPWG, 2012 SEC LEXIS 
844 at *24.
---------------------------------------------------------------------------

    The Commission also held in Atlantis and IPWG that if DTC believes 
that circumstances exist that justify imposing a suspension of services 
with respect to an issuer's securities, in advance of being able to 
provide the issuer with notice and an opportunity to be heard on the 
suspension, it may do so,\132\ provided that, in such circumstances, 
the process to impose such a suspension should balance the identifiable 
need for emergency action with the issuer's right to fair procedures 
under Section 17A(b)(3)(H) of the Act.\133\ Under such procedures, DTC 
would be authorized to act to avert an imminent harm, but it could not 
maintain such a suspension indefinitely without providing expedited 
fair process to the affected issuer.\134\
---------------------------------------------------------------------------

    \132\ Atlantis, 2015 SEC LEXIS 2394 at *18 n.9; IPWG, 2012 SEC 
LEXIS 844 at *29.
    \133\ 15 U.S.C. 78q-1(b)(3)(H); Atlantis, 2015 SEC LEXIS 2394 at 
*18 n.9; IPWG, 2012 SEC LEXIS 844 at *29.
    \134\ Atlantis, 2015 SEC LEXIS 2394 at *18 n.9; IPWG, 2012 SEC 
LEXIS 844 at *29.
---------------------------------------------------------------------------

    The Commission finds that the proposed rule change appropriately 
addresses the Commission's findings in IPWG and Atlantis by, among 
other things, limiting Restrictions primarily to circumstances in which 
there would be objective external criteria for the Restriction of which 
the issuer would clearly be on notice (i.e., a FINRA halt, Commission 
suspension, or Court order under Sections 1(a)-(c)), or where the 
Restriction would be necessary to avoid a specific imminent harm to DTC 
or one or more of DTC's Participants. Sections 2 and 3 of the proposed 
rule change would establish a clear, unambiguous framework for 
providing issuers with notice of a Restriction and an opportunity to be 
heard and object to the Restriction, as well as DTC's obligations to 
review and provide a response to any such objection. Under Section 2(a) 
of the proposed rule change, DTC would be required to provide the 
issuer with notice of a Restriction within three business days after 
imposition of the Restrictions. The Restriction Notice would be 
required to set forth with reasonable specificity (i) the basis for the 
Restriction; (ii) the date the Restriction was imposed; and (iii) the 
timing and procedural requirements for the issuer to object to the 
Restriction. The issuer would be permitted to submit a Restriction 
Response to DTC within 20 business days of receiving the Restriction 
Notice, setting forth its objection to the Restriction and detailing 
the reasons that the Restriction should be released pursuant to Section 
4(d). Under Section 3 of the proposed rule change, DTC would then have 
10 business days to provide the issuer with a Restriction Decision, 
which would be required to be made by an independent Review Officer, 
defined as an officer of DTC under DTC's By-Laws. Under Section 3(b) of 
the proposed rule change, in response to the Restriction Decision, the 
issuer would be permitted to submit a Supplement within 10 business 
days to establish that DTC made a clerical mistake or an oversight in 
reviewing the Restriction Response. Finally, DTC would be required to 
provide the issuer with a Supplement Decision within 10 business days 
of receiving the Supplement.
    As described above, commenters' concerns with the notice and 
objection procedures that would be established by the proposed rule 
change were as follows: (i) The proposed rule change could not be fair 
and could not satisfy the requirements set forth in IPWG if DTC is 
permitted to set its own standards and act on its own accord to impose 
a Restriction under Section 1(d) of the proposed rule change; \135\ 
(ii) DTC should limit any Restriction under Section 1(d) of the 
proposed rule change to only a single 10 day period with any fair 
process occurring during that 10 day period; \136\ and (iii) questions 
regarding whether the Review Officer would be sufficiently 
independent,\137\ including an assertion by one commenter that IPWG 
requires that appeals should be heard by parties independent of 
DTC.\138\ In addition, one commenter asserted that the proposed rule 
change fails to establish fair procedures as required by Section 
17A(b)(3)(H) of the Act and the Commission's decision in IPWG because 
there is no stated time period for the Review Officer to complete its 
review of the issuer's Restriction Response and issue a Restriction 
Decision.\139\ This comment is obviated by DTC's Amendment No. 1 to the 
proposed rule change,\140\ which modified the initial proposed rule 
change to add a 10 business-day time period for the Review Officer to 
complete the review and issue a Restriction Decision.
---------------------------------------------------------------------------

    \135\ Kesner Letter at 6.
    \136\ STA Letter I at 3.
    \137\ See, e.g., STA Letter I at 4
    \138\ Kesner Letter II at 2.
    \139\ STA Letter I at 3.
    \140\ See Securities Exchange Act Release No. 78774 (September 
6, 2016), 81 FR 62775 (September 12, 2016).
---------------------------------------------------------------------------

    The Commission believes that the limited discretion provided to DTC 
under Section 1(d) of the proposed rule change does not render the 
proposed rule change unfair or unable to satisfy the requirements of 
Section 17A(b)(3)(H) of the Act and the Commission's decision in IPWG. 
As the Commission previously articulated in IPWG, DTC may design fair 
procedures in accordance with its own internal needs and 
circumstances.\141\ Similarly, if DTC believes that circumstances exist 
that justify imposing a Restriction, even in advance of notifying the 
issuer of the Restriction, it may do so, as long as DTC's process for 
imposing the emergency Restriction balances the identifiable need with 
the issuer's right to fair procedures under the Act.\142\ Here, as 
discussed above, Section 1(d) strikes the appropriate balance between 
providing DTC with sufficient flexibility to address unforeseen harms 
and issuers and investors rights with respect to their securities. It 
also establishes a high standard for imposing a Restriction, and DTC's 
discretion under that provision is limited.
---------------------------------------------------------------------------

    \141\ 2012 SEC LEXIS 844 at *30 n.36.
    \142\ Id. at *32.
---------------------------------------------------------------------------

    Further, although Section 1(d) of the proposed rule change would 
authorize DTC to impose a Restriction to avert an imminent harm, DTC 
could not maintain the Restriction indefinitely without providing 
expedited fair

[[Page 89543]]

process to the affected issuer under Sections 2 and 3 of the proposed 
rule change. Further, to impose a Restriction under Section 1(d) of the 
proposed rule change, DTC would be required to identify or become aware 
of the need to avoid an imminent harm that could arise from further 
deposits or book-entry services, and would be required to provide the 
issuer notice and opportunity to appeal the Restriction pursuant to the 
specific procedures set forth in Sections 2 and 3 of the proposed rule 
change. As described above, these procedures establish a process to 
require DTC to promptly notify the issuer of a Restriction and give the 
issuer an opportunity to be heard upon the specific grounds for the 
Restriction, all within specified periods of time.
    With respect to the independence of the Review Officer, Section 3 
of the proposed rule change requires an officer of DTC, as defined in 
DTC's By-Laws, who did not have responsibility for the initial 
imposition of the Restriction, to review the Restriction Response and 
provide the Restriction Decision to the issuer. As the Commission 
previously articulated in IPWG, DTC may comply with the Act by 
designing fair procedures in accordance with its own internal needs and 
circumstances.\143\ The Commission finds that having a DTC officer who 
was not involved in imposing the Restriction review a Restriction 
Response is a fair procedure. This is consistent with similar 
procedures by other clearing agencies supervised by the Commission. For 
instance, the Commission has approved as a fair procedure the Options 
Clearing Corporation's (``OCC's'') use of a panel of OCC officers and a 
director of OCC in the review of suspension decisions.\144\
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    \143\ 2012 SEC LEXIS 844 at *30 n.36.
    \144\ See Rule 1110, OCC Rules, available at http://www.optionsclearing.com/components/docs/legal/rules_and_bylaws/occ_rules.pdf.
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    The Commission believes that the proposed rule change establishes 
clear, consistent, and fair procedures for the imposition of 
Restrictions and for providing issuers with notice of Restrictions and 
opportunity to be heard. Section 1 identifies the specific 
circumstances under which a Restriction will be imposed, Sections 2 and 
3 would establish clear, policies, procedures, and specific 
requirements for providing issuers with notice of Restrictions and an 
opportunity to be heard, and Section 4 of the proposed rule change 
would establish clear standards for determining when adequate exists to 
release a Restriction. The Commission therefore finds that the proposed 
rule change, as modified by Amendment No. 1, provides for fair 
procedures with respect to the prohibition or limitation by the 
clearing agency of any person with respect to access to services 
offered by the clearing agency, as required by Section 17A(b)(3)(H) of 
the Act.

V. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposal, as modified by Amendment No. 1, is consistent with the 
requirements of the Act and in particular with the requirements of 
Section 17A of the Act \145\ and the rules and regulations thereunder.
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    \145\ 15 U.S.C. 78q-1.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that proposed rule change SR-DTC-2016-003, as modified by Amendment No. 
1, be, and hereby is, Approved.\146\
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    \146\ In approving the proposed rule change, the Commission 
considered the proposal's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\147\
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    \147\ 17 CFR 200.30-3(a)(12).
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Robert W. Errett,
Deputy Secretary.
[FR Doc. 2016-29668 Filed 12-9-16; 8:45 am]
 BILLING CODE 8011-01-P