As a retail investor, I respectfully submit this petition for rulemaking pursuant to Rule 192 of the Securities and Exchange Commission’s (“SEC”) Rules of Practice [1], to request that the SEC amend Rules 18 and 22 of National Securities Clearing
Corporation (“NSCC”) Rules & Procedures [2] to provide investors with clarity and certainty regarding settlement of guaranteed transactions, strengthen the resilience of a registered Clearing agency (e.g., the NSCC) for their role as a central counterparty
(CCP), and support the stability of our financial markets and financial system by incentivizing appropriate risk management practices by market participants.
I respectfully submit this petition consistent with the SEC’s website for Petitions for Rulemaking Submitted to the SEC [3] which states “[a]ny person may request that the Commission issue, amend or repeal a rule of general application” where “petitions must
be filed with the Secretary of the Commission” and “petitions may be submitted via electronic mail to
(preferred method)”. This petition also satisfies requirements that “petitions must contain the text or substance of any proposed rule or amendment or specify the rule or portion of a
rule requested to be repealed” and “petitions must also include a statement of their interest and/or reasons for requesting Commission action.” [Id.]
It has come to the attention of retail investors, like myself, that NSCC Rules and Procedures do not codify strict procedures for closing out positions (e.g., in the event of a Member default). Per NSCC’s Disclosure Framework for Covered Clearing Agencies
and Financial Market Infrastructures, “as a cash market CCP, if a Member defaults, NSCC will need to complete settlement of guaranteed transactions on the failing Member’s behalf” [4 “Liquidity risk management framework”]. However, NSCC Rule 18 SEC. 6(a)
contains a provision that “if, in the opinion of the Corporation, the close out of a position in a specific security would create a disorderly market in that security, then the completion of such close-out shall be in the discretion of the Corporation”.
Retail investors like myself are concerned about potential market distortion and market manipulation arising from the discretion afforded to the NSCC based solely on the NSCC’s unreviewed and private opinion regarding the [in-]completion of a close-out of a
position in a specific security that could distort markets and/or create disorderly markets. A few questions must be considered:
-Who is responsible for the costs of closing out a position which would create a disorderly market?
With respect to the text of the proposed changes itemized below (blue and strikethrough,
where applicable), additions are identified by square brackets (i.e., “[“ and “]”) and double-dashes (i.e., “--”) indicate deletions.
NSCC Rule 4 Proposed Change
SEC. 4. Loss Allocation Waterfall, Off-the-Market Transactions.
Each Member[, including its executives,] shall
be obligated to the Corporation for the entire amount of any loss or liability incurred by the Corporation arising out of or relating to any Defaulting Member Event with respect to such Member. [To
the extent that such loss or liability is not satisfied by the Member, all executives of the Member (past or present) shall be obligated to the Corporation for an amount equivalent to the preceding 5 years of compensation from the Member.] To
the extent that such loss or liability is not satisfied pursuant to Section 3 of this Rule 4, the Corporation shall apply a Corporate Contribution thereto and charge the remaining amount of such loss or liability ratably to other Members, as further provided
below.
NSCC Rule 18 Proposed Change
SEC. 6. (a) Promptly after the Corporation has given notice that it has ceased to act for the Member, and in a manner consistent with the provisions of Section 3, the Net
Close Out Position with respect to each CNS Security shall be closed out (whether it be by buying in, selling out or otherwise liquidating the position) by the Corporation--; provided however, if, in the opinion of the
Corporation, the close out of a position in a specific security would create a disorderly market in that security, then the completion of such close-out shall be in the discretion of the Corporation--.
NSCC Rule 22 Proposed Change (Option A – Public Notice)
RULE 22. SUSPENSION OF RULES
The time fixed by these Rules, the Procedures or any regulations issued by the Corporation for the doing of any act or acts may be extended or the doing of any act
or acts required by these Rules, the Procedures or any regulations issued by the Corporation may be waived or any provision of these Rules, the Procedures or any regulations issued by the Corporation may be suspended
by the Board of Directors or by the Chairman of the Board, the President, the General Counsel or such other officers of the Corporation having a rank of Managing Director or higher whenever, in its or his judgment, such extension, waiver or suspension is necessary
or expedient.
A written report of any such extension, waiver or suspension (other than an extension of time of less than eight hours), stating the pertinent facts,
the identity of the person or persons who authorized such extension, waiver or suspension and the reason such extension, waiver or suspension was deemed necessary or expedient, shall be promptly made [and published
on the Corporation’s website for access by the general public within 1 business day] and filed with the Corporation’s records and shall be available for inspection by any [person,] Member,
Mutual Fund/Insurance Services Member, Municipal Comparison Only Member, Insurance Carrier/Retirement Services Member, TPA Member, TPP Member, Investment Manager/Agent Member, Fund Member, Data Services Only Member or AIP Member during regular business hours
on Business Days. Any such extension or waiver may continue in effect after the event or events giving rise thereto but shall not continue in effect for more than 60 calendar days after the date thereof unless it shall be approved [by] the
Board of Directors within such period of 60 calendar days [with a written report made and published as described by this paragraph].
NSCC Rule 22 Proposed Change (Option B – No Exceptions)
RULE 22. --SUSPENSION OF RULES--[NO
EXCEPTIONS]
--The time fixed by these Rules, the Procedures or any regulations issued by the Corporation for the doing of any act or acts may
be extended or the doing of any act or acts required by these Rules, the Procedures or any regulations issued by the Corporation may be waived or any provision of these Rules, the Procedures or any regulations issued by the Corporation may be suspended by
the Board of Directors or by the Chairman of the Board, the President, the General Counsel or such other officers of the Corporation having a rank of Managing Director or higher whenever, in its or his judgment, such extension, waiver or suspension is necessary
or expedient. A written report of any such extension, waiver or suspension (other than an extension of time of less than eight hours), stating the pertinent facts, the identity of the person or persons who authorized such extension, waiver or suspension and
the reason such extension, waiver or suspension was deemed necessary or expedient, shall be promptly made and filed with the Corporation’s records and shall be available for inspection by any Member, Mutual Fund/Insurance Services Member, Municipal Comparison
Only Member, Insurance Carrier/Retirement Services Member, TPA Member, TPP Member, Investment Manager/Agent Member, Fund Member, Data Services Only Member or AIP Member during regular business hours on Business Days. Any such extension or waiver may continue
in effect after the event or events giving rise thereto but shall not continue in effect for more than 60 calendar days after the date thereof unless it shall be approved the Board of Directors within such period of 60 calendar days.--
[The time fixed by these Rules, the Procedures or any regulations issued by the Corporation for the doing of any act or acts may not be extended.
The doing of any act or acts required by these Rules, the Procedures or any regulations issued by the Corporation may not be waived and any provision of these Rules, the Procedures or any regulations issued by the Corporation may not be suspended.
A written report of any deviation from these Rules, Procedures or any regulations issued by the Corporation (including extension,
waiver or suspension), stating the pertinent facts, the identity of the person or persons who authorized such extension, waiver or suspension and the reason such extension, waiver or suspension was deemed necessary or expedient, shall be promptly made and
published on the Corporation’s website for access by the general public within 1 business day and filed with the Corporation’s records and shall be available for inspection by any person, Member, Mutual Fund/Insurance Services Member, Municipal Comparison
Only Member, Insurance Carrier/Retirement Services Member, TPA Member, TPP Member, Investment Manager/Agent Member, Fund Member, Data Services Only Member or AIP Member during regular business hours on Business Days.]
Final Remarks
As a retail investor, I believe these enhancements to NSCC Rules 4, 18 and 22 will protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation in accordance with the SEC’s mission. Removing ambiguity and discretion by
codifying strict procedures for completing settlement of guaranteed transactions at our CCPs ensures consistent clearance and settlement procedures are well defined for all market participants fostering a level playing field for everyone. Of the two options
proposed for NSCC Rule 22, Option B “No Exceptions” is preferable to Option A in ensuring consistent application of Rules, Procedures, and regulations issued by the CCP. Option A is proposed with the acknowledgement that flexibility in managing situations
can be helpful, but NSCC Rule 22 would need to mandate full disclosure to the public to avoid distorting markets as reducing information asymmetries leads to more efficient and fair markets.
These enhancements to NSCC Rules foster a “you broke it, you bought it” environment where costs for closing out positions, including those which may be disruptive, are first paid by the defaulting Member(s) and its executives with defined and consistent application
of clearance and settlement procedures. Including liability for executive compensation in the loss allocation waterfall introduces another loss absorbing resource and incentivizes proactive risk management practices over the short, medium, and long term which
simultaneously discourages socializing losses for privatized profits. Thus, the proposed enhancements to the loss allocation waterfall enhances the liquidity and strengthens the resilience of registered Clearing agencies, such as the NSCC, which supports
the overall stability of our financial markets and financial system. [13]
Retail investors like myself appreciate the opportunity to submit this petition for rulemaking and respectfully request that the Commission act on it promptly for the NSCC with similar conforming changes for the DTC (e.g., Rules 4 and 18), FICC Government Securities
Division (e.g., Rules 4 and 42), FICC Mortgage Backed Securities Division (e.g., Rules 4 and 33), and elsewhere as applicable (e.g., Options Clearing Corporation which describes their loss allocation waterfall in “OCC’s Clearing Member Default Rules and Procedures”
[15]).
Sincerely,
Joseph Reid
Another Concerned Retail Investor
[1] 17 C.F.R. § 201.192(a)
[2] NSCC Rules & Procedures are currently available at
https://www.dtcc.com/~/media/Files/Downloads/legal/rules/nscc_rules.pdf
[3]
https://www.sec.gov/rules-regulations/petitions-rulemaking-submitted-to-sec
[4]
https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/NSCC_Disclosure_Framework.pdf
[5] For a publicly available description of this issue, see “This is how Wall St ensures heads they win and tails you lose” at
https://www.reddit.com/r/Superstonk/comments/yhx48w/this_is_how_wall_st_ensures_heads_they_win_and/ which describes the moral hazard problem created by Too Big To Fail based on a 1996 paper titled "Banks with Something to Lose: The Disciplinary Role of
Franchise Value" [
https://www.newyorkfed.org/research/epr/96v02n2/9610dems.html] available from the Federal Reserve Bank of NY.
[6] Decades after the Global Financial Crisis, options for resolving large financial institutions remain limited with bail-ins potentially replacing the unpopular bail outs. See, e.g, Investopedia (
https://www.investopedia.com/terms/b/bailin.asp)
and the Federal Reserve Bank of New York’s “Why Bail-In? And How!” (
https://www.newyorkfed.org/medialibrary/media/research/epr/2014/1412somm.pdf/1000). While bail-ins
are theoretically more palatable with creditors absorbing losses instead of taxpayers, self serving profit motivated financial institutions remain committed to shifting losses to others as exemplified by the Federal Reserve and Federal Deposit Insurance Corporation
(FDIC) which proposed to have new bond investors absorb losses first [2022 Proposed Rule Federal Reserve Docket R-1786 RIN 7100-AG4 and FDIC RIN 3064-AF86 available on the Federal Register at
https://www.federalregister.gov/documents/2022/10/24/2022-23003/resolution-related-resource-requirements-for-large-banking-organizations]. Additional discussion regarding this proposed rule may be found on Reddit (
https://www.reddit.com/r/Superstonk/comments/zdebh6/comment_against_the_federal_reserve_fdic_proposal/
and
https://www.reddit.com/r/Superstonk/comments/163ztcz/federal_reserve_fdic_seeking_bag_holders/) which note that this strategy was successfully implemented with the failure of Credit Suisse where AT1 “bonds were created precisely for such situations” to
“be fully written off in the event of a trigger event”.
[7] See, e.g.,
https://www.federalregister.gov/documents/2023/08/30/2023-18670/self-regulatory-organizations-national-securities-clearing-corporation-notice-of-filing-of-proposed which discusses the Existing Accord for the transfer between OCC and NSCC of responsibility
for settlement obligations including the time when OCC’s settlement guarantee ends and NSCC’s settlement guarantee begins.
[8]
https://www.dtcc.com/about/businesses-and-subsidiaries/nscc
[9] While a naked short position is used as an example here, it is only chosen as an example due to its inherent risk of unlimited loss. Any type of position could become risky as an extremely large long position could also lead to a disorderly market on close
out even with limited loss potential. A large short position (whether naked or borrowed) is of particular relevance as the SEC’s Staff Release GameStop Report [
https://www.sec.gov/page/sec-staff-release-gamestop-report]
noted that GameStop (GME) had significant short interest (as a percent of float) in January 2021 of 122.97% with “short interest of more than shares outstanding in January 2021” [Id. pg 21].
[10] Per the current NSCC Rule 22, only certain parties have access to records of any extension, waiver, or suspension of rules related to not closing out a position. A much smaller subset of those parties with access are actively made aware of the situation.
One option to mitigate market distortions would be to timely (i.e., immediately) make the written reports of Rule 22, including the pertinent facts, available to the SEC and to the general public as proposed for NSCC Rule 22 as Option A - Public Notice.
[11] For example, naked shorts and failures to deliver were documented in Dr. Susanne Trimbath’s book “Naked, Short and Greedy: Wall Street’s Failure to Deliver” and in 2008 the SEC halted short selling of financial stocks (and only financial stocks) in an
emergency action “to combat market manipulation” and “restore equilibrium to markets”. [See, e.g.,
https://www.sec.gov/news/press/2008/2008-211.htm]
[12] NSCC’s Loss Allocation Waterfall may be found in, for example, NSCC’s Rules Rule 4 SEC 4 “Loss Allocation Waterfall, Off-the-Market Transactions”. OCC’s Loss Allocation Waterfall is described in OCC’s Clearing Member Default Rules and Procedures [
https://www.theocc.com/getmedia/e8792e3c-8802-4f5d-bef2-ada408ed1d96/default-rules-and-procedures.pdf]
publicly linked to from the OCC’s website on Default Rules & Procedures [
https://www.theocc.com/risk-management/default-rules-and-procedures].
[13] The SEC has supported adoption of rules which “helps foster more resilient clearinghouses” [
https://www.sec.gov/newsroom/press-releases/2023-236] where the need for more resilient clearinghouses
is discussed in more detail on Reddit [
https://www.reddit.com/r/Superstonk/comments/17wzqc4/clearinghouses_busted_confirmation_bias_from_the/].
[14] See, e.g., DTC Rules [
https://www.dtcc.com/-/media/Files/Downloads/legal/rules/dtc_rules.pdf],
FICC Government Securities Division Rules [
https://www.dtcc.com/~/media/Files/Downloads/legal/rules/ficc_gov_rules.pdf],
and FICC Mortgage Backed Securities Division Rules [
https://www.dtcc.com/~/media/Files/Downloads/legal/rules/ficc_mbsd_rules.pdf]
where DTC Rule 18 “WAIVER OR SUSPENSION OF RULES AND PROCEDURES”, FICC Government Securities Division Rule 42 “SUSPENSION OF RULES”, and FICC Mortgage Backed Securities Division Rule 33 “SUSPENSION OF RULES IN EMERGENCY CIRCUMSTANCES” are similar to NSCC Rule
22 “SUSPENSION OF RULES” while DTC Rule 4 Section 5 “Loss Allocation Waterfall” and FICC’s Rule 4 “CLEARING FUND AND LOSS ALLOCATION” are similar to NSCC Rule 4 in defining their loss allocation waterfalls.
[15] See, e.g.,
https://www.theocc.com/getmedia/e8792e3c-8802-4f5d-bef2-ada408ed1d96/default-rules-and-procedures.pdf which is linked to from
https://www.theocc.com/risk-management/default-rules-and-procedures.