Comments of U.S. Postal Service on S7-27-03

White Paper on Mutual Fund Reform and the USPS Electronic Postmark®

Introduction

The Securities and Exchange Commission ("Commission") is proposing amendments to the rule under the Investment Company Act that requires forward pricing of redeemable securities issued by registered investment companies ("funds"). The amendments would provide that an order to purchase or redeem fund shares would receive the current day's price only if the fund, its designated transfer agent, or a registered securities clearing agency receives the order by the time that the fund establishes for calculating its net asset value. The amendments are designed to prevent unlawful late trading in fund shares.

This document describes how the USPS Electronic Postmark can provide time-stamping and non-repudiation services that will help prove when the orders are received, what the orders consist of, in a manner that cannot be altered or revoked after the deadline.

Overview of the EPM

The advent of the Internet increased the need for efficient communication of electronic information with the same level of trust and value that the public has come to expect from the USPSTM in the physical environment. The USPS Electronic Postmark® (USPS EPM®) was created to facilitate secure electronic communication for government and commercial systems and has the potential to strengthen the security, privacy, and productivity of communication in the nation's electronic future.

The USPS EPM is a web-based security service. It includes trusted time stamps and content authentication technology, as well as aspects of non-repudiation. The trusted time stamps are derived from the National Institute of Standards and Technology (NIST), the official US source of time for commerce. These time stamps are auditable such that for each time stamp issued, the system is able to produce upon demand the bracketing time synchronization events starting from NIST and following a secure chain of custody through any intermediary clocks.

Deterrence Value of the Electronic Postmark

Investigative capabilities of US Postal Inspection Service enhancing electronic data protection from fraud
Should USPS EPM tampering be detected, the matter will be referred to Postal Service Inspection Service (USPIS) for possible review and action consistent with federal statutes and USPIS guidelines
Supported by federal laws
1. 18 U.S.C 1343 Wire Fraud
2. 18 U.S.C 2701 Electronic Communications Privacy Act (ECPA)
3. 18 U.S.C. 2510 regarding electronic communications
4. 18 U.S.C 1028, Fraud and related activity in connection with identification documents and information

Legal Value of the Electronic Postmark

Non-repudiation of Transactions

Legal/technical concept - sufficient evidence to prevent parties to transactions from falsely denying them in a court of law

Supports ESIGN

Enables business and government to sign and verify many contracts, letters and agreements electronically

USPS Brand

The USPS EPM service applies federal statutes (ex. wire fraud) to electronic transactions.

Benefits of the EPM for the SEC and Broker/Dealers

The USPS is perhaps uniquely positioned to help the SEC ensure the integrity of time-stamps associated with mutual fund trading. AuthentiDate runs the USPS EPM service for the USPS today. The SEC or a consortium of trading firms could either utilize the existing EPM infrastructure or deploy its own copy of the EPM service. It is essential that the SEC be guaranteed a content authentication and non-repudiation service that is long lived and extensible to meet future requirements. While the USPS is firmly committed to ensuring the long-term success of the EPM, it is possible to make the source code of the EPM service available under escrow to guarantee the ability to continue to run the EPM service in the unlikely event that the USPS decides to discontinue it.

The USPS EPM service combines trusted time stamps with content authentication technology. This combination proves document authenticity when a resulting USPS EPM is associated with a document or transaction that can later be verified using the USPS EPM repository. Finally, the service enables digital signing applications by including support for digital certificates. The combination of these technologies maintained in the USPS EPM repository provides third party evidence to support non-repudiation of electronic transactions and is designed to detect the fraudulent tampering or inadvertent altering of electronic data.

Security experts agree that trusted time stamps and trusted third party archival of signatures and receipts are necessary to ensure long-term non-repudiation. A wide body of knowledge suggests that even today's best PKI technologies may be capable of being "broken" in the future, rendering signatures and receipts that are not archived by a trusted third party, untrustworthy (unless they are re-signed). Additionally, to ensure completeness and enable non-repudiation, e-commerce systems must have a third-party time-stamping system in place because it is simply too easy to alter dates on computer systems. Government and industry reporting requirements specifying that information must be submitted by a certain date and time can also be satisfied through the USPS EPM service.

All the techniques described above are today's industry standard techniques for proving identity, signing, and time stamping. According to RFC 3126, Electronic Signature Formats for Long Term Electronic Signatures, one of the best ways to ensure successful long term non-repudiation is to store signatures and time stamps in a trusted third party repository, which can vouch for their integrity. The USPS EPM service stores a signed hash of the file or transaction and an associated time stamp signed by the USPS. Should there ever be a need to utilize newer, stronger algorithms, a trusted third party could re-sign the signatures and time stamps, thus preserving a chain of trust from the original as far into the future as required.

Highlights and Comments from the Proposed Rule

Following are some highlights pertinent to the EPM from the proposed Amendments to Rules Governing Pricing of Mutual Fund Shares:

Note: comments in italics describe how the EPM can help address requirements of the SEC highlighted in bold.

The SEC requirement that the EPM is most suited to addressing is:

II Discussion (Page 5)
We also seek comment on an approach that has been suggested. This approach would require fund intermediaries, in order to be eligible to submit orders to designated transfer agents or Fund/SERV after 4:00 p.m., to have adopted certain protections designed to prevent late trading. Such protections could include:

Electronic or physical time-stamping of orders in a manner that cannot be altered or discarded once the order is entered into the trading system;

Other requirements for which the EPM is applicable include:

Page 6
Would such an approach be effective at stopping late trading? Some broker-dealers appear to have easily circumvented current system controls, including the time-stamping required by our rules.

The EPM can prove that orders are neither altered nor discarded once the order is postmarked. A post trader audit of trades against the EPM repository can verify that all orders are accounted for. The operation of the time date stamp service by the USPS minimizes the possibility of collusion.

Page 6
Under the proposed rule, fund designated transfer agents would be required to record the date and time they receive order information.27 These transfer agents and NSCC will operate, in effect, as time-stamping organizations, ensuring that orders are assigned the correct day's price.28 We believe these organizations, which are regulated by the Commission29 and operate large automated processing systems, will serve to ensure the integrity of fund pricing.30
Are there other intermediaries that could also serve this role? Are there intermediaries that may become involved in processing order information in the foreseeable future that would be capable of serving this role?

The USPS EPM could serve in this role as a trusted third party for time stamping and non-repudiation. Transfer agents could utilize the EPM service. The EPM service's architecture is modular and capable of incremental expansion to handle larger volumes of simultaneous transactions.

B. Purchase and Sale Orders; Exchanges (Page 7)
"We propose to define the term "order" in the rule to clarify when an order is complete (and therefore has been received) for purposes of obtaining the appropriate day's price. Under the proposed amendments an "order" would mean the direction to purchase or sell either (i) a specific number of shares of a fund (e.g., all the shares held in the account), or (ii) an indeterminate number of shares of a specific value (e.g., $10,000 of shares of the fund).32 The definition also would state that each order would be deemed irrevocable as of the next pricing time after receipt by the fund, its designated transfer agent, or registered clearing agency.33 This provision is designed to prevent the cancellation or modification of orders after the pricing time applicable to the order."

Because the USPS EPM acts as a trusted third party, holding evidence of each order, it will not be possible to delete, cancel, or modify orders without detection.

B. Costs (Page 9)
"Currently, orders for a fund's shares received by broker-dealers, 401(k) plan administrators, and other third-party intermediaries from their customers prior to the fund's pricing time are eligible to receive that day's price. The proposed amendments to rule 22c-1 would limit same-day pricing to orders received by the fund, its designated transfer agent, or a registered clearing agency prior to the fund's pricing time. As a result, third-party intermediaries (including broker-dealers and retirement plan administrators) and NSCC would incur certain costs, and funds and investors might incur costs.43 In addition, fund designated transfer agents would incur costs as a result of a recordkeeping requirement contained in the proposed amendments."

The EPM service can provide the time stamps on a cost-effective basis as the technology is already developed and commercially available (COTS).

"Third-party intermediaries would have to combine their fund share orders for processing prior to the pricing time, and therefore their customers may have to place their orders earlier in the day than investors who conduct business directly with the fund's designated transfer agent in order to receive that day's price.44 This would put intermediaries at a competitive disadvantage with designated transfer agents, and may result in a number of an intermediary's customers or potential customers bypassing the intermediary and purchasing or redeeming shares directly with the designated transfer agent. Alternatively, intermediaries, in order to compete with designated transfer agents, may upgrade their computer systems in order to process orders more quickly, thus allowing customers to place their orders as close to the pricing time as possible while qualifying for that day's price.45 We would expect that the systems would become increasingly efficient over time and thus reduce the delay between the intermediary's receipt of the order and transmission to Fund/SERV or the designated transfer agent. The Commission, however, has no reasonable basis for determining the number of customers or potential customers that intermediaries might lose or the costs associated with the potential lost customer orders. The computer system upgrade would impose one-time costs. The Commission, however, has no reasonable basis for determining the costs of the technological upgrades intermediaries might incur as a result of the proposed amendments, because each intermediary could upgrade in a way that it deems best for its particular computer system."

The EPM service's architecture is modular and capable of incremental expansion to handle larger volumes of simultaneous transactions. Even multiple incremental upgrades to the capacity of the system should not affect the price of the EPM.

C. Request for Comment (page 12)
The Commission requests comment on the potential costs and benefits of the proposed rule amendments. We also request comment on the potential costs and benefits of the approach under which intermediaries, in order to be eligible to submit orders to the fund after 4:00 p.m., would be required to adopt certain protections designed to prevent late trading. The Commission also requests comment on the potential costs and benefits of any other alternatives suggested by commenters. We encourage commenters to identify, discuss, analyze, and supply relevant data regarding any additional costs and benefits. For purposes of the Small Business Regulatory Enforcement Act of 1996,54 the Commission also requests information regarding the potential impact of the proposals on the U.S. economy on an annual basis. Commenters are requested to provide data to support their views.

The USPS EPM service can help minimize the costs of the proposed rule amendments because it a COTS solution to the problem. The EPM service cost the USPS and AuthentiDate millions of dollars to develop over the course of several years. The SEC and the funds can take advantage of this operational security certified solution at established known pricing.