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[Federal Register: August 23, 1996 (Volume 61, Number 165)]
[Rules and Regulations]
[Page 43625-43636]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr23au96-21]


[[Page 43625]]


_______________________________________________________________________

Part III





Department of the Treasury





_______________________________________________________________________



Fiscal Service



_______________________________________________________________________



31 CFR Part 306, et al.



Regulations Governing Book-Entry Treasury Bonds, Notes and Bills;
Conforming Book-Entry Changes; Final Rules


[[Page 43626]]



DEPARTMENT OF THE TREASURY

Fiscal Service

31 CFR Part 357

[Department of the Treasury Circular, Public Debt Series, No. 2-86]


Regulations Governing Book-Entry Treasury Bonds, Notes and Bills

AGENCY: Bureau of the Public Debt, Fiscal Service, Treasury.

ACTION: Final rule.

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SUMMARY: The Department of the Treasury is publishing a final rule
that, on and after the effective date, will govern Treasury bonds,
notes, and bills (Treasury securities) in book-entry form held in the
commercial book-entry system. The rule incorporates recent and
significant changes in commercial law addressing the holdings of
securities in book-entry form through financial intermediaries. The
rule replaces existing Treasury regulations that contain outdated legal
concepts.

EFFECTIVE DATE: January 1, 1997. The incorporation by reference of
certain publications listed in the regulations is approved by the
Director of the Federal Register as of January 1, 1997.

FOR FURTHER INFORMATION CONTACT: Walter T. Eccard, Chief Counsel (202)
219-3320, or Cynthia E. Reese, Deputy Chief Counsel, [phone].
Copies of the final rule are being made available for downloading from
the Bureau of the Public Debt home page at the following address:
http:\\www.ustreas.gov/treasury/bureaus/ pubdebt/pubdebt.html.

SUPPLEMENTARY INFORMATION:

I. Background

    On March 4, 1996, the Department published a proposed rule that
would govern securities held in the commercial book-entry system, now
referred to as the Treasury/Reserve Automated Debt Entry System
(``TRADES''). 61 FR 8420. Eleven written comment letters were received
in response to that proposed rule. All but one of the comment letters
were very supportive of the proposed rule. Most commenters recommended
adoption of the proposed rule with various suggested clarifications.
The Department found the comments extremely useful in making the
revisions described herein. Although some minor comments are not
addressed, all comments have been considered in the formulation of this
final rule.
    As indicated in the March 4 release, Treasury will include
commentary on TRADES in the Code of Federal Regulations. This
commentary can be found in Appendix B.
    Comments from several persons overlapped and those comments
addressed three general areas:
    (1) The scope of federal preemption and related issues involving
state variations on Revised Article 8 of the UCC as well as Treasury
procedures and notice regarding acceptance of state enactments of
Revised Article 8;
    (2) Coordination as to timeframes and notices to facilitate
revision and issuance of parallel rules for book-entry securities of
Government Sponsored Enterprises (GSEs) to conform to the final TRADES
rule; and
    (3) The need for further explanation and clarification, especially
the inclusion of hypotheticals, to illustrate how TRADES will apply to
a variety of transaction scenarios of varying complexity, including the
application of the federal law to transactions involving clearing
banks.

II. General Comment Discussion

    In the March 4 proposal, Treasury set forth its conclusion that,
because of the size and importance of the Treasury market, uniformity
of treatment of holders of interests in Treasury securities was
essential. In addition, Treasury set forth in some detail the reasons
it had concluded that Revised Article 8 was an appropriate vehicle to
use to obtain that uniformity. As of March 4, 13 states had adopted
Revised Article 8. As of the date of this release 28 states <SUP>1 have
adopted Revised Article 8 and it has been introduced in 4 additional
states and the District of Columbia.<SUP>2 This remarkable progress
reflects strong support for the legal concepts set forth in Revised
Article 8 and supports Treasury's decision to base TRADES on Revised
Article 8, which is incorporated by reference in this final rule.
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    \1\ Alabama, Alaska, Arizona, Arkansas, Colorado, Idaho, Iowa,
Illinois, Indiana, Kansas, Kentucky, Louisiana, Maryland,
Massachusetts, Minnesota, Mississippi, Nebraska, New Mexico,
Oklahoma, Oregon, Pennsylvania, Texas, Utah, Vermont, Virginia,
Washington, West Virginia, Wyoming.
    \2\ California, District of Columbia, Hawaii, New York, Ohio.
---------------------------------------------------------------------------

    In the March 4 release, Treasury proposed achieving uniformity for
Treasury securities in two ways. First, Section 357.10(a) established a
rule of Federal preemption in describing the rights and obligations of
Treasury and the Federal Reserve Banks. Second, TRADES established a
choice of law rule that mandated use of Revised Article 8 in the event
the state determined by the application of the choice of law rule had
not adopted Revised Article 8.
    Commenters generally supported Treasury's conclusion that
uniformity was important for the market and investors in Treasury
securities. In addition commenters were supportive of the use of
Revised Article 8 to achieve this uniformity. Three different
questions, however, were raised about the manner in which Treasury
achieved uniformity and used Revised Article 8.

A. Federal Preemption

    First, 5 commenters questioned whether Secs. 357.10(c) and
357.11(d) were intended to be a complete or limited preemption of a
state's law if the state had not adopted Revised Article 8. As set
forth in the March 4 release, the preemption in TRADES is limited. See
the commentary in Appendix B. In order to clarify this issue, Treasury
has adopted language in both Secs. 357.10(c) and 357.11(d) suggested by
a commenter to make the limited nature of the preemption clearer. This
language provides that, if a state has not adopted Revised Article 8,
that state's laws shall be viewed as though that state had adopted
Revised Article 8.
    Second, 4 commenters noted that while in the discussion section of
the March 4 release Treasury stated that minor variations made by a
state in adopting Revised Article 8 would not affect Treasury's
conclusion that a state had adopted Revised Article 8, the language of
the proposed rule had no similar qualification. Further, commenters
noted that while the standard in the commentary seemed appropriate,
determination of what constituted minor variations could be difficult.
In response to these comments, and in an attempt to provide certainty,
Treasury is taking the following actions. Treasury has reviewed the
form of Revised Article 8 adopted by the 28 states <SUP>3 that have
adopted Revised Article 8 as of the date of this release and has
concluded that the changes made by these states indeed are minor.
Therefore, Treasury has concluded that they all are substantially
similar to Revised Article 8. Accordingly, if either Sec. 357.10(b) or
357.11(a) directs a person to one of these 28 states, the provisions of
Secs. 357.10(c) and 357.11(d) are not applicable. In addition, as
additional states adopt Revised Article 8, Treasury will, after review
of the statute, publish in the Federal Register a notice setting forth
its conclusion as to whether Secs. 357.10(c) and 357.11(d) remain
applicable to those states.
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    \3\ See Note 1 supra.

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[[Page 43627]]

    Third, a commenter raised a question of what Treasury would do in
the event a state adopted Revised Article 8 and then subsequently
amended Revised Article 8 in a fashion that resulted in an
unsatisfactory lack of uniformity. Treasury believes such an event is
unlikely. In addition, once Treasury has announced its determination
that a state has adopted Revised Article 8, the market is entitled to
rely on that decision.<SUP>4 Nonetheless, if such an unlikely event
were to occur, Treasury has the authority to take the action that would
result in Secs. 357.10(c) and 357.11(d) (or their equivalent) being
reapplied. Any such action would be published in the Federal Register.
---------------------------------------------------------------------------

    \4\ One commenter noted that Article 9 is currently being
revised, which could lead to the result that a state could adopt
different Article 9 provisions than are included in the Article 8
conforming amendments. Treasury does not anticipate that such an
event would result in the need to reapply Secs. 357.10(c) and
357.11(d). If that were necessary, Treasury would take the same
action, after notice, as described herein.
---------------------------------------------------------------------------

B. Action With Respect to GSEs

    Several commenters noted that market participants and practitioners
were concerned about coordination among Treasury and other GSEs that
issue book-entry securities. The assumption is that the substance of
any such regulations will be substantially identical to the Treasury
proposed rule. Treasury is working with the GSEs and their regulators
toward the goal of having the effective dates of all final book-entry
regulations timed to coincide. One commenter specifically suggested
delaying the effective date of the final TRADES rule to provide
sufficient lead time to GSE issuers. Treasury understands the market's
desire for simultaneous adoption of book-entry rules substantially
similar to TRADES for GSEs. While adoption of rules for GSEs is subject
to the control of the various GSEs and the entities that promulgate
their rules, Treasury has taken several steps to facilitate the
simultaneous adoption of parallel GSE rules. These steps have included
meetings with representatives of the GSEs and their regulators to
inform them of the actions Treasury was taking with respect to TRADES
and the timetable for adoption of TRADES. Consistent with this
supportive approach, Treasury has determined that it will, at the
request of the Federal Farm Credit Banks Funding Corporation, delay the
effectiveness of TRADES until January 1. That should permit sufficient
time for rules similar to TRADES to be in place for GSEs by the
effective date of TRADES.

C. Request for Hypotheticals

    Several commenters suggested that Treasury include in the
Commentary to the final regulations various hypotheticals to illustrate
the manner in which selected transactions would be treated under the
TRADES regulations.
    Initially, Treasury notes that Revised Article 8 provides numerous
hypotheticals that explain the operation of Revised Article 8. Treasury
has studied those hypotheticals carefully and believes that they are
very useful in understanding Revised Article 8. In light of those
hypotheticals, and since TRADES is based, in large measure, on Revised
Article 8, Treasury has concluded that developing hypotheticals
explaining the operation of Revised Article 8 is unnecessary. On the
other hand, TRADES does provide for an interaction of federal and state
law. Since the results in a particular factual situation could depend
on which law is applicable, Treasury has concluded that hypotheticals
that illustrate what law would apply in different situations would be
useful. Accordingly, the Commentary contains hypotheticals to explain
the interaction of federal and state law.

III. Other Comments

    In addition to the general comments described above, Treasury
received a number of other comments. Many of these included technical
drafting suggestions.
    One commenter noted concerns with the tiered nature of the
commercial book-entry system and indicated that investors may not be
aware of how the commercial book-entry system works. Treasury agrees
that it is important that investors understand the operation of both
the book-entry system and TRADES. The discussion in the March 4
Proposed Rule was designed to promote that understanding. In addition,
the inclusion of a commentary on TRADES in the Code of Federal
Regulations is another effort to promote an understanding of both
TRADES and the book-entry system. Furthermore, Treasury plans to
continue its investor education efforts in the coming months.
    One commenter questioned the use of the term ``Security
Entitlement'' to describe the interest of a Participant in a Treasury
book-entry security. The commenter noted that the term ``Security
Entitlement'' is used in Revised Article 8 and its use in TRADES to
describe the interest of a Participant could be confusing. Treasury
considered using different terms to describe this interest but
concluded that Security Entitlement was the most useful. In order to
avoid confusion, there was language in the commentary in the March 4
release that attempted to make it clear that the term ``Security
Entitlement'' has a special meaning in TRADES. Additional language has
been added to the commentary to clarify this further. Due to Treasury's
obligation to pay a Participant (see Sec. 357.13(b)), the interest of a
Participant and a person holding in TREASURY DIRECT are, in practical
terms, the same since both the Participant and the person holding in
TREASURY DIRECT have a direct claim against the United States.
    One commenter proposed adding a new defined term, ``State,'' and
made certain other drafting changes to the definitions. Those
suggestions mainly clarify the meaning intended by Treasury in the
March release and were adopted. In adopting these drafting suggestions,
Treasury concluded that a new defined term, ``Adverse Claim'' was
needed. This definition is based on the definition of that term in
Revised Article 8. By adding this term, Treasury is able to adopt the
suggestions that it delete the general incorporation reference in the
definition section that appeared in the March release. Section 357.2 is
complete and reference to other definitions is unnecessary.
    One commenter found the language of Sec. 357.10(b) unclear and
proposed drafting suggestions to clarify its meaning. Section 357.10(b)
decribes the law that governs security interests granted to Federal
Reserve Banks. The Commentary, and hypotheticals included in the
commentary, explain how Sec. 357.10(b) works. In addition Treasury has
redrafted Sec. 357.10(b) in order to make its meaning clearer.
    Several comments stated that Sec. 357.11(c) should be modified to
conform to the choice of law rule in Section 9-103(6)(f) of Revised
Article 8. Treasury agrees with this comment and has made changes to
Sec. 357.11(c). In particular, Treasury agrees that it is appropriate
to delete reference to priority so that, as provided in
Sec. 357.11(a)(5), the law of the Securities Intermediary's
jurisdiction governs on this issue.

Procedural Requirements

    This final rule does not meet the criteria for a ``significant
regulatory action'' pursuant to Executive Order 12866.
    The notice and public comment procedures requirements of the
Administrative Procedure Act are inapplicable, pursuant to 5 U.S.C.
553(a)(2).
    As no notice of proposed rulemaking was required, the provisions of
the

[[Page 43628]]

Regulatory Flexibility Act (5 U.S.C. 601, et seq.) do not apply.
    There are no collections of information contained in this final
rule. Therefore, the Paperwork Reduction Act does not apply.

List of Subjects in 31 CFR Part 357

    Bonds, Electronic funds transfer, Federal Reserve System,
Government securities, Incorporation by reference, Securities.

    For the reasons set forth in the preamble, title 31, chapter II,
subchapter B, part 357 is amended as follows:

PART 357--[AMENDED]

    1. The authority citation for part 357 continues to read as
follows:

    Authority: 31 U.S.C. chapter 31; 5 U.S.C. 301; 12 U.S.C. 391.

    2. Sections 357.0 and 357.1 are added to read as follows:


Sec. 357.0  Dual book-entry systems.

    (a) Treasury securities shall be maintained in either of the
following two book-entry systems:
    (1) Treasury/Reserve Automated Debt Entry System (TRADES). A
Treasury security is maintained in TRADES if it is credited by a
Federal Reserve Bank to a Participant's Securities Account. See subpart
B of this part for rules pertaining to TRADES.
    (2) TREASURY DIRECT Book-entry Securities System (TREASURY DIRECT).
A Treasury security is maintained in TREASURY DIRECT if it is credited
to a TREASURY DIRECT account as described in Sec. 357.20. Such accounts
may be accessed by investors in accordance with subpart C of this part
through any Federal Reserve Bank or the Bureau of the Public Debt. See
subpart C of this part for rules pertaining to TREASURY DIRECT.
    (b) A Treasury security eligible to be maintained in TREASURY
DIRECT under the terms of its offering circular or pursuant to notice
published by the Secretary may be transferred to or from an account in
TRADES from or to an account in TREASURY DIRECT in accordance with
Sec. 357.22(a).


Sec. 357.1  Effective date.

    Subpart B of this Part, the definitions of ``Adverse Claim,''
``Book-entry Security,'' ``Entitlement Holder,'' ``Federal Reserve Bank
Operating Circular,'' ``Funds Account,'' ``Issue,'' ``Participant,''
``Participant's Securities Account,'' ``Person,'' ``Revised Article
8,'' ``Securities Intermediary,'' ``Security Entitlement,'' ``State,''
and ``Transfer Message'' and revisions to the definitions of
``Security'' and ``TRADES,'' and Secs. 357.42 and 357.44 and the
revisions to Sec. 357.41 are effective January 1, 1997. All other
provisions in effect prior to January 1, 1997, remain in effect.
    3. Section 357.3 is redesignated Sec. 357.2, in the definition of
``depository institution'' paragraphs (a) through (f) are redesignated
as paragraphs (1) through (6), the definition of ``security interest
and pledge'' is removed, the definitions of ``Security'' and ``TRADES''
are revised, and the remaining definitions are added in alphabetical
order as follows:


Sec. 357.2  Definitions.

* * * * *
    Adverse Claim means a claim that a claimant has a property interest
in a Security and that it is a violation of the rights of the claimant
for another Person to hold, transfer, or deal with the Security.
* * * * *
    Book-entry Security means, in subpart B of this part, a Treasury
Security maintained in TRADES and, in subpart C of this part, a
Treasury Security maintained in TREASURY DIRECT.
* * * * *
    Entitlement Holder means a Person to whose account an interest in a
Book-entry Security is credited on the records of a Securities
Intermediary.
* * * * *
    Federal Reserve Bank Operating Circular means the publication
issued by each Federal Reserve Bank that sets forth the terms and
conditions under which the Reserve Bank maintains Book-entry Securities
accounts and transfers Book-entry Securities.
* * * * *
    Funds Account means a reserve and/or clearing account at a Federal
Reserve Bank to which debits or credits are posted for transfers
against payment, book-entry securities transaction fees, or principal
and interest payments.
* * * * *
    Issue means a group of securities, as defined in this section, that
is identified by the same CUSIP (Committee on Uniform Securities
Identification Practices) number.
* * * * *
    Participant means a Person that maintains a Participant's
Securities Account with a Federal Reserve Bank.
    Participant's Securities Account means an account in the name of a
Participant at a Federal Reserve Bank to which Book-entry Securities
held for a Participant are or may be credited.
    Person means and includes an individual, corporation, company,
governmental entity, association, firm, partnership, trust, estate,
representative and any other similar organization, but does not mean or
include the United States or a Federal Reserve Bank.
* * * * *
    Revised Article 8 means Uniform Commercial Code, Revised Article 8,
Investment Securities (with Conforming and Miscellaneous Amendments to
Articles 1, 3, 4, 5, 9, and 10) 1994 Official Text. Revised Article 8
of the Uniform Commercial Code is incorporated by reference in this
Part pursuant to 5 U.S.C. 552(a) and 1 CFR part 51. Article 8 was
adopted by the American Law Institute and the National Conference of
Commissioners On Uniform State Laws and approved by the American Bar
Association on February 14, 1995. Copies of this publication are
available from the Executive Office of the American Law Institute, 4025
Chestnut Street, Philadelphia, PA 19104, and the National Conference of
Commissioners on Uniform State Laws, 676 North St. Clair Street, Suite
1700, Chicago, IL 60611. Copies are also available for public
inspection at the Department of the Treasury Library, Room 5030, Main
Treasury Building, 1500 Pennsylvania Avenue, NW., Washington DC 20220,
and at the Office of the Federal Register, 800 North Capitol Street,
NW., Suite 700, Washington DC.
    Securities Intermediary means:
    (1) A Person that is registered as a ``clearing agency'' under the
federal securities laws; a Federal Reserve Bank; any other person that
provides clearance or settlement services with respect to a Book-entry
Security that would require it to register as a clearing agency under
the federal securities laws but for an exclusion or exemption from the
registration requirement, if its activities as a clearing corporation,
including promulgation of rules, are subject to regulation by a federal
or state governmental authority; or
    (2) A Person (other than an individual, unless such individual is
registered as a broker or dealer under the federal securities laws)
including a bank or broker, that in the ordinary course of its business
maintains securities accounts for others and is acting in that
capacity.
    Security means a bill, note, or bond, each as defined in this
section. It also means any other obligation issued by the Department
that, by the terms of the applicable offering circular or announcement,
is made subject to this part. Solely for purposes of this part, it also
means:
    (1) The interest and principal components of a security eligible
for

[[Page 43629]]

Separate Trading of Registered Interest and Principal of Securities
(``STRIPS''), if such security has been divided into such components as
authorized by the express terms of the offering circular under which
the security was issued and the components are maintained separately on
the books of one or more Federal Reserve Banks; and
    (2) The interest coupons that have been converted to book-entry
form under the Treasury's Coupons Under Book-Entry Safekeeping Program
(``CUBES''), pursuant to agreement and the regulations in 31 CFR part
358.
    Security Entitlement means the rights and property interest of an
Entitlement Holder with respect to a Book-entry Security.
* * * * *
    State means any State of the United States, the District of
Columbia, Puerto Rico, the Virgin Islands, or any other territory or
possession of the United States.
* * * * *
    TRADES is the Treasury/Reserve Automated Debt Entry System, also
referred to as the commercial book-entry system.
* * * * *
    Transfer Message means an instruction of a Participant to a Federal
Reserve Bank to effect a transfer of a Book-entry Security maintained
in TRADES, as set forth in Federal Reserve Bank Operating Circulars.
* * * * *
    4. Subpart B, consisting of Secs. 357.10 through 357.14, is added
to read as follows:

Subpart B--Treasury/Reserve Automated Debt Entry System (TRADES)

Sec. 357.10  Law governing rights and obligations of United States
and Federal Reserve Banks; rights of any Person against United
States and Federal Reserve Banks.
Sec. 357.11  Law governing other interests.
Sec. 357.12  Creation of ``Participant's Security Entitlement;
security interests.
Sec. 357.13  Obligations of United States; no Adverse Claims.
Sec. 357.14  Authority of Federal Reserve Banks.

Subpart B--Treasury/Reserve Automated Debt Entry System (TRADES)


Sec. 357.10  Law governing rights and obligations of United States and
Federal Reserve Banks; rights of any Person against United States and
Federal Reserve Banks.

    (a) Except as provided in paragraph (b) of this section, the rights
and obligations of the United States and the Federal Reserve Banks with
respect to: A Book-entry Security or Security Entitlement and the
operation of the Treasury book-entry system; and the rights of any
Person, including a Participant, against the United States and the
Federal Reserve Banks with respect to: A Book-entry Security or
Security Entitlement and the operation of the Treasury book-entry
system; are governed solely by Treasury regulations, including the
regulations of this Part, the applicable offering circular (which is 31
CFR part 356, in the case of securities issued on and after March 1,
1993), the announcement of the offering, and Federal Reserve Bank
Operating Circulars.
    (b) A security interest in a Security Entitlement that is in favor
of Federal Reserve Bank from a Participant and that is not recorded on
the books of a Federal Reserve Bank pursuant to Sec. 357.12(c)(1), is
governed by the law (not including the conflict-of-law rules) of the
jurisdiction where the head office of the Federal Reserve Bank
maintaining the Participant's Securities Account is located. A security
interest in a Security Entitlement that is in favor of a Federal
Reserve Bank from a Person that is not a Participant, and that is not
recorded on the books of a Federal Reserve Bank pursuant to
Sec. 357.12(c)(1), is governed by the law determined in the manner
specified in Sec. 357.11.
    (c) If the jurisdiction specified in the first sentence of
paragraph (b) of this section is a State that has not adopted Revised
Article 8 (incorporated by reference, see Sec. 357.2) then the law
specified in paragraph (b) of this section shall be the law of that
State as though Revised Article 8 had been adopted by that State.


Sec. 357.11  Law governing other interests.

    (a) To the extent not inconsistent with these regulations, the law
(not including the conflict-of-law rules) of a Securities
Intermediary's jurisdiction governs:
    (1) The acquisition of a Security Entitlement from the Securities
Intermediary;
    (2) The rights and duties of the Securities Intermediary and
Entitlement Holder arising out of a Security Entitlement;
    (3) Whether the Securities Intermediary owes any duties to an
adverse claimant to a Security Entitlement;
    (4) Whether an Adverse Claim can be asserted against a Person who
acquires a Security Entitlement from the Securities Intermediary or a
Person who purchases a Security Entitlement or interest therein from an
Entitlement Holder; and
    (5) Except as otherwise provided in paragraph (c) of this section,
the perfection, effect of perfection or non-perfection and priority of
a security interest in a Security Entitlement.
    (b) The following rules determine a ``Securities Intermediary's
jurisdiction'' for purposes of this section:
    (1) If an agreement between the Securities Intermediary and its
Entitlement Holder specifies that it is governed by the law of a
particular jurisdiction, that jurisdiction is the Securities
Intermediary's jurisdiction.
    (2) If an agreement between the Securities Intermediary and its
Entitlement Holder does not specify the governing law as provided in
paragraph (b)(1) of this section, but expressly specifies that the
securities account is maintained at an office in a particular
jurisdiction, that jurisdiction is the Securities Intermediary's
jurisdiction.
    (3) If an agreement between the Securities Intermediary and its
Entitlement Holder does not specify a jurisdiction as provided in
paragraph (b)(1) or (b)(2) of this section, the Securities
Intermediary's jurisdiction is the jurisdiction in which is located the
office identified in an account statement as the office serving the
Entitlement Holder's account.
    (4) If an agreement between the Securities Intermediary and its
Entitlement Holder does not specify a jurisdiction as provided in
paragraph (b)(1) or (b)(2) of this section and an account statement
does not identify an office serving the Entitlement Holder's account as
provided in paragraph (b)(3) of this section, the Securities
Intermediary's jurisdiction is the jurisdiction in which is located the
chief executive office of the Securities Intermediary.
    (c) Notwithstanding the general rule in paragraph (a)(5) of this
section, the law (but not the conflict-of-law rules) of the
jurisdiction in which the Person creating a security interest is
located governs whether and how the security interest may be perfected
automatically or by filing a financing statement.
    (d) If the jurisdiction specified in paragraph (b) of this section
is a State that has not adopted Revised Article 8 (incorporated by
reference, see Sec. 357.2), then the law for the matters specified in
paragraph (a) of this section shall be the law of that State as though
Revised Article 8 had been adopted by that State. For purposes of the
application of the matters specified in paragraph (a) of this section,
the Federal Reserve Bank maintaining the Securities Account is a
clearing corporation, and the

[[Page 43630]]

Participant's interest in a Book-entry Security is a Security
Entitlement.


Sec. 357.12  Creation of Participant's Security Entitlement; security
interests.

    (a) A Participant's Security Entitlement is created when a Federal
Reserve Bank indicates by book entry that a Book-entry Security has
been credited to a Participant's Securities Account.
    (b) A security interest in a Security Entitlement of a Participant
in favor of the United States to secure deposits of public money,
including without limitation deposits to the Treasury tax and loan
accounts, or other security interest in favor of the United States that
is required by Federal statute, regulation, or agreement, and that is
marked on the books of a Federal Reserve Bank is thereby effected and
perfected, and has priority over any other interest in the securities.
Where a security interest in favor of the United States in a Security
Entitlement of a Participant is marked on the books of a Federal
Reserve Bank, such Reserve Bank may rely, and is protected in relying,
exclusively on the order of an authorized representative of the United
States directing the transfer of the security. For purposes of this
paragraph, an ``authorized representative of the United States'' is the
official designated in the applicable regulations or agreement to which
a Federal Reserve Bank is a party, governing the security interest.
    (c) (1) The United States and the Federal Reserve Banks have no
obligation to agree to act on behalf of any Person or to recognize the
interest of any transferee of a security interest or other limited
interest in favor of any Person except to the extent of any specific
requirement of Federal law or regulation or to the extent set forth in
any specific agreement with the Federal Reserve Bank on whose books the
interest of the Participant is recorded. To the extent required by such
law or regulation or set forth in an agreement with a Federal Reserve
Bank, or the Federal Reserve Bank Operating Circular, a security
interest in a Security Entitlement that is in favor of a Federal
Reserve Bank or a Person may be created and perfected by a Federal
Reserve Bank marking its books to record the security interest. Except
as provided in paragraph (b) of this section, a security interest in a
Security Entitlement marked on the books of a Federal Reserve Bank
shall have priority over any other interest in the securities.
    (2) In addition to the method provided in paragraph (c)(1) of this
section, a security interest, including a security interest in favor of
a Federal Reserve Bank, may be perfected by any method by which a
security interest may be perfected under applicable law as described in
Sec. 357.10(b) or Sec. 357.11. The perfection, effect of perfection or
non-perfection and priority of a security interest are governed by that
applicable law. A security interest in favor of a Federal Reserve Bank
shall be treated as a security interest in favor of a clearing
corporation in all respects under that law, including with respect to
the effect of perfection and priority of the security interest. A
Federal Reserve Bank Operating Circular shall be treated as a rule
adopted by a clearing corporation for such purposes.


Sec. 357.13  Obligations of the United States; no Adverse Claims.

    (a) Except in the case of a security interest in favor of the
United States or a Federal Reserve Bank or otherwise as provided in
Sec. 357.12(c)(1), for the purposes of this subpart B, the United
States and the Federal Reserve Banks shall treat the Participant to
whose Securities Account an interest in a Book-entry Security has been
credited as the person exclusively entitled to issue a Transfer
Message, to receive interest and other payments with respect thereof
and otherwise to exercise all the rights and powers with respect to the
Security, notwithstanding any information or notice to the contrary.
Neither the Federal Reserve Banks nor Treasury is liable to a Person
asserting or having an Adverse Claim to a Security Entitlement or to a
Book-entry Security in a Participant's Securities Account, including
any such claim arising as a result of the transfer or disposition of a
Book-entry Security by a Federal Reserve Bank pursuant to a Transfer
Message that the Federal Reserve Bank reasonably believes to be
genuine.
    (b) The obligation of the United States to make payments of
interest and principal with respect to Book-entry Securities is
discharged at the time payment in the appropriate amount is made as
follows:
    (1) Interest on Book-entry Securities is either credited by a
Federal Reserve Bank to a Funds Account maintained at the Bank or
otherwise paid as directed by the Participant.
    (2) Book-entry Securities are redeemed in accordance with their
terms by a Federal Reserve Bank withdrawing the securities from the
Participant's Securities Account in which they are maintained and by
either crediting the amount of the redemption proceeds, including both
principal and interest, where applicable, to a Funds Account at the
Bank or otherwise paying such principal and interest as directed by the
Participant. No action by the Participant is required in connection
with the redemption of a Book-entry Security.


Sec. 357.14  Authority of Federal Reserve Banks.

    (a) Each Federal Reserve Bank is hereby authorized as fiscal agent
of the United States to perform functions with respect to the issuance
of Book-entry Securities offered and sold by the Department to which
this Subpart applies, in accordance with the terms of the applicable
offering circular and with procedures established by the Department; to
service and maintain Book-entry Securities in accounts established for
such purposes; to make payments of principal and interest, as directed
by the Department; to effect transfer of Book-entry Securities between
Participants' Securities Accounts as directed by the Participants; and
to perform such other duties as fiscal agent as may be requested by the
Department.
    (b) Each Federal Reserve Bank may issue Operating Circulars not
inconsistent with this Part, governing the details of its handling of
Book-entry Securities, Security Entitlements, and the operation of the
book-entry system under this Part.
    5. In subpart D, Sec. 357.41 is revised and the text of
Secs. 357.42 and 357.44 are added, to read as follows:

Subpart D--Additional Provisions


Sec. 357.41  Waiver of regulations.

    The Secretary reserves the right, in the Secretary's discretion, to
waive any provision(s) of these regulations in any case or class of
cases for the convenience of the United States or in order to relieve
any person(s) of unnecessary hardship, if such action is not
inconsistent with law, does not adversely affect any substantial
existing rights, and the Secretary is satisfied that such action will
not subject the United States to any substantial expense or liability.


Sec. 357.42  Liability of Department and Federal Reserve Banks.

    The Department and the Federal Reserve Banks may rely on the
information provided in a tender, transaction request form, or Transfer
Message, and are not required to verify the information. The Department
and the Federal Reserve Banks shall not be liable for any action taken
in accordance with the information set out in a tender, transaction
request form, or Transfer

[[Page 43631]]

Message, or evidence submitted in support thereof.


Sec. 357.44  Notice of attachment for securities in TRADES.

    The interest of a debtor in a Security Entitlement may be reached
by a creditor only by legal process upon the Securities Intermediary
with whom the debtor's securities account is maintained, except where a
Security Entitlement is maintained in the name of a secured party, in
which case the debtor's interest may be reached by legal process upon
the secured party. These regulations do not purport to establish
whether a Federal Reserve Bank is required to honor an order or other
notice of attachment in any particular case or class of cases.
    6. Appendix B to part 357 is added to read as follows:

Appendix B to Part 357--TRADES Commentary

Introduction

    The adoption of regulations for the Treasury/Reserve Automated
Debt Entry System (``TRADES'') is the culmination of a multi-year
Treasury process of moving from issuing securities only in
definitive (physical/certificated/paper) form to issuing securities
exclusively in book-entry form. The TRADES regulations provide the
legal framework for all commercially-maintained Treasury book-entry
securities. For a more detailed explanation of the procedural and
legal development of book-entry and the TRADES regulations, see the
preamble to the rule proposed March 4, 1996 (61 FR 8420), as well as
the earlier proposals cited therein 51 FR 8846 (March 14, 1986); 51
FR 43027 (November 28, 1986); 57 FR 12244 (April 9, 1992).

Comparison of TRADES and Treasury Direct

    A person may hold interests in Treasury book-entry securities
either in TRADES <SUP>1 or TREASURY DIRECT. The following summarizes
the major differences between the two systems.
---------------------------------------------------------------------------

    \1\ In TRADES a Person's interest in a Treasury book-entry
security is a Security Entitlement, as described in TRADES. A
Participant's interest in a marketable Treasury book-entry security
also is a Security Entitlement. A Participant's Security Entitlement
is different than a Security Entitlement as described in Revised
Article 8, with respect to the Participant's rights against the
issuer. A non-Participant's Security Entitlement is described in
Revised Article 8.
---------------------------------------------------------------------------

    Persons holding Treasury book-entry securities in TRADES hold
their interests in such securities in a tiered system of ownership
accounts. In TRADES, Treasury, through its fiscal agents, the
Federal Reserve Banks, recognizes the identity only of Participants
(persons with a direct account relationship with a Federal Reserve
Bank). While Participants may be beneficial owners of interests in
Treasury book-entry securities, there are many beneficial owners of
such interests that are not Participants. Such beneficial owners
hold their interests through one or more Securities Intermediaries
such as banks, brokerage firms or securities clearing organizations.
    In TRADES, the rights of non-Participant beneficial owners may
be exercised only through their Securities Intermediaries. Neither
Treasury nor the Federal Reserve Banks have any obligation to a non-
Participant beneficial owner of an interest in a Treasury book-entry
security. Two examples illustrate this principle. First, except
where a pledge has been recorded directly on the books of a Federal
Reserve Bank pursuant to Sec. 357.12(c)(1), Federal Reserve Banks,
as Treasury's fiscal agents, will act only on instructions of the
Participant in whose Securities Account the Treasury book-entry
security is maintained in recording transfers of an interest in a
Treasury book-entry security. A beneficial owner of the interest
that is a non-Participant has no ability to direct a transfer on the
books of a Federal Reserve Bank. Second, Treasury discharges its
payment obligation with respect to a Treasury book-entry security
when payment is credited to a Participant's account or paid in
accordance with the Participant's instructions. Neither Treasury nor
a Federal Reserve Bank has any payment obligation to a non-
Participant beneficial owner of an interest in a Treasury book-entry
security. A non-Participant beneficial owner receives its payment
when its Securities Intermediary credits the owner's account.
    Persons holding Treasury book-entry securities in TREASURY
DIRECT, on the other hand, hold their securities accounts on records
maintained by Treasury through its fiscal agents, the Federal
Reserve Banks. The primary characteristic of TREASURY DIRECT is a
direct account relationship between the beneficial owner of a
Treasury book-entry security and Treasury. In TREASURY DIRECT,
Treasury discharges its payment obligation when payment is credited
to the depository institution specified by the beneficial owner of
the Treasury book-entry security, paid directly to the beneficial
owner by check, or paid in accordance with the beneficial owner's
instructions. Unlike TRADES, TREASURY DIRECT does not provide a
mechanism for the exchange of cash to settle a secondary market
transaction, nor are pledges of Treasury book-entry securities held
in TREASURY DIRECT generally recognized. Accordingly, TREASURY
DIRECT is suited for persons who plan to hold their Treasury
securities until maturity, and provides an alternative for investors
who are concerned about holding securities through intermediaries
and who do not wish to hold their interests in Treasury securities
indirectly in TRADES.

Scope of Regulation

    Just as the scope of Revised Article 8 is limited,<SUP>2 the
scope of this regulation is limited. It is not a comprehensive
codification of the law governing securities, transactions in
securities or the law of contracts for the purchase or sale of
securities. Similarly, it is not a codification of all laws that
could affect a person's interest in a Treasury book-entry security.
For example, state laws regarding divorce or intestate succession
could well affect which persons have rights in the interest in a
Treasury book-entry security. Moreover, the regulations deal with
certain aspects of transactions in Treasury securities, such as
perfection of a security interest and its effects and not other
aspects, such as the contractual relationship between a debtor and
its secured party, which are left to applicable law <SUP>3 See the
discussion under Sec. 357.10 of the Section-by-Section Analysis.
---------------------------------------------------------------------------

    \2\ U.C.C. Revised Article 8, Prefatory Note at 12.
    \3\ The regulations in 31 CFR 306.118(b), which are being
supplanted by TRADES, state that ``applicable law'' covers how a
transfer or pledge is ``effected'' as well as perfected. Except with
respect to security interests marked on the books of a Federal
Reserve Bank, TRADES does not address how a security interest in a
Treasury book-entry security is created or what law governs the
creation of a security interest. Section 357.11(a) of TRADES, which
establishes the choice of law for interests other than those covered
by Sec. 357.10, addresses the choice of law with respect to the
perfection, effect of perfection or non-perfection, and priority of
security interests, but does not address the law governing creation
or attachment of a security interest. This is consistent with the
scope and choice of law provisions of Revised Article 8.
---------------------------------------------------------------------------

Section-by-Section Analysis

Section 357.0  Dual Book-entry Systems

    Section 357.0 sets forth that Treasury provides two systems for
maintaining Treasury book-entry securities--TRADES and TREASURY DIRECT.
Subpart A of part 357 of 31 CFR contains general information about
TRADES and TREASURY DIRECT. Subpart B contains the TRADES regulations.
Subpart C contains the TREASURY DIRECT regulations. Subpart D contains
miscellaneous provisions. Thus, in its totality, Part 357 sets forth in
one place the complete set of governing rules for Treasury securities
issued in book-entry form.

Section 357.1  Effective Date

    Section 357.1 establishes the effective date for TRADES. TRADES
applies to outstanding securities formerly governed by 31 CFR part
306, subpart O. Conforming changes to parts 306, 356, and 358 are
being made to coincide with the publication of TRADES in final form.
Consistent with the approach set forth in Revised Article 8 (see
Sec. 8-603 and the official comment thereto), on and after the
effective date these regulations will apply to all transactions,
including transactions commenced prior to the effective date.
Revised Article 8, in Section 8-603, gave secured parties four
months after the effective date to take action to continue the
perfection of their security interests. TRADES, through its delayed
effectiveness, provides a similar period. In TRADES, January 1,
1997, becomes the date by which such actions must be completed.
    The effective date for TRADES is January 1, 1997. While TRADES
is based in large part on Revised Article 8 that has received
widespread attention in the financial community and already has been
adopted in

[[Page 43632]]

28 states,\4\ Treasury has determined that TRADES will be effective
on January 1, 1997, to ensure a smooth transition to TRADES. In
making that determination, Treasury has taken into account the time
required by other Government-Sponsored Enterprises (GSEs) to
promulgate similar regulations for their securities. Such an
effective date, when combined with TRADES having been published in
proposed form with a 60-day comment period, should provide
sufficient time for an orderly transition to the new TRADES rules.
---------------------------------------------------------------------------

    \4\ As of August 1, 1996, those states are: Alabama, Alaska,
Arizona, Arkansas, Colorado, Idaho, Illinois, Indiana, Iowa, Kansas,
Kentucky, Louisiana, Maryland, Massachusetts, Minnesota,
Mississippi, Nebraska, New Mexico, Oklahoma, Oregon, Pennsylvania,
Texas, Utah, Vermont, Virginia, Washington, West Virginia and
Wyoming. See discussion accompanying footnote 11.
---------------------------------------------------------------------------

Section 357.2  Definitions

    Section 357.2 contains definitions for use in subparts B and C.
While most of the definitions are straightforward, four terms--
Participant, Entitlement Holder, Security Entitlement and Securities
Intermediary--are critical to an understanding of the proposed
TRADES regulations.
    (a) Participant
    A Participant is a person that has a securities account
relationship in its name with a Federal Reserve Bank. Accordingly,
the Federal Reserve Bank and Treasury know both the identity of the
persons maintaining these accounts and the Treasury book-entry
securities held in these accounts.
    (b) Securities Intermediary
    Securities Intermediaries are persons (other than individuals,
except as described below) that are in the business of holding
interests in Treasury book-entry securities for others. Participants
can be, and usually are, Securities Intermediaries.
    In addition, entities such as clearing corporations, banks,
brokers and dealers can be Securities Intermediaries in a single
chain of ownership of a Treasury security. An individual, unless
registered as a broker or dealer under the federal securities laws,
cannot be a Securities Intermediary. As an illustration of a
possible chain of ownership, in the following chart, the Federal
Reserve Bank, Participant and Broker-Dealer are all Securities
Intermediaries.

                                Treasury

                          Federal Reserve Bank
                                    |
                               Participant
                                    |
                              Broker-Dealer
                                    |
                            Individual Holder


    (c) Entitlement Holder
    An Entitlement Holder is any person for whom a Securities
Intermediary holds an interest in a Treasury book-entry security. In
the above example Individual Holder, Broker-Dealer and Participant
are all Entitlement Holders. Thus, a person can be both a Securities
Intermediary and an Entitlement Holder. See also the commentary on
``Security Entitlement.''
    (d) Security Entitlement
    A Security Entitlement is the interest that an Entitlement
Holder has in a Treasury book-entry security. In the example,
Participant, Broker-Dealer and Individual Holder all hold Security
Entitlements. The rights and property interests associated with a
Security Entitlement of a Participant held on the books of a Federal
Reserve Bank (``Participant's Security Entitlement'') are, however,
different from the rights and property interests associated with
other Security Entitlements. As provided in Sec. 357.10(a), Federal
law defines the scope and nature of a Participant's Security
Entitlement. While TRADES is based in large part on Revised Article
8, the meaning of Security Entitlement under federal law is
different than under Revised Article 8. For example, Participants
have a direct claim against the United States for interest and
principal even though, under state law, an Entitlement Holder would
only have a claim against its Securities Intermediary for such
payment. To the extent not inconsistent with this regulation, the
scope and nature of a Security Entitlement of an Entitlement Holder
below the level of a Participant, (Broker-dealer and Individual
Holder in the example above), is defined by applicable state law, as
determined pursuant to Sec. 357.11. It should also be noted that
while a Participant's rights have Federal law components under
Sec. 357.10(a), the nature of a Security Entitlement held by a lower
tier intermediary on the books of a Participant is determined
pursuant to applicable law as provided in Sec. 357.11.

Section 357.10  Law Governing the United States and Reserve Banks

    Section 357.10(a) provides that the rights and obligations of
the United States and the Federal Reserve Banks (with one exception
detailed below), with respect to both the TRADES system and Treasury
book-entry securities maintained in TRADES are governed solely and
exclusively by Federal law. Thus, claims against the United States
and Federal Reserve Banks of both Participants and all other persons
with an interest (or claiming an interest) in a Treasury book-entry
security maintained in TRADES are governed by Federal law. Federal
law is defined to include TRADES, the offering circulars pursuant to
which the Treasury securities are sold, the offering announcements
and Federal Reserve Bank Operating Circulars.<SUP>5 Prior to March
1, 1993, the terms of each offering of Treasury securities, except
for Treasury bills were set forth in an offering circular published
in the Federal Register.<SUP>6 Since March 1, 1993, all Treasury
book-entry securities have been offered pursuant to a uniform
offering circular set forth at 31 CFR part 356.
---------------------------------------------------------------------------

    \5\ A ``Federal Reserve Bank Operating Circular'' is defined in
Sec. 357.2 as the publication issued by each Federal Reserve Bank
that sets forth the terms and conditions under which the Reserve
Bank maintains Book-entry Securities Accounts and transfers Book-
entry Securities.
    \6\ Treasury bills were issued pursuant to one master offering
circular (31 CFR part 349, removed, and replaced by 31 CFR part 356)
effective March 1, 1993. (58 FR 412)
---------------------------------------------------------------------------

    While TRADES is based in large measure on Revised Article 8, a
fundamental principle of these regulations (and a divergence from
Revised Article 8) is that the obligations of the issuer (the United
States) and the Federal Reserve Banks, as well as all claims with
respect to TRADES or a Treasury book-entry security against Treasury
or a Federal Reserve Bank, are governed solely by Federal law. Thus,
for example, those parts of Revised Article 8 that detail
obligations of issuers (or their agents) of securities are not
applicable to either the United States or Federal Reserve
Banks.<SUP>7 In addition, neither the United States nor Federal
Reserve Banks have any obligations to persons holding their
interests in a Treasury book-entry security at levels below the
level of a Participant or to any other person claiming an interest
in a Treasury book-entry security (with the limited exception set
out in Sec. 357.12(c)(1)). Thus, there are no derivative rights
against either the United States or the Federal Reserve Banks.
---------------------------------------------------------------------------

    \7\ The regulations in subpart C of this part set out other
obligations of the United States and the Federal Reserve Banks for
securities held in TREASURY DIRECT. These regulations preempt
applicable state law.
---------------------------------------------------------------------------

    In interpreting this section, it is important to note that the
scope of TRADES, like that of Revised Article 8, is limited.
Accordingly, the governing law set forth in Sec. 357.10(a) is
applicable only to the matters set forth in Sec. 357.10(a). Other
laws remain applicable and could affect the holders of book-entry
securities.
    For example, the tax treatment of Securities Entitlements is
outside the scope of TRADES and other law (the Federal income tax
code) is applicable in determining such tax treatment. Similarly,
nothing in Sec. 357.10(a) limits the applicability of other laws to
matters such as whether the activities of Participants or Securities
Intermediaries with respect to interests in Treasury book-entry
securities are subject to banking or securities laws.
    While TRADES in Sec. 357.10(a) defines what law governs the
contract between the United States, as issuer, and the holder of a
Security Entitlement, it is not a complete statement of the contract
law applicable to the United States or Federal Reserve Banks. For
example, if a Participant obtains a discount window loan from a
Federal Reserve Bank and agrees to pledge collateral, including
Treasury book-entry securities, to the Federal Reserve Bank as
security for the loan, Sec. 357.10(a) does not establish the law for
determining the validity or enforceability of the contract or the
law applicable to the creation and perfection of security interests
in property that is not a Treasury book-entry security. Section
357.10(a) does provide the law applicable for how a security
interest in Treasury book-entry securities is perfected, the
priority of such interest and, if Sec. 357.12(c)(1) is applicable,
how such security interest is created. Similarly, nothing in
Sec. 357.10(a) affects the continuing applicability or
enforceability of Federal Reserve Bank operating circulars such as
the circular setting forth provisions regarding

[[Page 43633]]

electronic access to services provided by Federal Reserve Banks and
agreements executed in connection with such circulars.
    The law applicable with respect to interests granted to a
Federal Reserve Bank depends on the manner in which the security
interest is granted.
    Where a security interest in favor of a Federal Reserve Bank is
marked on the books of the Federal Reserve Bank under Section
357.12(c)(1), Sec. 357.10(a) establishes the applicable law. A
security interest in favor of a Federal Reserve Bank would be
recorded on the Federal Reserve Bank's books where, for example, the
Federal Reserve Bank made a discount window loan to a depository
institution and any Treasury book-entry securities provided by the
depository institution as collateral have been deposited to a pledge
account on the books of the Federal Reserve Bank. For a borrowing
depository institution that is not a Participant, the book-entry
securities used as collateral generally would be deposited to the
Federal Reserve Bank pledge account by the borrowing institution's
Securities Intermediary. See Hypothetical 5.
    Section 357.10(b) sets forth law applicable with respect to
security interests in favor of a Federal Reserve Bank that have not
been marked on the books of a Federal Reserve Bank. A security
interest in the Securities Entitlement of a Participant in favor of
a Federal Reserve Bank that is not marked on the books of the
Federal Reserve Bank is governed by the law of the state in which
the head office of the Federal Reserve Bank is located. Such a
security interest could arise, for example, where the delivery of
book-entry securities to the securities account of the Participant
results in an overdraft in the Participant's Funds Account. The
extent to which the Federal Reserve Bank has an interest in the
Participant's book-entry securities to secure the overdraft
therefore would be determined under the law of the state in which
the Reserve Bank's head office is located. If the State in which the
head office of the Federal Reserve Bank is located has not adopted
Revised Article 8, under Sec. 357.10(c) that State is deemed to have
adopted Revised Article 8.
    In certain very limited circumstances, a Federal Reserve Bank
also may have a security interest in the book-entry securities of a
non-Participant that is not marked on the books of the Federal
Reserve Bank. Section 357.10(b) provides a separate rule for such a
security interest, which would be governed by the law of the non-
Participant's Securities Intermediary, as determined under
Sec. 357.11. Under Sec. 357.11, the perfection, effect of
perfection, and priority of a security interest created under such
an agreement would be governed by the law of the Securities
Intermediary's jurisdiction, as determined under Sec. 357.11(b).
Under Sec. 357.11(d), if the jurisdiction specified in
Sec. 357.11(b) has not adopted Revised Article 8, jurisdiction would
be deemed to have adopted Revised Article 8.\8\
---------------------------------------------------------------------------

    \8\ An interest in book-entry securities of a non-Participant
that is not marked on the books of the Federal Reserve Bank, while
uncommon, could arise where the Federal Reserve Bank lends to a non-
Participant depository institution and enters into a triparty
agreement with the depository institution and its Securities
Intermediary rather than requiring the deposit of the book-entry
securities in a pledge account on the books of the Federal Reserve
Bank through an instruction given by the non-Participant depository
institution to its Securities Intermediary.
---------------------------------------------------------------------------

    For purposes of applying the state law chosen under the rules of
Sec. 357.10(b), Federal Reserve Banks are treated as clearing
corporations. As a result, a security interest in a Securities
Entitlement of a Participant in favor of a Federal Reserve Bank
under Sec. 357.12(c)(2) has the same priority as security interests
granted to other clearing corporations under state law. This is
consistent with the treatment accorded to Federal Reserve Banks
generally under Revised Article 8.

Section 357.11  Law Governing Other Interests

(a) Law Governing the Rights and Obligation of Participants and Third
Parties

    Section 357.11 is a choice of law rule. The substantive matters
subject to this choice of law rule are set forth in Sec. 357.11(a).
The matters set forth in Sec. 357.11(a) are meant to be coextensive
with those matters covered by Revised Article 8 with respect to a
person's interest in a Treasury book-entry security (other than
those related to a person's relationship to Treasury or a Federal
Reserve Bank which are governed solely by federal law). For purposes
of these choice of law rules Participants are Securities
Intermediaries.
    Section 357.11(b) adopts Revised Article 8's general choice of
law rule. Section 357.11(c) sets forth a special choice of law rule
with respect to security interests perfected automatically or by
filing, which also is included in Revised Article 8. Generally, the
law applicable to the Securities Intermediary will govern matters
involving an interest in a book-entry security held through that
intermediary. This approach is not followed with respect to
perfection of security interests automatically or by filing. In
those cases, the law of the jurisdiction in which the debtor is
located is the governing law. Since filing systems are based on the
location of the debtor, this approach should reduce uncertainty and
preserve the normal practice of searching records based on the
debtor's location.\9\ The language ``person creating a security
interest'' is used in lieu of the term ``debtor'' in this provision
to avoid any confusion. The word ``debtor'' has two meanings in the
Uniform Commercial Code and the expression ``person creating a
security interest'' provides clarity with respect to who is covered
by this section. The term does not refer to a creditor. The language
``is located'' is intended to conform to its meaning under
applicable law, as it may be amended from time to time. See, e.g.,
U.C.C. section 9-103(3)(d). Section 357.11(d) provides for the
application of Revised Article 8 if the choice of law analysis
required by Sec. 357.11(b) results in the choice of the law of a
State that has not yet adopted Revised Article 8. As noted
elsewhere, in such a situation, the State's law is viewed as if it
had adopted Revised Article 8. This section also provides that, for
purposes of applying state law, the Federal Reserve Banks are
clearing corporations and Participants' interests in book-entry
securities are Security Entitlements.
---------------------------------------------------------------------------

    \9\ The substantive effect of filing is limited and applies only
in states which have adopted Revised Article 8. Since the effect of
filing is a unique state law matter, in this one area, Treasury has
determined that possible lack of uniformity does not justify
altering state law.
---------------------------------------------------------------------------

(b) Limited Scope of Federal Preemption

    In an earlier TRADES proposal Treasury contemplated adopting a
comprehensive regulation governing the rights of all persons in
Treasury book-entry securities held in TRADES. Such an approach was
proposed because Treasury believed that a uniform rule was necessary
to preserve the efficiency and liquidity of the market for Treasury
securities--the most liquid and efficient market in the world.
Treasury believed then, and believes now, that the material rights
of a holder in the United States of an interest in a Treasury
security should not vary solely by virtue of such holder's
geographic location or the location of the financial institution
through which it holds its interest in Treasury securities. In light
of Revised Article 8, Treasury has determined that it is possible to
achieve this uniformity without developing an independent system of
Federal commercial law.\9\ The questions inherent in a tiered system
of ownership have been analyzed, and, in Treasury's view,
satisfactorily addressed by Revised Article 8.
---------------------------------------------------------------------------

    \9\ As noted previously, the substantive scope of this
regulation is limited.
---------------------------------------------------------------------------

    As of August 1, 1996, 28 states have adopted Revised Article 8
and Treasury understands that it will soon be adopted in additional
states. As with all uniform laws, the adoption process takes several
years. In order to assure uniformity, in light of the unavoidable
delays in the state-by-state adoption process of Revised Article 8,
Treasury is promulgating regulations with a limited form of
preemption. As provided in both Secs. 357.10(c) and 357.11(d), if
the choice of law rules set forth in TRADES would lead to the
application of the law of a State that has not yet adopted Revised
Article 8, TRADES will apply Revised Article 8 (with conforming and
miscellaneous amendments to other Articles) in the form approved by
the ALI and NCCUSL. Treasury expects that these provisions will be
operative only during the state-by-state adoption process and would
plan to amend TRADES to delete reference to these provisions once
the adoption process has been completed.
    While Revised Article 8 is defined to mean the official text of
Article 8 as approved by the ALI and NCCUSL, Treasury recognizes
that states may make minor changes in that text when adopting
Article 8. Treasury has concluded that minor changes should not
prevent Revised Article 8, as adopted by a state, from being the
appropriate law. In other words, if a state passes a version of
Article 8 that is substantially identical to Revised Article 8,
reference to Revised Article 8 (as defined) would no longer be
required. Treasury has determined that the

[[Page 43634]]

versions of Article 8 passed by 28 states \10\ that have enacted
Article 8 as of the date this rule is published in the Federal
Register meet this standard. Accordingly, Secs. 357.10(c) and
357.11(d) would not be applicable if the choice of law provisions of
TRADES directed a person to one of those states. As additional
states adopt Revised Article 8, Treasury will provide notice in the
Federal Register as to whether the enactments are ``substantially
identical'' to the uniform version for purposes of these regulations
and on an annual basis, the Commentary will be amended to reflect
subsequent enactments. This approach represents a significantly
reduced form of preemption of state law from former versions of
TRADES and preserves Treasury's preeminent interest in a uniform
system of rules applicable to all holders of interests in Treasury
book-entry securities.
---------------------------------------------------------------------------

    \10\ Alabama, Alaska, Arizona, Arkansas, Colorado, Idaho, Iowa,
Illinois, Indiana, Kansas, Kentucky, Louisiana, Maryland,
Massachusetts, Minnesota, Mississippi, Nebraska, New Mexico,
Oklahoma, Oregon, Pennsylvania, Texas, Utah, Vermont, Virginia,
Washington, West Virginia, Wyoming.
---------------------------------------------------------------------------

Section 357.12  Obtaining an Interest in a Book-entry Security

(a) Creation of a Participant's Security Entitlement

    A Participant's interest in a Treasury book-entry security is a
Securities Entitlement. Section 357.12(a) provides that a
Participant's Securities Entitlement is created when a Federal
Reserve Bank indicates by book entry that a Book-entry Security has
been credited to a Participant's Securities Account. Instead of the
concept of initial credit and transfer of a Treasury book-entry
security, as set forth in the existing regulations, this proposal
focuses on the creation of a Participant's Securities Entitlement
and, in this way, is similar to Section 8-501 of Revised Article 8.
    The regulation focuses on the creation of a Participant's
Security Entitlement because Security Entitlement is the term used
to describe the Participant's interest in a Treasury book-entry
security. Once a Participant obtains that interest, the regulation
sets forth what that interest is. Thus, as provided in Sec. 357.10,
federal law describes a Participant's rights against the United
States and the Federal Reserve Bank where it maintains its
Securities Account. To the extent not inconsistent with Sec. 357.10,
Sec. 357.11 describes the applicable law to determine Participants'
rights and obligations with respect to all other persons. Under
these regulations, Participants can still transfer their interests
in a Treasury book-entry security as they did before--by issuing a
Transfer Message to the Federal Reserve Bank where they hold such
interest. Transfer of interests between Participants can occur by a
Participant holding such interest issuing a Transfer Message. As a
result of such message, the Federal Reserve Bank will make a book
entry in favor of the receiving Participant (thereby creating a
Security Entitlement in favor of such Participant) and also will
make a book entry deleting the initiator Participant's interest in
such Treasury book-entry security (thereby eliminating that
Participant's Security Entitlement). In addition, if authorized
under applicable state law, Participants may enter into agreements
with other Participants that, as to the Participants, constitute a
transfer. Such action is without effect to either the United States
or a Federal Reserve Bank.

(b) Creation and Priority of a Security Interest

    (i)  Security Interests of the United States. Section 357.12(b)
provides that a security interest in favor of the United States has
priority over the interests of any other person in a Treasury book-
entry security. The United States obtains security interests in
Treasury securities as collateral to secure funds in a variety of
situations such as Treasury Tax and Loan accounts; government agency
funds or funds under the control of the Federal Courts held at
financial institutions; and securities pledged in lieu of surety by
contractors and others. The priority provided the United States in
these situations is consistent with existing law.
    In addition, Federal Reserve Banks do recognize on their books
and records security interests in favor of the United States. In
that situation, the Federal Reserve Bank will not transfer the
security without the permission of the United States. This section
provides that a Federal Reserve Bank may rely exclusively on the
directions of an authorized representative of the United States to
transfer a security and is protected in so relying. Ordinarily, an
authorized representative of the United States would take such
action under circumstances such as the default or insolvency of the
pledgor.
    (ii)  Security Interests on the Books of a Reserve Bank. Where
required by Federal law or regulation or pursuant to a specific
agreement with a Federal Reserve Bank, a security interest in favor
of a Federal Reserve Bank or other person may be created or
perfected by a Federal Reserve Bank marking its books to record the
security interest under Sec. 357.12(c)(1). An example of a security
interest that is marked on the books of a Federal Reserve Bank would
be the pledge in favor of a Federal Reserve Bank of a Participant's
book-entry securities as collateral for a discount window loan.\11\
For limited categories of pledges, Federal Reserve Banks may agree
to record a security interest in favor of a third party on their
books. For example, in some circumstances a Federal Reserve Bank may
permit the establishment of a pledge account to hold book-entry
securities pledged to governmental entities other than the United
States government. It is important to note that there is no
obligation for either Treasury or a Federal Reserve Bank to agree to
record a security interest on the books of a Federal Reserve Bank,
except as required by Federal law or regulation. If they do so, the
security interest is perfected when the Federal Reserve Bank records
a security interest on its books. In addition, the security interest
has priority over all other interests in the Treasury book-entry
security except an interest of the United States.
---------------------------------------------------------------------------

    \11\ Book-entry securities pledged by a non-Participant to a
Federal Reserve Bank generally would be deposited by the non-
Participant's Securities Intermediary to a pledge account at the
Federal Reserve Bank, and therefore also would be marked on the
books of the Federal Reserve Bank. See the discussion under D.
(Sec. 357.10).
---------------------------------------------------------------------------

    (iii)  Other Security Interests. As provided in
Sec. 357.12(c)(2), a security interest in a book-entry security may
be perfected by any method available under applicable state law, as
determined under Sec. 357.10(b) or Sec. 357.11.\12\ The perfection
and priority of such interests shall be governed by applicable law.
Security interests under this section may include security interests
in favor of a Federal Reserve Bank, such as a clearing lien or
pledge by a non-participant of book-entry securities held through a
Securities Intermediary where the securities have not been deposited
to a Federal Reserve Bank pledge account. Consistent with Revised
Article 8, a Federal Reserve Bank would be treated as a clearing
corporation under the applicable state law.
---------------------------------------------------------------------------

    \12\ Under both of these sections, if the state has not yet
adopted Revised Article 8, the applicable law would be that state's
law as it would be amended by Revised Article 8.
---------------------------------------------------------------------------

    If a Person perfects a security interest pursuant to
Sec. 357.12(c)(2), obligations of the Treasury and the Federal
Reserve Banks with respect to that security interest are limited.
Specifically, unless special arrangements are agreed to by the
United States or a Federal Reserve Bank pursuant to
Sec. 357.12(c)(1), neither the Federal Reserve Bank nor the United
States will recognize the interests of any person other than the
person in whose securities account the interest in a Treasury book-
entry security is maintained. This does not mean that such a
security interest is invalid. Rather, it means that the creditor's
recourse will be solely against the debtor Participant or other
third party.

Section 357.13  Rights and Obligations of Treasury and the Reserve
Banks

    (a)   Adverse Claims
    Section 357.13(a) sets forth the general rule that, with limited
exceptions, Treasury and the Federal Reserve Banks will recognize
only the interest of a Participant in a Treasury book-entry security
in whose Securities Account such interest is maintained.
    As noted previously, Treasury book-entry securities maintained
in TRADES are held in a tiered system of ownership. The records of a
Federal Reserve Bank reflect only the ownership at the top tier.
Institutions maintaining a Securities Account with a Federal Reserve
Bank frequently will hold interests in Treasury book-entry
securities for their customers (which can include broker-dealers and
other Securities Intermediaries) and in certain cases those
customers will hold interests in securities for their customers.
Accordingly, neither Treasury nor a Federal Reserve Bank will know
the identity or recognize a claim of a Participant's customer if
that customer were to present it to Treasury or a Federal Reserve
Bank.
    In addition, except in the limited case where a security
interest is marked on the books of a Federal Reserve Bank pursuant
to Sec. 357.12(c)(1), neither the Treasury nor a Federal Reserve
Bank will recognize the claims of any other person asserting a claim

[[Page 43635]]

in a Treasury book-entry security. Persons at levels below the
Participant level must present their claims to their Securities
Intermediary.

(b)  Payment obligations

    Section 357.13(b) contains a corollary to the rule set forth in
Sec. 357.13(a). This section provides that Treasury discharges its
payment responsibility with respect to a security that it has issued
when a Federal Reserve Bank credits the funds account of a
Participant with amounts due on that security or makes payment in
some other manner specified by the Participant. This is consistent
with existing law and the first TRADES proposal.<SUP>13 In Revised
Article 8, the issuer discharges its obligations when it makes
payment to an owner registered on its books. Under common commercial
practice, the registered owner in the indirect system may be a
clearing corporation or the clearing corporation's nominee. Although
the Federal Reserve Banks are treated as clearing corporations under
both Revised Article 8 and TRADES, Treasury remains liable until
payment is made to, or in accordance with the instructions of, a
Participant. Section 357.13(b)(2) establishes the mechanism of how
Treasury book-entry securities are paid at maturity. It is intended
to cover a variety of procedures, including where the proceeds of
pledged securities are credited to a suspense account pending
substitution or release. This paragraph makes clear that the payment
takes place automatically and that, unlike with physical
certificates, there is no act of presentment required by the
Participant.
---------------------------------------------------------------------------

    \13\ 51 FR 8846, 8848 (March 14, 1986).
---------------------------------------------------------------------------

Section 357.14  Authority of Reserve Banks

    Section 357.14 provides that Federal Reserve Banks are
authorized, as fiscal agents of Treasury, to operate the commercial
book-entry system for Treasury.

Section 357.44  Notices

    Section 357.44 contains a revised version of a provision that
appeared in earlier TRADES proposals. Similar to the rule in Revised
Article 8 (see section 8-112), it provides where certain legal
process should be directed. While providing instructions on where
notice should be directed, it makes clear that the regulations do
not establish whether a Federal Reserve Bank is required to honor
any such order or notice.

J.  Hypotheticals

HYPOTHETICAL 1

                                TREASURY

                          FEDERAL RESERVE BANK
                                    |
                               PARTICIPANT
                                    |
                                 DEALER
                                    |
                                INVESTOR


    The first hypothetical is designed to show what law applies at
different levels of the tiered book-entry system. TRADES provides
that federal law, and only federal law (defined in Sec. 357.10(a)),
governs the rights and obligations of the United States and the
Federal Reserve Banks (except for those matters involving Federal
Reserve Banks set forth in Sec. 357.10(b)). Thus, for example,
Treasury discharges its payment obligations with respect to a
security it has issued in the manner described in Sec. 357.13(b).
Federal law both defines the payment obligation and describes how
Treasury fulfills that obligation. Those portions of Revised Article
8 dealing with issuer obligations are not applicable to Treasury or
the Federal Reserve Banks.<SUP>14 Similarly, with certain limited
exceptions as set forth in Sec. 357.12(c)(1), Treasury and the
Federal Reserve Banks will recognize only the interest of a
Participant in a Treasury book-entry security in whose Security
Account the interest is maintained. Accordingly, as a matter of
federal law, neither Treasury nor a Federal Reserve Bank will
recognize any claim by Dealer or Investor.<SUP>15
---------------------------------------------------------------------------

    \14\ As provided in Sec. 357.14, Federal Reserve Banks, among
other things, effect transfers of book-entry securities between
Participants' Security Accounts.
    \15\ One comment questioned whether similar language in the
March 4, 1996 release implied that, under Revised Article 8, in the
above example Investor could have a claim against Participant. No
such implication was intended. The only point of the language is to
make it clear that Federal, not state, law governs the rights and
obligations of Treasury and the Federal Reserve Banks.
---------------------------------------------------------------------------

    In the hypothetical above, as between Participant and Dealer,
Participant is the Securities Intermediary. With respect to the
matters set forth in Sec. 357.11(a), the law of the Securities
Intermediary's jurisdiction governs. Thus, with respect to the
matters in Sec. 357.11(a), the law of Participant's jurisdiction
applies as between Participant and Dealer.<SUP>16 If Participant's
jurisdiction, as determined under Sec. 357.11(b), has not adopted
Revised Article 8, the law of Participant's jurisdiction, as it
would be amended by Revised Article 8, applies. Similarly, as
between Dealer and Investor, Dealer is a Securities Intermediary,
with respect to the matters in Sec. 357.11(a), the law of Dealer's
jurisdiction applies as between Dealer and Investor. If Dealer's
jurisdiction has not adopted Revised Article 8, the law of Dealer's
jurisdiction, as it would be amended by Article 8, applies.

HYPOTHETICAL 2
---------------------------------------------------------------------------

    \16\ As described in the March 4 Release, the scope of TRADES is
limited. As a general rule, if a matter is not covered in
Sec. 357.11(a), TRADES is not applicable. One comment questioned
whether TRADES covered the creation and attachment of a security
interest. The omission of creation and attachment in Sec. 357.11(a)
is intentional.


                                                    TREASURY

                                              FEDERAL RESERVE BANK
                                                   |           |
                                         PARTICIPANT A       PARTICIPANT B
                                                   |           |
                                              DEALER A       DEALER B


    Assume that Dealer A sells its interest in a Treasury book-entry
security to Dealer B. The transaction likely would take the
following form. Dealer A will instruct Participant A to transfer its
interest in a Treasury security to Participant B against cash
payment. Dealer B will instruct Participant B to transfer cash to
Participant A against delivery of an interest in the specified
securities. Participant A will instruct the Federal Reserve Bank to
transfer its interest in the Treasury security to Participant B
against simultaneous credit of cash. The Federal Reserve Bank will
debit Participant A's security account and credit Participant B's
security account and simultaneously credit Participant A's cash
account and debit Participant B's cash account. Participant A will
mark its books to show that it has debited Dealer A's securities
account and credited Dealer A's cash account. Participant B will
mark its books to show the Security Entitlement in the Treasury
security in favor of Dealer B and a debit against Dealer B's cash
account. Federal law, set forth in Sec. 357.12(a) provides that
Participant B acquires its interest in the Treasury book-entry
security when the Federal Reserve Bank indicates by book-entry that
the interest in the security has been credited to Participant B's
Securities Account. Pursuant to Sec. 357.11(a), but subject to
Sec. 357.11(d), Participant B's jurisdiction governs Dealer B's
acquisition of a Securities Entitlement from Participant B.

HYPOTHETICAL 3


                                TREASURY

                          FEDERAL RESERVE BANK
                                    |
                               PARTICIPANT


    Assume Participant wishes to obtain a loan from Federal Reserve
Bank and, as part of the transaction, will grant Federal Reserve
Bank a security interest in its Securities Entitlement with respect
to Treasury book-entry securities. The transaction can be
accomplished in one of two ways. Pursuant to Sec. 357.12(c)(1), the
Federal Reserve Bank can mark its books to reflect the security
interest. As a matter of federal law, that action creates and
perfects the Federal Reserve Bank's security interest and grants the
Federal Reserve Bank priority over all other claimants (other than
the United States pursuant to Sec. 357.12(b)).<SUP>17 A second
method for completing the transaction, as set forth in
Sec. 357.12(c)(2), would be to take whatever actions are authorized
by applicable law. In that case, applicable law is the law of the
jurisdiction of the head office of the Federal Reserve Bank. If that
jurisdiction had adopted Revised Article 8, it would be the law of
that jurisdiction. If that jurisdiction had not adopted Revised
Article 8, it would

[[Page 43636]]

be the law of that jurisdiction as if the jurisdiction had adopted
Revised Article 8. Under Revised Article 8, the Federal Reserve
Bank's interest would be that of a clearing corporation.
---------------------------------------------------------------------------

    \17\ In certain limited circumstances, a Federal Reserve Bank
may enter into an agreement under which it agrees to record on its
books an interest in Participant's book-entry securities in favor of
a non-Participant, such as a governmental entity. Under these
circumstances, the non-Participant would have a perfected security
interest with priority over other claimants (other than the United
States under Sec. 357.12(b)). It should be noted that, as set forth
in Sec. 357.12(c)(1), there is no requirement that either the United
States or a Federal Reserve Bank agree to creation and perfection of
a security interest in this way, except as provided in
Sec. 357.12(c)(1).

HYPOTHETICAL 4

                                                    TREASURY

                                              FEDERAL RESERVE BANK
                                                   |           |
                                         PARTICIPANT A       PARTICIPANT B


    Assume that Participant A wishes to borrow from Participant B
and grant Participant B a security interest in its Security
Entitlement in Treasury book-entry securities. As provided in
Sec. 357.12(c)(2), the transaction would be completed pursuant to
applicable law determined in accordance with 357.11. Although such
an interest could be recorded on the books of a Federal Reserve Bank
under Sec. 357.12(c)(1), Federal Reserve Banks generally do not mark
their books to record this type of security interest for
Participants.

HYPOTHETICAL 5


                                TREASURY

                          FEDERAL RESERVE BANK
                                    |
                              PARTICIPANT A
                                    |
                                DEALER A
                                    |
                                 BANK A


    Assume that Bank A wishes to borrow from the Federal Reserve
Bank and will pledge its interest in Treasury book-entry securities
held at Dealer A to collateralize that loan. The transaction could
be accomplished in two ways. Pursuant to Sec. 357.12(c)(1), the
interest could be created and perfected on the books of a Federal
Reserve Bank. Such a transaction would take place in the following
fashion. Bank A could have Dealer A instruct Participant A to
deposit securities to a pledge account specified by the Federal
Reserve Bank. The Federal Reserve Bank likely would create an
account on its books and specify that account to Bank A as the
account to receive Bank A's interest in Treasury book-entry
securities. Participant A, upon receiving Dealer A's instructions,
would then instruct the Federal Reserve Bank to debit its account at
the Federal Reserve Bank and credit the account created by the
Federal Reserve Bank. The second way the transaction could take
place is by any method permitted by the law of Dealer A's (Bank A's
Securities Intermediary) jurisdiction. This could involve a tri-
party agreement among the Federal Reserve Bank, Dealer A, and Bank
A. As set forth in Sec. 357.11(b)(1), that agreement likely would
specify which jurisdiction's law is to govern the transaction and
could specify that such choice of law supersedes any other choice of
law agreement previously entered into by Dealer A and Bank A. If
Dealer A's jurisdiction has not adopted Revised Article 8, the
applicable law would be the law of Dealer A's jurisdiction as it
would be amended by Revised Article 8.

    Dated: August 16, 1996.
Gerald Murphy,
Fiscal Assistant Secretary.
[FR Doc. 96-21469 Filed 8-20-96; 1:29 pm]
BILLING CODE 4810-39-P