A 4660 - September 26, 1997
P&S 4229

TO: ALL PARTICIPANTS

ATTENTION: MANAGING PARTNER/OFFICER, OPERATIONS PARTNER/OFFICER

SUBJECT: CHANGES IN MEMBERSHIP STANDARDS

National Securities Clearing Corporation ("NSCC" or the "Corporation") has filed a rule change with the Securities and Exchange Commission (the "Commission") amending NSCC’s membership standards to increase the minimum excess net capital requirements imposed on Members and applicants for membership.

The purpose of the proposed rule change is to amend the Corporation's membership standards to increase the amount of net capital required over the Commission’s minimum net capital requirements ("excess net capital"). Currently, the Corporation’s excess net capital requirement for all Members is $50,000. The proposed amendments: (i) will increase the excess net capital requirement for full service Members to $500,000, except for Municipal Securities Brokers' Brokers for which the excess net capital requirement will be $100,000 and (ii) will increase the excess net capital requirement for Members that clear for other broker-dealers to $1,000,000.

NSCC’s current excess net capital requirements were implemented in 1976 when NSCC was formed. The environment in which NSCC Members operate has changed significantly since that time. In terms of the change in the value of money alone, $50,000 in 1976 is equivalent to nearly $150,000 today. Trading volumes, and the average value of securities traded, have increased even more significantly. The Commission has also changed its minimum net capital requirements for most NSCC Members during this time period from $25,000 (one-half of NSCC’s minimum current excess net capital requirement) to $250,000 (one-half of NSCC’s proposed minimum excess net capital requirement).

As a result of the changing environment, it has been NSCC’s recent experience that when a Member with less than $500,000 in excess net capital has problems with even one transaction that would not be considered large by today’s standards, concerns arise with respect to that Member’s ability to settle on a timely basis and to post additional required collateral with NSCC. Additionally, even though the size of the exposure due to the failure of any one of these small firms is relatively small, NSCC believes that the time and resources that it must spend addressing problems related to small firms is disproportionate to the magnitude of the potential loss and is unjustifiably disruptive of NSCC’s daily surveillance process.

NSCC also believes that the owners or principals of an NSCC Member should have a meaningful amount of their own assets at stake to absorb losses before a Member’s excess net capital falls below regulatory minimums and the Member is required to cease doing business. NSCC believes that this provides a strong motivation for firms to implement appropriate risk management controls on their own. In today’s environment, NSCC does not believe that $50,000 is a meaningful amount and believes that $500,000 is a more appropriate amount.

In addition, NSCC has recognized that Members who clear for other broker-dealers present special risks to the clearance and settlement process. These firms become legally responsible for the settlement of transactions of other firms and generally do not have complete control over those transactions. Many of these firms have surveillance procedures and other risk controls in place and can cease clearing for a correspondent broker-dealer if they perceive a risk has developed. But the clearing arrangements of these firms and marketplace rules generally require that the clearing firm (the NSCC Member) take on settlement responsibility for most of the correspondent broker-dealer’s transactions before the clearing firm has had a chance to review such transactions. This increases the possibility that a clearing firm will be responsible for problematic or risky transactions. In light of the higher risk presented by these firms, NSCC believes that they should be subject to higher minimum capital standards.

NSCC proposes that the new standard become effective on the later of (a) one year from the date of publication in the Federal Register of the notice of the filing of this rule change or (b) the date of Commission approval of this rule change. NSCC believes that this effective date will give those firms who do not currently meet the higher excess net capital requirement sufficient time to obtain appropriate capital infusions or make other clearing arrangements.

NSCC also proposes that the new standard for firms who clear for other firms become effective on the later of (a) six months from the date of publication in the Federal Register of the notice of the filing of this rule change or (b) the date of Commission approval of this rule change. NSCC believes that this effective date will give those firms who do not currently meet the higher excess net capital requirement sufficient time to obtain appropriate capital infusions.

During the interim period, if any, between the SEC approval of this rule change and its effective date, NSCC will not consider applicants that do not meet the new minimum capital standards, other than those firms applying for membership in connection with the agreement between NSCC and Stock Clearing Corporation of Philadelphia (SCCP) under which SCCP has agreed to cease operations as a clearing corporation.

The text of the proposed rule change may be obtained by contacting the NSCC Legal Department at (212) 412-8634.

Written comments on the proposed rule filing may be addressed to David F. Hoyt, Assistant Secretary, National Securities Clearing Corporation, 55 Water Street, New York, New York 10041, and your comments will be forwarded to the Securities and Exchange Commission. You may also address your written comments to the Secretary of the Commission, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, D.C. 20549. We request that you provide NSCC with a copy of your comments.

Questions regarding the rule filing should be directed to Peter J. Axilrod, Managing Director -- Surveillance, Membership and Risk Management, at (212) 412-8567.

Robert J. Woldow
Managing Director and General Counsel