17f-4 Supporting Statement 2018

17f-4 Supporting Statement 2018.pdf

Rule 17f-4 (17 CFR 270.17f-4) under the Investment Company Act of 1940, "Custody of Investment Company Assets with a Securities Depository"

OMB: 3235-0225

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SUPPORTING STATEMENT
For the Paperwork Reduction Act Information Collection Submission for
Rule 17f-4
A.

JUSTIFICATION
1.

Necessity for the Information Collection

Section 17(f) of the Investment Company Act of 1940 (the “Act”) 1 permits registered
management investment companies and their custodians to deposit the securities they own in a
system for the central handling of securities (“securities depositories”), subject to rules adopted
by the Securities and Exchange Commission (“Commission”). Rule 17f-4 specifies the
conditions for the use of securities depositories by funds 2 and their custodians. 3 Rule 17f-4
contains two general conditions. First, a fund’s custodian must be obligated, at a minimum, to
exercise due care in accordance with reasonable commercial standards in discharging its duty as
a securities intermediary to obtain and thereafter maintain financial assets. 4 If the fund deals
directly with a depository, the depository’s contract or written rules for its participants must

1

15 U.S.C. 80a.

2

As amended in 2003, rule 17f-4 permits any registered investment company, including a unit
investment trust or a face-amount certificate company, to use a security depository. See Custody
of Investment Company Assets With a Securities Depository, Investment Company Act Release
No. 25934 (Feb. 13, 2003) (68 FR 8438 (Feb. 20, 2003)). The term “fund” is used in this
Supporting Statement to mean a registered investment company.

3

17 CFR 270.17f-4.

4

Rule 17f-4(a)(1). This provision incorporates into the rule the standard of care provided by
section 504(c) of Article 8 of the Uniform Commercial Code when the parties have not agreed to
a standard. Rule 17f-4 does not impose any substantive obligations beyond those contained in
Article 8. Uniform Commercial Code, Revised Article 8 -- Investment Securities (1994 Official
Text with Comments) (“Revised Article 8”). This obligation does not contain a collection of
information because it does not impose identical reporting, recordkeeping or disclosure
requirements. Funds and custodians may determine the specific measures the custodian will take
to comply with this obligation. Moreover, the rule does not impose any requirement regarding
evidence of the obligation.

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provide that the depository will meet similar obligations, 5 which is a collection of information
for purposes of the Paperwork Reduction Act of 1995 (“PRA”). 6 Second, the custodian must
provide, promptly upon request by the fund, such reports as are available about the internal
accounting controls and financial strength of the custodian. 7 If a fund deals directly with a
depository, the depository’s contract with or written rules for its participants must provide that
the depository will provide similar financial reports, which is a collection of information under
the PRA. 8
If a fund deals directly with a securities depository, rule 17f-4 also requires that the fund
implement internal control systems reasonably designed to prevent an unauthorized officer’s
instructions (by providing at least for the form, content, and means of giving, recording, and
reviewing all officers’ instructions). 9
2.

Purpose and Use of the Information Collection

The general purpose of rule 17f-4 is to enable funds to participate, with minimum risks,
in the potential benefits incident to the deposit of assets in securities depositories. The
conditions a fund must satisfy in order to rely on rule 17f-4, including the collections of
information are designed to assure that the fund’s own custodian or securities depository would
comply with the specified duties of a securities intermediary or issuer under Revised Article 8 of

5

Rule 17f-4(b)(1)(i).

6

44 U.S.C. 3501-3520.

7

Rule 17f-4(a)(2).

8

Rule 17f-4(b)(1)(ii).

9

Rule 17f-4(b)(2).

2

the Uniform Commercial Code. 10 This assurance is important because Revised Article 8 sharply
limits the ability of a fund to seek recourse from any party other than its own custodian for assets
mishandled by the custodian. 11
3.

Consideration Given to Information Technology

Rule 17f-4 permits funds to take advantage of information technology that enables the
securities industry to handle a large volume of securities transactions without physical delivery
of securities. Custodians also may use electronic data transmissions to funds to meet the
reporting requirement. This rule does not require information systems; hence, start-up and
maintenance costs required for this rule are zero.
4.

Duplication

The Commission periodically evaluates rule-based reporting and recordkeeping
requirements for duplication, and reevaluates them whenever it proposes a rule or a change in a
rule. Rule 17f-4 does not require duplicative reporting or recordkeeping.
5.

Effect on Small Entities

10

The securities intermediary’s duties under commercial law include: (i) maintaining sufficient
unencumbered financial assets to cover all security entitlements of all entitlement holders, see
Revised Article 8, 10, § 8-504; (ii) obtaining for the entitlement holder payments made by the
issuer of a financial asset, see id., § 8-505; (iii) exercising rights with respect to a financial asset
(such as the right to vote proxy materials) as directed by the holder, see id., § 8-506;
(iv) complying with orders given by the holder concerning financial assets (such as to dispose of
entitlements), see id., § 8-507; and (v) changing the holder's entitlement into another available
form of holding upon request (such as converting it into a security certificate in a direct holding
arrangement), see id., § 8-508. A transfer agent may be subject to the duties of an issuer under
commercial law. See, e.g., Revised Article 8, § 8-207 (duties of issuer concerning registered
owner); § 8-401 (duty of issuer to register transfer).

11

See Revised Article 8, §§ 8-116, 8-502, 8-503 and cmts. 2-3, 8-510 (providing that adverse claims
may not be asserted against a purchaser who acquires a security entitlement for value and without
notice of the adverse claims; an entitlement holder may assert a claim against a purchaser other
than its securities intermediary only if its own intermediary is insolvent and lacks sufficient assets
to satisfy its claims, and the purchaser knowingly colluded with the intermediary to violate duties
to the holder).

3

Rule 17f-4 specifies the conditions for the use of securities depositories by all funds
regardless of the size of the fund, or the size of its custodian or securities depository. The risks
accompanying a fund’s use of a securities depository do not vary based on the size of the entity
involved.
6.

Consequences of Not Conducting Collection

Rule 17f-4 requires periodic reporting by the custodian or securities depository to the
fund of internal accounting controls and financial strength. This information assures that the
fund assets are safe and secure, and assists the Commission in implementing its examination
program.
7.

Inconsistencies With Guidelines in 5 CFR 1230.5(d)(2)

Not applicable.
8.

Consultation Outside the Agency

The Commission requested public comment on the collection of information
requirements in rule 17f-4 before it submitted this request for extension and approval to OMB.
The Commission received no comments in response to this request.
In addition, the Commission and its staff participate in an ongoing dialogue with
representatives of the investment company industry through public conferences, meetings and
informal exchanges. These various forums provide the Commission and the staff with a means of
ascertaining and acting upon paperwork burdens confronting the industry.
9.

Payment or Gift

Not applicable.
10.

Confidentiality

Not applicable.

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11.

Sensitive Questions

No information of a sensitive nature, including social security numbers, will be required
under this collection of information. The information collection does not collect personally
identifiable information (PII). The agency has determined that a system of records notice
(SORN) and privacy impact assessment (PIA) are not required in connection with the collection
of information.
12.

Burden of Information Collection

The Commission staff estimates that 142 respondents (including an estimated 80 active
funds that may deal directly with a securities depository, an estimated 49 custodians, and 13
possible securities depositories) 12 are subject to the requirements in rule 17f-4. The rule is
elective, but most, if not all, funds use depository custody arrangements. 13
Rule 17f-4 contains two general conditions. First, a fund’s custodian must be obligated,
at a minimum, to exercise due care in accordance with reasonable commercial standards in
discharging its duty as a securities intermediary to obtain and thereafter maintain financial assets.
If the fund deals directly with a depository, the depository’s contract or written rules for its
participants must provide that the depository will meet similar obligations. All funds that deal
directly with securities depositories in reliance on rule 17f-4 should have either modified their
contracts with the relevant securities depository, or negotiated a modification in the securities
12

The Commission staff estimates that, as permitted by the rule, an estimated 2% of all active funds
may deal directly with a securities depository instead of using an intermediary. The number of
custodians is estimated based on information from Morningstar DirectSM. The Commission staff
estimates the number of possible securities depositories by adding the 12 Federal Reserve Banks
and one active registered clearing agency. The Commission staff recognizes that not all of these
entities may currently be acting as a securities depository for fund securities.

13

Based on responses to Item 18 of Form N-SAR (17 CFR 274.101), approximately 97 percent of
funds’ custodians maintain some or all fund securities in a securities depository pursuant to rule
17f-4.

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depository’s written rules when the rule was amended. Therefore, we estimate there is no
ongoing burden associated with this collection of information. 14
Second, the custodian must provide, promptly upon request by the fund, such reports as
are available about the internal accounting controls and financial strength of the custodian. If a
fund deals directly with a depository, the depository’s contract with or written rules for its
participants must provide that the depository will provide similar financial reports. Custodians
and depositories usually transmit financial reports to funds twice each year. 15 The Commission
staff estimates that 49 custodians spend approximately 914 hours (by support staff) annually in
transmitting such reports to funds. 16 In addition, approximately 80 funds (i.e., two percent of all
funds) deal directly with a securities depository and may request periodic reports from their
depository. Commission staff estimates that depositories spend approximately 19 hours (by
support staff) annually transmitting reports to the 80 funds. 17 The total annual burden estimate
for compliance with rule 17f-4’s reporting requirement is therefore 933 hours. 18

14

The Commission staff assumes that new funds relying on 17f-4 would choose to use a custodian
instead of directly dealing with a securities depository because of the high costs associated with
maintaining an account with a securities depository. Thus, new funds would not be subject to this
condition.

15

The estimated 49 custodians would handle requests for reports from 3,917 fund clients
(approximately 80 fund clients per custodian) and the depositories from the remaining 80 funds
that choose to deal directly with a depository. It is our understanding based on staff
conversations with industry representatives that custodians and depositories transmit these reports
to clients in the normal course of their activities as a good business practice regardless of whether
they are requested. Therefore, for purposes of this PRA estimate, the Commission staff assumes
that custodians transmit the reports to all fund clients.

16

(3,917 fund clients x 2 reports) = 7,834 transmissions. The staff estimates that each transmission
would take approximately 7 minutes for a total of approximately 914 hours (7 minutes x 7,834
transmissions).

17

(80 fund clients who may deal directly with a securities depository x 2 reports) = 160
transmissions. The staff estimates that each transmission would take approximately 7 minutes for
a total of approximately 19 hours (7 minutes x 160 transmissions).

18

914 hours for custodians and 19 hours for securities depositories.

6

If a fund deals directly with a securities depository, rule 17f-4 requires that the fund
implement internal control systems reasonably designed to prevent an unauthorized officer’s
instructions (by providing at least for the form, content, and means of giving, recording, and
reviewing all officers’ instructions). All funds that seek to rely on rule 17f-4 should have already
implemented these internal control systems when the rule was amended. Therefore, there is no
ongoing burden associated with this collection of information requirement. 19
Based on the foregoing, the Commission staff estimates that the total annual hour burden
of the rule’s collection of information requirements is 933 hours. As displayed in Table 1 below,
the total estimated annual cost of the burden hours is $84,903. This figure is based on 933 hours
of support staff time at $91.00 per hour. 20
The estimate of average burden hours is made solely for the purposes of the PRA. The
estimate is not derived from a comprehensive or even representative survey or study of
Commission rules.

19

The Commission staff assumes that new funds relying on 17f-4 would choose to use a custodian
instead of directly dealing with a securities depository because of the high costs associated with
maintaining an account with a securities depository. Thus new funds would not be subject to this
condition.

20

933 hours x $91.00 (salary for an executive assistant) = $84,903. The Commission staff’s
estimates concerning the wage rates for support staff time are from the Securities Industry
Association’s Report on Office Salaries in the Securities Industry 2013, modified to account for
an 1800-hour work-year and inflation, and multiplied by 2.93 to account for bonuses, firm size,
employee benefits and overhead.

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Table 1: Summary of Revised Annual Responses, Burden Hours, and Burden Hour Costs
Estimates for Each Rule 17f-4 Information Collection (“IC”)
IC
IC1
IC2

Rule 17f-4 IC Description

No. of
Responses

Custodians transmit periodic reports to funds
Securities depositories transmit periodic reports to funds
Totals for all ICs

13.

Burden
Hours

Burden
Hour Costs

3,917
80

914
19

$83,174
$1,729

3,997

933

$84.903

Cost to Respondents

Commission staff believes that compliance with rule 17f-4 does not require special startup costs or other capital expenditures, because electronic systems and other resources needed to
comply with the rule are essential to doing business as a custodian, agent, fund or securities
depository. Rule 17f-4 does not impose any paperwork related cost burden not discussed in
item 12 above.
14.

Cost to the Federal Government

There is no cost to the federal government of administering the information collection
requirements in rule 17f-4.
15.

Changes in Burden

The estimated total annual burden for rule 17f-4 has decreased from 945 hours to 933
hours. The decrease in hourly burden is attributable to a decrease in the estimated number of
active registered investment companies, custodians and securities depositories.
16.

Information Collection Planned for Statistical Purposes

Not applicable.
17.

Approval to Omit OMB Expiration Date

The Commission is not seeking approval to omit the OMB expiration date

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18.

Exceptions to Certification Statement for Paperwork Reduction Act

Submission
Not applicable.
B.

COLLECTIONS OF INFORMATION EMPLOYING STATISTICAL METHODS
Not applicable.

9


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