[Federal Register Volume 61, Number 117 (Monday, June 17, 1996)]
[Notices]
[Pages 30650-30653]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-15274]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37298; File Nos. SR-OCC-96-04 and SR-NSCC-96-11]
Self-Regulatory Organizations; The Options Clearing Corporation;
National Securities Clearing Corporation; Notice of Filing of Proposed
Rule Changes Relating to an Amended and Restated Options Exercise
Settlement Agreement Between the Options Clearing Corporation and the
National Securities Clearing Corporation
June 10, 1996.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on February 6, 1996, and
April 6, 1996, The Options Clearing Corporation (``OCC'') and the
National Securities Clearing Corporation (``NSCC''), respectively,
filed with the Securities and Exchange Commission (``Commission'') the
proposed rule changes (File Nos. SR-OCC-96-04 and SR-NSCC-96-11) as
described in Items I, II, and III below, which items have been prepared
primarily by OCC and NSCC, respectively. The Commission is publishing
this notice to solicit comments on the proposed rule changes from
interested persons.
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\1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Changes
The purpose of the proposed rule changes is to put into effect the
Third Amended and Restated Options Exercise Settlement Agreement
(``Third Restated Agreement'') \2\ between OCC and NSCC providing for
the settlement of exercises and assignments of equity options.\3\ The
proposal also seeks to make related changes to OCC's Rules, primarily
to Rule 601, which sets forth the calculation of margin requirements
for equity options, and to make related changes in NSCC's clearing fund
formula in order to exclude from the clearing fund calculation trades
for which NSCC has protection under the terms of the Third Restated
Agreement.
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\2\ A copy of the executed Third Restated Agreement is attached
as Exhibit A to OCC's and to NSCC's filings. A copy of each of the
filings and all exhibits is available for copying and inspection in
the Commission's Public Reference Room or through OCC or NSCC,
respectively.
\3\ OCC has provided Stock Clearing Corporation of Philadelphia
(``SCCP'') with a Third Restated Agreement which has terms
substantially parallel to the terms of the Third Restated Agreement
between OCC and NSCC. OCC has advised SCCP that it is prepared to
execute a Third Restated Agreement with SCCP if and when SCCP wishes
to do so. Because Midwest Clearing Corporation (``MCC'') has
withdrawn from the clearance and settlement business, OCC plans to
propose entering into a termination agreement with MCC to formally
terminate the Second Restated Agreement between OCC and MCC.
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II. Self-Regulatory Organizations' Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Changes
In their filings with the Commission, OCC and NSCC included
statements concerning the purpose of and basis for the proposed rule
changes and discussed any comments they received on the proposed rule
changes. The text of these statements may be examined at the places
specified in Item IV below. OCC and NSCC have prepared summaries, set
forth in sections (A), (B), and (C) below, of the most significant
aspects of such statements.\4\
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\4\ The Commission has modified the text of the summaries
prepared by OCC and NSCC.
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(A) Self-Regulatory Organizations' Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Changes
In 1977, OCC signed an Options Exercise Settlement Agreement with
Stock Clearing Corporation (NSCC's predecessor), with MCC, and with
SCCP. In 1991, OCC and NSCC, MCC, and SCCP each signed a Restated
Options Exercise Agreement (``Restated Agreements''). The Restated
Agreements never became effective because in 1993, prior to Commission
approval of proposed rule changes pertaining to these Restated
Agreements, OCC and NSCC, MCC, and SCCP each signed a Second Restated
Options Exercise Agreement (``Second Restated Agreements'').\5\ The
Commission approved the proposed rule changes pertaining to the Second
Restated Agreements.\6\ However, after the proposals were approved the
parties to the Second Restated Agreements agreed to suspend the
effectiveness of those agreements because OCC's proposed implementation
of a two product group margin system would have caused increases in the
margin requirements far in excess of the increases which had been
anticipated when the Second Restated Agreements were originally
proposed. The Second Restated Agreements never became effective.
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\5\ The three Second Restated Agreements were filed by OCC with
the Commission in Amendment No. 2 to File No. SR-OCC-92-5, and also
were filed by NSCC, SCCP, and MCC in amendments to File No. SR-NSCC-
91-7, File No. SR-SCCP-92-01, and File No. SR-MCC-92-02,
respectively.
\6\ Securities Exchange Act Release No. 33543 (January 28,
1994), 59 FR 5639 [File Nos. SR-OCC-92-05, SR-NSCC-91-07, SR-SCCP-
92-01, and SR-MCC-92-02].
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OCC and NSCC now propose to make effective the Third Restated
Agreement executed by them. The Third Restated Agreement will become
effective upon approval by the Commission of the proposed rule changes
herein.
Changes Made by the Third Restated Agreements
The Third Restated Agreement alters the provisions of the Second
Restated Agreement between OCC and NSCC principally to establish a two-
way guarantee between OCC and NSCC and to change the guarantee
formulas. In the Second Restated Agreement, OCC guaranteed compensation
to NSCC for losses incurred by NSCC in closing out the exercise and
assignment activity (``E&A activity'') of a defaulting OCC clearing
member, and NSCC agreed to guarantee settlement of pending stock trades
arising from E&A activity commencing at the same time that it
guarantees regular-way settlements of ordinary stock transactions
(i.e., at midnight of T+1). However, the Second Restated Agreement did
not require NSCC to return to OCC any net value remaining from the
liquidation of the E&A activity of a defaulting clearing member. As a
result, OCC provided for a two product group margin system for equity
options to ensure that OCC gave no margin credit for net positive
values of a clearing member's E&A activity that would be unavailable to
OCC if NSCC were to liquidate the clearing member's positions at NSCC
arising from its E&A activity.
The Third Restated Agreement provides for a two-way guarantee
between OCC and NSCC. Thus, if NSCC suspends a common member \7\ and
[[Page 30651]]
incurs a loss, OCC would owe NSCC an amount determined in accordance
with the formula described below, and if OCC suspends a common member
and incurs a loss, NSCC would owe OCC an amount determined in
accordance with the formula described below. The guarantee from NSCC to
OCC entitles OCC to reimbursement from NSCC if OCC were to incur a loss
in liquidating the positions of a suspended clearing member to whom OCC
had been giving margin credit for its E&A activity which had been
reported to NSCC for settlement. This entitlement permits OCC to give
margin credit for long option positions in firm accounts and market-
maker's and specialist's accounts that have been reported to NSCC for
settlement and therefore allows OCC to calculate margin for equity
options in one product group.
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\7\ In the Third Restated Agreement, the term common member
refers to an OCC clearing member that also is an NSCC member and
that has designated NSCC as its designated clearing corporation for
purposes of effecting settlement of its E&A activity. Under the
Third Restated Agreement, like the Second Restated Agreement, three
alternatives are available to a clearing member that does not want
to become a member of NSCC or SCCP but wants to settle its E&A
activity through another entity which is a member of NSCC or SCCP. A
clearing member may appoint (1) another OCC clearing member (an
``appointed clearing member''), (2) a member of NSCC (a ``nominated
correspondent''), or (3) if the OCC clearing member is a Canadian
clearing member, the Canadian Depository for Securities. These three
alternative settlement arrangements are described in detail in
Amendment No. 2 to File No. SR-OCC-92-5. This notice of filing
describes the provisions of the Third Restated Agreement with
respect to an OCC clearing member that is a common member, but the
provisions of the Third Restated Agreement are designed to apply to
each of the alternative settlement arrangements.
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The guarantee of each clearing corporation to the other in the
Third Restated Agreement is unconditional in that each clearing
corporation's guarantee is not dependent on the ability of the clearing
corporation to use assets of its suspended member to make a guarantee
payment. Therefore, OCC and NSCC believe that the trustee for a
bankrupt OCC clearing member or for a bankrupt NSCC member should not
be able to successfully attack OCC's or NSCC's right to receive
guarantee payments from each other or to make guarantee payments to
each other in accordance with the provisions of the Third Restated
Agreement. OCC or NSCC would seek recovery of the amount of any
guarantee payment which either made to the other from the assets of the
suspended clearing member whose failure necessitated the payment. OCC
and NSCC believe that its authority to do so would be within the
special provisions of the Bankruptcy Code that protect the close-out
activities of securities clearing agencies.\8\
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\8\ 11 U.S.C. Secs. 555 and 559.
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Guarantee Formulas
The Second Restated Agreement between NSCC and OCC provided that
OCC would compensate NSCC for losses incurred by NSCC in closing out
the E&A activity of a defaulting participating member \9\ reported by
OCC to NSCC. The amount that OCC guaranteed to NSCC would be the
smallest of three quantities referred to in the Second Restated
Agreement as the net options loss, the net overall loss, and the
maximum guarantee.\10\ The Third Restated Agreement between OCC and
NSCC sets forth a revised formula for the calculation of the amount
which OCC would owe NSCC if NSCC were to suspend a common member. It
also provides an analogous formula for the calculation of the amount
which NSCC would owe OCC if OCC were to suspend a common member.
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\9\ As defined in the Second Restated Agreement, the term
participating member generally refers to an entity that is an OCC
clearing member and also is a participant in a correspondent
clearing corporation (``CCC'') (i.e., NSCC, MCC, or SCCP) or an
entity that is a party to any of the three alternative arrangements
for effecting settlement through a CCC as provided under the Second
Restated Agreement.
\10\ The net options loss was essentially the actual net loss
incurred by NSCC in closing out the E&A activity with respect to
which NSCC was unconditionally obligated at the time of the default.
The net overall loss was essentially the actual net loss incurred by
NSCC in closing out all transactions of the defaulting participating
member with respect to which NSCC was unconditionally obligated at
the time of the default. The maximum guarantee amount was
essentially the sum of the mark-to-market amounts, positive and
negative, for all E&A activity with respect to which NSCC was
unconditionally obligated at the time of the default. The term mark-
to-market amount was defined in the Second Restated Agreement to
mean the difference between the exercise price of an option and the
closing price of the underlying stock on the trading day immediately
preceding the then most recently completed regular morning
settlement with OCC of the participating member. As set forth in
footnote 13 below, the term is defined somewhat differently in the
Third Restated Agreement.
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Pursuant to the Third Restated Agreement, the formula for payment
by OCC under its guarantee to NSCC provides that if NSCC were to
suspend a common member, OCC would owe NSCC the lesser of the common
member's (i) net member debit to NSCC or (ii) calculated margin
requirement. The formula for payment by NSCC under its guarantee to OCC
provides that if OCC were to suspend a common member, NSCC would owe
OCC the lesser of the common member's (i) net member debit to OCC or
(ii) calculated margin Credit.\11\ The term net member debit to NSCC is
defined to mean the actual net overall debit or loss, if any, realized
by NSCC from its close-out of the common member (i.e., the debit or
loss after application of all assets available to NSCC including the
common member's contribution to NSCC's clearing fund).\12\ The term net
member debit to OCC is defined to mean the actual net overall debit or
loss, if any, realized by OCC from its close-out of the common member
(i.e., the debit or loss after application of all assets available to
OCC including the common member's margin deposits and contribution to
OCC's clearing fund). The term calculated margin credit is defined to
mean the algebraic sum of the mark-to-market amounts \13\ calculated by
OCC's margin system relating to settlements arising from E&A activity
with respect to which NSCC has become unconditionally obligated to
settle and the mark-to-market amounts calculated by NSCC's system for
offsetting activity in NSCC's system in the same underlying stocks if
the algebraic sum is positive (i.e., if the sum represents a net
positive value of the settlements). The term calculated margin
requirement is defined to mean the same algebraic sum if the algebraic
sum is negative (i.e., if the sum represents a net negative value of
the settlements).\14\
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\11\ Generally, if either NSCC or OCC suspended a common member,
the other would also suspend the common member. OCC's Rule 1102(a)
entitles OCC to suspend a clearing member which had been suspended
by its designated clearing corporation (Securities Exchange Act
Release No. 33543 (January 28, 1994) 59 FR 5639 [File No. SR-OCC-92-
05]). However, the two formulas under the Third Restated Agreement
would require at most a payment by one of the two clearing
corporations to the other and not to a payment by each clearing
corporation to the other. This is true because the suspended common
member's E&A activity in settlement at NSCC would generate either a
calculated margin requirement or a calculated margin credit but not
both. Thus, the application of at least one of the two formulas
would result in a guaranteed amount equal to zero.
\12\ The net member Debit to NSCC concept is similar to the net
overall loss concept under the Second Restated Agreement. However,
the concepts differ in that the net overall loss was the net loss
resulting from the close-out of all of a suspended member's
settlement activity at NSCC whereas the net member debit to NSCC is
the net debit remaining after application of all of a suspended
member's assets that are available to NSCC. The difference in these
concepts reflects a judgment on the part of the two clearing
corporations that the guarantee of each of the other should not
obligate either to make any payment to the other if the other in
fact has sufficient assets of the suspended member to make itself
whole without recourse to the clearing fund deposits of its other
members.
\13\ Under the Third Restated Agreement, the term mark-to-market
amount is defined to mean: (i) with respect to any option exercise
or assignment position, the difference between the value of the
position calculated using its exercise price and its closing price
on the preceding trading day and (ii) with respect to any other
position at NSCC, the difference between the value of the position
calculated using its trade price and its closing price on the
preceding trading day.
\14\ The calculated margin requirement concept is similar to the
maximum guarantee amount concept under the Second Restated
Agreement. The concepts differ in that the maximum guarantee amount
did not take into account offsetting activity in NSCC's system in
the same underlying stocks. OCC and NSCC have concluded that the
calculated margin requirement and calculated margin credit concepts
render the net options loss concept under the Second Restated
Agreement superfluous. Thus, there is no counterpart in the
guarantee formula in the Third Restated Agreement to the net options
loss concept in the Second Restated Agreement.
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The calculation of the calculated margin requirement or calculated
margin credit will take into account the value of offsetting deliver
and receive obligations at NSCC including fails but including free
deliver and receive obligations in the underlying stocks in which each
common member has E&A activity. NSCC will give OCC a report of
[[Page 30652]]
offsetting deliver and receive obligations in its system on a daily
basis prior to 8:00 P.M. Central Time.
The calculation of the calculated margin requirement or calculated
margin credit is perhaps best illustrated with an example. Suppose that
ABC is a common member of NSCC and OCC, that ABC is assigned the
exercise of 100 XYZ June 85 call options, that the closing price of XYZ
on the day after the exercise (``E+1'') is 90, and that ABC has no
other E&A activity at all. If ABC also has no non-E&A settlements in
XYZ in settlement at NSCC, the calculated margin requirement for ABC
would be $50,000 (90 minus 85 equals $5.00 per share for each of 10,000
shares). If ABC's non-E&A activity at NSCC in XYZ netted to a right to
receive 5000 shares at a weighted average price of 87, and if NSCC gave
OCC notice to that effect prior to 8:00 P.M. on E+1, then the $15,000
in-the-money value of those shares would be taken into account as an
offsetting obligation, and the calculated margin requirement for ABC
would be $35,000 commencing at the time on E+2 when OCC is scheduled to
make regular daily money settlement with ABC.\15\ If ABC's non-E&A
activity at NSCC in XYZ instead netted to a right to receive 15,000
shares at a weighted average price of 87 and if NSCC gave OCC notice to
that effect prior to 8:00 P.M. on E+1, the value of only 10,000 of
those shares (i.e., the amount on the opposite side of the market from
the obligation to deliver created by the assigned call) would be taken
into account in calculating the calculated margin requirement. Those
10,000 shares would have an in-the-money value of $30,000, and the
calculated margin requirement for ABC would be $20,000 commencing at
the time on E+2 when OCC is scheduled to make regular daily money
settlement with ABC.
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\15\ OCC currently collects from clearing members who owe OCC a
net dollar amount in regular daily settlement at 9:00 A.M. and pays
clearing members who are entitled to receive a net dollar amount in
regular daily settlement at 10:00 A.M. In the example in the text,
OCC would be obligated to take the in-the-money value of ABC's non-
E&A activity into account in calculating ABC's calculated margin
requirement if NSCC suspended ABC after 10:00 A.M. (at the latest)
even if ABC in fact failed to make money settlement with OCC on E+2.
OCC staff has concluded after discussing with NSCC staff the
question of when offsetting non-E&A activity should be taken into
account that the time of regular daily money settlement is an
appropriate time to incorporate the information in the preceding
evening's report from NSCC into calculations of the calculated
margin requirement or calculated margin credit.
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OCC reports E&A activity to NSCC each night. Offsetting positions
information reported back to OCC by NSCC on the evening of E+1 would be
taken into account in the calculation of the calculated margin
requirement or calculated margin credit and would be reflected in OCC's
regular morning settlement on the morning of E+2. Information reported
back to OCC by NSCC on the evening of E+2 would be taken into account
in any calculation of the calculated margin requirement or calculated
margin credit and would be reflected in OCC's regular morning
settlement on the morning of E+3.
Although NSCC will provide OCC with reports of offsetting deliver
and receive obligations in its system on a daily basis and although OCC
will monitor these reports for unusual position concentrations, OCC
will not actually use the information in the reports in its margin
calculations for its members.\16\
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\16\ Unlike NSCC, OCC employs three types of accounts for its
members: customer accounts, market-maker accounts, and firm
accounts. Separate margin calculations are made with respect to each
type of member account. Therefore, in order to use the information
in NSCC's reports in OCC's margin calculations, OCC would have to
disaggregate the information received from NSCC on an account-by-
account basis. This disaggregation, even if possible, could not be
done without major changes in both OCC's and NSCC's systems.
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OCC's guarantee in the Third Restated Agreement is similar to its
guarantee in the Second Restated Agreement in that the guarantee does
not cover the exposure of NSCC to loss from exercise settlements that
would result if a participating member \17\ transfers settlements from
its account at NSCC to the account of any other member of NSCC (even
another participating member or another member that is an affiliate of
the participating member) and that second member defaults on its
obligations to NSCC with respect to those settlements.
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\17\ Under the Third Restated Agreement the term participating
member specifically refers to (1) a common member, (2) an NSCC
clearing member that (i) has been appointed as an appointed clearing
member by an OCC clearing member that is an appointing clearing
member and (ii) has designated NSCC as its designated clearing
corporation for the settlement of its E&A activity. (3) an OCC
clearing member that (i) is a nominating clearing member, (ii) has
appointed a nominated correspondent that is an NSCC member, and
(iii) has designated NSCC as its designated clearing corporation for
the settlement of its E&A activity, and (4) an OCC clearing member
that is a Canadian clearing member. The terms appointing clearing
member, appointed clearing member, nominating clearing member, and
nominated correspondent are defined in Article I of OCC's By-Laws.
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Delivery of Stock Held in Escrow
The Second Restated Agreement between NSCC and OCC contemplated
that OCC would, if necessary, deliver to NSCC stock held in lieu of
margin to cover a suspended clearing member's short call positions
against payment by NSCC of the exercise price for the positions and
that the value of any such covered short position would not be taken
into account in determining the amount guaranteed by OCC to NSCC. In
contrast, the Third Restated Agreement does not contemplate that OCC
will deliver stock held to cover short call positions because, as
described above, the Third Restated Agreement provides for taking the
value of offsetting deliver and receive obligations at NSCC into
account in the calculation of the calculated margin requirement or
calculated margin credit.
Amendments to OCC Rule 601
Because of the guarantee extended by NSCC to OCC, OCC proposes to
amend Rule 601 to enable OCC to give margin credit for long option
positions in firm, market-makers', and specialists' accounts that have
been reported to NSCC for settlement. As a result, OCC will be able to
calculate margin for equity options in one product group. The
amendments to Rule 601 essentially reverse changes which were proposed
in File No. SR-OCC-92-5.\18\
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\18\ Supra note 6.
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Amendment to OCC Rule 1107
OCC proposes to amend Rule 1107 to provide that OCC will liquidate
securities deposited to cover assigned short call positions and use the
proceeds to reimburse itself for the incremental amount, if any, which
OCC is obligated to pay to the designated clearing corporation by
reason of the covered short positions as well as for the exercise price
of the covered options and for any costs associated with the
liquidation.
Amendment to NSCC's Clearing Fund Formula
NSCC proposes to amend its clearing fund formula in order to
exclude from the calculation trades for which NSCC has protection under
the terms of the Third Restated Agreement.\19\
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\19\ The complete text of the amendments to NSCC's clearing fund
formula is set forth in Exhibit A to NSCC's filing. A copy of the
filing and all exhibits is available for copying and inspection in
the Commission's Public Reference Room or through NSCC.
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OCC and NSCC believe the proposed rule changes are consistent with
the purposes and requirements of Section 17A of the Act because the
proposals (i) will enhance the system used by OCC to effect settlement
of exercises and assignments of equity options by providing for a two-
way guarantee between OCC and NSCC thereby permitting OCC to return to
a one product group margin system and (ii)
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will enhance NSCC's ability to protect itself and its members against
loss.
(B) Self-Regulatory Organizations' Statement on Burden on Competition
OCC and NSCC do not believe the proposed rule changes will impose
any material burden on competition.
(C) Self-Regulatory Organizations' Statement on Comments on the
Proposed Rule Changes Received From Members, Participants or Others
Written comments were not and are not intended to be solicited by
OCC or NSCC with respect to the proposed rule changes, and none have
been received by OCC or NSCC.
III. Date of Effectiveness of the Proposed Rule Changes and Timing for
Commission Action
Within thirty-five days of the date of publication of this notice
in the Federal Register or within such longer period (i) as the
Commission may designate up to ninety days of such date if it finds
such longer period to be appropriate and publishes its reasons for so
finding or (ii) as to which OCC and NSCC consent, the Commission will:
(A) By order approve the proposed rule changes or
(B) Institute proceedings to determine whether the proposed rule
changes should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule changes that are filed
with the Commission, and all written communications relating to the
proposed rule changes between the Commission and any person, other than
those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. Sec. 552, will be available for inspection and
copying in the Commission's Public Reference Room, 450 Fifth Street,
N.W., Washington, D.C. 20549. Copies of such filing will also be
available for inspection and copying at the principal office of OCC and
NSCC. All submission should refer to the File Nos. SR-OCC-96-04 and SR-
NSCC-96-11 and should be submitted by July 8, 1996.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\20\
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\20\ 17 CFR 200.30-3(a)(12) (1995).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-15274 Filed 6-14-96; 8:45 am]
BILLING CODE 8010-01-M