[Federal Register Volume 62, Number 29 (Wednesday, February 12, 1997)]
[Rules and Regulations]
[Pages 6474-6484]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-3479]


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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240

[Release No. 34-38248; File No. S7-7-94]
RIN 3235-AG14


Net Capital Rule

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
amending Rule 15c3-1 under the Securities Exchange Act of 1934 
(``Exchange Act''), the net capital rule, to permit broker-dealers to 
employ theoretical option pricing models in determining net capital 
requirements for listed options and related positions. Alternatively, 
broker-dealers may elect a strategy-based methodology. The amendments 
are intended to simplify the net capital rule's treatment of options 
for capital purposes and more accurately reflect the risk inherent in 
broker-dealer options positions.

EFFECTIVE DATE: The amendments become effective September 1, 1997.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate 
Director (202) 942-0131, Peter R. Geraghty, Assistant Director (202) 
942-0177, or Louis A. Randazzo, Special Counsel (202) 942-0191, 
Division of Market Regulation, Securities and Exchange Commission, 450 
Fifth Street, N.W., Mail Stop 5-1, Washington, D.C. 20549.

SUPPLEMENTARY INFORMATION:

I. Introduction

    The Commission is adopting amendments to Rule 15c3-1 under the 
Exchange Act to permit broker-dealers to employ theoretical option 
pricing models to calculate required net capital for listed options and 
the related positions that hedge those options. In adopting these 
amendments, the Commission is continuing its process of revising the 
net capital rule that was contemplated when the Commission solicited 
comments on a range of capital related issues in 1993.1 The 
amendments being adopted today were proposed in initial form in March 
of 1994 and would allow broker-dealers to use an options pricing model 
to determine capital charges for listed options and related 
positions.2 Simultaneously with the Commission's proposal, the 
Division of Market Regulation (``Division'') issued a no-action letter 
allowing broker-dealers to utilize the options pricing approach 
immediately.3 Based on the experience gained by the Commission 
under the no-action letter, and the nature of the comments received 
during the public comment period, the Commission is

[[Page 6475]]

adopting the proposed amendments with certain changes discussed herein. 
The rules will become effective on September 1, 1997; however, broker-
dealers that desire to apply the rule before the effective date may do 
so.
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    \1\ Securities Exchange Act Release No. 32256 (May 4, 1993), 58 
FR 27486 (May 10, 1993) (``Concept Release'').
    \2\ Securities Exchange Act Release No. 33761 (March 15, 1994), 
59 FR 13275 (March 21, 1994) (``Proposing Release'').
    \3\ Letter from Brandon Becker, Division of Market Regulation, 
SEC to Mary L. Bender, First Vice President, CBOE and Timothy 
Hinkas, Vice President, The Options Clearing Corporation (``OCC'') 
(March 15, 1994) (``1994 No-Action Letter'').
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A. The Net Capital Rule Generally

    The Commission adopted its first net capital rule in 1942.4 
The rule requires that every registered broker-dealer maintain certain 
specified minimum levels of net capital. The primary purpose of the 
rule is to protect the customers of a broker-dealer from losses that 
can be incurred upon the broker-dealer's failure. Rule 15c3-1 requires 
registered broker-dealers to maintain sufficient liquid assets to 
enable those firms that fall below the minimum net capital requirements 
to liquidate in an orderly fashion without the need for a formal legal 
proceeding. The rule prescribes different required minimum levels based 
upon both the method a firm adopts in computing its net capital and the 
type of securities business it conducts. A firm engaging in a general 
securities business (which would allow the firm to clear and carry 
customer accounts) must maintain a minimum net capital level of the 
greater of $250,000 or 6\2/3\ percent of its liabilities (with certain 
exclusions), or if the firm chooses the alternative method, the greater 
of $250,000 or 2 percent of its customer-related receivables. The 
different minimum levels of net capital for firms based on categories 
of business activity are designed to address the perceived risk in the 
broker-dealers' business. For example, if a broker-dealer carries no 
customer accounts and does not engage in certain specified activities, 
it can maintain as little as $5,000 in net capital.
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    \4\ The section 8(b) of the Securities Exchange Act that was 
adopted in 1934 contained a rudimentary net capital ratio 
requirement for members of national securities exchanges and broker-
dealers conducting business through members. In 1942, the Commission 
adopted its first net capital rule. Section 8(b) was repealed by 
section 5(2) of the Securities Act Amendments of 1975, which also 
required the adoption of the uniform net capital rule applicable to 
all broker-dealers.
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    Under the net capital rule, a broker-dealer takes its net worth, 
computed in accordance with generally accepted accounting principles, 
deducts certain illiquid assets (such as goodwill), certain percentages 
from its proprietary securities or commodities inventory, and adds back 
certain liabilities to arrive at net capital. This number is then 
compared to its requirement to determine compliance. Much of the rule 
itself is comprised of the haircut deductions which account for the 
market and other risks inherent in a trading business. The Commission 
believes the net capital rule has performed its customer protection 
function well over the years, has enabled the Commission and the self-
regulatory organizations (``SROs'') to identify financial problems at 
early stages, and has allowed the Commission and the SROs to perform 
self-liquidations of failing securities firms without both customer 
loss and the need for proceedings under the Securities Investor 
Protection Act of 1970.5
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    \5\ 15 U.S.C. 78aaa et seq.
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    Currently, the net capital rule provides two basic capital 
treatments for option positions held by broker-dealers. The first 
approach, which is set forth in Appendix A to Rule 15c3-1, was designed 
for firms clearing their proprietary listed option and related 
positions, and assumes that the option will be exercised or held to 
expiration. The second approach, which is set forth in Rule 15c3-
1(c)(2)(x), is a premium-based approach. Both methodologies of 
computing charges provide for lower haircuts for certain risk 
offsetting positions held by broker-dealers, although the premium-based 
approach recognizes more types of offsetting positions and gives value 
for the portion of the premium which is related to time.

B. The Development of the Options Pricing Approach to Capital

    In 1973, Fischer Black and Myron Scholes introduced a formula to 
calculate the value of European style options. The Black-Scholes 
formula assumes that the primary factors affecting the price of an 
option are: the value of the underlying asset, the exercise price of 
the option, the volatility of the underlying asset, the risk-free rate 
of interest, and the remaining time to expiration. Subsequent to the 
development of the Black-Scholes formula, the Cox-Ross-Rubinstein 
binomial pricing formula was developed. By calculating different 
probable option values at various intervals, the formula is able to 
more easily incorporate dividends, the term structure of the yield 
curve, and the early exercise feature of American style options. Other 
models which are based on the Cox-Ross-Rubinstein formula have since 
been developed, including OCC's Theoretical Intermarket Margining 
System (``TIMS''), which is used to measure the market risk associated 
with participants' positions and to establish clearing house margin 
requirements.
    The sharp market breaks in 1987 and 1989 made it imperative for the 
Commission to review the adequacy of the current options haircut 
methodology. The Chicago Board Options Exchange (``CBOE'') and OCC 
formed a task force to determine whether a more rigorous and predictive 
approach to haircuts could be developed. As noted, the current 
methodology requires that positions be allocated to specific recognized 
strategies which are then haircut at the prescribed levels. The 
aggregate haircut for a class, or product group in the case of indexes, 
is the sum of the haircuts calculated for each individually identified 
strategy. CBOE and OCC believed that the current strategy-based 
approach did not effectively recognize the risk reduction of offsetting 
positions within a class or product group, and therefore such approach 
required excessive amounts of capital to maintain such offsetting 
positions. In addition, CBOE and OCC maintained that the haircuts 
associated with short, unhedged, out-of-the-money options were an 
insufficient measure of capital adequacy with respect to rapid, 
material changes in market prices. At that time, OCC had been utilizing 
an options pricing model to establish clearing house margin 
requirements. In addition, traders and risk managers had been using 
options pricing models in the development of trading strategies and the 
management of market risk. Thus, the task force determined to explore 
the impact of haircuts calculated through the use of an options pricing 
model.
    CBOE and OCC conducted a preliminary study which compared haircut 
and account equity data obtained from three options market-maker 
clearing firms with position risk calculated using a derivation of TIMS 
for a three month time frame in late 1990. Current haircuts and equity 
were compared to the maximum loss under TIMS per class or product group 
for each market-maker account. The preliminary study disclosed that 
haircuts would be reduced for well-hedged, strategy-diverse positions, 
and increased for unhedged positions. The study further disclosed that 
the subject clearing firms maintained sufficient capital to continue in 
capital compliance under the new approach. Based upon the results of 
this study, the Division invited CBOE and OCC to propose a formal pilot 
program specifically designed for calculating haircuts for listed 
options on currencies, equities, and securities and futures indexes.
    The Division, CBOE, and OCC agreed upon the criteria to be used in 
the pilot program, and OCC staff developed the software and performed 
the operations

[[Page 6476]]

to calculate the risk-based haircuts. TIMS was used to project prices. 
Projected price moves were calculated based upon the closing underlying 
asset price for each day plus and minus moves at ten equidistant data 
points over a range of market movements. The greatest loss at any one 
of these points would become the haircut. The volatility implied from 
the closing price of the options series was used for the calculation of 
each projected price for that series. To account for liquidation risk, 
a minimum charge of \1/8\ point per option contract was applied when 
the haircut for the class or product group reflected little or no 
market exposure.
    The results of the pilot program were consistent with earlier 
findings in that accounts having primarily hedged positions reflected 
significant haircut reductions; unhedged portfolios received higher 
capital charges. Based in part on this experience, the Commission 
issued the Proposing Release for comment.

C. The Commission's Proposal

    The proposed amendments provided that, with respect to each option 
series 6 it clears, OCC would collect certain information on a 
daily basis.7 Using this information and TIMS, OCC would measure 
the implied volatility for each option series. After measuring the 
implied volatility for each option series, OCC would input to the model 
the resulting implied volatility for each option series. For each 
option series, the model would calculate theoretical prices at 10 
equidistant valuation points within a range consisting of an increase 
or a decrease of the following percentages of the daily market price of 
the underlying instrument:

    \6\ An option series includes option contracts of the same type 
(either a call or a put) and exercise style covering the same 
underlying instrument with the same exercise price, expiration date, 
and number of underlying units. The Commission notes that for the 
purposes of the final amendments, the term listed option includes 
listed warrants.
    \7\ Under the proposed rule, OCC would collect the following 
information: (1) the dividend streams for the underlying securities, 
(2) interest rates (either the current call rate or the Eurodollar 
rate for the maturity date which approximates the expiration date of 
the option), (3) days to expiration, and (4) closing underlying 
security and option prices from various vendors.
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(i) +(-) 15% for equity securities with a ready market, narrow-based 
indexes, and non-high-capitalization diversified indexes,8
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    \8\ In order to avoid confusion with the designation of indexes 
for margin or futures eligibility, the final amendments and the 
remainder of this release refer to ``broad-based'' indexes as 
``diversified'' indexes.
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(ii) +(-) 6% for major market currencies,9
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    \9\ The major market currencies are: Deutsche Mark, British 
Pound, Swiss Franc, French Franc, Canadian Dollar, Japanese Yen and 
European Currency Unit.
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(iii) +(-) 10% for high-capitalization diversified indexes,10 and
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    \10\ The Commission indicated in the Proposing Release that 
underlying price movement assumptions for the proposed theoretical 
pricing model should be consistent with the volatility assumptions 
currently incorporated in the net capital rule.
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(iv) +(-) 20% for currencies other than major market currencies.

    After the model calculated the theoretical gain/loss valuations, 
OCC would provide the valuations to broker-dealers. Broker-dealers 
would download this information into a spreadsheet from which the 
broker-dealer would calculate the profit/loss for each of its 
proprietary and market-maker options positions.11 The greatest 
loss at any one valuation point would be the haircut.12
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    \11\ For those broker-dealers which choose to use TIMS but do 
not obtain a computer interface with OCC, OCC has developed a dial-
up service by which such broker-dealers may obtain, on a daily 
basis, theoretical gains and losses. Other third-party vendors would 
presumably offer a similar service. Any such dial-up service may be 
a more practical option for those broker-dealers that do not find it 
economically feasible to maintain a computerized interface with a 
third-party source, but that do not wish to apply the alternative 
strategy-based methodology, as discussed below.
    \12\ The spreadsheet would be programmed to compute a minimum 
haircut charge and identify the greater of the computed or minimum 
charge as the haircut. For example, assume a portfolio consisting of 
IBM common stock and various puts and calls on IBM common stock with 
different strikes and expiration dates. OCC would re-price each 
option position assuming that the price of the IBM common stock had 
moved up or down by a maximum of 15%, at 10 valuation points (i.e., 
-15%, -12%, -9%, -6%, -3%, +3%, +6%, +9%, +12%, +15%). The single, 
maximum net loss amount at any one of the 10 valuation points would 
become the haircut for the portfolio.
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    Depending upon the type of positions a broker-dealer sought to 
offset, a percentage of a position's gain at any one valuation point 
would offset another position's loss at the same valuation point. The 
proposed amendments allowed the following offsets: (1) within any 
portfolio type involving the same underlying stock, index, or currency, 
100% of a position's gain at any one valuation point would offset 
another position's loss at the same valuation point; (2) between 
qualified stock baskets (provided the stock basket represented no less 
than 90% of a high-capitalization diversified index's capitalization or 
100% of the capitalization of a narrow diversified index) offset by 
index options, or futures, or futures options on the same underlying 
index, 95% of gains would offset losses at the same valuation point; 
(3) among high-capitalization diversified index options, futures, and 
futures options, 90% of the gain on one high-capitalization index 
position in the same product group would offset the loss on a position 
on a different high-capitalization diversified index at the same 
valuation point; and (4) among non-high-capitalization diversified 
index options, futures, and futures options, 75% of the gain on one 
non-high-capitalization diversified index position would offset the 
loss on a different non-high-capitalization diversified index at the 
same valuation point.
    Under the proposed amendments, required deductions were: (1) the 
amount of losses at any of the 10 equidistant valuation points 
representing the largest theoretical loss after applying the 
permissible offsets; or (2) a minimum charge equal to \1/4\ of a point 
13 times the multiplier for each options contract (or $25.00 per 
option contract assuming that option contract covers 100 shares) and 
each related instrument within the option's class or product group, or 
$25 for each option on a major market foreign currency; plus (3) in the 
case of portfolio types involving index options and related instruments 
offset by a qualified stock basket, a minimum charge of 5% of the 
market value of the qualified stock basket for high-capitalization 
indexes, whether diversified or narrow-based; or (4) in the case of 
portfolio types involving index options and related instruments offset 
by a qualified stock basket, a minimum charge of 10% of the market 
value of the qualified stock basket for diversified non-high-
capitalization indexes.
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    \13\ As noted earlier, the pilot program applied a minimum 
haircut of \1/8\ of a point. Pursuant to a recommendation by CBOE 
and OCC, the Proposing Release increased the minimum charge to \1/4\ 
of a point per option contract. The Commission believed this 
increase was appropriate to account for liquidation and decay risk 
in options prices in situations where application of the proposed 
amendments resulted in little or no charge.
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    In proposing the amendments, the Commission recognized that certain 
broker-dealers may not want to, or may not find it cost effective to 
use an options pricing methodology because of their limited dealings in 
options. Accordingly, the proposed amendments also included an 
alternative strategy-based haircut methodology that generally followed, 
but was more limited than, the haircut approach embodied in the current 
rule.
    Under the current rule, a broker-dealer that carries accounts of 
listed options specialists must take a charge against capital as of the 
close of business each day even though the broker-dealer does not know 
the level of the charges until the following day. The proposed 
amendments provided broker-

[[Page 6477]]

dealers with additional time by which to take the capital charge. 
Specifically, the proposed amendments provided that broker-dealers 
could adjust their net worth by deducting as of noon of the next 
business day the charges computed as of the prior business day. In 
addition, the proposed amendments provided that the required deductions 
could be reduced by the deposit of funds or securities by noon of the 
next business day.

D. Summary of Comments

    The Commission received ten comment letters in response to the 
Proposing Release.14 The comments, in general, were supportive of 
the Commission's proposal. Most commenters, however, suggested that, in 
addition to TIMS, the Commission permit the use of other pricing 
models.15 In addition, some commenters suggested that the 
Commission allow the use of theoretical pricing models in connection 
with over-the-counter (``OTC'') options and positions in U.S. Treasury 
securities.
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    \14\ The comment letters are available for public inspection and 
copying in the Commission's public reference room located at 450 
Fifth Street, N.W., Washington, D.C. 20549 (File No. S7-7-94).
    \15\ Some commenters suggested the use of broker-dealer 
proprietary models or the Chicago Mercantile Exchange's Standard 
Portfolio Analysis System (``SPAN'') which is used by many futures 
exchanges to calculate margin requirements. Letter from Jeffrey 
Bernstein, Chairman, Capital Committee of the Securities Industry 
Association (``SIA'') to Jonathan G. Katz, Secretary, SEC (September 
16, 1994), and Letter from Thomas R. Donovan, President and Chief 
Executive Officer, Chicago Board of Trade to Jonathan G. Katz, 
Secretary, SEC (May 13, 1994).
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    The commenters also suggested that the underlying price assumption 
for high-capitalization diversified indexes be reduced and that the 
rule permit implied volatility inputs to fluctuate within certain 
parameters. In addition, a few commenters suggested that the minimum 
charge of \1/4\ of a point per option contract be reduced. These 
issues, as well as others, are discussed below.

II. Description of Rule Amendments

A. Use of TIMS Versus Other Pricing Models

    In the Proposing Release and under the 1994 No-Action Letter, 
broker-dealers were required to use the OCC TIMS system as the 
exclusive means of determining theoretical options prices. While TIMS 
is a theoretically sound options pricing methodology, it is not the 
only recognized methodology in the marketplace. Other models, using 
different formulae, are also capable of arriving at legitimate results. 
In response to the comments and based on additional experience with 
models, the Commission is removing the requirement that TIMS be used. 
The final rule permits the use of a model (other than a proprietary 
model) maintained and operated by any third-party source and approved 
by an examining authority designated pursuant to Section 17(d) of the 
Exchange Act (``DEA''). The DEA shall submit to the Commission for 
consideration a description of its methods for approving models.16 
The model must consider at a minimum the following factors in pricing 
the option: (1) the current spot price of the underlying asset; (2) the 
exercise price of the option; (3) the remaining time until the option's 
expiration; (4) the volatility of the underlying asset; (5) any cash 
flows associated with ownership of the underlying asset that can 
reasonably be expected to occur during the remaining life of the 
option; and (6) current information about interest rates. Any such 
approval of a model by a DEA must include appropriate provisions 
relating to the obligations of the third-party vendor to supply timely 
and accurate information to the broker-dealers. Once a model has been 
approved by a DEA, broker-dealers may use the model in order to 
calculate haircuts. For purposes of this rule, the TIMS system as 
operated by OCC will be deemed to be an approved model for a period of 
two years from the effective date of these amendments. OCC, however, 
should clarify its vendor status by appropriate DEA approval.
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    \16\ The Commission notes that any such third-party source, 
including OCC, may charge broker-dealers a fee for the services they 
provide in connection with these amendments.
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    In addition to the commenters' suggestions that the final 
amendments permit broker-dealers to utilize theoretical pricing systems 
other than TIMS, certain commenters argued that the Commission should 
permit the use of internal proprietary models for both listed products 
and OTC options. The staff of the Division is preparing a separate 
release which will propose for comment further amendments to the net 
capital rule to permit the use of proprietary models to value listed 
options.

B. Implied Volatilities

    The TIMS model uses implied options volatilities to calculate 
theoretical prices of options. It was suggested that because TIMS does 
not alter implied volatilities as the theoretical price of the option 
changes, the model overlooks an important element that could have a 
major effect on capital requirements. In fact, requiring alteration of 
the implied volatilities would cause numerous additional computations 
without substantial benefits given the wide range in assumed underlying 
price movements. The Commission notes, however, that the amendments 
have been liberalized and permit the use of differing options pricing 
models. The properties of each model can then be evaluated during the 
model approval process established in the amendments.

C. Underlying Price Movement Assumptions

    The proposed amendments included underlying price movement 
assumptions for the theoretical pricing model that are consistent with 
the volatility assumptions currently incorporated in the net capital 
rule. The Commission believes that requiring the model to ``shock'' the 
portfolio in the amounts currently incorporated into the net capital 
rule is necessary to ensure consistent treatment of options and the 
underlying positions. Since the amendments permit broker-dealers to 
take haircuts on equities after taking into consideration options on 
those equities, broker-dealers with limited options positions might 
seek to apply the assumptions to all of their positions (both equities 
and options) if the options pricing amendments utilized assumptions 
that were less robust than those currently in the net capital rule for 
the underlying positions. If this were the case, broker-dealers could 
potentially obtain more favorable treatment on their equity positions 
than currently contemplated by the net capital rule.
    The Commission notes that the 1994 No-Action Letter contained a 
reduction in the underlying price movements for non-clearing 
specialists and market-makers to +(-)4\1/2\% for major market foreign 
currency positions, +(-)10% for non-high-capitalization diversified 
indexes, and +6(-8)% for high-capitalization diversified indexes. In 
that letter, the Division expressly declined to extend this position to 
other broker-dealers.17 The concession for market-makers and non-
clearing specialists was based upon the important role that non-
clearing specialists and market-makers perform in maintaining fair and 
orderly markets. The Commission is incorporating the reduced 
requirements for market-makers into the final rule in light of these 
considerations, however, this concession expires two years from the 
effective date of the amendments unless

[[Page 6478]]

it can be demonstrated by the non-clearing specialists and market-
makers that retention of reduced capital requirements is in the public 
interest. Therefore, the Commission is adopting the minimum price 
movements substantially as proposed.
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    \17\ See 1994 No-Action Letter, supra note 3, at note 5.
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    Similarly, some commenters suggested that the +(-)10% price move 
assumption for high-capitalization diversified indexes (such as the S&P 
500) was too high and should be reduced. During the time the 1994 No-
Action Letter has been in effect using a +(-)10% assumption, there does 
not appear to have been any evidence of liquidity or execution problems 
in the option markets from application of this assumption. The 
Commission notes that this assumption is intended to cover the risks of 
uncovered, out-of-the-money option positions. Accordingly, the 
amendment retains the +(-)10% underlying assumption for high-
capitalization diversified indexes.

D. Permissible Offsets

    The proposed amendments permitted specified offsets between 
differing categories of instruments. The rule being adopted today 
maintains the concept of specifying offsets, but with a few significant 
changes. With respect to the offset between qualified stock baskets, 
the Commission received one comment which contended that rather than 
requiring that a basket contain a certain minimum amount of stock to be 
considered a qualified stock basket, the rule should permit a broker-
dealer to convert every basket into a qualified stock basket by taking 
a haircut on the missing or excess stocks, depending on whether too 
little or too much of a stock was in the basket.
    The Commission believes that the better approach is to maintain the 
stock basket capitalization requirement. The purpose of the minimum 
capitalization requirement is to ensure that a broker-dealer has a 
sufficient number of stocks that match those in the index so that the 
stocks correlate with the index. The Commission, however, believes that 
a decrease in the capitalization requirement is appropriate. 
Accordingly, under the rule amendment, to be a qualified stock basket, 
the basket must represent no less than 50% of a diversified index's 
capitalization and, for a narrow-based index, the basket must represent 
no less than 95% capitalization. The proposed amendments allowed 
offsets only between the same type of indexes and related positions. 
Commenters suggested that offsets be allowed between different 
diversified index product groups, and the Commission agrees it is 
appropriate to permit offsets for positions among different diversified 
index product groups. The groupings and netting allowances are set 
forth below.
    In addition, questions have arisen regarding the methodology that 
should be used to designate indexes as high-capitalization diversified 
or non-high capitalization diversified for purposes of the rule. Set 
forth below is a list of those indexes which are to be treated as high 
capitalization diversified or non-high capitalization diversified, and 
the appropriate offsets. The offsets designated in the groupings are 
based on historical correlations. The Commission recognizes that this 
approach does not provide for the treatment of new indexes, however, 
the Commission intends to issue a release which will set forth generic 
guidelines for adding and deleting indexes (and designating appropriate 
offsets) for purposes of the net capital rule.
     U.S. Market Group A (i) Institutional Index (``XII''), 
(ii) Major Market Index (``XMI''), (iii) S&P 100 Index (``OEX''), (iv) 
S&P 500 Index (``SPX''), (v) New York Stock Exchange Composite Index 
(``NYA''), (vi) Big-Cap Sector Index (``MKT''), and (vii) PHLX US Top 
100 Index (``TPX''). A 90% offset is permitted between classes within 
this product group, an 85% offset with U.S. Market Group B, and a 50% 
offset with the non-high capitalization diversified U.S. Market Product 
Group and the U.S. NASD Market Group.
     U.S. Market Group B (i) S&P Barra Growth Index, and (ii) 
S&P Barra Value Index. An 80% offset is permitted within this product 
group, an 85% offset with U.S. Market Group A, and a 50% offset with 
the non-high capitalization diversified U.S. Market Product Group and 
the U.S. NASD Market Group.
     Japan Market Group A (i) Japan Index (``JPN''), (ii) CBOE 
Nikkei 300 Index (``NIK''), and (iii) the Nikkei 225 Index (``NK''). A 
90% offset is permitted within this product group.
     Japan Market Group B consists of the CBOE Japanese Export 
Warrant Index.
     European Market Product Group consists of the EuroTop 100 
Index (``TOP'').
     United Kingdom Market Product Group consists of the 
Financial Times Exchange Index (``FT-SE'').
    The following indexes are designated non high-capitalization 
diversified market indexes:
     U.S. Market Product Group (i) MidCap Index (``MID''), (ii) 
Russell 2000 Index (``RUT''), (iii) Value Line Index (``VLE''), (iv) 
Wilshire 250 Index (``WSX''), and (v) the S&P 600 Smallcap Index 
(``SML''). A 75% offset is permitted within this product group, and a 
50% offset with the U.S. NASD Market Group and with high-capitalization 
diversified U.S. Market Groups A and B.
     U.S. NASD Market Group (i) NASDAQ 100 Index (``NDX''), and 
(ii) National OTC Index (``XOC''). A 75% offset is permitted within 
this product group and a 50% offset with the U.S. Market Product Group 
and with high-capitalization diversified U.S. Market Groups A and B.
     Mexican Market Product Group consists of the Index of 
Prices and Quotations (``IPC'').
    The following indexes are designated narrow-based index options 
within the following sector product groups.
     Bank Sector Product Group (i) S&P Banking Index (``BIX''), 
and (ii) PHLX KBW Bank Index (``BKX''). A 90% offset is permitted 
within this product group.
     Technology Sector Product Group (i) Morgan Stanley High 
Tech 35 Index (``MSH''), (ii) PSE Technology Index (``PSE''), (iii) 
CBOE Technology Index (``TXX''), (iv) AMEX Computer Technology Index 
(``XCI''), (v) Goldman Sachs Technology Index (``GSTI'') Composit Index 
(``GTC''), (vi) GSTI Hardware Index (``GHA''), (vii) GSTI Multimedia 
Network Index (``GIP''), and (viii) GSTI Software Index (``GSO''). A 
75% offset is permitted within this group. In addition, the PSE may be 
offset 75% with the U.S. NASD Market Group.
     Internet Product Group (i) CBOE Internet Index, (ii) AMEX 
Internet Index, and (iii) GSTI Internet Index (``GIN''). A 75% offset 
is permitted within this group.
     Oil Product Group (i) CBOE Oil Index (``OIX''), and (ii) 
AMEX Oil and Gas Index (``XOI''). A 90% offset is permitted within this 
product group.
     Gold Product Group (i) CBOE Gold Index (``GOX''), and (ii) 
PHLX Gold/Silver Index (``XAU''). A 90% offset is permitted within this 
product group.
     Semiconductor Product Group (i) PHLX Semiconductor Index 
(``SOX''), and (ii) GSTI Semiconductor Index (``GSM''). A 90% offset is 
permitted within this product group.
     Semiconductor Product Group (General) All remaining 
narrow-based indexes. No offset is permitted within this product group.

E. Minimum Charges

    The minimum charge specified in the rule is designed to account for 
liquidation and decay risk in the prices of long and short options in 
those

[[Page 6479]]

instances in which applications of the theoretical pricing methodology 
results in little or no capital requirement. One commenter noted that 
the use of a minimum charge of a \1/4\ of a point was a fair method of 
estimating the liquidation risk of out-of-the-money options. Another 
commenter indicated that the impact of the minimum charge was to cause 
spreads for out-of-the-money calls and puts to expand because market-
makers are reluctant to sell these options.
    Thus far, there is no evidence that these concerns have been borne 
out, however, the Commission intends to monitor the impact of the 
amendments and whether these concerns arise in fact. In the meantime, 
the Commission believes that the minimum charge should be retained as 
proposed. The rule as adopted, therefore, requires a minimum charge of 
\1/4\ of a point or $25.00 per option contract assuming that the basic 
equity option contract covers 100 shares. To the extent that an option 
or futures contract exceeds the size of a basic option contract, the 
minimum charge will be increased by the additional percentage amount of 
underlying units. For example, an option or a futures contract on the 
S&P 500 Index covers 500 shares (rather than 100 shares for a basic 
equity option contract) and therefore the minimum charge would be 
$125.00 (5 x $25.00).
    In addition to the \1/4\ of a point minimum charge, the proposed 
amendments required an additional deduction of 10% for each qualified 
stock basket of non-high-capitalization diversified indexes, and 5% for 
each qualified stock basket of high-capitalization diversified and 
narrow-based indexes for those positions hedging an options or futures 
contract subject to the minimum charge. In response to concerns that, 
in the case of non-high-capitalization indexes, the 10% charge was 
excessive, the Commission believes it is appropriate to decrease this 
charge to 7.5%. For high-capitalization indexes, the proposed 5% charge 
will be adopted.

F. Alternative Strategy-Based Methodology

    The proposed amendments provided that broker-dealers could elect to 
use the alternative strategy-based method for calculating haircuts. One 
commenter contended that the alternative strategy-based methodology 
contained in the proposal, because it contained very few simple 
strategies, would impose haircuts on a trading book which are larger 
than the haircuts in the current rule. The commenter recommended that 
the Commission explore the possibility of adopting a strategy-based 
calculation that would include common strategies currently used by 
firms.
    The Commission notes that the new rule is designed in part to 
eliminate the complicated overlay of strategies and interpretations 
that developed out of the necessity to accommodate all dealer options 
strategies. To attempt to recognize many classes of strategies in the 
alternative section would result in a return to the system the 
Commission is revising today. Hence, the Commission believes that a 
simple strategy-based alternative should be retained in the rule. 
Limiting the alternative to simple strategies will tend to encourage 
firms with any options positions of substance to utilize the pricing 
model methodology. Because the recognized strategies in the alternative 
section are minimal, limited hedges will be recognized with the result 
that a book of any significance will incur larger charges under the 
strategy-based method than the options pricing methodology. This will 
provide an economic incentive for firms active in options to develop 
the capability to use up-to-date modelling techniques.

G. Clearing Firm Capital Deposits

    The net capital rule requires broker-dealers carrying the accounts 
of listed options specialists to take capital charges reflecting 
haircuts required due to specialists' trading activity. The capital 
rule historically has required the clearing firm to take the required 
charge as of the close of business each day to ensure it has sufficient 
capital to open the next morning. However, the carrying firm generally 
will not know the full extent of its requirements as to its specialists 
until that next morning. Generally, clearing firms will seek to bring 
in money, either from the specialist or from elsewhere during the 
morning. This is a conservative charge considering the rule's usual 
acceptance of allowing time for margin calls. To remedy this, the 
proposal allowed the clearing firm until noon to obtain funds or 
arrange financing. All of the commenters who addressed the issue 
supported it; accordingly, the Commission is adopting the provision 
with the clarification that ``noon'' is determined according to the 
local time where the carrying firm has its headquarters. In any event, 
this provision will not be available for a market-maker account in 
deficit.

III. Technical Amendments to the Rule

    As noted in the Proposing Release, in connection with the adoption 
of the amendments, the Commission is making the following technical 
amendments to the net capital rule necessitated by the new amendments 
and to codify a long-standing staff interpretation:

A. Deletion of Paragraph (a)(7) of the Net Capital Rule

    As previously stated, the net capital rule, as it currently is 
written, contains two haircut methodologies, the premium-based approach 
set forth in Rule 15c3-1(c)(2)(x) and the approach embodied in Appendix 
A to Rule 15c3-1. Currently, pursuant to the provisions of paragraph 
(a)(7) of the net capital rule, the premium-based approach is available 
to a clearing firm if its business is limited almost exclusively to 
effecting (either directly or as agent) and clearing market-making 
transactions in listed options.
    The final rule deletes paragraph (a)(7) of the net capital rule. 
The Commission believes that this provision is no longer necessary 
because the final rule eliminates the distinction between the premium-
based approach set forth in 15c3-1(c)(2)(x) and the approach set forth 
in Appendix A to 17 CFR 240.15c3-1.

B. Steps To Be Taken by a Broker-Dealer Carrying the Account of an 
Option Market-Maker When Equity in That Account is Insufficient to 
Cover Haircuts

    Pursuant to an interpretation letter,18 carrying broker-
dealers may extend credit in a market-maker account even when haircuts 
for that account exceed the equity in the account.19 This 
interpretation is conditioned upon the carrying broker-dealer taking a 
charge against its capital to the extent that the equity in the market-
maker's account is insufficient to cover the haircuts. The amendments 
incorporate this interpretation into the net capital rule.
---------------------------------------------------------------------------

    \18\ Letter from Lee A. Pickard, Director, Division of Market 
Regulation, SEC, to Joseph W. Sullivan, President, CBOE (April 8, 
1977).
    \19\ Currently, paragraph (c)(2)(x)(F) of Rule 15c3-1 provides 
that, if the haircuts for a particular market-maker's account exceed 
the equity in the account, the carrying broker-dealer may not extend 
further credit to the market-maker unless the carrying broker-dealer 
requires the additional deposit of sufficient equity to eliminate 
the net capital charge.
---------------------------------------------------------------------------

IV. Summary of the Final Regulatory Flexibility Analysis

    The Regulatory Flexibility Act, which became effective on January 
1, 1981, imposes procedural steps applicable to agency rule making 
which has a ``significant economic impact on a substantial number of 
small entities.'' 20

[[Page 6480]]

The Commission has prepared a Final Regulatory Flexibility Analysis 
(``Analysis'') in accordance with 5 U.S.C. Sec. 604 regarding the 
amendments. The Analysis states that the Commission did not receive any 
comments concerning the Initial Regulatory Flexibility Analysis.
---------------------------------------------------------------------------

    \20\ Although Section 601(b) of the Regulatory Flexibility Act 
defines the term ``small entity,'' the statute permits agencies to 
formulate their own definitions. The Commission has adopted 
definitions of the term ``small entity'' for purposes of Commission 
rulemaking in accordance with the Regulatory Flexibility Act. Those 
definitions are set forth in Rule 0-10, 17 CFR 240.0-10. See 
Securities Exchange Act Release No. 18452 (January 28, 1982), 47 FR 
5215 (February 4, 1982). A broker-dealer is a ``small business'' or 
``small organization'' under Rule 0-10, if the broker-dealer (i) had 
total capital (net worth plus subordinated liabilities) of less than 
$500,000 on the date in the prior fiscal year as of which its 
audited financial statements were prepared pursuant to 17 CFR 
240.17-5(d) or, if not required to file such statements, a broker-
dealer that had total net capital (net worth plus subordinated 
liabilities) of less than $500,000 on the last business day of the 
preceding fiscal year (or in the time that it has been in business, 
if shorter); and (ii) is not affiliated with any person (other than 
a natural person) that is not a small business or small organization 
as defined in 17 CFR 240.0-10.
---------------------------------------------------------------------------

    The Analysis notes that the amendments implement a haircut 
methodology which employs a mathematical formula to determine the 
theoretical value of options. The purpose of the amendments is to make 
haircuts more accurately reflect the risks associated with dealer 
option positions than is possible under the current rule and to 
simplify the net capital rule's treatment of options for capital 
purposes. The amendments permit the use of a model (other than a 
proprietary model) maintained and operated by a third-party source, 
including OCC, and approved according to the terms of the amendments. 
The amendments will impact approximately 247 ``small entities'' which 
are subject to the provisions of Rule 15c3-1 and have listed options 
positions insofar as they would be required to implement a computer 
interface with a third-party vendor in order to receive reliable data 
to calculate haircuts. The Commission recognizes, however, that some 
broker-dealers with very limited options positions might find it cost 
prohibitive to install such computerized interface with a model 
provider. In order to reduce the economic impact on these broker-
dealers, the amendments include an alternative haircut methodology that 
is based on the basic options strategies used by broker-dealers, and is 
similar to the approach used in the current rule.
    The Analysis also states that no federal securities laws duplicate, 
overlap, or conflict with the amendments, and adds that the Commission 
does not believe any less burdensome alternatives are available to 
accomplish the objectives of the amendments. In addition, the Analysis 
notes that the staff carefully considered the possibility that smaller 
broker-dealers who elect the strategy-based approach may receive more 
severe haircut treatment than under the current rule because the 
strategy-based approach under the amendments is limited to a few very 
simple strategies. Because the Commission intended to eliminate the 
complicated overlay of strategies and interpretations that developed 
under the former rule to accommodate all dealer options strategies, and 
because smaller broker-dealers which elect the alternate approach will 
not be required to incur the costs associated with adopting a new 
system to employ models, the Commission believes the amendments should 
have a minimal adverse impact on small businesses or small 
organizations. As such, the amendments contain no additional reporting, 
recordkeeping, or other compliance requirements. For additional 
information, a copy of the Analysis may be obtained by contacting Peter 
Geraghty (202/942-0177) or Louis A. Randazzo (202/942-0191), Division 
of Market Regulation, Securities and Exchange Commission, Washington, 
D.C. 20549.

V. Paperwork Reduction Act

    The text of the amendments contain ``collection of information'' 
requirements within the meaning of the Paperwork Reduction Act of 1995 
(``PRA'').21 Broker-dealers subject to the rule are required to 
notify the Commission and the appropriate designated examining 
authority whenever their level of net capital falls below a prescribed 
level for any period exceeding three business days, and whenever there 
is a liquidating deficit in a specialist's market-maker account. These 
same notification obligations exist under the present rule before 
adoption of the amendments.22 Consequently, the amendment does not 
change the PRA collection of information requirements or burden under 
Rule 15c3-1. The Commission recently received an extension from the 
Office of Management and Budget (``OMB'') for the collection of 
information requirements contained in Rule 15c3-1. The title of the 
collection of information is ``Net Capital Requirements for Brokers and 
Dealers, Rule 15c3-1.'' The OMB control number is 3235-0200. The 
Commission also reminds brokers and dealers subject to the amendments 
about their related recordkeeping obligations under Rule 17a-4.
---------------------------------------------------------------------------

    \21\ 44 U.S.C. Sec. 3501 et seq.
    \22\ See Rule 15c3-1(c)(2)(x).
---------------------------------------------------------------------------

VI. Statutory Analysis

    Pursuant to the Securities Exchange Act of 1934 and particularly 
Section 15(c)(3), (15 U.S.C. 78o(c)(3)) thereof, the Commission is 
adopting amendments to Sec. 240.15c3-1 of Title 17 of the Code of 
Federal Regulations in the manner set forth below.

List of Subjects in 17 CFR Part 240

    Brokers, Reporting and recordkeeping requirements, Securities.

Text of Final Rule

    In accordance with the foregoing, Title 17, chapter II, part 240 of 
the Code of Federal Regulations is amended as follows:

Part 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    1. The authority citation for Part 240 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77eee, 77ggg, 
77nnn, 77sss, 77ttt, 78c, 78d, 78f, 78i, 78j, 78k, 78k-1, 78l, 78m, 
78n, 78o, 78p, 78q, 78s, 78w, 78x, 78ll(d), 79q, 79t, 80a-20, 80a-
23, 80a-29, 80a-37, 80b-3, 80b-4 and 80b-11, unless otherwise noted.
* * * * *
    2. Section 240.15c3-1 is amended by removing and reserving 
paragraph (a)(7).
    3. Section 240.15c3-1 is amended by adding an undesignated center 
heading before paragraph (c)(2)(x) and revising paragraph (c)(2)(x) to 
read as follows:


Sec. 240.15c3-1  Net capital requirements for brokers or dealers.

* * * * *
    (c) * * *
    (2) * * *

Brokers or Dealers Carrying Accounts of Listed Options Specialists

    (x)(A) With respect to any transaction of a specialist in listed 
options, who is either not otherwise subject to the provisions of this 
section or is described in paragraph (c)(2)(vi)(N) of this section, for 
whose specialist account a broker or dealer acts as a guarantor, 
endorser, or carrying broker or dealer, such broker or dealer shall 
adjust its net worth by deducting as of noon of each business day the 
amounts computed as of the prior business day pursuant to 
Sec. 240.15c3-1a. The required deductions may be reduced by any 
liquidating equity that exists in such specialist's market-maker 
account as of that time and shall be increased to the extent of any 
liquidating deficit in such account. Noon shall be determined according 
to

[[Page 6481]]

the local time where the broker or dealer is headquartered. In no event 
shall excess equity in the specialist's market-maker account result in 
an increase of the net capital of any such guarantor, endorser, or 
carrying broker or dealer.
    (B) Definitions. (1) The term listed option shall mean any option 
traded on a registered national securities exchange or automated 
facility of a registered national securities association.
    (2) For purposes of this section, the equity in an individual 
specialist's market-maker account shall be computed by:
    (i) Marking all securities positions long or short in the account 
to their respective current market values;
    (ii) Adding (deducting in the case of a debit balance) the credit 
balance carried in such specialist's market-maker account; and
    (iii) Adding (deducting in the case of short positions) the market 
value of positions long in such account.
    (C) No guarantor, endorser, or carrying broker or dealer shall 
permit the sum of the deductions required pursuant to Sec. 240.15c3-1a 
in respect of all transactions in specialists' market-maker accounts 
guaranteed, endorsed, or carried by such broker or dealer to exceed 
1,000 percent of such broker's or dealer's net capital as defined in 
Sec. 240.15c3-1(c)(2) for any period exceeding three business days. If 
at any time such sum exceeds 1,000 percent of such broker's or dealer's 
net capital, then the broker or dealer shall:
    (1) Immediately transmit telegraphic or facsimile notice of such 
event to the Division of Market Regulation in the headquarters office 
of the Commission in Washington, D.C., to the district or regional 
office of the Commission for the district or region in which the broker 
or dealer maintains its principal place of business, and to its 
examining authority designated pursuant to section 17(d) of the Act (15 
U.S.C. 78q(d)) (``Designated Examining Authority''); and
    (2) Be subject to the prohibitions against withdrawal of equity 
capital set forth in Sec. 240.15c3-1(e) and to the prohibitions against 
reduction, prepayment, and repayment of subordination agreements set 
forth in paragraph (b)(11) of Sec. 240.15c3-1d, as if such broker or 
dealer's net capital were below the minimum standards specified by each 
of those paragraphs.
    (D) If at any time there is a liquidating deficit in a specialist's 
market-maker account, then the broker or dealer guaranteeing, 
endorsing, or carrying listed options transactions in such specialist's 
market-maker account may not extend any further credit in that account, 
and shall take steps to liquidate promptly existing positions in the 
account. This paragraph shall not prevent the broker or dealer from, 
upon approval by the broker's or dealer's Designated Examining 
Authority, entering into hedging positions in the specialist's market-
maker account. The broker or dealer also shall transmit telegraphic or 
facsimile notice of the deficit and its amount by the close of business 
of the following business day to its Designated Examining Authority and 
the Designated Examining Authority of the specialist, if different from 
its own.
    (E) Upon written application to the Commission by the specialist 
and the broker or dealer guaranteeing, endorsing, or carrying options 
transactions in such specialist's market-maker account, the Commission 
may approve upon specified terms and conditions lesser adjustments to 
net worth than those specified in Sec. 240.15c3-1a.
* * * * *
    4. Section 240.15c3-1a is revised to read as follows:


Sec. 240.15c3-1a  Options (Appendix A to 17 CFR 240.15c3-1).

    (a) Definitions. (1) The term unlisted option shall mean any option 
not included in the definition of listed option provided in paragraph 
(c)(2)(x) of Sec. 240.15c3-1.
    (2) The term option series refers to listed option contracts of the 
same type (either a call or a put) and exercise style, covering the 
same underlying security with the same exercise price, expiration date, 
and number of underlying units.
    (3) The term related instrument within an option class or product 
group refers to futures contracts and options on futures contracts 
covering the same underlying instrument. In relation to options on 
foreign currencies a related instrument within an option class also 
shall include forward contracts on the same underlying currency.
    (4) The term underlying instrument refers to long and short 
positions, as appropriate, covering the same foreign currency, the same 
security, or a security which is exchangeable for or convertible into 
the underlying security within a period of 90 days. If the exchange or 
conversion requires the payment of money or results in a loss upon 
conversion at the time when the security is deemed an underlying 
instrument for purposes of this Appendix A, the broker or dealer will 
deduct from net worth the full amount of the conversion loss. The term 
underlying instrument shall not be deemed to include securities 
options, futures contracts, options on futures contracts, qualified 
stock baskets, or unlisted instruments.
    (5) The term options class refers to all options contracts covering 
the same underlying instrument.
    (6) The term product group refers to two or more option classes, 
related instruments, underlying instruments, and qualified stock 
baskets in the same portfolio type (see paragraph (b)(1)(ii) of this 
section) for which it has been determined that a percentage of 
offsetting profits may be applied to losses at the same valuation 
point.
    (b) The deduction under this Appendix A to Sec. 240.15c3-1 shall 
equal the sum of the deductions specified in paragraphs (b)(1)(v)(C) or 
(b)(2) of this section.

Theoretical Pricing Charges

    (1)(i) Definitions.
    (A) The terms theoretical gains and losses shall mean the gain and 
loss in the value of individual option series, the value of underlying 
instruments, related instruments, and qualified stock baskets within 
that option's class, at 10 equidistant intervals (valuation points) 
ranging from an assumed movement (both up and down) in the current 
market value of the underlying instrument equal to the percentage 
corresponding to the deductions otherwise required under Sec. 240.15c3-
1 for the underlying instrument (See paragraph (a)(1)(iii) of this 
section). Theoretical gains and losses shall be calculated using a 
theoretical options pricing model that satisfies the criteria set forth 
in paragraph (a)(1)(i)(B) of this section.
    (B) The term theoretical options pricing model shall mean any 
mathematical model, other than a broker-dealer proprietary model, 
approved by a Designated Examining Authority. Such Designated Examining 
Authority shall submit the model to the Commission, together with a 
description of its methods for approving models. Any such model shall 
calculate theoretical gains and losses as described in paragraph 
(a)(1)(i)(A) of this section for all series and issues of equity, index 
and foreign currency options and related instruments, and shall be made 
available equally and on the same terms to all registered brokers or 
dealers. Its procedures shall include the arrangement of the vendor to 
supply accurate and timely data to each broker-dealer with respect to 
its services, and the fees for distribution of the services. The data 
provided to brokers or dealers shall also contain the minimum 
requirements set forth in paragraphs (b)(1)(v)(C) of this section and 
the

[[Page 6482]]

product group offsets set forth in paragraphs (b)(1)(v)(B) of this 
section. At a minimum, the model shall consider the following factors 
in pricing the option:

(1) The current spot price of the underlying asset;
(2) The exercise price of the option;
(3) The remaining time until the option's expiration;
(4) The volatility of the underlying asset;
(5) Any cash flows associated with ownership of the underlying asset 
that can reasonably be expected to occur during the remaining life of 
the option; and
(6) The current term structure of interest rates.

    (C) The term major market foreign currency shall mean the currency 
of a sovereign nation whose short-term debt is rated in one of the two 
highest categories by at least two nationally recognized statistical 
rating organizations and for which there is a substantial inter-bank 
forward currency market. For purposes of this section, the European 
Currency Unit (ECU) shall be deemed a major market foreign currency.
    (D) The term qualified stock basket shall mean a set or basket of 
stock positions which represents no less than 50% of the capitalization 
for a high-capitalization or non-high-capitalization diversified market 
index, or, in the case of a narrow-based index, no less than 95% of the 
capitalization for such narrow-based index.
    (ii) With respect to positions involving listed options in a single 
specialist's market-maker account, and, separately, with respect to 
positions involving listed option positions in its proprietary or other 
account, the broker or dealer shall group long and short positions into 
the following portfolio types:
    (A) Equity options on the same underlying instrument and positions 
in that underlying instrument;
    (B) Options on the same major market foreign currency, positions in 
that major market foreign currency, and related instruments within 
those options' classes;
    (C) High-capitalization diversified market index options, related 
instruments within the option's class, and qualified stock baskets in 
the same index;
    (D) Non-high-capitalization diversified index options, related 
instruments within the index option's class, and qualified stock 
baskets in the same index; and
    (E) Narrow-based index options, related instruments within the 
index option's class, and qualified stock baskets in the same index.
    (iii) Before making the computation, each broker or dealer shall 
obtain the theoretical gains and losses for each options series and for 
the related and underlying instruments within those options' class in 
each specialist's market-maker account guaranteed, endorsed, or carried 
by a broker or dealer, or in the proprietary or other accounts of that 
broker or dealer. For each option series, the theoretical options 
pricing model shall calculate theoretical prices at 10 equidistant 
valuation points within a range consisting of an increase or a decrease 
of the following percentages of the daily market price of the 
underlying instrument:

(A) +(-)15% for equity securities with a ready market, narrow-based 
indexes, and non-high-capitalization diversified indexes;
(B) +(-)6% for major market foreign currencies;
(C) +(-) 20% for all other currencies; and
(D) +(-)10% for high-capitalization diversified indexes.

    (iv)(A) As to non-clearing option specialists and market-makers, 
the percentages of the daily market price of the underlying instrument 
shall be:

(1) +(-) 4\1/2\% for major market foreign currencies; and
(2) +6(-)8% for high-capitalization diversified indexes.
(3) +(-) 10% for a non-clearing market-maker, or specialist in non-high 
capitalization diversified index product group.

    (B) The provisions of this paragraph (b)(1)(iv) shall expire two 
years from September 1, 1997, unless otherwise extended by the 
Commission.
    (v)(A) The broker or dealer shall multiply the corresponding 
theoretical gains and losses at each of the 10 equidistant valuation 
points by the number of positions held in a particular options series, 
the related instruments and qualified stock baskets within the option's 
class, and the positions in the same underlying instrument.
    (B) In determining the aggregate profit or loss for each portfolio 
type, the broker or dealer will be allowed the following offsets in the 
following order, provided, that in the case of qualified stock baskets, 
the broker or dealer may elect to net individual stocks between 
qualified stock baskets and take the appropriate deduction on the 
remaining, if any, securities:
    (1) First, a broker or dealer is allowed the following offsets 
within an option's class:
    (i) Between options on the same underlying instrument, positions 
covering the same underlying instrument, and related instruments within 
the option's class, 100% of a position's gain shall offset another 
position's loss at the same valuation point;
    (ii) Between index options, related instruments within the option's 
class, and qualified stock baskets on the same index, 95%, or such 
other amount as designated by the Commission, of gains shall offset 
losses at the same valuation point;
    (2) Second, a broker-dealer is allowed the following offsets within 
an index product group:
    (i) Among positions involving different high-capitalization 
diversified index option classes within the same product group, 90% of 
the gain in a high-capitalization diversified market index option, 
related instruments, and qualified stock baskets within that index 
option's class shall offset the loss at the same valuation point in a 
different high-capitalization diversified market index option, related 
instruments, and qualified stock baskets within that index option's 
class;
    (ii) Among positions involving different non-high-capitalization 
diversified index option classes within the same product group, 75% of 
the gain in a non-high-capitalization diversified market index option, 
related instruments, and qualified stock baskets within that index 
option's class shall offset the loss at the same valuation point in 
another non-high-capitalization diversified market index option, 
related instruments, and qualified stock baskets within that index 
option's class or product group;
    (iii) Among positions involving different narrow-based index option 
classes within the same product group, 90% of the gain in a narrow-
based market index option, related instruments, and qualified stock 
baskets within that index option's class shall offset the loss at the 
same valuation point in another narrow-based market index option, 
related instruments, and qualified stock baskets within that index 
option's class or product group;
    (iv) No qualified stock basket should offset another qualified 
stock basket; and
    (3) Third, a broker-dealer is allowed the following offsets between 
product groups: Among positions involving different diversified index 
product groups within the same market group, 50% of the gain in a 
diversified market index option, a related instrument, or a qualified 
stock basket within that index option's product group shall offset the

[[Page 6483]]

loss at the same valuation point in another product group;
    (C) For each portfolio type, the total deduction shall be the 
larger of:
    (1) The amount for any of the 10 equidistant valuation points 
representing the largest theoretical loss after applying the offsets 
provided in paragraph (b)(1)(v)(B) if this section; or
    (2) A minimum charge equal to 25% times the multiplier for each 
equity and index option contract and each related instrument within the 
option's class or product group, or $25 for each option on a major 
market foreign currency with the minimum charge for futures contracts 
and options on futures contracts adjusted for contract size 
differentials, not to exceed market value in the case of long positions 
in options and options on futures contracts; plus
    (3) In the case of portfolio types involving index options and 
related instruments offset by a qualified stock basket, there will be a 
minimum charge of 5% of the market value of the qualified stock basket 
for high-capitalization diversified and narrow-based indexes; and
    (4) In the case of portfolio types involving index options and 
related instruments offset by a qualified stock basket, there will be a 
minimum charge of 7\1/2\% of the market value of the qualified stock 
basket for non-high-capitalization diversified indexes.

Alternative Strategy Based Method

    (2) A broker or dealer may elect to apply the alternative strategy 
based method in accordance with the provisions of this paragraph 
(b)(2).
    (i) Definitions. (A) The term intrinsic value or in-the-money 
amount shall mean the amount by which the exercise value, in the case 
of a call, is less than the current market value of the underlying 
instrument, and, in the case of a put, is greater than the current 
market value of the underlying instrument.
    (B) The term out-of-the-money amount shall mean the amount by which 
the exercise value, in the case of a call, is greater than the current 
market value of the underlying instrument, and, in the case of a put, 
is less than the current market value of the underlying instrument.
    (C) The term time value shall mean the current market value of an 
option contract that is in excess of its intrinsic value.
    (ii) Every broker or dealer electing to calculate adjustments to 
net worth in accordance with the provisions of this paragraph (b)(2) 
must make the following adjustments to net worth:
    (A) Add the time value of a short position in a listed option; and
    (B) Deduct the time value of a long position in a listed option, 
which relates to a position in the same underlying instrument or in a 
related instrument within the option class or product group as 
recognized in the strategies enumerated in paragraph (b)(2)(iii)(D) of 
this section; and
    (C) Add the net short market value or deduct the long market value 
of listed options as recognized in the strategies enumerated in 
paragraphs (b)(2)(iii)(E)(1) and (2) of this section.
    (iii) In computing net capital after the adjustments provided for 
in paragraph (b)(2)(ii) of this section, every broker or dealer shall 
deduct the percentages specified in this paragraph (b)(2)(iii) for all 
listed option positions, positions covering the same underlying 
instrument and related instruments within the options' class or product 
group.

Uncovered Calls

    (A) Where a broker or dealer is short a call, deducting the 
percentage required by paragraphs (c)(2)(vi) (A) through (K) of 
Sec. 240.15c3-1 of the current market value of the underlying 
instrument for such option reduced by its out-of-the-money amount, to 
the extent that such reduction does not operate to increase net 
capital. In no event shall this deduction be less than the greater of 
$250 for each short call option contract for 100 shares or 50% of the 
aforementioned percentage.

Uncovered Puts

    (B) Where a broker or dealer is short a put, deducting the 
percentage required by paragraphs (c)(2)(vi) (A) through (K) of 
Sec. 240.15c3-1 of the current market value of the underlying 
instrument for such option reduced by its out-of-the-money amount, to 
the extent that such reduction does not operate to increase net 
capital. In no event shall the deduction provided by this paragraph be 
less than the greater of $250 for each short put option contract for 
100 shares or 50% of the aforementioned percentage.

Long Positions

    (C) Where a broker or dealer is long puts or calls, deducting 50 
percent of the market value of the net long put and call positions in 
the same options series.

Certain Security Positions With Offsetting Options

    (D)(1) Where a broker or dealer is long a put for which it has an 
offsetting long position in the same number of units of the same 
underlying instrument, deducting the percentage required by paragraphs 
(c)(2)(vi) (A) through (K) of Sec. 240.15c3-1 of the current market 
value of the underlying instrument for the long offsetting position, 
not to exceed the out-of-the-money amount of the option. In no event 
shall the deduction provided by this paragraph be less than $25 for 
each option contract for 100 shares, provided that the minimum charge 
need not exceed the intrinsic value of the option.
    (2) Where a broker or dealer is long a call for which it has an 
offsetting short position in the same number of units of the same 
underlying instrument, deducting the percentage required by paragraphs 
(c)(2)(vi) (A) through (K) of Sec. 240.15c3-1 of the current market 
value of the underlying instrument for the short offsetting position, 
not to exceed the out-of-the-money amount of the option. In no event 
shall the deduction provided by this paragraph be less than $25 for 
each option contract for 100 shares, provided that the minimum charge 
need not exceed the intrinsic value of the option.
    (3) Where a broker or dealer is short a call for which it has an 
offsetting long position in the same number of units of the same 
underlying instrument, deducting the percentage required by paragraphs 
(c)(2)(vi) (A) through (K) of Sec. 240.15c3-1 of the current market 
value of the underlying instrument for the offsetting long position 
reduced by the short call's intrinsic value. In no event shall the 
deduction provided by this paragraph be less than $25 for each option 
contract for 100 shares.

Certain Spread Positions

    (E)(1) Where a broker or dealer is short a listed call and is also 
long a listed call in the same class of options contracts and the long 
option expires on the same date as or subsequent to the short option, 
the deduction, after adjustments required in paragraph (b) of this 
section, shall be the amount by which the exercise value of the long 
call exceeds the exercise value of the short call. If the exercise 
value of the long call is less than or equal to the exercise value of 
the short call, no deduction is required.
    (2) Where a broker or dealer is short a listed put and is also long 
a listed put in the same class of options contracts and the long option 
expires on the same date as or subsequent to the short option, the 
deduction, after the adjustments required in paragraph (b) of this 
section, shall be the amount by which the exercise value of the short 
put exceeds the exercise value of the long put. If the exercise value 
of the long put is equal to or greater than the

[[Page 6484]]

exercise value of the short put, no deduction is required.
    (c) With respect to transactions involving unlisted options, every 
broker or dealer shall determine the value of unlisted option positions 
in accordance with the provision of paragraph (c)(2)(i) of 
Sec. 240.15c3-1, and shall deduct the percentages of all securities 
positions or unlisted options in the proprietary or other accounts of 
the broker or dealer specified in this paragraph (c). However, where 
computing the deduction required for a security position as if the 
security position had no related unlisted option position and positions 
in unlisted options as if uncovered would result in a lesser deduction 
from net worth, the broker or dealer may compute such deductions 
separately.

Uncovered Calls

    (1) Where a broker or dealer is short a call, deducting 15 percent 
(or such other percentage required by paragraphs (c)(2)(vi) (A) through 
(K) of Sec. 240.15c3-1) of the current market value of the security 
underlying such option reduced by any excess of the exercise value of 
the call over the current market value of the underlying security. In 
no event shall the deduction provided by this paragraph be less than 
$250 for each option contract for 100 shares.

Uncovered Puts

    (2) Where a broker or dealer is short a put, deducting 15 percent 
(or such other percentage required by paragraphs (c)(2)(vi) (A) through 
(K) of Sec. 240.15c3-1) of the current market value of the security 
underlying the option reduced by any excess of the market value of the 
underlying security over the exercise value of the put. In no event 
shall the deduction provided by this paragraph be less than $250 for 
each option contract for 100 shares.

Covered Calls

    (3) Where a broker or dealer is short a call and long equivalent 
units of the underlying security, deducting 15 percent (or such other 
percentage required by paragraphs (c)(2)(vi) (A) through (K) of 
Sec. 240.15c3-1) of the current market value of the underlying security 
reduced by any excess of the current market value of the underlying 
security over the exercise value of the call. No reduction under this 
paragraph shall have the effect of increasing net capital.

Covered Puts

    (4) Where a broker or dealer is short a put and short equivalent 
units of the underlying security, deducting 15 percent (or such other 
percentage required by paragraphs (c)(2)(vi) (A) through (K) of 
Sec. 240.15c3-1) of the current market value of the underlying security 
reduced by any excess of the exercise value of the put over the market 
value of the underlying security. No such reduction shall have the 
effect of increasing net capital.

Conversion Accounts

    (5) Where a broker or dealer is long equivalent units of the 
underlying security, long a put written or endorsed by a broker or 
dealer and short a call in its proprietary or other accounts, deducting 
5 percent (or 50 percent of such other percentage required by 
paragraphs (c)(2)(vi) (A) through (K) of Sec. 240.15c3-1) of the 
current market value of the underlying security.
    (6) Where a broker or dealer is short equivalent units of the 
underlying security, long a call written or endorsed by a broker or 
dealer and short a put in his proprietary or other accounts, deducting 
5 percent (or 50 percent of such other percentage required by 
paragraphs (c)(2)(vi) (A) through (K) of Sec. 240.15c3-1) of the market 
value of the underlying security.

Long Options

    (7) Where a broker or dealer is long a put or call endorsed or 
written by a broker or dealer, deducting 15 percent (or such other 
percentage required by paragraphs (c)(2)(vi) (A) through (K) of 
Sec. 240.15c3-1) of the market value of the underlying security, not to 
exceed any value attributed to such option in paragraph (c)(2)(i) of 
Sec. 240.15c3-1.

    By the Commission.

    Dated: February 6, 1997.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-3479 Filed 2-11-97; 8:45 am]
BILLING CODE 8010-01-P