[Federal Register Volume 62, Number 96 (Monday, May 19, 1997)]
[Notices]
[Pages 27285-27286]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-17034]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38622; File No. SR-NSCC-97-04]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of Filing and Order Extending Temporary Approval on 
an Accelerated Basis of a Proposed Rule Change that Establishes 
Additional Procedures for Class A Surveillance of Certain Settling 
Members and Permits the Collection of Clearing Fund and Other 
Collateral Deposits From These Settling Members

May 13, 1997.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on March 27, 1997, the 
National Securities Clearing Corporation (``NSCC'') filed with the 
Securities and Exchange Commission (``Commission'') the proposed rule 
change (File No. SR-NSCC-97-04) as described in Items I and II below, 
which items have been prepared primarily by NSCC. The Commission is 
publishing this notice to solicit comments on the proposed rule change 
from interested persons and to extend on an accelerated basis temporary 
approval of the proposed rule change through May 31, 1998.
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    \1\ 15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The proposed rule change seeks to extend the temporary approval of 
additional procedures which govern the placement of NSCC members on 
Class A surveillance and the clearing fund deposit and other collateral 
requirements for such members.\2\
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    \2\ Securities Exchange Act Release No. 37202 (May 10, 1996), 61 
FR 24993 [File No. SR-NSCC-95-17] (temporary approval of proposed 
rule change) (``May approval order'').
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II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NSCC included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. NSCC has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of such 
statements.\3\
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    \3\ The Commission has modified the text of the summaries 
submitted by NSCC.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    NSCC seeks to extend the temporary approval of a rule change 
governing the application of Class A surveillance procedures \4\ and 
the additional collateralization requirements to settling members that 
engage in certain over-the-counter (``OTC'') market making 
activities.\5\ To decrease the risks associated with OTC market makers, 
NSCC has added Addendum O to its rules and procedures. Addendum O 
permits NSCC to place settling members on Class A surveillance if they 
clear for or are themselves OTC market makers and (1) they do not have 
sufficient capital or access to capital to support either potential 
increases in market making activity in dominated issues or (2) any 
additional risk factors are present.\6\
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    \4\ Class A surveillance permits NSCC, among other things, to 
increase a settling member's clearing fund requirement by an amount 
equal to (i) up to 5% of the settling member's CNS long fail 
positions plus (ii) up to 5% of the settling member's short fail 
positions plus (iii) 2.5% or at NSCC's discretion up to 5% of the 
settling member's average non-CNS and non-mutual fund service 
credits. NSCC Rules and Procedures, Addendum B, IV (C).
    \5\ NSCC's Board of Directors has determined that under certain 
circumstances settling members which clear securities transactions 
for OTC market makers or which themselves engage in OTC market 
making, can have their financial viability materially impacted by 
such business (e.g., if a market maker takes net positions that are 
a disproportionately large percentage of one side of the market 
(i.e., dominates the issue)). Furthermore, if these market makers 
have insufficient capital or insufficient access to capital and 
engage in market domination with regard to a particular issue either 
directly by participating in OTC market making or indirectly by 
clearing transactions for OTC market makers, NSCC believes that the 
risk of default by the settling member increases. In turn, this 
could potentially increase NSCC's exposure because NSCC is obligated 
to complete defaulting settling members' unsettled trades once 
NSCC's trade guarantee attaches.
    \6\ These risk factors include, without limitation:
    (1) concentrated short selling in dominated issues;
    (2) undue concentration of securities held in inventory by 
market maker(s) for dominated issues;
    (3) dominated issues also being IPOs less than six months past 
initial issuance particularly when the current value of the issue is 
significantly different from its initial sales price or there is 
undue concentration of inventory in the managing underwriter(s); and
    (4) clearing positions of market makers in dominated issues away 
from their primary clearing brokers.
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    To further reduce its potential exposure to OTC market making 
activities, NSCC also has adopted an interim collateralization policy 
which permits NSCC in its discretion to require settling members placed 
on Class A surveillance that clear for or are themselves OTC market 
makers to deposit special collateral in amounts based upon the settling 
member's OTC activities relative to its amount of excess net 
capital.\7\ The special collateralization requirements are interim 
measures for settling members on Class A surveillance to be in effect 
until NSCC has gained enough experience in surveillance of OTC market 
maker trading activities to impose permanent special collateralization 
requirements.
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    \7\ For a complete description of the special collateralization 
requirements, refer to the May approval order, supra note 2.
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    Because NSCC believes that its settling members on Class A 
surveillance present a higher than normal risk of default and 
insolvency, NSCC now bases such settling members' clearing fund 
deposits on the close-out risk presented by their unsettled positions 
in NSCC's systems. Under the temporary rule change, NSCC has the 
discretion to compute the Continuous Net Settlement (``CNS'') component 
of the clearing fund requirements for any settling member on Class A 
surveillance according to an alternative formula based upon such close-
out risk.\8\
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    \8\ For a complete description of the alternative CNS clearing 
fund formula, refer to the May approval order, supra note 2.
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    The Commission approved the proposed rule change on a temporary 
basis so that NSCC could gain additional experience in the surveillance 
of OTC market makers and the risks posed by clearing such activity. The 
Commission also noted in its May approval order that NSCC would be able 
to gain experience with the additional collateralization requirements 
and alternative clearing fund formula for settling members subject to 
Class A surveillance. NSCC believes that additional experience with 
respect to these matters is desirable before seeking permanent approval 
of these requirements.
    NSCC believes that the proposed rule change is consistent with the

[[Page 27286]]

requirements of Section 17A(b)(3)(F) \9\ of the Act and the rules and 
regulations thereunder since it will facilitate the prompt and accurate 
clearance and settlement of securities transactions and, in general, 
will protect investors and the public interest.
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    \9\ 15 U.S.C. 78q-1(b)(3)(F).
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(B) Self-Regulatory Organization's Statement on Burden on Competition

    NSCC does not believe that the proposed rule change will have an 
impact on or impose a burden on competition.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants, or Others

    No written comments relating to the proposed rule change have been 
solicited or received. NSCC will notify the Commission of any written 
comments received by NSCC.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Section 17A(b)(3)(F) \10\ of the Act requires that the rules of a 
clearing agency be designed to assure the safeguarding of securities 
and funds which are in the custody or control of the clearing agency 
and generally to protect investors and the public interest. The 
Commission believes the proposed rule change is consistent with NSCC's 
obligations under the Act because it will allow NSCC to take particular 
action to protect itself, its members, and investors in situations 
where settling members pose an increased risk because of their 
involvement in OTC market making.
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    \10\ Id.
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    Under the proposal, NSCC will continue to have the authority with 
respect to settling members which participate in OTC market making 
activities or clear for correspondents that engage in such activity (1) 
to place such members on Class A surveillance, (2) to require such 
members to post additional collateral with NSCC, and (3) to calculate 
an alternative clearing fund requirement for such members when 
additional risk factors are present. Collectively, the higher level of 
surveillance, the additional level of collateralization, and the 
alternative clearing fund requirements should help to ameliorate NSCC's 
exposure which in turn should assist NSCC in fulfilling its obligations 
under the Act to safeguard securities and funds for which it has 
control of or is responsible for and to protect investors and the 
public interest.
    At NSCC's request, the Commission is extending temporary approval 
of the proposed rule change through May 31, 1998, so that NSCC can gain 
additional experience in the surveillance of OTC market makers and the 
risks posed by clearing such activity prior to permanent imposition of 
the new Class A surveillance procedures, collateralization 
requirements, and alternative clearing fund formula. Temporary approval 
also will allow both the Commission and NSCC to continue to observe 
whether the additional collateralization and alternative clearing fund 
requirements adequately protect NSCC, its members, and investors from 
the expected risks of participating in and clearing OTC market maker 
activity and whether adjustments to the procedures are necessary.\11\
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    \11\ As noted in the May approval order, prior to filing a 
proposed rule change seeking permanent approval of the procedures 
set forth in this temporary approval order, NSCC shall present to 
the Commission a more detailed report on its findings regarding the 
adequacy of the controls and discussing any changes to be made to 
the procedures. During the temporary approval period, NSCC will 
continue to apprise the Commission from time to time on the 
operation of the Class A surveillance procedures, additional 
collateralization requirements, and alternative clearing fund 
formula to enable the Commission to monitor the implementation of 
such requirements.
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    The Commission finds good cause for approving the proposed rule 
change prior to the thirtieth day after the date of publication of 
notice of filing because accelerated approval will allow NSCC to 
continue to utilize its Class A surveillance procedures, the interim 
collateralization policy, and the alternative clearing fund formula 
without interruption and therefore to continue to protect itself, its 
participants, and investors in general from the potential risks of OTC 
market making activities.

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 change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change 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. 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 NSCC. All submissions should 
refer to the file number SR-NSCC-97-04 and should be submitted by June 
9, 1997.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-NSCC-97-04) be, and hereby 
is, approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-17034 Filed 5-16-97; 8:45 am]
BILLING CODE 8010-01-M