[Federal Register Volume 62, Number 115 (Monday, June 16, 1997)]
[Notices]
[Pages 32669-32672]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-15713]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38729; File No. SR-NASD-97-14]
Self-Regulatory Organizations; Order Granting Approval of
Proposed Rule Change and Notice of Filing and Order Granting
Accelerated Approval of Amendment No. 1 Thereto by the National
Association of Securities Dealers, Inc., Relating to the Amendment of
its Margin Rules
June 10, 1997.
I. Introduction
On February 26, 1997, the NASD Regulation, Inc. (``NASD
Regulation'') submitted to the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to amend certain sections of the
National Association of Securities Dealers, Inc.'s (``NASD'' or
``Association'') margin rules.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4
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The proposed rule change was published for comment in Securities
Exchange Act Release No. 38463 (April 1, 1997), 62 FR 17260 (April 9,
1997). the NASD submitted to the Commission Amendment No. 1 on May 30,
1997.\3\ No comments were received on the proposal.
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\3\ See Letter from Elliot R. Curzon, Assistant General Counsel,
NASD Regulation, to Katherine A. England, Assistant Director,
Division of Market Regulation (``Market Regulation''), Commission,
dated May 30, 1997 (``NASD Amendment No. 1'').
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This order approves the proposed rule change.
II. Description of the Proposal
The NASD Regulation proposes to amend its margin rule, Rule 2520 of
the Conduct Rules, of the NASD. Specifically, the NASD Regulation
proposes to amend Rule 2420 (``old Rule 2520) to: (1) renumber
paragraphs (a) and (b) as Rules 2521 and 2522, respectively, and
renumber paragraph (c) as Rule 2520 (referred to herein as ``Rule
2520''); (2) conform Rule 2520 to recent amendments to Regulation T
(``Regulation T'') \4\ of the Board of Governors of the Federal Reserve
System (``Federal Reserve Board'' or ``Board''); and (3) add margin
requirements for various over-the-counter (``OTC'') options and
interest rate composite securities.
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\4\ 12 CFR 220.1 through 19 (1996).
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As a result of the Federal Reserve Board's recent amendments to
Regulation T, which governs the extension of credit by broker/
dealers,\5\ and the NYSE's proposed amendments to its margin rule, NYSE
Rule 431,\6\ NASD Regulation proposes to renumber old Rule 2520 so as
to permit its members and others to more easily use and compare the
provisions of the rule with NYSE Rule 431. In addition, NASD Regulation
proposes amendments to Rule 2520, the NASD's margin rule, to conform
the NASD's margin requirements to those of Regulation T and NYSE Rule
431.
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\5\ See 61 FR 20386 (May 6, 1996) (Federal Reserve Board's
release adopting certain changes to Regulation T).
\6\ See Securities Exchange Act Release No. 38708 (June 2, 1997)
(Commission order approving SR-NYSE-97-01, margin rule changes by
NYSE).
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Numbering
The NASD Regulation proposes to renumber old Rule 2520 by: (1)
Renumbering paragraphs (a) and (b) as Rules 2521 and 2522,
respectively; and (2) renumbering paragraph (c) as Rule 2520. The NASD
Regulation states that this renumbering will cause most of the
paragraphs and subparagraphs of Rule 2520 to have the same numbering as
those of NYSE Rule 431, thereby facilitating comparison and use of the
two rules. The renumbered Rule 2520 is set forth in Exhibit 2 to the
rule filing; however, the former numbering of each subsection is not
shown.
Amendments to Conform Rule 2520 to Regulation T
The NASD Regulation proposes two technical changes to Rule 2520 (as
renumbered) to correct references to recently-repealed or renumbered
provisions of Regulation T: (1) definition of OTC margin bond, and (2)
cash equivalent. NASD Rule 2520(e)(2)(C), which refers to the
definition of OTC margin bond as stated in Regulation T, 12 CFR
220.2(t),\7\ is proposed to be amended to eliminate the ``(t)'' because
Regulation T, 12 CFR 220.2 has been amended to eliminate subsection
numbering. NASD Rule 2520(f)(2)(H)(iv), which refers to cash
equivalents as ``those instruments referred to in Section
220.8(a)(3)(ii) of Regulation T,'' is proposed to be amended to change
the reference to ``Section 220.2 of Regulation T.''
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\7\ The definition of OTC margin bond in Regulation T, 12 CFR
220.2 refers to several types of debt securities with specifically
defined characteristics, all of which are sold or traded over-the-
counter, not on an exchange.
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Amendments to Conform Rule 2520 to Recent Amendments to NYSE Rule 431
Option Products and Interest Rate Composites. NASD Rule 2520
currently
[[Page 32670]]
requires customer margin for short OTC stock and index options of 100%
of the option premium plus 45% of the current market value of the
underlying security. The NASD proposes to amend this rule by adding
specific margin requirements for OTC options equal to a specific
percentage of the current value of the underlying component to conform
these provisions with the corresponding provisions of NYSE Rule 431. In
addition, a new definition of the term ``underlying component'' is
being proposed as paragraph 2522(a)(66) to replace more complex
references to ``underlying security or the product of the current index
group value of the underlying index stock group.''
The principal amendments to Rule 2520, paragraphs (f)(2) (D) and
(F), include new initial and maintenance margin requirements (including
provisions for reduced margin requirements under certain circumstances)
for:
OTC options on stock and convertible corporate debt (30%),
industry index stock groups (30%) and broad index stock groups (20%).
OTC options on 30-year U.S. Treasury bonds and nonmortgage
backed U.S. Government agency debt securities that qualify for
exemption pursuant to SEC Rule 3a12-7 (3%).
OTC options on all other U.S. Government securities
including agency debt (5%), and marginable corporate debt securities
(15%). OTC options on all other securities including CMO's remain
subject to the current 45% general OTC option margin requirement.
Interest rate contracts (10%) to be consistent with other
exchanges.
In addition, the proposed amendments recognize certain spread and
straddle positions for margin purposes between listed and OTC options
when a customer's long and short positions are controlled by the same
broker-dealer.
Specialists and Market-Makers Options Margin. NASD Regulation has
also proposed to adopt specific provisions governing permitted offset
treatment for options market-makers and specialists that were deleted
from Regulation T as of June 1, 1997. The proposed rule sets forth
various permitted offset positions which may be cleared and carried by
a member organization on behalf of one or more options market-markers
or specialists upon a margin basis satisfactory to the concerned
parties (``good faith'' margin). In addition, it requires that the
amount of an deficiency between the equity maintained by the options
market-maker or specialists and the haircuts specified in SEC Rule
15c3-1 \8\ shall be considered as a deduction from net worth in the net
capital computation of the carrying broker.
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\1\ See Securities Exchange Act Release No. 38248 (February 6,
1997) 62 FR 6474 (February 12, 1997) (Final rule adopting changes to
SEC Rule 15c3-1).
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III. Discussion
After careful review of the NASD's proposed amendment to its margin
rules, and for the reasons discussed below, the Commission believes
that the proposed rule filing is consistent with the requirements of
the Act and the rules and regulations thereunder applicable to an
association, and, in particular, with the requirements of Section
15A(b).\9\
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\9\ 15 U.S.C. 78o-3.
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Specifically, the Commission believes the proposed rule filing is
consistent with the Section 15A(b)(6) requirements that an association
have rules that are designed to prevent fraudulent and manipulative
acts and practices, to promote just and equitable principles of trade,
to foster cooperation and coordination with persons engaged in
regulating, clearing, settling, processing information with respect to,
and facilitating transactions in securities, to remove impediments to
protect and perfect the mechanism of free and open market and a
national market system, and in general, to protect investors and the
public interest.\10\
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\10\ In approving these rules, the Commission has considered the
proposed rules' impact on efficiency, competition, and capital
formation. 15 U.S.C. Sec. 78c(f).
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Numbering
The Commission supports the NASD's decision to renumber its Rule
2520 in order to streamline comparison with NYSE Rule 431. According to
the NASD, its former Article III, Section 30 of the NASD Rules of Fair
Practice had substantially the same margin requirements as NYSE Rule
431. The NASD states that several years ago Section 30 was amended to
adopt the same numbering scheme as NYSE Rule 431 in order to facilitate
the use and comparison of the two rules. Thus, any member could find
the provisions in both the NASD and NYSE's rules under the same
subsection number ``(f)(2).''
However, in 1996 the NASD Manual was reorganized and a new rule
numbering conventions were adopted that resulted in the renumbering of
Article III, Section 30, as old Rule 2520. Under the 1996 numbering
scheme, old Section 30.3(f)(2), for example, became old Rule
2520(c)(6)(B). As a result of these numbering changes, comparison
between old Rule 2520 and NYSE Rule 431 became more problematic.
NASD Regulation proposes to renumber old Rule 2520 by: (1)
Renumbering paragraphs (a) and (b) as Rules 2521 and 2522,
respectively; and (2) renumbering paragraph (c) as Rule 2520. The
proposed changes will once again result in most of the paragraphs and
subparagraphs of Rule 2520 having the same numbering as NYSE Rule 431,
thereby facilitating comparison and use of the two rules.
The Commission believes that the NASD, by renumbering its margin
rules to conform with NYSE Rule 431, is ensuring that a cohesive cross
reference is available to guide NASD members and interested
parties.\11\ The Commission believes the proposal by the NASD
Regulation will promote coordination in regulating, clearing, settling,
and facilitating transactions in securities by providing for uniformity
in the SROs' margin schemes and reducing confusion among customers. The
Commission believes that a more unified set of margin rules will
improve market efficiency, competition and capital formation, while at
the same time reducing the risk for conflict and misunderstanding which
can have detrimental effects on the market place especially regarding
the use of margins.
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\11\ The Commission notes that approval was granted to a
proposal by the Chicago Board Options Exchange, Incorporated
(``CBOE'') which conforms several of its margin rules to those of
the NYSE. See Securities Exchange Act Release No. 38709 (June 2,
1997), (Commission order approving SR-CBOE-97-17).
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Amendments to Conform Rule 2520 to Regulation T
The NASD Regulation proposes two technical changes to Rule 2520 (as
renumbered) to correct references to recently-repealed or renumbered
provisions of Regulation T: (1) definition of OTC margin bond, and (2)
cash equivalent. NASD Rule 2520(e)(2)(C), which refers to the
definition of OTC margin bond as stated in Regulation T, 12 CFR
220.2(t),\12\ is proposed to be amended to eliminate the ``(t)''
because Regulation T, 12 CFR 220.2 has been amended to eliminate
subsection numbering. NASD Rule 2520(f)(2)(H)(iv), which refers to cash
equivalents as ``those instruments referred to in Section
220.8(a)(3)(ii) of Regulation T,'' is proposed to be amended to change
the reference to ``Section 220.2 of Regulation T.'' This is necessary
because when Regulation T was amended, Section 220.8(a)(3)(ii) was
amended to eliminate conditions relating to cash equivalents and
Section
[[Page 32671]]
220.2 was amended by adding a definition of cash equivalents.
Accordingly, the Commission finds that these technical changes are
reasonable.
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\12\ See supra note 7.
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Amendments To Conform Rule 2520 to Recent Amendments to NYSE Rule 431
Option Products and Interest Rate Composites. NASD Rule 2520, which
currently requires customer margin for short OTC stock and index
options of 100% of the option premium plus 45% of the current market
value of the underlying security, is proposed to be amended by adding
specific margin requirements for OTC options equal to a specific
percentage of the current value of the underlying component to conform
this provision with corresponding provisions contained in NYSE Rule
431. In addition, a new definition of the term ``underlying component''
is being added as paragraph 2522(a)(66) to replace more complex
references to ``underlying security or the product of the current index
group value of the underlying index stock group.''
According to the NASD, the principal amendments to Rule 2520,
paragraphs (f)(2) (D) and (F), include new initial and maintenance
margin requirements (including provisions for reduced margin
requirements under certain circumstances) for:
OTC options on stock and convertible corporate debt (30%),
industry index stock groups (30%) and broad index stock groups (20%).
OTC options on 30-year U.S. Treasury bonds and non-
mortgage-backed U.S. Government agency debt securities that qualify for
exemption pursuant to SEC Rule 3a12-7 (3%).
OTC options on all other U.S. Government securities
including agency debt (5%), and marginable corporate debt securities
(15%). OTC options on all other securities including CMO's remain
subject to the current 45% general OTC option margin requirement.
Interest rate contracts (10%) to be consistent with other
exchanges.\13\
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\13\ The NASD does not have a margin requirement for interest
rate contracts in its rules. NASD Regulation is adding this
provision for interest rate contracts pursuant to this rule filing
in order to be consistent with the margin provisions of the NYSE.
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In addition, the proposed amendments recognize certain spread and
straddle positions for margin purposes between listed and OTC options
when a customer's long and short positions are controlled by the same
broker-dealer.
The margin treatment of OTC options proposed by the NASD Regulation
is being patterned after, and is nearly identical to, the provisions
contained in NYSE Rule 431(f)(2)(D)(iii). Given the near identical
nature of the NASD Regulation's proposal to the NYSE's previously
approved proposal, the Commission believes that adoption of these
proposed standards is reasonable. The Commission also believes that
this approach will promote coordination in regulating, clearing,
settling, and facilitating transactions in securities by providing for
uniformity in this area of the SROs' margin schemes and reducing
confusion among customers.
Specialists and Market-Makers Options Margin. The NASD Regulation
proposes changes to subparagraph (f)(2)(J) of Rule 2520 to make it
substantially identical to that of the NYSE rule dealing with margin
requirements for options transactions for market-makers and
specialists. NASD Regulation has also proposed adopting specific
provisions governing permitted offset treatment for market-makers and
specialists that were deleted from Regulation T as of June 1, 1997. The
proposed rule sets forth various permitted offset positions which may
be cleared and carried by a member organization on behalf of one or
more market-makers upon a margin basis satisfactory to the concerned
parties (``good faith'' margin). In addition, it requires that the
amount of any deficiency between the equity maintained by the market-
maker and the haircuts specified in SEC Rule 15c3-1 shall be considered
as a deduction from net worth in the net capital computation of the
carrying broker.
A permitted offset position will be defined to mean, in the case of
an option in which a market-maker makes a market, a position in the
underlying instrument or other related instrument, and in the case of
other securities in which a market-maker makes a market, a position in
options overlying the securities in which a market-maker makes a
market, if the account holds the following positions: (i) A long
position in the underlying instrument offset by a short option position
which is ``in- or at-the-money;'' (ii) a short position in the
underlying instrument offset by a long option position which is ``in-
or at-the-money;'' (iii) a stock position resulting from the assignment
of a market-maker short option position; (iv) a stock position
resulting from the exercise of a market-maker long position; (v) a net
long position in a security (other than an option) in which a market-
maker makes a market; (vi) a net short position in a security (other
than an option) in which the market-maker makes a market; or (vii) an
offset position as defined in SEC Rule 15c3-1.
The six proposed offsets described in proposed NASD Rule
2520(f)(2)(J) (a) to (f) codify the existing permitted offsets that
were provided under Regulation T until June 1, 1997. These offset
reflect well-recognized market-making hedging transactions involving
certain options offset strategies involving the related underlying
stock. The addition of NASD Rule 2520(f)(2)(J)(g), allowing any offset
position defined under SEC Rule 15c3-1,\14\ constitutes a significant
expansion of permitted offset positions. According to the NASD
Regulation, the inclusion of item (g) recognizes that options market-
makers and specialists must engage in various hedging transactions to
manage the risk involved in fulfilling their role, and, therefore,
allows a member organization to clear and carry options market-makers
and specialists offset positions as defined in SEC Rule 15c3-1 upon a
good faith margin basis. The NASD Regulation has clarified its proposal
to reflect that options market-makers and specialists are permitted to
relieve good faith margin for all permitted offset positions only if
they are effected for market-making purposes such as hedging, reducing
the risk of rebalancing, liquidating open positions of the market-
maker, accommodating customer orders, or another similar market-making
purpose.\15\
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\14\ See supra note 8.
\15\ See NASD Amendment No. 1, supra note 3.
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The Commission believes that the proposal is a reasonable effort by
NASD Regulation to accommodate the needs of options market-makers and
specialists in undertaking their market-making responsibilities as it
recognizes the occasional need for options market-makers and
specialists to effect transactions in their course of dealing in
options classes for which they are not registered. The Commission
believes that this approach will not adversely affect the depth and
liquidity necessary to maintain fair and orderly markets. The
Commission expects clearing firms that are members of the NASD and
other NASD members that extend margin to options market-makers and
specialists to implement adequate procedures to ensure that the elected
offsets are recorded accurately and cleared into appropriate accounts.
In addition, such members should have a reasonable basis for
determining that the offset transactions satisfy the market-making
requirements set forth in NASD Rule 462(d)2(J). The Commission believes
that these requirements will ensure that transactions effected by
options market-makers and specialists receiving the offset treatment
are in fact directly related to their market-making function
[[Page 32672]]
and are not effected for speculative purposes on a margin basis which
should be available only for bona fide market-making activity.
The proposed definition by NASD Regulation of ``in- or at-the-
money,'' for purposes of permitted offset transactions, represents a
codification of a long standing practice of permitting the financing of
options market-makers underlying stock positions on a good faith basis
when offset on a share-for-share basis by options which are ``in- or
at-the-money,'' i.e., where the current market price of the underlying
security is not more than two standard exercise price intervals below
(with respect to a call option) or above (with respect to a put option)
the exercise price of the option.\16\ At this time, the Commission
believes that it is reasonable for the NASD Regulation to adopt the
codification of a longstanding industry practice.
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\16\ The Commission approved a similar provision by the CBOE and
noted the CBOE's assertion that it has received oral no-action
relief from the Federal Reserve Board permitting the two standard
exercise price interval interpretation. See supra note 11.
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The Commission finds good cause for approving Amendment No. 1 prior
to the thirtieth day after the date of publication of notice of filing
thereof. Amendment No. 1 addresses technical changes by correcting
certain typographical errors appearing in the rule filing and also
clarifies that the availability of good faith margin for options
market-makers and specialists permitted offsets is limited to only bona
fide market-making transactions. Based on the above, the Commission
finds that there exists good cause consistent with Section 15A(b) of
the Act, to accelerate approval of the amendment.
IV Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 1. 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. Copies of all such
filing will also be available for inspection and copying at the
principal office of the NASD Regulation. All submissions should refer
to the file number SR-NASD-97-14 and should be submitted by July 7,
1997.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\17\ that the proposed rule change (SR-NASD-97-14) is approved.
\17\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\18\
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\18\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-15713 Filed 6-13-97; 8:45 am]
BILLING CODE 8010-01-M