[Federal Register Volume 63, Number 174 (Wednesday, September 9, 1998)]
[Notices]
[Pages 48286-48289]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-24092]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40384; File No. SR-CHX-98-12]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 to the Proposed Rule Change by the Chicago 
Stock Exchange, Inc. Relating to Joint Back Office Arrangements

August 31, 1998.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on May 28, 1998, the Chicago 
Stock Exchange, Inc. (``CHX'' or ``Exchange'') filed with the 
Securities and Exchange Commission (``SEC'' or ``Commission'') the 
proposed rule change as described in Items I, II, and III below, which 
Items have been prepared by the CHX.\2\ The Commission is publishing 
this notice to solicit comments on the proposed rule change from 
interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ On July 16, 1998, the CHX amended its proposal to replace 
incorrect references to Section 220.11 of Regulation T, ``Credit by 
Brokers and Dealers,'' of the Board of Governors of the Federal 
Reserve System (``FRB'') with reference to Section 220.7 of 
Regulation T. See Letter from David T. Rusoff, Foley & Lardner, to 
Yvonne Fraticelli, Attorney, Division of Market Regulation 
(``Division''), SEC, dated July 16, 1998 (``Amendment No. 1'').
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I. Self Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The CHX proposes to amend Interpretation .01 to CHX Article VI, 
Rule 3, ``Training and Examination Requirements,'' and CHX Article X, 
Rule 3, ``Initial Margin Rule.'' The CHX also proposes to adopt new CHX 
Rule 3A, ``Joint Back Office Participants,'' to CHX Article XI, 
``Financial Responsibility and Reporting Requirements.'' This proposal 
establishes examination, margin, and net capital requirements for joint 
back office (``JBO'') participants and clearing firms.
    The text of the proposed rule change is attached as Exhibit A.

II. Self Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the CHX included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposal. The text of these 
statements may be examined at the places specified in Item IV below. 
The CHX has prepared summaries, set forth in Sections A, B, and C 
below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Exchange proposes to amend Interpretation .01 to CHX Article 
VI, Rule 3 and CHX Article X, Rule 3, and to adopt new CHX Rule 3A to 
CHX Article XI to establish examination, margin and net capital 
requirements for JBO participants and clearing firms. JBO arrangements 
permit a participating broker-dealer to be deemed to be self-clearing 
for margin purposes and entitled to good faith credit.
    In recent amendments to Regulation T,\3\ the FRB placed its 
reliance on the authority of self-regulatory organizations (``SROs'') 
to ensure the reasonableness of JBO arrangements.\4\ When the provision 
permitting JBO arrangements was first adopted, the FRB assumed there 
would be a reasonable relationship between the good faith credit 
extended to a JBO participant and its ownership interest in the 
clearing firm. Consequently, the FRB did not establish any explicit 
requirement for the amount of ownership each participant should have in 
the JBO. Because Regulation T does not provide an ownership 
standard,\5\ however, good

[[Page 48287]]

faith credit has been extended to ``owners'' holding merely a nominal 
interest in a clearing firm.
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    \3\ 12 CFR 220. Regulation T is administered by the FRB pursuant 
to Section 7 of the Act.
    \4\ See FRB Docket No. R-0722 (April 26, 1996), 61 FR 20386 (May 
6, 1996).
    \5\ According to the CHX, Section 220.7(c) of Regulation T only 
requires that a JBO clearing firm be ``a clearing and servicing 
broker or dealer owned jointly or individually by other [broker-
dealers].''
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    In conjunction with other SROs, which received input from 
representatives of the securities industry, the Exchange has 
established standards for JBO participants and clearing firms.\6\ These 
standards will permit the extension of good faith credit to clearing 
firm ``owners'' only when the owners maintain meaningful assets on 
deposit with the JBO clearing firm, and the clearing firm maintains 
sufficient net capital and risk control procedures to carry such 
accounts. The Exchange's proposal will establish the following 
requirements:
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    \6\ The CHX's proposal is substantially similar to proposals 
filed with the Commission by other SROs. See Securities Exchange Act 
Release Nos. 39418 (December 10, 1997), 62 FR 66154 (December 17, 
1997) (notice of filing of File No. SR-CBOE-97-58); 39419 (December 
10, 1997), 62 FR 66169 (December 17, 1997) (notice of filing of File 
No. SR-PHLX-97-56); 39497 (December 29, 1997), 63 FR 899 (January 7, 
1998) (notice of filing of File No. SR-NYSE-97-28); and 39680 
(February 18, 1998), 63 FR 9622 (February 25, 1998) (notice of 
filing of File No. SR-PCX-97-49).
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    Notification. The proposed rule change will require a member or 
member organization for which the Exchange is the Designated Examining 
Authority (``DEA'') that wishes either to carry a JBO account or to be 
a JBO participant \7\ to notify the Exchange in writing of its 
intention.
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    \7\ The proposal defines a JBO participant as a member or member 
organization for which the CHX is the DEA that maintains a JBO 
arrangement with a carrying broker-dealer.
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    Net capital requirements. Proposed new Rule 3A to CHX Article XI 
will require each JBO participant to be a registered broker-dealer 
subject to the net capital requirements prescribed by SEC Rule 15c3-
1.\8\ JBO participants may not claim the net capital exemption 
available to option market makers under SEC Rule 15c3-1(b)(1)(i).\9\ 
JBO participants will be required to deposit and maintain minimum 
account equity of $1,000,000, with each broker-dealer where an account 
of the JBO participant is carried. JBO participants also will be 
subject to Financial and Operational Combined Uniform Single Report 
(``FOCUS'') filings and certified audits. In addition, each JBO 
participant must meet and maintain the ownership standards established 
by the JBO clearing member.
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    \8\ 17 CFR 240.15c3-1.
    \9\ 17 CFR 240.15c3-1(b)(i).
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    To ensure that adequate procedures exist for complying with these 
requirements, JBO participants will be required to designate one 
registered person associated with the member or member organization as 
a financial and operations principal. That person must successfully 
complete the Series 27 Financial and Operations Principal Examination 
(``Series 27 Examination'') administered by the National Association of 
Securities Dealers. JBO participants must file a Form U-4 (Uniform 
Application for Securities Industry Registration or Transfer) for the 
financial and operations principal and list such person as a ``control 
person'' on Schedule A of its Form BD (Uniform Application for Broker-
Dealer Registration).
    The financial and operations principal will have to register to 
take the Series 27 Examination within 30 days of the Exchange's 
publication of the order approving this requirement in a Notice to 
Members and promptly notify the Exchange that they have so registered. 
They will have six months from the date of the Notice of Members in 
which to pass the Series 27 Examination. A financial and operationss 
principal who (i) does not file such registration within the time frame 
specified above, (ii) does not notify the Exchange of such 
registration, or (iii) fails to successfully complete the Series 27 
Examination within the time frame specified above will not be allowed 
to serve as a financial or operations principal for JBO participant 
until he or she successfully completed the Series 27 Examination. 
Further, a JBO participant that has designated a financial and 
operation principal that has not met the requirement listed above 
concerning the Series 27 Examination will not be allowed to participate 
in JBO arrangements until is has a financial and operations principal 
that has successfully completed the Series 27 Examination.
    In addition, the proposed rule change will require a member or 
member organization for which the Exchange is the DEA that wishes to 
carry the accounts of JBO participants to comply with additional net 
capital requirements prescribed by the Exchange. Such a member must 
maintain either: (i) Tentative net capital of $25 million; \10\ or (ii) 
net capital of $10 million, if the member's primary business is the 
clearance of option market maker accounts.\11\ A member carrying the 
accounts of JBO participants will be deemed to conduct a primary 
options market maker business if at least 60% of the gross haircuts 
calculated for all options market maker and accounts of JBO 
participants in aggregate is attributable to options market maker 
transactions. A member carrying the accounts of JBO participants and 
conducting a primary options market maker business must include the 
gross deductions calculated for all accounts of JBO participants in its 
ratio of gross options market maker deductions to adjusted net capital.
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    \10\ ``Tentative net capital'' refers to a member's net capital 
before the application of haircuts and undue concentration 
deductions.
    \11\ Currently, the CHX does not act as the DEA for any member 
whose primary business is the clearance of option market maker 
accounts. However, the Exchange proposes to adopt this provision so 
that the CHX will have a rule in place if, in the future, the CHX 
becomes the DEA for a member whose primary business is the clearance 
of option market maker accounts. Telephone conversation between 
David T. Rusoff, Foley and Lardner, and Yvonne Fraticelli, Attorney, 
Division, Commission, on July 21, 1998.
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    Future, each member carrying the accounts of JBO participants shall 
adjust its net worth daily by deducting any deficiency between a JBO 
participant's account equity and the proprietary haircut calculated 
pursuant to SEC Rule 15c3-1 for the positions maintained in the JBO 
account. As previously referenced, each member carrying the accounts of 
JBO participants must require and maintain equity of $1,000,000 for 
each JBO participant. The member carrying the accounts of JBO 
participants must issue a margin call if the JBO participant's account 
equity falls below the $1,000,000 threshold. Finally, each member 
carrying the accounts of JBO participants must establish and maintain 
written ownership standards for JBO accounts. The member carrying the 
accounts of JBO participants also must develop risk analysis standards 
for assessing the amount of credit extended to JBO participants, which 
shall be made available to the Exchange upon request.
    Margin requirements. The Exchange proposes to revise CHX Article X, 
Rule 3 to permit a member organization to carry the accounts of JBO 
participants on a good faith margin basis. The JBO accounts must comply 
with the requirements established in Regulation T Section 220.7 and CHX 
Article XI, Rule 3A. JBO participants must maintain equity of not less 
than $1,000,000 in their accounts. If the equity falls below 
$1,000,0000, then the carrying member must make a call for additional 
funds or securities and the JBO participant must make a deposit in an 
amount sufficient to eliminate the deficiency within five business 
days.
    Phase-In of $1,000,000 equity requirement. To ease the burden on 
existing JBO participants,\12\ the

[[Page 48288]]

Exchange proposes to give existing JBO participants six months from the 
date of the Exchange's publication in a Notice to members of 
information contained in the order approving the requirement in which 
to comply with the $1,000,000 requirement. Existing JBO participants 
who fail to comply with the equity requirement within the time frame 
specified above will not be allowed to continue the JBO arrangement 
until they have complied with this requirement.
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    \12\ For purposes of the proposal, existing JBO participants are 
CHX members or member organizations that are part of a JBO 
arrangement approved by the CHX as of the date of the filing of the 
current proposal with the SEC. According to the CHX, there were 15 
existing JBO arrangements as of the date of the filing of the CHX's 
proposal. Conversation between David T. Rusoff, Foley & Lardner, and 
Yvonne Fratecelli, Attorney, Division, Commission, on July 20, 1998.
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2. Statutory Basis
    The CHX believes that the proposed rule change is consistent with 
Section 6 of the Act, in general, and furthers the objectives of 
Section 6(b)(5) of the Act, in particular, in that it is designed to 
perfect the mechanism of a free and open market and a national market 
system and to protect investors and the public interest. In addition, 
the CHX believes that the proposed rule change is designed to ensure 
the reasonableness of JBO arrangements in accordance with the FRB's 
directive in its recent amendments to Regulation T.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The CHX believes that no burden will be placed on competition as a 
result of the proposed rule change.

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

    No written comments were solicited or received.

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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period: (i) As the Commission 
may designate up to 90 days of such date if it finds such longer period 
to be appropriate and publishes its reasons for so finding or, (ii) as 
to which the self-regulatory organization consents, the Commission will 
by order approve such proposed rule change, or institute proceedings to 
determine whether the proposed rule change should be disapproved.

IV. Solicitation of Comments

    Interested person are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. 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 such filing will also be 
available for inspection and copying at the principal office of the 
CHX. All submissions should refer to File No. SR-CHX-98-12 and should 
be submitted by September 30, 1998.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.

Exhibit A

    Additions are italicized.
Article VI
Restrictions and Requirements
Training and Examination Requirements
    Rule 3. No change in text.
    Interpretations and Policies:
    .01 (a)-(b). No change in text.

(3) Joint Back Office Participants

    All registered persons associated with Joint Back Office (``JBO'') 
Participants (as defined in Article XI, Rule 3A, section (a)) 
designated as financial and operations principals must successfully 
complete the Financial and Operations Principal Examination, Series 27.
Article X
Margins
Initial Margin Rule
    Rule 3.(a)-(b) No change in text.
Exceptions to Rule
    (c)(1)-(6) No change in text.
    (7) Joint Back Office Participant Accounts--A member or member 
organization may carry the accounts of joint back office (``JBO'') 
participants upon a margin basis which is satisfactory to both parties, 
provided the requirements of Regulation T Section 220.7 (or any 
successor thereto) and Article XI, Rule 3A are adhered to.
     Interpretations and Policies:
    .01 Under the provisions of Regulation T Section 220.7 a clearing 
broker may extend good faith financing to an owner of the clearing 
broker under certain conditions. Such financing is typically provided 
under what is termed a joint back office arrangement.
    (d) No change in text.
Article XI
Financial Responsibility and Reporting Requirements

Joint Back Office Participants

    RULE 3A. An arrangement may be established between two or more 
registered broker-dealers pursuant to Regulation T Section 220.7 to 
form a joint back office (``JBO'') arrangement for carrying and 
clearing or carrying accounts of participating broker-dealers. Members 
and member organizations for which the Exchange is the Designated 
Examining Authority (``DEA'') shall provide written notification to the 
Exchange prior to becoming a JBO Participant (as defined below) and 
prior to carrying a JBO account.
    (a) Requirements for Joint Back Office Participants. In addition to 
complying with the requirements of Rule 3 of this Article XI, a member 
or member organization for which the Exchange is the DEA that maintains 
a joint back office (``JBO'') arrangement (a ``JBO Participant'') with 
a carrying broker-dealer subject to the requirements of Regulation T 
Section 220.7 (or any successor thereto) of the Federal Reserve System 
shall:
    1. Be registered as a broker-dealer pursuant to Section 15 of the 
Securities Exchange Act of 1934;
    2. Be subject to the capital requirements prescribed by Rule 15c3-1 
therein, and shall not be eligible to operate under the provisions of 
SEC Rule 15c3-1(b)(i)[sic];
    3. Meet and maintain a minimum account equity requirement of 
$1,000,000 with each broker-dealer where an account of the JBO 
Participant is carried. If equity decreases below $1,000,000 the JBO 
Participant shall deposit an amount sufficient to eliminate this 
deficiency within five business days;
    4. Meet and maintain the ownership standards established by the 
carrying broker-dealer; and
    5. Designate one registered person associated with such member as a 
financial and operations principal, whose responsibilities shall 
include:

[[Page 48289]]

    (A) final approval and responsibility for the accuracy of financial 
reports submitted to any duly established securities industry 
regulatory body;
    (B) final preparation of such reports;
    (C) Supervision of individuals who assist in the preparation of 
such reports;
    (D) supervision of and responsibility for individuals who are 
involved in the actual maintenance of the member's books and records 
from which such reports are derived;
    (E) supervision and/or performance of the member's responsibilities 
under all Exchange or SEC financial responsibility rules; and
    (F) overall supervision of and responsibility for the individuals 
who are involved in the administration and maintenance of the member's 
back office operations.
    Such person shall successfully complete the Series 27 Financial and 
Operations Principal Examination.
    (b) Requirements for Members or Member Organizations Carrying the 
Accounts of JBO Participants. A member or member organization that 
carries the accounts of JBO Participants shall:
    1. Maintain (i) tentative net capital of not less than $25 million 
as computed pursuant to SEC Rule 15c3-1 or (ii) net capital of not less 
than $10 million as computed pursuant to SEC Rule 15c3-1, provided that 
such member or member organization has as its primary business the 
clearance of options market maker accounts and provided that at least 
60% of the sum of gross haircuts calculated for all options market 
maker accounts and accounts of JBO Participants, without regard to 
related account equity or clearing firm net capital charges, is 
attributable to options market maker transactions. Any member or member 
organization operating pursuant to subsection (ii) of this paragraph 
must include the gross deductions calculated for all accounts of JBO 
Participants in such member's or member organization's ratio of gross 
options market maker deductions to adjust net capital in accordance 
with the provisions of SEC Rule 15c3-1;
    2. Require and maintain equity of $1,000,000 for each JBO 
Participant. If equity decreases below $1,000,000 the member or member 
organization carrying the JBO Participant's account shall issue a call 
for additional funds or securities which shall be obtained within five 
business days;
    3. Adjust its net worth daily by deducting any deficiency between a 
JBO Participant's account equity and the proprietary haircut calculated 
pursuant to SEC Rule 15c3-1 for the positions maintained in such 
account;
    4. Establish and maintain written ownership standards for accounts 
of JBO Participants; and
    5. Develop risk analysis standards for assessing the amount of 
credit extended to JBO Participants which shall be made available to 
the Exchange upon request.
     Interpretations and Policies:
    .01 JBO Participants shall not be considered self-clearing for any 
purpose other than the extension of credit under Article X, Rule 3 or 
under the comparable rules of another self regulatory organization.

[FR Doc. 98-24092 Filed 9-8-98; 8:45 am]
BILLING CODE 8010-01-M