[Federal Register Volume 63, Number 233 (Friday, December 4, 1998)]
[Notices]
[Pages 67155-67157]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-32329]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40708; File No. SR-CBOE-97-58]


Self-Regulatory Organizations; Notice of Filing of Amendment No. 
1 to Proposed Rule Change by the Chicago Board Options Exchange, 
Incorporated Relating to Capital and Margin Requirements for Joint Back 
Office Arrangements

November 25, 1998.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on July 27, 1998, the Chicago Board Options Exchange, Incorporated 
(``Exchange'' or ``CBOE'') filed with the Securities and Exchange 
Commission (``Commission'') Amendment No. 1 to the proposed rule change 
as described in Items I, II, and III below, which Items have been 
prepared by the Exchange. The Commission is publishing this notice to 
solicit comments on Amendment No. 1 to the proposed rule change from 
interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Exchange seeks to establish margin and net capital requirements 
for Joint Back Office (``JBO'') participants and clearing firms. Under 
the provisions of Regulation T promulgated by the Board of Governors of 
the Federal Reserve System (``Federal Reserve Board''),\3\ a clearing 
broker may extend good faith financing to an owner of the clearing 
broker who is either a broker-dealer or an exchange member. These 
financing relationships are referred to as ``JBO arrangements.''
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    \3\ See 12 CFR 220. Regulation T is entitled ``Credit by Brokers 
and Dealers'' and was issued by the Federal Reserve Board pursuant 
to the Act.
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    The text of the proposed rule change, as amended, is available at 
the Office of the Secretary, the Exchange, and at the Commission.

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 Exchange 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. The Exchange 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
    a. Background. The Exchange filed its JBO proposal with the 
Commission on October 23, 1997, shortly after the New York Stock 
Exchange (``NYSE'') submitted its own JBO filing.\4\ Notice of the 
Exchange's proposal was issued on December 10, 1997.\5\ Among other 
matters, the Exchange's JBO filing proposes minimum financial standards 
for JBO participants and for the firms which clear JBO accounts.
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    \4\ The NYSE's JBO filing, SR-NYSE-97-28, was filed with the 
Commission on October 2, 1997, and notice of its filing was issued 
on December 29, 1997. See Securities Exchange Act Release No. 39497 
(Dec. 29, 1997), 63 FR 899 (Jan. 7, 1998). The NYSE filed Amendment 
No. 1 to its JBO filing on May 21, 1998, and Amendment No. 2 on 
September 28, 1998. Notice of Amendment Nos. 1 and 2 was issued on 
November 25, 1998. See Securities Exchange Act Release No. 40709 
(Nov. 25, 1998).
    \5\ See Securities Exchange Act Release No. 39418 (Dec. 10, 
1997), 62 FR 66154 (Dec. 17, 1997).
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    In its 1996 amendments to Regulation T, the Federal Reserve Board 
directed the securities self-regulatory organizations (``SROs'') to 
develop appropriate standards for JBO participants and their clearing 
firms.\6\ The Exchange anticipates that all SROs will implement uniform 
standards for JBO arrangements. The NYSE formed a member firm 
subcommittee to develop appropriate standards for JBO participants and 
their clearing firms. The NYSE member firm subcommittee proposed that 
clearing firms maintain a minimum of $25 million in tentative net 
capital. The Exchange urged that an alternative standard be provided 
for options market-maker clearing firms to accommodate the JBO 
activities of the clearing firms' options market-maker clients. The 
compromise standard of $10 million net capital was agreed upon and 
incorporated into the JBO filings submitted by the Exchange and the 
NYSE.
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    \6\ See Board of Governors of the Federal Reserve System Docket 
No. R-0772 (Apr. 26, 1996), 61 FR 20386 (May 6, 1996).
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    Although at that time not all Exchange options market-maker 
clearing firms needed to maintain the $10 million level of capital to 
cover the haircut and financing needs of their market-maker and JBO 
clients, it was believed their actual capital needs would grow to 
exceed the $10 million standard by the time the Commission approved the 
Exchange's JBO proposal. While the capital needs of options market-
marker clearing firms have in fact grown, they do not in all instances 
consistently satisfy the $10 million level.\7\ As a result, the 
Commission received a number of comment letters from Exchange member 
firms that expressed concern over the $10 million standard.
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    \7\ The Exchange has represented that all Exchange options 
market-maker clearing firms currently maintain net capital 
sufficient to meet the proposed $7 million net capital standard. 
However, fluctuations in a clearing firm's net capital may occur due 
to changes in daily net deductions for the options market-maker and 
JBO participant accounts carried. Many clearing firms maintain 
revolving subordinated loan arrangements in order to cover such 
potential capital swings. According to the Exchange, there is a one 
time charge to establish such a facility of approximately $10,000 
per $1 million (1%). The cost to maintain such a facility, undrawn, 
approximates $10,000 per year per $1 million (1%), or $28 per day. 
The cost to draw down such a facility approximates $95,000 per year 
per $1 million of drawn funds (at 1% over an 8\1/2\% prime), or $264 
per day. Drawn down revolving subordinated debt may be repaid 
beginning the following day, with the term of the loan not to exceed 
1 year. The Exchange believes these costs do not appear to be 
excessively burdensome to clearing firms that carry the accounts of 
JBO participants.
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    b. Amendment No. 1. In response to the concerns of its members, the 
Exchange seeks to amend its JBO filing

[[Page 67156]]

to reduce from $10 million to $7 million, the proposed net capital 
requirement for JBO clearing firms. The Exchange also proposes to allow 
options market-maker clearing firms, that elect to operate under this 
alternative standard, to be permitted to maintain net capital of less 
than $7 million for a period not to exceed three consecutive business 
days. Immediate notice to the Exchange would be required when a JBO 
clearing firm's net capital drops below the $7 million requirement, or 
its tentative net capital drops below the $25 million requirement. In 
addition, such a clearing firm would be subject to prohibitions against 
the withdrawal of equity capital and prohibitions against reduction, 
prepayment, and repayment of subordination agreements as specified in 
the commission's net capital rule.\8\
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    \8\ The commission's net capital rule, ``Net Capital 
Requirements for Brokers or Dealers,'' is designated as Rule 15c3-1. 
See 17 CFR 240.15c3-1(e) and 17 CFR 240.15c3-1d(b).
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    The Exchange believes the proposed ``three business day'' provision 
is consistent with other provisions of the Commission's net capital 
rule.\9\ The provision would make allowances for fluctuations in net 
capital resulting from daily changes in market-maker and JBO 
participant related clearing firm capital charges. The Exchange 
believes this provision will permit clearing firms to avoid unnecessary 
and inadvertent violations of the margin requirement at certain times 
such as options expiration week when capital needs are more volatile.
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    \9\ The Commission's net capital rule requires that the ratio of 
options market-maker gross deductions to adjusted net capital not 
exceed 10:1 for a period of more than three consecutive business 
days. See 17 CFR 240.15c3-1.
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    If approved, the proposal would provide JBO participants and 
clearing firms already conducting JBO business at the time of the 
Commission's approval six months to implement such changes. The 
proposed rule change would be applied within thirty calendar days of 
the Commission's approval for all other Exchange members seeking to 
engage in such JBO businesses.
    In addition, the Exchange seeks to amend its JBO proposal to 
specify that, should the equity in a JBO participant's account fall 
below $1 million and the deficiency is not eliminated within five 
business days, the account shall lose its JBO status. Thereupon, the 
clearing member carrying the account would be required to apply the 
standard Regulation T and Exchange Rule 12.3 customer margin 
requirements. This provision mirrors the JBO proposal presented by the 
NYSE.
    As currently amended, both the Exchange's and the NYSe's JBO 
filings contain provisions which, for the purpose of net capital 
computation, require the member organization carrying the account of a 
JBO participant to deduct from net worth any amount by which the equity 
in a JBO participant's account is below the haircuts required by the 
Commission's net capital rule. However, the NYSE's requirements for JBO 
arrangements, which are proposed to be set forth within its margin rule 
(NYSE Rule 431), would permit, for certain specified securities, a 
lesser amount to be deduced in lieu of the Exchange Act Rule 15c3-1 
haircut on such securities.\10\ The proposed alternative deduction is 
the NYSE's maintenance margin requirement for the specified securities 
when held in ``exempt accounts.'' \11\ The Exchange's JBO filing does 
not incorporate an alternative deduction because, unlike the NYSE, the 
Exchange has not promulgated special maintenance margin requirements 
for exempt accounts, and for particular securities held in those 
accounts. However, Exchange member organizations that also are members 
of the NYSE can elect to be bound by the margin rules of the NYSE as 
permitted under Exchange Rule 12.11.\12\ By electing to be bound by 
NYSE margin rules, organizations that are members of both the Exchange 
and the NYSE may avoid a violation of the Exchange's rules if they wish 
to utilize the alternative deduction proposed by the NYSE. At this 
time, the Exchange is not proposing rules to implement specialized 
maintenance requirements as an alternative to the haircut deduction for 
the organizations that are members of the Exchange only. The Exchange 
believes that special, lower maintenance margin requirements would not 
be critical to most of its member firms because the JBO accounts they 
carry do not have a concentration in the specified securities.
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    \10\ Under the NYSE's JBO proposal, the alternative deduction 
would apply to transactions in securities covered by paragraphs 
(e)(2)(F) and (e)(2)(G) of NYSE Rule 431. The Commission notes that 
the NYSE has submitted a separate rule filing, SR-NYSE-98-14 
(``Related Filing''), that would revise the types of securities 
included in paragraphs (e)(2)(F) and (e)(2)(G) of NYSE Rule 431 to 
include: exempted securities, mortgage related securities, major 
foreign sovereign debt securities, highly rated foreign sovereign 
debt securities, and investment grade debt securities. The 
Commission has published notice of the NYSE's Related Filing but has 
not taken any dispositive action on the proposal. See Securities 
Exchange Act Release No. 40278 (July 29, 1998), 63 FR 41882 (Aug. 5, 
1998).
    \11\ The Related Filing proposes to adopt a new paragraph 
(a)(13) to NYSE Rule 431 that would define an ``exempt account'' as: 
a member organization; non-member broker-dealer; ``designated 
account;'' or any person having a net worth of at least $40 million. 
The Related Filing also proposes to revise existing paragraph (a)(3) 
of NYSE Rule 431 to define a ``designated account'' as the account 
of: (i) a bank; (ii) a savings association; (iii) an insurance 
company; (iv) an investment company; (v) a state or political 
subdivision thereof; or (vi) a pension or profit sharing plan.
    \12\ Exchange Rule 12.11 specifies that in lieu of meeting the 
Exchange's margin requirements, a member firm may elect to be bound 
by the initial and maintenance margin requirements of the NYSE. If 
such an election is made, the member firm is bound to comply with 
the NYSE's margin rules as though they were part of the Exchange's 
rules.
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    The Exchange believes the revised capital requirements for JBO 
clearing firms and the delayed date of effectiveness for existing JBO 
businesses, as proposed by Amendment No.1, are responsive to the 
concerns raised by its members.
2. Statutory Basis
    The Exchange believes the proposed rule change, as amended, is 
consistent with and furthers the objectives of Section 6(b)(5) of the 
Act,\13\ in that it is designed to perfect the mechanisms of a free and 
open market and to protect investors and the public interest. The 
Exchange further believes its proposal is designed to ensure the 
reasonableness of JBO arrangements as directed by the Federal Reserve 
Board in its recent amendments to Regulation T.\14\
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    \13\ 15 U.S.C. 78f(b)(5).
    \14\ See note 6 supra.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange believes the proposed rule change will not impose any 
inappropriate burden on competition.

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

    The Exchange did not solicit or receive written comments with 
respect to the proposed rule change.

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 Exchange consents, the Commission will:
    (A) by order approve the proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

[[Page 67157]]

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 1, including whether the proposed 
rule change, as modified by Amendment No. 1, 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 submissions, 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 persons, 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 Section, 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 the Exchange. All submissions should refer 
to File No. SR-CBOE-97-58 and should be submitted by December 28, 1998.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-32329 Filed 12-3-98; 8:45 am]
BILLING CODE 8010-01-M