[Federal Register Volume 66, Number 192 (Wednesday, October 3, 2001)]
[Notices]
[Pages 50487-50488]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-24657]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44848; File No. SR-OCC-2001-02]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Granting Approval of Proposed Rule Change Relating to Deposits of 
Nasdaq SmallCap Securities as Margin Collateral Pursuant to Rule 604(d)

September 25, 2001.
    On April 11, 2001, The Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange Commission (``Commission'') a proposed 
rule change (File No. SR-OCC-2001-02) pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'').\1\ Notice of the 
proposal was published in the Federal Register on August 3, 2001.\2\ No 
comment letters were received. For the reasons discussed below, the 
Commission is granting approval of the proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 44608 (July 27, 2001), 
66 FR 40764.
---------------------------------------------------------------------------

I. Description

    The primary purpose of the filing is to allow securities traded in 
the Nasdaq SmallCap market to be deposited as collateral pursuant to 
OCC Rule 604(d). The rule change also makes certain other technical 
changes to the rule.
    In 1984, OCC received Commission approval to amend Rule 604(d) to 
allow the deposit of securities traded in the Nasdaq National Market 
System (``NMS'') as a form of margin collateral.\3\ Nasdaq formed the 
NMS market in 1982 to distinguish NMS securities as those securities 
that met is highest listing standards and that were subject to real-
time sale price and volume reporting. Securities that did not meet NMS 
standards were termed ``regular Nasdaq securities.'' While the 
eligibility criteria found in Rule 604(d) have remained relatively 
unchanged since 1984, the structure of the Nasdaq market has evolved 
substantially since then.
---------------------------------------------------------------------------

    \3\ Securities Exchange Act Release No. 20558 (January 18, 
1984), 49 FR 2183 [File No. SR-OCC-83-17] (order approving an OCC 
rule change allowing clearing members to deposit certain common 
stocks not underlying options to satisfy their margin obligations).
---------------------------------------------------------------------------

    The Nasdaq market structure has had many notable changes. For 
example, in 1992, all Nasdaq securities became subject to real-time 
last sale price and volume reporting requirements, increasing the 
transparency for all Nasdaq issues (i.e., NMS and regular Nasdaq 
securities).\4\ Then, in 1994, the Nasdaq Stock Market was created with 
two distinct tiers: the Nasdaq National Market (``NNM,'' 
formerly the NMS market) and the SmallCap market (formerly the regular 
Nasdaq securities).\5\ Later, in 1997, the qualification standards of 
both the NNM and the SmallCap market tiers were substantially 
upgraded.\6\
---------------------------------------------------------------------------

    \4\ Securities Exchange Act Release No. 30569 (April 16, 1992), 
57 FR 13396 [File No. SR-NASD-91-50] (order approving a rule change 
requiring real-time trade reporting of transactions in Nasdaq 
securities, except convertible debt, and allowing the NASD to 
publicly disseminate the information).
    \5\ Securities Exchange Act Release No. 34928 (November 9, 
1994), 59 FR 55906 [File No. SR-NASD-94-48] (order clarifying the 
two tiers of the Nasdaq Stock Market as the Nasdaq SmallCap Market 
and the Nasdaq National Market).
    \6\ Securities Exchange Act Release No. 38961 (August 29, 1997), 
62 FR 45895 [File No. SR-NASD-97-16] (order revising the listing and 
maintenance standards to increase the quality of companies listed on 
Nasdaq and raising the level of investor protection).
---------------------------------------------------------------------------

    The upgraded qualification standards applicable to Nasdaq SmallCap 
issuers set forth minimum and ongoing financial criteria (e.g., assets, 
capitalization, and income), share float and price criteria, corporate 
governance (e.g., independent directors, audit committee formation and 
activities, auditor peer review, and voting rights), and public 
disclosure (e.g., timely filing and distribution of annual and interim 
financial reports and annual meeting of shareholders).\7\ These 
qualification criteria exceed the standards that governed the Nasdaq 
NMS securities at the time those securities were approved for margin 
purposes in 1984. The Nasdaq SmallCap qualification standards 
approximate American Stock Exchange (``Amex'') listing criteria 
applicable to equity securities.\8\ Such Amex listed equity securities 
are accepted by OCC for margin purposes. OCC therefore believes that 
the qualification standards that are applicable to SmallCap issues 
provide sufficient safeguards to address concerns about the quality of 
securities traded in that market tier.
---------------------------------------------------------------------------

    \7\ NASD Rules 4310 and 4350.
    \8\ American Stock Exchange Company Guide, Sections 101, 102, 
and 120-132.
---------------------------------------------------------------------------

    The ten dollar minimum price per share requirement and 
concentration limit (i.e., the securities of any one issuer cannot 
exceed 10% of the margin requirement for any one clearing member 
account) of Rule 604(d) also provide additional safeguards to minimize 
issuer quality concerns. OCC has analyzed the market and liquidity 
risks associated with accepting SmallCap securities for margin purposes 
by utilizing daily price movements and volume statistics for the last 
four years. Average daily price movements and standard deviation of 
average daily price movements for the entire population of SmallCap 
securities as well as subset of that population having a price of 
greater than ten dollars per share were computed. For comparison, a 
similar computation was performed for NNM securities. A summary of this 
analysis is outlined below:

----------------------------------------------------------------------------------------------------------------
                                                                                                      Average
                                                   Average range   Average range  Average move 1     standard
                      Class                        minimum  (in    maximum  (in     (in percent)  deviation  (in
                                                     percent)        percent)                        percent)
----------------------------------------------------------------------------------------------------------------
NNM (All).......................................           -24.5           +86.2             3.6             7.5
NNM (>$10)......................................           -21.3           +29.9             3.2             4.8
SmallCap (All)..................................           -33.9          +128.2             5.0            10.7
SmallCap (>$10).................................           -21.1           +51.4             2.6             5.3
----------------------------------------------------------------------------------------------------------------
1 Computed on the basis of the absolute value daily price movements.


[[Page 50488]]

Based on this analysis, OCC has concluded that the average SmallCap 
security presents market risks similar to that of NNM securities 
especially for those securities that trade at a price greater than ten 
dollars per share.\9\ This analysis also confirms that the current 70% 
valuation rate provides a sufficient cushion to protect against adverse 
market moves in SmallCap securities.
---------------------------------------------------------------------------

    \9\ Approximately 12% of SmallCap securities trade at over ten 
dollars per share.
---------------------------------------------------------------------------

    Finally, OCC performed a volume analysis to assess the liquidity of 
SmallCap securities over the same four-year period which confirmed that 
SmallCap securities are not as liquid as NNM securities.\10\ However, 
the analysis also showed that a material portion of this average share 
volume is concentrated in a relatively small number of NNM issuers. For 
example, 20% of the NNM average share volume is attributable to the 
shares of five issuers. However, there are over 2,150 additional NNM 
securities that may be deposited for margin purposes. In light of the 
concentration within the NNM, OCC believes that there is sufficient 
liquidity in SmallCap issues over ten dollars to support their 
acceptance for margin purposes.
---------------------------------------------------------------------------

    \10\ Average daily share volume of NNM securities trading over 
ten dollars per share was 594,632 while the average daily share 
volume of SmallCap securities trading above ten dollars was 15,005 
shares.
---------------------------------------------------------------------------

    The proposed rule change also makes certain changes to Rule 604(d) 
to conform it to recent changes made elsewhere in OCC's By-Laws and 
Rules. As it has already done in other of its rules, OCC is deleting 
the term ``primary market'' from Rule 604(d).\11\ Removing the term 
``primary market'' has been prompted by recognition that the equity 
markets are becoming increasingly fragmented. Rule 604(d) currently 
provides that no security that has been suspended from trading or is 
subject to special margin requirements by its ``primary market'' may be 
deposited as margin. OCC is amending Rule 604(d) so that no security 
that has been suspended from trading or is subject to special margin 
requirements by the market that listed or qualified the issue for 
trading may be deposited as margin.
---------------------------------------------------------------------------

    \11\ Securities Exchange Act Release Nos. 44652 (August 3, 
2001), 66 FR 42580 [File No. SR-OCC-00-04] (order approving proposed 
rule change revising OCC's price determination rules); and 41089 
(March 1, 1999), 64 FR 10051 [File No. SR-OCC-98-14] (order 
approving the revision of OCC Rules 805 with respect to closing 
prices in expiration processing).
---------------------------------------------------------------------------

    Rule 604(d) also currently defines the current market value of a 
stock or bond to be its closing price on the ``primary market'' for 
such stock or bond. In order to avoid disputes over which market is a 
stock's primary market, OCC is amending the rule so that it has the 
discretion to designate the market whose closing price will serve as 
the benchmark.
    Another conforming change concerns the time when a ``closing 
price'' is determined. To address any questions that may arise with the 
growth of after-hours trading, OCC is proposing to amend Rule 604(d) to 
provide that the closing price will be determined ``at the close of 
regular trading hours (as determined by the Corporation).* * *'' This 
change allows OCC to avoid potential disputes by (i) eliminating any 
basis for arguing that the closing price should be determined based on 
after-hours trading and (ii) giving OCC the discretion to determine 
when ``regular trading hours'' end.
    Finally, OCC is eliminating those provisions of Rule 604(d) that 
require stocks that are deposited as margin to be subject to last sales 
reporting. It is OCC's understanding that all exchange traded and 
Nasdaq Stock Market securities are now subject to last sales reporting, 
making the requirement unnecessary.

II. Discussion

    Section 17A(b)(3)(F) 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 clearing agency's custody or control or for 
which it is responsible. In connection with this rule change, which 
allows OCC clearing members to deposit Nasdaq SmallCap market 
securities as margin collateral, OCC has done extensive market and 
liquidity analysis and is subjecting any deposits of Nasdaq SmallCap 
market securities to its existing margin deposit requirements (e.g., 
ten dollar per share minimum and ten percent issuer concentration 
prohibition). Therefore, the Commission finds that OCC's proposed rule 
change is consistent with Section 17A(b)(3)(F) of the Act and the rules 
and regulations thereunder.

III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
in particular Section 17A of the Act and the rules and regulations 
thereunder.
    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. OCC-2001-02) be and hereby is 
approved.

    For the Commission, by the Division of Market Regulation 
pursuant to delegated authority.\12\
---------------------------------------------------------------------------

    \12\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-24657 Filed 10-2-01; 8:45 am]
BILLING CODE 8010-01-M