[Federal Register Volume 67, Number 178 (Friday, September 13, 2002)]
[Notices]
[Pages 58093-58095]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-23310]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46469; File No. SR-OCC-2002-02]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Granting Approval of a Proposed Rule Change Relating to Providing 
Clearing Services to Options Exchanges That Are Not Stockholders

September 6, 2002.

I. Introduction

    On January 25, 2002, The Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') a 
proposed rule change (File No. SR-OCC-2002-02) pursuant to section 
19(b)(1) of the Securities Exchange Act of 1934 (``Act'').\1\ On July 
9, 2002, OCC amended the proposed rule change. Notice of the proposal 
was published in the Federal Register on July 31, 2002.\2\ No comment 
letters were received. For the reasons discussed below, the Commission 
is approving the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 46257 (July 25, 2002), 
67 FR 49729.
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II. Description

    The proposed rule change amends OCC by-laws and rules so that OCC 
can provide clearing services to new options exchanges without having 
those exchanges become stockholders of OCC. Under OCC's existing by-
laws, any new

[[Page 58094]]

options market desiring to clear options transactions through OCC is 
required to purchase common stock in OCC and to execute the 
Stockholders Agreement to which the existing stockholder exchanges are 
parties. Management of OCC has concluded that the practice of issuing 
new equity to each market for which OCC provides clearing services is 
no longer either necessary or appropriate. Indeed, the practice has 
already been abandoned with respect to providing clearing services to 
markets trading only security futures or commodity futures.\3\ OCC will 
now be able to clear options transactions for new options exchanges on 
a similar basis. OCC believes that there is no more reason to permit or 
require new options exchanges to become OCC stockholders than to permit 
or require those other markets to do so.
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    \3\ Article XII of the by-laws permits OCC to clear ``security 
futures'' for ``security futures exchanges'' without issuing equity 
to such exchanges and permits OCC to provide clearing services for 
other futures products on the same basis (Securities Exchange Act 
Release Nos. 44434 (June 15, 2001), 66 FR 33283 [File No. SR-OCC-
2001-05] and 45946 (May 16, 2002), 67 FR 36056 [File No. SR-OCC-
2001-16]).
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    Exchange ownership of clearing organizations is not required under 
section 17A of the Act or under any other provision of the federal 
securities laws. State law at one time made such ownership necessary. 
Article VIII of the Uniform Commercial Code (``UCC''), as in effect in 
Illinois prior to the 1973 amendment, defined a ``clearing 
corporation'' as ``a corporation all of the capital stock of which is 
held by or for a national securities exchange or association registered 
under a statute of the United States such as the Securities Exchange 
Act of 1934.'' \4\ The UCC as now in effect in all U.S. jurisdictions 
no longer defines ``clearing organization'' in terms of ownership, and 
therefore, the UCC is no longer a constraint in determining the 
ownership of OCC.
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    \4\ The 1973 amendment identified certain other entities that 
could be owners of a clearing corporation while retaining securities 
exchanges or associations among the permitted owners.
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    Not only is there no continuing need to have new markets seeking 
clearing services become stockholders, there are a number of reasons 
not to do so. First, increasing the number of stockholders could 
adversely affect OCC's ability to pursue new business opportunities. 
Stock ownership gives the existing participant exchanges the right to a 
representative on OCC's board of directors and veto rights over certain 
significant transactions (e.g., a merger) or amendments to certain 
provisions of the constituent documents (e.g., Article VII of the by-
laws regarding exchange qualifications).\5\ The participant exchanges 
have divergent and sometimes conflicting interests, and this will only 
become more prevalent as the number and types of options exchanges 
proliferates. Expanding the number of stockholders with veto rights 
increases the likelihood that a single stockholder might block action 
that is in the best interests of OCC and its other stockholders. 
Second, continuing to add stockholders could soon result in substantial 
increases in the size of the OCC board. After the number of exchange 
directors reaches seven, each addition of an exchange director would 
require the addition of another member director in order to maintain 
the allocation between member directors and exchange directors called 
for under OCC's constituent documents. Ultimately, the OCC board could 
reach an unwieldy size. Finally, issuing additional common stock for 
each new market would continually dilute the interests of the existing 
participant exchanges.
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    \5\ Holders of OCC Class A common stock have the right, by 
majority vote, to elect member directors of OCC. Holders of Class B 
common stock vote on the election of the management director and 
exchange directors of OCC. In addition, the votes of Class B common 
stock holders are required to amend OCC's certificate of 
incorporation, to adopt an agreement of merger or consolidation of 
OCC with or into any other corporation, to authorize or consent to 
the sale, lease, or exchange of all or substantially all of the 
property and assets of OCC, to authorize or consent to the 
dissolution of OCC, to receive dividends, and to receive assets upon 
partial or final liquidation or dissolution of OCC. All OCC Class A 
and Class B common stock is owned by its current participant options 
exchanges.
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    OCC is creating a new category of ``non-equity exchange'' to which 
markets that desire options clearing services from OCC will be 
admitted. In lieu of purchasing common stock of OCC, new participant 
exchanges will be required to enter into a Noteholders Agreement and to 
purchase a promissory note from OCC in the principal amount of $1 
million, which was the amount specified in Article VII, Section 2 of 
the by-laws as the maximum purchase price for additional equity 
required to be purchased by a new equity exchange. Instead of the 
equity interest received by such equity exchanges, non-equity exchanges 
will receive promissory notes bearing an interest rate return on their 
investments as described below.
    Non-equity exchanges will be subject to admission requirements 
identical to those imposed on the current participant exchanges that 
hold equity. Among other things, new participant exchanges must be 
registered under the Act, must be in compliance with the rules 
promulgated thereunder by the Commission, and must furnish information 
to OCC concerning such things as the exchange's operations, management, 
rules and membership.
    OCC will provide clearing services to non-equity exchanges on the 
same basis that it provides services to the equity exchanges. Non-
equity exchanges will become parties to the existing Restated 
Participant Exchange Agreement in the same way that new participant 
exchanges have done in the past. No modification to the agreement is 
necessary because it does not address matters relating to an exchange's 
role as stockholder, which are confined to the Stockholders Agreement.
    The rights of the existing participant exchanges as stockholders, 
including their rights to representation on OCC's board and their veto 
rights, have been preserved in Article VIIA, ``Equity Exchanges.'' 
Although non-equity exchanges will not have representation on OCC's 
board, their members that are clearing members of OCC will be 
``participants'' in OCC within the meaning of section 17A(b)(3)(C) of 
the Act and will be entitled under that provision to ``fair 
representation * * * in the selection of (OCC's) directors and 
administration of its affairs.'' Fair representation will be assured 
because participants that are members of non-equity exchanges will 
participate in the selection of OCC's member directors on the same 
basis as members of the equity exchanges.\6\
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    \6\ OCC has represented to the Commission that OCC management 
will (1) provide non-equity exchanges with the opportunity to make 
presentations to the OCC board or the appropriate board committee 
upon request and (2) will promptly pass on to non-equity exchanges 
any information that management considers to be of competitive 
significance to such exchanges disclosed to exchange directors at or 
in connection with any meeting or action of the OCC board or any 
board committee. Letter from William H. Navin, Executive Vice 
President, General Counsel, and Secretary, OCC (July 8, 2002).
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    The Noteholders Agreement in this rule filing contains restrictions 
on the transfer of promissory notes issued to non-equity exchanges and 
provides for the repurchase of the notes by OCC under certain 
circumstances parallel to the provisions applicable to the repurchase 
by OCC of its stock.\7\ These provisions are designed to ensure that 
the promissory notes remain in the hands of participant exchanges of 
OCC and to give withdrawing exchanges the right to ``put'' the notes 
back to OCC. The promissory notes will bear interest at a rate 
determined by reference to provisions of the Internal Revenue

[[Page 58095]]

Code.\8\ The interest rate will be reset annually. Interest will be 
payable annually in arrears on the promissory note's anniversary date. 
If a promissory note is repurchased by OCC in less than six years from 
the date of the initial sale of the note, the purchase price of the 
note will be the principal amount plus any accrued and unpaid interest 
less a reduction based on the length of time since initial sale.\9\ 
After six years, there would be no reduction, and a promissory note 
would be redeemable at its aggregate principal amount plus any accrued 
and unpaid interest. Under the terms of Section VIII of the Noteholders 
Agreement, OCC's obligations to a noteholder are subordinated to the 
claims of all other creditors of OCC except that the obligation to 
repurchase a note from any noteholder ranks pari passu with OCC's 
obligations to repurchase notes from any other noteholders and to 
repurchase its common stock from any stockholder. The provisions of the 
Noteholders Agreement are generally parallel to corresponding 
provisions of the Stockholders Agreement.
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    \7\ The Noteholders Agreement is attached as Exhibit I to OCC's 
filing.
    \8\ The interest rate for the promissory notes will be equal to 
the short-term applicable federal rate for purposes of Section 
1274(d) of the Internal Revenue Code of 1986.
    \9\ The amount of the reduction, which is set forth in the 
Noteholders Agreement, would be $300,000 if the note is purchased by 
OCC within two years of its original sell date, $240,000 if more 
than two years but less than three years, $180,000 if more than 
three years but less than four years, $120,000 if more than four 
years but less than five years, and $60,000 if more than five years 
but less than six years.
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III. Discussion

    Section 19(b)(2) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
such proposed rule change is consistent with the requirements of the 
Act and the rules and regulations thereunder applicable to such 
organization. section 17A(b)(3)(F) of the Act requires that the rules 
of a clearing agency be designed to remove impediments to and perfect 
the mechanism of a national system for the prompt and accurate 
clearance and settlement of securities transactions.\10\ The Commission 
believes that by allowing OCC to amend its by-laws and rules so that 
they limit the number of OCC's stockholders and in turn the size of 
OCC's board, OCC will be better able to continue to work to remove 
impediments to and perfect the mechanism of the national clearance and 
settlement system. Accordingly, the Commission finds that the proposal 
is consistent with Section 17A(b)(3)(F).
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    \10\ 15 U.S.C. 78q-1(b)(3)(F).
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    Sections 17A(b)(3)(C) and (I) of the Act require that the rules of 
a clearing agency assure fair representation of its shareholders and 
participants in the selection of its directors and administration of 
its affairs and that the rules of a clearing agency do not impose any 
burden on competition that is not necessary or appropriate in 
furtherance of the Act.\11\ The fact that members of non-equity 
exchanges that are also members of OCC will participate in the 
selection of OCC member directors should help to assure fair 
representation of all OCC's members. OCC's representations to the 
Commission that OCC's management will provide non-equity exchanges with 
the opportunity to make presentations to the OCC board and will 
promptly pass on to non-equity exchanges any information disclosed at 
or in connection with OCC board meetings that management considers to 
be of competitive significance should help to ensure that no burden on 
competition that is not necessary or appropriate in furtherance of the 
Act will occur.\12\ Therefore, the Commission also finds that OCC's 
rule change is consistent with the requirements of Section 17A(b)(3)(C) 
and (I).
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    \11\ 15 U.S.C. 78q-1(b)(3)(C) and (I).
    \12\ Id.
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IV. 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 with the requirements of section 17A of the Act and the 
rules and regulations thereunder applicable.
    It is therefore ordered, pursuant to section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-OCC-2002-02) be, and hereby 
is, approved.

    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.
[FR Doc. 02-23310 Filed 9-12-02; 8:45 am]
BILLING CODE 8010-01-P