[Federal Register Volume 67, Number 247 (Tuesday, December 24, 2002)]
[Notices]
[Pages 78543-78550]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-32318]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46995; File No. SR-NASD-2002-166]


Self-Regulatory Organizations; Notice of Filing of a Proposed 
Rule Change and Amendment No. 1 Thereto by the National Association of 
Securities Dealers, Inc. Relating to Margin Rule Amendments for 
Security Futures Contracts

December 13, 2002.
    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 November 15, 2002, the National Association of Securities Dealers, 
Inc. (``NASD'') 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 NASD. On 
November 22, 2002, NASD filed an amendment to the proposed rule

[[Page 78544]]

change.\3\ The Commission is publishing this notice to solicit comments 
on the proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Gary L. Goldsholle, Associate General 
Counsel, NASD to Katherine England, Assistant Director, Division of 
Market Regulation (``Division''), Commission, dated November 22, 
2002 (``Amendment No. 1''). Amendment No. 1 makes technical changes 
to the proposed rule text.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD is proposing to amend NASD Rule 2520 (``Margin Requirements'') 
to establish margin requirements for security futures contracts. The 
proposed rule change is being made to make NASD's margin rule 
consistent with the margin rules already adopted by the SEC, the 
Commodity Futures Trading Commission (``CFTC''), and other self-
regulatory organizations (``SROs'') regarding security futures 
contracts. Below is the text of the proposed rule change. Proposed new 
language is in italics; proposed deletions are in brackets.
* * * * *

2520. Margin Requirements

(a) Definitions
    For the purposes of this paragraph, the following term shall have 
the meanings specified below:
    (1) The term ``basket'' shall mean a group of stocks that NASD or 
any national securities exchange designates as eligible for execution 
in a single trade through its trading facilities and that consists of 
stocks whose inclusion and relative representation in the group are 
determined by the inclusion and relative representation of their 
current market prices in a widely-disseminated stock index reflecting 
the stock market as a whole.
    (2) The term ``current market value'' means the total cost or net 
proceeds of a security on the day it was purchased or sold or at any 
other time the preceding business day's closing price as shown by any 
regularly published reporting or quotation service, except for security 
futures contracts (see paragraph (f)(11)(C)(ii)). If there is no 
closing price, a member organization may use a reasonable estimate of 
the market value of the security as of the close of business on the 
preceding business day.
    (3) The term ``customer'' means any person for whom securities are 
purchased or sold or to whom securities are purchased or sold whether 
on a regular way, when issued, delayed or future delivery basis. It 
will also include any person for whom securities are held or carried 
and to or for whom a member organization extends, arranges or maintains 
any credit. The term will not include the following: (a) A broker or 
dealer from whom a security has been purchased or to whom a security 
has been sold for the account of the member organization or its 
customers, or (b) an ``exempted borrower'' as defined by Regulation T 
of the Board of Governors of the Federal Reserve System (``Regulation 
T''), except for the proprietary account of a broker/dealer carried by 
a member organization pursuant to Section (e)(6) of this Rule.
    (4) The term ``designated account'' means the account of a bank, 
trust company, insurance company, investment trust, state or political 
subdivision thereof, charitable or nonprofit educational institution 
regulated under the laws of the United States or any state, or pension 
or profit sharing plan subject to ERISA or of an agency of the United 
States or of a state or a political subdivision thereof.
    (5) The term ``equity'' means the customer's ownership interest in 
the account, computed by adding the current market value of all 
securities ``long'' and the amount of any credit balance and 
subtracting the current market value of all securities ``short'' and 
the amount of any debit balance. Any variation settlement received or 
paid on a security futures contract shall be considered a credit or 
debit to the account for purposes of equity.
    (6) The term ``exempted security'' or ``exempted securities'' has 
the meaning as in Section 3(a)(12) of the Act.
    (7) The term ``margin'' means the amount of equity to be maintained 
on a security position held or carried in an account.
    (8) The term ``person'' has the meaning as in Section 3(a)(9) of 
the Act.
(b) Initial Margin
    For the purpose of effecting new securities transactions and 
commitments, the customer shall be required to deposit margin in cash 
and/or securities in the account which shall be at least the greater 
of:
    (1) the amount specified in Regulation T, or Rules 400 through 406 
under the Act or Rules 41.42 through 41.48 under the Commodity Exchange 
Act (``CEA''); or
    (2) the amount specified in Section (c)(3) of this Rule; or
    (3) such greater amount as NASD may from time to time require for 
specific securities; or
    (4) equity of at least $2,000 except that cash need not be 
deposited in excess of the cost of any security purchased (this equity 
and cost of purchase provision shall not apply to ``when distributed'' 
securities in a cash account). The minimum equity requirement for a 
``pattern day trader'' is $25,000 pursuant to paragraph (f)(8)(B)(iv)a. 
of this Rule.\4\
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    \4\ See Amendment No. 1, supra note 3.
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    Withdrawals of cash or securities may be made from any account 
which has a debit balance, ``short'' position or commitments, provided 
it is in compliance with Regulation T and Rules 400 through 406 under 
the Act and Rules 41.42 through 41.48 under the CEA, and after such 
withdrawal the equity in the account is at least the greater of $2,000 
($25,000 in the case of a ``pattern day trader '') \5\ or an amount 
sufficient to meet the maintenance margin requirements of this 
paragraph.
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    \5\ Id.
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(c) Maintenance Margin
    The margin that must be maintained in all accounts of customers, 
except for cash accounts subject to other provisions of this rule, 
shall be as follows:
    (1) 25 percent of the current market value of all securities, 
except for security futures contracts, ``long'' in the account; plus
    (2) $2.50 per share or 100 percent of the current market value, 
whichever amount is greater, of each stock ``short'' in the account 
selling at less than $5.00 per share; plus
    (3) $5.00 per share or 30 percent of the current market value, 
whichever amount is greater, of each stock ``short'' in the account 
selling at $5.00 per share or above; plus
    (4) 5 percent of the principal amount or 30 percent of the current 
market value, whichever amount is greater, of each bond ``short'' in 
the account.
    (5) The minimum maintenance margin levels for security futures 
contracts, long and short, shall be 20 percent of the current market 
value of such contract. (See paragraph (f) of this Rule for other 
provisions pertaining to security futures contracts.)
* * * * *
(e)(6) Broker/Dealer Accounts
    (A) A member may carry the proprietary account of another broker/
dealer, which is registered with the Commission, upon a margin basis 
which is satisfactory to both parties, provided the requirements of 
Regulation T and Rules 400 through 406 under the Act and Rules 41.42 
through 41.48 under the CEA are adhered to and the account is not 
carried in a deficit equity condition. The amount of any

[[Page 78545]]

deficiency between the equity maintained in the account and the haircut 
requirements pursuant to SEC Rule 15c3-1 shall be charged against the 
member's net capital when computing net capital under SEC Rule 15c3-1.
(e)(7) Nonpurpose Credit
    In a nonsecurities credit account, a member may extend and maintain 
nonpurpose credit to or for any customer without collateral or on any 
collateral whatever, provided:
    (A) the account is recorded separately and confined to the 
transactions and relations specifically authorized by Regulation T;
    (B) the account is not used in any way for the purpose of evading 
or circumventing any regulation of NASD or of the Board of Governors of 
the Federal Reserve System and Rules 400 through 406 under the Act and 
Rules 41.42 through 41.48 under the CEA; and
    (C) the amount of any deficiency between the equity in the account 
and the margin required by the other provisions of this paragraph shall 
be charged against the member's net capital as provided in SEC Rule 
15c3-1.
    The term ``nonpurpose credit'' means an extension of credit other 
than ``purpose credit,'' as defined in Section 220.2 of Regulation T.
* * * * *

(f)(11) Customer Margin Rules Relating to Security Futures

    (A) Applicability. No member may effect a transaction involving, or 
carry an account containing, a security futures contract with or for a 
customer in a margin account, without obtaining proper and adequate 
margin as set forth in this section.
    (B) Amount of customer margin.
    (i) General Rule. As set forth in paragraphs (b) and (c) of this 
rule, the minimum initial and maintenance margin levels for each 
security futures contract, long and short, shall be twenty (20) percent 
of the current market value of such contract.
    (ii) Excluded from the rule's requirements are arrangements between 
a member and a customer with respect to the customer's financing of 
proprietary positions in security futures, based on the member's good 
faith determination that the customer is an ``Exempted Person,'' as 
defined in Rule 401(a)(9) under the Act, and Rule 41.43(a)(9) under the 
CEA, except for the proprietary account of a broker/dealer carried by a 
member pursuant to paragraph (e)(6)(A) of this Rule. Once a registered 
broker or dealer, or member of a national securities exchange ceases to 
qualify as an ``Exempted Person,'' it shall notify the member of this 
fact before establishing any new security futures positions. Any new 
security futures positions will be subject to the provisions of this 
paragraph.
    (iii) Permissible Offsets. Notwithstanding the minimum margin 
levels specified in paragraph (f)(11)(B)(i) of this Rule, customers 
with offset positions involving security futures and related positions 
may have initial or maintenance margin levels (pursuant to the offset 
table below) that are lower than the levels specified in paragraph 
(f)(11)(B)(i) of this Rule.

----------------------------------------------------------------------------------------------------------------
                                       Security underlying the       Initial margin         Maintenance margin
        Description of offset              security future            requirement              requirement
----------------------------------------------------------------------------------------------------------------
(1) Long security future (or basket    Individual stock or      20 percent of the        The lower of: (1) 10
 of security futures representing       narrow-based security    current market value     percent of the
 each component of a narrow-based       index.                   of the long security     aggregate exercise
 securities index) and long put                                  future, plus pay for     price of the put plus
 option on the same underlying                                   the long put in full.    the aggregate put out-
 security (or index).                                                                     of-the-money amount,
                                                                                          if any; or (2) 20
                                                                                          percent of the current
                                                                                          market value of the
                                                                                          long security future.
(2) Short security future (or basket   Individual stock or      20 percent of of the     20 percent of the
 of security futures representing       narrow-based security    current market value     current market value
 each component of a narrow-based       index.                   of the short security    of the short security
 securities index) and short put                                 future, plus the         future, plus the
 option on the same underlying                                   aggregate put in-the-    aggregate put in-the-
 security (or index).                                            money amount, if any.    money amount, if any.
                                                                 Proceeds from the put
                                                                 sale may be applied.
(3) Long security future and short     Individual stock or      The initial margin       5 percent of the
 position in the same security (or      narrow-based security    required under           current market value
 securities basket) underlying the      index.                   Regulation T for the     as defined in
 security future.                                                short stock or stocks.   Regulation T of the
                                                                                          stock or stocks
                                                                                          underlying the
                                                                                          security future
(4) Long security future (or basket    Individual stock or      20 percent of the        20 percent of the
 of security futures representing       narrow-based security    current market value     current market value
 each component of a narrow-based       index.                   of the long security     of the long security
 securities index) and short call                                future, plus the         future, plus the
 option on the same underlying                                   aggregate call in-the-   aggregate call in-the-
 security (or index).                                            money amount, if any.    money amount, if any.
                                                                 Proceeds from the call
                                                                 sale may be applied.
(5) Long a basket of narrow-based      Narrow-based security    20 percent of the        20 percent of the
 security futures that together         index.                   current market value     current market value
 tracks a broad based index and short                            of the long basket of    of the long basket of
 a broad-based security index call                               narrow-based security    narrow-based security
 option contract on the same index.                              futures, plus the        futures, plus the
                                                                 aggregate call in-the-   aggregate call in-the-
                                                                 money amount, if any.    money amount, if any.
                                                                 Proceeds from the call
                                                                 sale may be applied.
(6) Short a basket of narrow-based     Narrow-based security    20 percent of the        20 percent of the
 security futures that together         index.                   current market value     current market value
 tracks a broad-based security index                             of the short basket of   of the short basket of
 and short a broad-based security                                narrow-based security    narrow-based security
 index put option contract on the                                futures, plus the        futures, plus the
 same index.                                                     aggregate put in-the-    aggregate put in-the-
                                                                 money amount, if any.    money amount, if any.
                                                                 Proceeds from the put
                                                                 sale may be applied.

[[Page 78546]]

 
(7) Long a basket of narrow-based      Narrow-based security    20 percent of the        The lower of: (1) 10
 security futures that together         index.                   current market value     percent of the
 tracks a broad-based security index                             of the long basket of    aggregate exercise
 and long a broad-based security                                 narrow-based security    price of the put, plus
 index put option contract on the                                futures, plus pay for    the aggregate put out-
 same index.                                                     the long put in full.    of-the-money amount,
                                                                                          if any; or (2) 20
                                                                                          percent of the current
                                                                                          market value of the
                                                                                          long basket of
                                                                                          security futures.
(8) Short a basket of narrow-based     Narrow-based security    20 percent of the        The lower of: (1) 10
 security futures that together         index.                   current market value     percent of the
 tracks a broad-based security index                             of the short basket of   aggregate exercise
 and long a broad-based security                                 narrow-based security    price of the call,
 index call option contract on the                               futures, plus pay for    plus the aggregate
 same index.                                                     the long call in full.   call out-of-the-money
                                                                                          amount, if any; or (2)
                                                                                          20 percent of the
                                                                                          current market value
                                                                                          of the short security
                                                                                          futures.
(9) Long security future and short     Individual stock or      The greater of: (1) 5    The greater of: (1) 5
 security future on the same            narrow-based security    percent of the current   percent of the current
 underlying security (or index).        index.                   market value of the      market value of the
                                                                 long security future;    long security future;
                                                                 or (2) 5 percent of      or (2) 5 percent of
                                                                 the current market       the current market
                                                                 value of the short       value of the short
                                                                 security future.         security future.
(10) Long security future, long put    Individual stock or      20 percent of the        10 percent of the
 option and short call option. The      narrow-based security    current market value     aggregate exercise
 long security future, long put and     index.                   of the long security     price, plus the
 short call must be on the same                                  future, plus the         aggregate call in-the-
 underlying security and the put and                             aggregate call in-the-   money amount, if any.
 call must have the same exercise                                money amount, if any,
 price (conversion).                                             plus pay for the put
                                                                 in full. Proceeds from
                                                                 the call sale may be
                                                                 applied.
(11) Long security future, long put    Individual stock or      20 percent of the        The lower of: (1) 10
 option and short call option. The      narrow-based security    current market value     percent of the
 long security future, long put and     index.                   of the long security     aggregate exercise
 short call must be on the same                                  future, plus the         price of the put plus
 underlying security and the put                                 aggregate call in-the-   the aggregate put out-
 exercise price must be below the                                money amount, if any,    of-the-money amount,
 call exercise price (Collar).                                   plus pay for the put     if any, or (2) 20
                                                                 in full. Proceeds from   percent of the
                                                                 call sale may be         aggregate exercise
                                                                 applied.                 price of the call,
                                                                                          plus aggregate call in-
                                                                                          the-money amount, if
                                                                                          any.
(12) Short security future and long    Individual stock or      The initial margin       5 percent of the
 position in the same security (or      narrow-based security    required under           current market value,
 securities basket) underlying the      index.                   Regulation T for the     as defined in
 security future.                                                long security or         Regulation T, of the
                                                                 securities.              long stock or stocks.
(13) Short security future and long    Individual stock or      The initial margin       10 percent of the
 position in a security immediately     narrow-based security    required under           current market value,
 convertible into the same security     index.                   Regulation T for the     as defined in
 future, without restriction,                                    long security or         Regulation T, of the
 including the payment of money.                                 securities.              long stock or stocks.
(14) Short security future (or basket  Individual stock or      20 percent of the        The lower of: (1) 10
 of security futures representing       narrow-based             current market value     percent of the
 each component of a narrow-based       securities index.        of the short security    aggregate price of the
 securities index) and long call                                 future, plus pay for     call, plus the
 option or warrant on the same                                   the call in full.        aggregate call out-of-
 underlying security (or index).                                                          money amount, if any;
                                                                                          or (2) 20 current of
                                                                                          the market value of
                                                                                          the short security
                                                                                          security future.
(15) Short security future, short put  Individual stock or      20 percent of the        10 percent of the
 option long call option. The short     narrow-based security    current market value     aggregate exercise
 security future, short put and long    index.                   of the short security    price, plus the
 call must be on the same underlying                             future, plus the         aggregate put in-the-
 security and the put and call must                              aggregate put in-the-    money amount, if any.
 have the same exercise price.                                   money amount amount,
 (Reverse Conversion).                                           if any, plus pay for
                                                                 the call in full.
                                                                 Proceeds from put sale
                                                                 may be applied.
(16) Long (short) a security future    Individual stock and     The greater of: (1) 3    The greater of: (1) 3
 and short (long) an identical \6\      narrow-based security    percent of the current   percent of the current
 security future traded on a            index.                   market value of the      market value of the
 different market.                                               long security            long security
                                                                 future(s); or (2) 3      future(s); or (2) 3
                                                                 percent of the current   percent of the current
                                                                 market value of the      market value of the
                                                                 short security           short security
                                                                 future(s).               future(s).
(17) Long (short) a basket of          Individual stock and     The greater of: (1) 5    The greater of: (1) 5
 security futures that together         narrow-based security    percent of the current   percent of the current
 tracks a narrow-based index and        index.                   market value of the      market value of the
 short (long) a narrow-based index                               long security            long security
 future.                                                         future(s); or (2) 5      future(s); or (2) 5
                                                                 percent of the current   percent of the current
                                                                 market value of the      market value of the
                                                                 short security           short security
                                                                 future(s).               future(s).
----------------------------------------------------------------------------------------------------------------



[[Page 78547]]

    Note: \6\ Two security futures contract will be considered 
``identical'' for this purpose if they are issued by the same 
clearing agency of cleared and guaranteed by the same derivatives 
clearing organization, have identical specifications, and would 
offset each other at the clearing level. See Amendment No.1, Supra 
note 3.

    (C) Definitions. For the purposes of paragraph (f)(11) of this Rule 
and the offset table noted above, with respect to the term ``security 
futures contracts,'' the following terms shall have the meanings 
specified below:
    (i) The term ``security futures contract'' means a ``security 
future'' as defined in Section 3(a)(55) of the Act.
    (ii) The term ``current market-value'' has the same meaning as 
defined in Rule 401(a)(4) under the Act and Rule 41.43(a)(4) under the 
CEA.
    (iii) The term ``underlying security'' means, in the case of 
physically settled security futures contracts, the security that is 
delivered upon expiration of the contract, and, in the case of cash 
settled security futures contracts, the security or securities index 
the price or level of which determines the final settlement price for 
the security futures contract upon its expiration.
    (iv) The term ``underlying basket'' means, in the case of a 
securities index, a group of security futures contracts where the 
underlying securities as defined in subparagraph (iii) above include 
each of the component securities of the applicable index and that meets 
the following conditions: (1) the quantity of each underlying security 
is proportional to its representation in the index, (2) the total 
market value of the underlying securities is equal to the aggregate 
value of the applicable index, (3) the basket cannot be used to offset 
more than the number of contracts or warrants represented by its total 
market value, and (4) the security futures contracts shall be 
unavailable to support any other contract or warrant transaction in the 
account.
    (v) The term ``underlying stock basket'' means a group of 
securities that includes each of the component securities of the 
applicable index and that meets the following conditions: (1) The 
quantity of each stock in the basket is proportional to its 
representation in the index, (2) the total market value of the basket 
is equal to the underlying index value of the index options or warrants 
to be covered, (3) the securities in the basket cannot be used to cover 
more than the number of index options or warrants represented by that 
value, and (4) the securities in the basket shall be unavailable to 
support any other option or warrant transaction in the account.
    (vi) The term ``variation settlement'' has the same meaning as 
defined in Rule 401(a) under the Act and Rule 41.43(a)(32) under the 
CEA.
    (D) Security Futures Dealers' Accounts.
    (i) Notwithstanding the other provisions of this paragraph (f)(11), 
a member may carry and clear the market maker permitted offset 
positions (as defined below) of one or more security futures dealers in 
an account that is limited to bona fide market maker transactions, upon 
a ``Good Faith'' margin basis that is satisfactory to the concerned 
parties, provided the ``Good Faith'' margin requirement is not less 
than the Net Capital haircut deduction of the member carrying the 
transaction pursuant to Rule 15c3-1 under the Act. In lieu of 
collecting the ``Good Faith'' margin requirement, a carrying member may 
elect to deduct in computing its Net Capital the amount of any 
deficiency between the equity maintained in the account and the ``Good 
Faith'' margin required.
    For the purpose of this paragraph (f)(11)(D), the term ``security 
futures dealer'' means a security futures dealer as defined in Rule 400 
(c)(2)(v) under the Act and Rule 41.42(c)(2)(v) under the CEA.
    (ii) For purposes of this paragraph (f)(11)(D), a permitted offset 
position means in the case of a security futures contract in which a 
security futures dealer makes a market, a position in the underlying 
asset or other related assets, or positions in options overlying the 
asset or related assets. Accordingly, a security futures dealer may 
establish a long or short position in the assets underlying the 
security futures contracts in which the security futures dealer makes a 
market, and may purchase or write options overlying those assets if the 
account holds the following permitted offset positions:
    a. A long position in the security futures contract or underlying 
asset offset by a short option position that is ``in or at the money'';
    b. A short position in the security futures contract or underlying 
asset offset by a long option position that is ``in or at the money'';
    c. A position in the underlying asset resulting from the assignment 
of a market-maker short option position or making delivery in respect 
of a short security futures contract;
    d. A position in the underlying asset resulting from the assignment 
of a market-maker long option position or taking delivery in respect of 
a long security futures contract;
    e. A net long position in a security futures contract in which a 
security futures dealer makes a market or the underlying asset;
    f. A net short position in a security futures contract in which a 
security futures dealer makes a market or the underlying asset; or
    g. An offset position as defined in Rule 15c3-1 under the Act, 
including its appendices, or any applicable SEC staff interpretation or 
no-action position.
    (E) Approved Options Specialists' or Market Maker Accounts.
    (i) Notwithstanding the other provisions of (f)(11) and (f)(2)(J), 
a member may carry and clear the market-maker permitted offset 
positions (as defined below) of one or more approved options 
specialists or market-makers in an account that is limited to bona fide 
approved options specialist or market maker transactions, upon a ``Good 
Faith'' margin basis that is satisfactory to the concerned parties, 
provided the ``Good Faith'' margin requirement is not less than the Net 
Capital haircut deduction of the member carrying the transaction 
pursuant to Rule 15c3-1 under the Act. In lieu of collecting the ``Good 
Faith'' margin requirement, a carrying member may elect to deduct in 
computing its Net Capital the amount of any deficiency between the 
equity maintained in the account and the ``Good Faith'' margin 
required. For the purpose of this paragraph (f)(11)(E), the term 
``approved options specialist or market-maker'' means a specialist, 
market-maker, or registered trader in options as referenced in 
paragraph (f)(2)(J) of this Rule, who is deemed a specialist for all 
purposes under the Act and who is registered pursuant to the rules of a 
national securities exchange.
    (ii) For purposes of this paragraph (f)(11)(E), a permitted offset 
position means a position in the underlying asset or other related 
assets. Accordingly, a specialist or marker maker may establish a long 
or short position in the assets underlying the options in which the 
specialist or market maker makes a market, or a security futures 
contract thereon, if the account holds the following permitted offset 
positions:
    a. A long position in the underlying instrument or security futures 
contract offset by a short option position that is ``in or at the 
money'';
    b. A short position in the underlying instrument or security 
futures contract

[[Page 78548]]

offset by a long option position that is ``in or at the money'';
    c. A stock position resulting from the assignment of a market-maker 
short option position or delivery in respect of a short security 
futures contract;
    d. A stock position resulting from the exercise of a market-maker 
long option position or taking delivery in respect of a long security 
futures contract;
    e. A net long position in a security (other than an option) in 
which the market maker makes a market;
    f. A net short position in a security (other than an option) in 
which the market maker makes a market; or
    g. An offset position as defined in Rule 15c3-1 under the Act, 
including its appendices, or any applicable SEC staff interpretation or 
no-action position.
    (iii) For purposes of paragraphs (f)(11)(D) and (E), the term ``in 
or at the money'' means that the current market price of the underlying 
security is not more than two standard exercise intervals below (with 
respect to a call option) or above (with respect to a put option) the 
exercise price of the option; the term ``in the money'' means that the 
current market price of the underlying asset or index is not below 
(with respect to a call option) or above (with respect to a put option) 
the exercise price of the option; the term ``overlying option'' means a 
put option purchased or a call option written against a long position 
in an underlying asset; or a call option purchased, or a put option 
written against a short position in an underlying asset.
    (iv) Securities, including options and security futures contracts, 
in such accounts shall be valued conservatively in light of current 
market prices and the amount that might be realized upon liquidation. 
Substantial additional margin must be required or excess Net Capital 
maintained in all cases where the securities carried: (a) Are subject 
to unusually rapid or violent changes in value including volatility in 
the expiration months of options or security futures contracts, (b) do 
not have an active market, or (c) in one or more or all accounts, 
including proprietary accounts combined, are such that they cannot be 
liquidated promptly or represent undue concentration of risk in view of 
the carrying member's Net Capital and its overall exposure to material 
loss.
    (F) Approved Specialists' Accounts--others.
    (i) Notwithstanding the other provisions of (f)(11) and (f)(2)(J), 
a member may carry the account of an ``approved specialist,'' which 
account is limited to bona fide specialist transactions including hedge 
transactions with security futures contracts upon a margin basis that 
is satisfactory to both parties. The amount of any deficiency between 
the equity in the account and haircut requirement pursuant to Rule 
15c3-1 shall be charged against the member's net capital when computing 
net capital under SEC Rule 15c3-1.\7\
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    \7\ See Amendment No. 1, supra note 3.
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    (ii) For purposes of this paragraph (f)(11)(F), the term ``approved 
specialist'' means a specialist who is deemed a specialist for all 
purposes under the Act and who is registered pursuant to the rules of a 
national securities exchange.
    (G) Additional Requirements.
    (i) Money market mutual funds, as defined in Rule 2a-7 under the 
Investment Company Act of 1940, can be used for satisfying margin 
requirements under this paragraph (f)(11), provided that the 
requirements of Rule 404(b) under the Act and Rule 46(b)(2) under the 
CEA are satisfied.
    (ii) Day trading of security futures is subject to the minimum 
requirements of this Rule. If deemed a pattern day-trader, the customer 
must maintain equity of $25,000. The 20 percent requirement, for 
security futures contracts, should be calculated based on the greater 
of the initial or closing transaction and any amount exceeding NASD 
excess must be collected. The creation of a customer call subjects the 
account to all the restrictions contained in Rule 2520(f)(8)(B).
    (iii) The use of the ``time and tick'' method is based on the 
member's ability to substantiate the validity of the system used. 
Lacking this ability dictates the use of the aggregate method.
    (iv) Security futures contracts transacted or held in a futures 
account \8\ shall not be subject to any provision of this Rule.
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    \8\ Id.
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* * * * *

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

    In its filing with the Commission, NASD 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. NASD 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

Background

    In December 2000, the Commodity Futures Modernization Act of 
2000\9\ (the ``CFMA'') was signed into law. The CFMA, among other 
things, repealed the Shad-Johnson Accord, and now permits, for the 
first time, the trading of futures on narrow-based indices and single 
stocks (collectively referred to as ``security futures contracts'' or 
``SFCs''). SFCs are hybrid products in that they have characteristics 
traditionally associated with both securities and futures. Accordingly, 
the CFMA requires that these products be treated as both ``securities'' 
and ``futures,'' and thus they are subject to regulation by the SEC and 
the CFTC. The enactment of the CFMA surfaced a number of regulatory 
issues, including determining the appropriate margin treatment for 
SFCs.
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    \9\ Appendix E of Pub. L. No. 106-554, 114 Stat. 2763 (2000).
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    The CFTC and SEC have adopted customer margin requirements for SFCs 
(``SEC/CFTC Margin Regulations'') \10\ pursuant to authority delegated 
to them by the Federal Reserve Board (``FRB'') under Section 7(c)(2)(B) 
of the Act.\11\ As noted in the adopting release,\12\ Section 7(c)(2) 
of the Act provides that the customer margin requirements for SFCs must 
satisfy four requirements: (1) They must preserve the financial 
integrity of markets trading security futures contracts; (2) they must 
prevent systemic risk; (3) they must (a) be consistent with the margin 
requirements for comparable options traded on an exchange registered 
pursuant to Section 6(a) of the Act,\13\ and (b) provide for initial 
and maintenance margin that are not lower than the lowest level of 
margin, exclusive of premium, required for comparable exchange traded 
options; and (4) they must be and remain consistent with the margin 
requirements established by the FRB under Regulation T.\14\ These 
margin regulations became effective on September 13, 2002. The 
amendments discussed below are being proposed to conform NASD margin 
rules to these

[[Page 78549]]

new requirements, and to be comparable to those of the NYSE.
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    \10\ 17 CFR 242.400 through 406.
    \11\ 15 U.S.C. 78g(c)(2)(B).
    \12\ Securities Exchange Act Release No. 46292 (August 1, 2002), 
67 FR 53146 (August 14, 2002).
    \13\ 15 U.S.C. 78f.
    \14\ 12 CFR 220.
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Proposed Rule Change

    NASD Rule 2520 prescribes specific margin requirements for members 
of NASD that must be maintained in all accounts of their customers, 
based on the type of securities product held in such accounts.
    As proposed, NASD Rule 2520(b) and (c) would be amended to provide 
that the amount of initial and maintenance margin required for long and 
short SFCs held in a securities account shall be 20 percent of the 
current market value of such SFC. In doing so, NASD believes this would 
essentially make margin requirements for SFCs consistent with the 
margin requirements for comparable exchange-traded options contracts, 
which are premium plus 20 percent of the underlying securities.
    NASD Rule 2520(e)(6) (``Broker/Dealer Accounts'') is being amended 
to permit introducing broker/dealers trading SFCs to deduct from their 
proprietary accounts the amount of any deficiency between the equity in 
the account and the haircut requirements pursuant to Rule 15c3-1 under 
the Act (``Net Capital Rule'') \15\ in computing the net capital of the 
member, in lieu of collecting margin.
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    \15\ 17 CFR 240.15c3-1.
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    NASD Rule 2520(f)(11) (``Customer Margin Rules Relating to Security 
Futures'') is a new provision that will provide that transactions in 
SFCs in a securities account be subject to all other provisions of NASD 
Rule 2520, including Rule 2520(f)(8)(B) (``Day Trading''). Excluded 
from the margin requirements of the Rule are arrangements between a 
creditor and a borrower, whereby the borrower is defined as an 
``Exempted Person'' under Rule 401(a)(9) \16\ of the Act, and Rule 
41.43(a)(9) \17\ under the Commodity Exchange Act. SFCs transacted in a 
futures account would not be subject to the requirements of NASD Rule 
2520.
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    \16\ 17 CFR 242.401(a)(9).
    \17\ 17 CFR 41.43(a)(9).
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    NASD Rule 2520(f)(11)(B)(iii) (``Permissible Offsets'') is a new 
provision that will permit margin lower than the 20 percent general 
requirement, and thereby recognize the hedged nature of certain 
offsetting positions involving SFCs and related positions. In doing so, 
margin levels for offsetting positions involving SFCs and related 
positions would be lower than would be required if those positions were 
margined separately. Further, the proposed rule change makes NASD's 
Rule consistent with the table of offsets included in the recently 
adopted SEC/CFTC margin regulations noted above.
    NASD Rule 2520(f)(11)(C) is a new provision that would provide 
certain definitions that apply specifically to SFCs including, among 
other things, the definitions of ``security futures contract,'' 
``current market value,'' and ``underlying security.''
    NASD Rule 2520(f)(11)(D) (``Security Futures Dealers' Accounts''), 
NASD Rule 2520(f)(11)(E) (``Approved Options Specialists' or Market 
Maker's Accounts''), and NASD Rule 2520(f)(11)(F) (``Approved 
Specialists' Accounts--others'') are new rule provisions. As proposed, 
the rule would permit ``good faith'' margin treatment for specified 
hedged offset positions carried in the accounts noted above. However, 
unlike the amendments proposed by other SROs \18\ on security futures, 
NASD believes that its proposal will permit members to accord offset 
treatment in accounts carried for such specialists, market makers and 
security futures dealers only when their activity is limited to bona 
fide specialist or market making transactions. According to NASD, the 
limitations imposed are consistent with NASD's belief that market 
makers bear the primary responsibility and obligation to maintain fair 
and orderly markets, and provide liquidity to the marketplace. Were a 
revenue or other test substituted for the affirmative obligation 
standard here proposed, NASD believes that entities other than 
qualified market makers would be permitted to receive the more 
favorable market maker margin treatment. NASD believes that such was 
not the Commission's or CFTC's intent when adopting these rules.
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    \18\ See e.g., Securities Exchange Release No. 46555 (September 
26, 2002), 67 FR 61707 (October 1, 2002).
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    NASD Rule 2520(f)(11)(G)(i) is a new proposed provision that would 
permit money market mutual funds as defined in Rule 2a-7 under the 
Investment Company Act of 1940 to be used for satisfying margin 
requirements for securities transactions, provided that the 
requirements of Rule 404(b) \19\ under the Act and Rule 41.46(b)(2) 
\20\ under the CEA are satisfied. Presently, money market mutual funds 
may be used as collateral to satisfy margin requirements under 
Regulation T in a securities margin account. The amendments to NASD 
Rule 2520 would now permit the use of such funds as collateral for SFCs 
as is required by the new SEC/CFTC Margin Regulations described above.
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    \19\ 12 CFR 242.404(b).
    \20\ 12 CFR 41.46(b)(2).
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    Except as otherwise intended, NASD believes that these proposed 
amendments are consistent with other SRO rule amendments addressing 
margin requirements for SFCs (i.e., Nasdaq-Liffe Markets, OneChicago, 
LLC).
2. Statutory Basis
    NASD believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\21\ which requires, among 
other things, that NASD's rules must be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest by establishing margin rules for security futures that 
are comparable with those developed by the SEC and CFTC and proposed by 
other SROs.
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    \21\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

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

    Written comments were neither solicited nor 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:
    A. By order approve such proposed rule change, or
    B. Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities

[[Page 78550]]

and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-
0609. 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 NASD. 
All submissions should refer to the File No. SR-NASD-2002-166 and in 
the caption above and should be submitted by January 14, 2003.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\22\
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    \22\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-32318 Filed 12-23-02; 8:45 am]
BILLING CODE 8010-01-P