[Federal Register Volume 67, Number 249 (Friday, December 27, 2002)]
[Notices]
[Pages 79199-79202]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-32798]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47034; File No. SR-CBOE-2002-70]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by the Chicago Board Options 
Exchange, Inc. Relating to Day Trading Margin Requirements

December 19, 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 December 9, 2002, the Chicago Board Options Exchange, Inc. (``CBOE'' 
or ``Exchange'') submitted to the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I and 
II below, which Items have been prepared by the Exchange. The Exchange 
submitted the proposed rule change pursuant to section 19(b)(3)(A) of 
the Act,\3\ and Rule 19b-4(f)(6) thereunder,\4\ which renders the 
proposed rule change effective upon filing with the Commission. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ 15 U.S.C. 78s(b)(3)(A).
    \4\ 17 CFR 240.19b-4(f)(6).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to amend Chapter 12 of its rules 
(``Margins'') to implement specific requirements for day trading in 
customer accounts of member organizations. The text of the proposed 
rule change follows. New rule language is italicized.
CHAPTER 12: Margins
Rules 12.1 and 12.2: No change.
Rule 12.3
    (a) through (i)(3): No change.
    (i)(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 Rule 12.3(j)(4).
    Withdrawals of cash or securities may be made from any account 
which has a debit balance, ``short'' position or commitments, provided 
the account is in compliance with Regulation T of the Board of 
Governors of the Federal Reserve System and after such withdrawal the 
equity in the account is at least the greater of $2,000 ($25,000 in the 
case of ``pattern day traders'') or an amount sufficient to meet the 
maintenance margin requirements of this Rule.

Day Trading

    (j)(1) The term ``day trading'' means the purchasing and selling, 
or the selling and purchasing, of the same security on the same day in 
a margin account except for:
    (A) a long security position held overnight and sold the next day 
prior to any new purchases of the same security, or
    (B) a short security position held overnight and purchased the next 
day prior to any new sales of the same security.
    (2) The term ``pattern day trader'' means any customer who executes 
four (4) or more day trades within five (5) business days. However, if 
the number of day trades is 6% or less of total trades for the five (5) 
business day period, the customer will no longer be considered a

[[Page 79200]]

pattern day trader and the special requirements under paragraph 
12.3(j)(4) of this Rule will not apply.
    (3) The term ``day trading buying power'' means the equity in a 
customer's account at the close of business of the previous day, less 
any maintenance margin requirement as prescribed in paragraph (b) of 
this Rule, multiplied by four (4), for equity securities.
    Whenever day trading occurs in a customer's margin account, the 
special maintenance margin required for the day trades in equity 
securities shall be 25% of the cost of all the day trades made during 
the day. For non-equity securities, the special maintenance margin 
shall be as required pursuant to the other provisions of this Rule. 
Alternatively, when two or more day trades occur on the same day in the 
same customer's account, the margin required may be computed utilizing 
the highest (dollar amount) open position during that day. To utilize 
the highest open position computation method, a record showing the 
``time and tick'' of each trade must be maintained to document the 
sequence in which each day trade was completed.
    (4) Special Requirements for Pattern Day Traders.
    (A) Minimum Equity Requirement for Pattern Day Traders. The minimum 
equity required for the accounts of customers deemed to be pattern day 
traders shall be $25,000. This minimum equity must be maintained in the 
customer's account at all times (see Interpretations and Policies .16 
and .17 of this Rule).
    (B) Pattern day traders cannot trade in excess of their day trading 
buying power as defined in paragraph (j)(3) above. In the event a 
pattern day trader exceeds its day trading buying power, which creates 
a special maintenance margin deficiency, the following actions will be 
taken by the member organization:
    (1) The account will be margined based on the cost of all the day 
trades made during the day, and
    (2) The customer's day trading buying power will be limited to the 
equity in the customer's account at the close of business of the 
previous day, less the maintenance margin required in paragraph (b) of 
this Rule, multiplied by two, for equity securities.
    (C) Pattern day traders who fail to meet their special maintenance 
margin calls as required within five (5) business days from the date 
the margin deficiency occurs will be permitted to execute transactions 
only on a cash available basis for 90 days or until the special 
maintenance margin call is met.
    (D) Pattern day traders are restricted from utilizing the 
guaranteed account provision under Rule 12.8 for meeting the 
requirements of this Rule 12.3(j).
    (E) Funds, deposited into a pattern day trader's account to meet 
the minimum equity or maintenance margin requirements of this Rule 
12.3(j), cannot be withdrawn for a minimum of two (2) business days 
following the close of business on the day of deposit.
    (5) When the equity in a customer's account, after giving 
consideration to the other provisions of this Rule, is not sufficient 
to meet the requirements of Rule 12.3(j), additional cash or securities 
must be received into the account to meet any deficiency within five 
(5) business days of the trade date.
    In addition, on the sixth business day only, member organizations 
are required to deduct from net capital the amount of unmet maintenance 
margin calls pursuant to SEC Rule 15c3-1.
    Interpretations and Policies:
    .16 In the event that the member organization at which a customer 
seeks to open an account, or resume day trading in an existing account, 
knows or has a reasonable basis to believe that the customer will 
engage in pattern day trading, then the minimum equity required under 
Rule 12.3(j)(4)(A) must be deposited in the account prior to 
commencement of day trading.
    .17 When a customer engages in pattern day trading, the minimum 
equity required under Rule 12.3(j)(4)(A) must be deposited in the 
account before such customer may continue day trading.
    .18 For purposes of Rule 12.3(j)(3), ``time and tick'' (i.e., 
calculating margin utilizing each trade in the sequence that it is 
executed, using the highest open position during the day) may not be 
used for a pattern day trader who exceeds their day trading buying 
power.
    .19 For purposes of Rules 12.3(j)(3) and 12.3(j)(4)(B)(2) above, 
the day trading buying power for non-equity securities shall, at a 
minimum, be computed using the applicable maintenance margin 
requirements pursuant to Rule 12.3.

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
    The CBOE proposes to implement specific margin requirements for day 
trading in Chapter 12 of its rules (``Margins''). These requirements 
would be incorporated into Rule 12.3 under new paragraph (j). The CBOE 
is essentially adopting the requirements contained in a New York Stock 
Exchange (``NYSE'') rule filing approved by the Commission. The 
Commission simultaneously approved fundamentally comparable rules filed 
by the National Association of Securities Dealers.\5\
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    \5\ See NYSE Rule 431 and NASD Rule 2520; Securities Exchange 
Act Release No. 34-44009 (February 27, 2001); 66 FR 13608 (March 6, 
2001) (order approving File Nos. SR-NYSE-99-47 and SR-NASD-00-03).
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    Day trading is the purchasing and selling (or the selling and 
purchasing) of the same security on the same day in a margin account. 
Day traders attempt to profit from intra-day price movements of 
securities. Excessive day trading can pose significant credit risk to a 
broker-dealer.
    The day trading of securities by customers of broker-dealers has 
increased greatly in recent years. The rise in the popularity of day 
trading is due in large part to the proliferation of on-line trading 
and broker-dealers that specialize in providing instruction on, and 
accommodating, day trading. Day trading has also become a more 
attractive endeavor because of the ever increasing speed at which 
orders can be routed and executed. Given the general increase in day 
trade activity and the new day trading requirements of the NYSE and 
NASD, the CBOE believes it prudent to implement day trading 
requirements at this time.
    When an investor purchases a security on margin, the investor pays 
for part of the purchase cost (i.e., the margin requirement) and the 
broker-dealer loans the investor the amount needed to pay for the 
balance. The use of margin increases both the potential return and 
financial risk to the investor. This is because margin enables an 
investor to purchase more of the security with a given amount of funds 
than the investor could purchase on a strictly cash basis.
    Pursuant to Section 7(a) of the Act,\6\ the Board of Governors of 
the Federal

[[Page 79201]]

Reserve System (the ``Federal Reserve'') is vested with the authority 
to regulate the extension of credit by broker-dealers on customers' 
securities transactions. In order to prevent the excessive use of 
credit for the purchase or carrying of securities as intended by 
Section 7(a), the Federal Reserve instituted Regulation T.\7\ 
Regulation T contains initial margin requirements only, and allows all 
trades executed during a day to be netted in order to determine if a 
margin deficiency exists at the end of the day. For a day trade, the 
margin currently required under Regulation T is any loss. Day traders, 
therefore, are not required under Regulation T to meet the initial 
margin requirement on a security position held for part of the day. 
However, the day trader, and the firm, has been exposed to intra-day 
risk. In actuality, day traders receive an extension of credit from 
their broker-dealers on an intra-day basis when they effect day trades, 
even though a day trade results in no open position at the end of the 
day.
    The Exchange's current rules establish minimum levels of margin 
that must be maintained in customer accounts (i.e., maintenance 
margin). These requirements only apply to the positions in an account 
at the end of the day and, like Regulation T, do not cover security 
positions held for only a fraction of a day. For options, the 
Exchange's margin rules also prescribe initial margin requirements as 
permitted by Regulation T, provided such rules have been approved by 
the Commission. Again, like Regulation T, these initial margin 
requirements do not cover positions that are opened and closed in an 
account before the end of the day.
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    \6\ 15 U.S.C. 78g(a).
    \7\ 12 CFR 220 et seq.
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    The aim of this proposal is to deter excessive day trading by 
requiring day traders to deposit and maintain minimum levels of equity 
and margin to support their day trading activity. This is consistent 
with Regulation T in that Regulation T permits a registered securities 
exchange to impose additional requirements.\8\ For uniformity, the 
Exchange is adopting essentially the same day trading requirements set 
forth in NYSE Rule 431 and NASD Rule 2520.
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    \8\ See 12 CFR 220.1(b)(2).
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    The elements of the day trading requirements proposed by the 
Exchange are summarized below.
Definitions
    The proposed rule defines ``day trading'' as the purchasing and 
selling, or the selling and purchasing, of the same security on the 
same day in a margin account. An exception is provided for liquidations 
of positions held overnight that are followed by a transaction that 
restores the same position.
    The designation ``pattern day trader'' refers to a customer that 
executes at least four (4) day trades within five (5) business days, 
provided the number of day trades represents more than 6% of total 
trades in the customer's account for the five day period. Thus, if the 
number of day trades is 6% or less of the total number of transactions, 
the customer need not be classified as a pattern day trader. The 
Exchange believes that this aspect of the proposal provides fairness 
because four day trades would be insignificant in proportion to a large 
number of transactions.
    The term ``day trading buying power'' is established in order to 
allow day trading to be conducted up to a set maximum, beyond which a 
day trading margin call is incurred. It is defined as the equity in a 
customer's account at the close of business of the previous day less 
the total maintenance margin required multiplied by 4 for equity 
securities.
Requirement for Non-Pattern Day Traders
    Customers will be required to have enough equity to meet the 
maintenance margin on all day trades. For equity securities, the 
maintenance margin would be 25% of the cost of all day trades. If the 
customer's account has insufficient equity to meet the maintenance 
margin, the customer will have five (5) business days to deposit the 
amount needed. If a deposit is not made, the member organization must 
take a one time capital charge on the sixth business day for any unmet 
deficiency.
Additional Requirements for Pattern Day Traders
    A pattern day trader must have account equity of at least $25,000 
at all times. If a member organization knows, or there is a reasonable 
basis for believing, that a new account will pattern day trade, or that 
an existing account will resume pattern day trading, the member 
organization must require that the $25,000 minimum equity be in the 
account prior to accepting any opening orders. A pattern day trader may 
not be allowed to continue day trading if account equity falls below 
$25,000. Additionally, a pattern day trader's account may not be 
guaranteed by another account for the day trading margin requirement. 
In prohibiting guarantees, each pattern day trader must demonstrate 
actual financial ability to engage in day trading, independently.
    The day trading margin requirement for pattern day traders is the 
same as for non-pattern day traders (25% of the cost, or proceeds, for 
equity securities). Pattern day traders, however, incur a penalty if 
they exceed their day trading buying power. If they exceed their day 
trading buying power, two restrictions must be imposed until the 
deficiency is deposited or for five business days, whichever comes 
first. The restrictions are as follows:
    1. All subsequent day trades must be margined based on the cost of 
all the day trades made during the day; and
    2. The day trade margin requirement for equity securities must be 
increased from 25% to 50%. (For day trades involving purchases of 
options eligible for loan value, the day trade maintenance margin 
requirement must be increased from 75% to 100%.)
    As with non-pattern day traders, pattern day traders must deposit 
any maintenance margin deficiency as a result of day trading within 
five (5) business days. However, in the event the deficiency is not met 
within the requisite five business days, a pattern day trader may not 
be permitted to execute new transactions unless the margin required is 
on deposit. This restriction must remain in effect for 90 days or until 
a deposit sufficient to cover the deficiency is received. Again, as 
with non-pattern day traders, the member organization must take a one 
time capital charge on the sixth business day for any unmet deficiency.
    When a pattern day trader deposits funds to meet a day trade equity 
or maintenance margin requirement, those funds may not be withdrawn for 
a minimum of two (2) business days following the close of business on 
the day of deposit. This requirement is intended to curtail day trading 
that is not supported by the day trader's own funds. Day traders are 
able in many instances to borrow on an overnight basis from various 
sources in order to meet a day trading requirement. By disallowing 
next-day withdrawals of funds deposited to meet a day trading 
requirement, it is expected that lenders will be less inclined to loan 
funds to a day trader if the funds can't be repaid the following day.
    When two or more day trades occur on the same day, the margin 
required may be computed utilizing the highest individual open position 
in dollar terms on that day, provided a record of the ``time and tick'' 
of each transaction is maintained showing the sequence in which each 
day trade was completed. This provision is applicable to both

[[Page 79202]]

non-pattern and pattern day traders. As noted above for pattern day 
traders, this privilege must be withdrawn if the day trading buying 
power is exceeded.
2. Statutory Basis
    The proposed day trading rules are intended to control the amount 
of day trading customers can undertake and thereby prevent excessive 
use of credit on an intra-day basis. As such, the proposed rule change 
is consistent with and furthers the objectives of Section 6(b)(5) of 
the Act,\9\ in that it is designed to perfect the mechanisms of a free 
and open market and to protect investors and the public interest. 
Furthermore, the proposed day trading rules are consistent with Section 
7(a) of Act \10\ and the rules and regulations of the Board of 
Governors of the Federal Reserve System, in that control of excessive 
credit for purchasing or carrying securities is the fundamental 
purpose.
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    \9\ 15 U.S.C. 78(f)(b)(5).
    \10\ 15 U.S.C. 78g(a).
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B. Self-Regulatory Organization's Statement on Burden on Competition

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

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

    No written comments were solicited or received with respect to the 
proposed rule change.

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

    The foregoing rule change has become effective upon filing pursuant 
to Section 19(b)(3)(A)(iii) of the Act \11\ and Rule 19b-4(f)(6) \12\ 
thereunder because the proposed rule change does not (i) significantly 
affect the protection of investors or the public interest; (ii) impose 
any significant burden on competition; and (iii) become operative for 
30 days from the date on which the proposed rule change was filed, or 
such shorter time as the Commission may designate. At any time within 
60 days of the filing of the proposed rule change, the Commission may 
summarily abrogate such rule change if it appears to the Commission 
that such action is necessary or appropriate in the public interest, 
for the protection of investors, or otherwise in furtherance of the 
purposes of the Act.
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    \11\ 15 U.S.C. 78s(b)(3)(A)(iii).
    \12\ 17 CFR 240.19b-4(f)(6).
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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 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 4 change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the CBOE. All submissions should refer to File No. 
SR-CBOE-2002-70 and should be submitted by January 17, 2003.

    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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J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 02-32798 Filed 12-26-02; 8:45 am]
BILLING CODE 8010-01-P