[Federal Register Volume 68, Number 22 (Monday, February 3, 2003)]
[Notices]
[Pages 5317-5319]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-2484]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47244; File No. SR-NASD-2002-166]


Self-Regulatory Organizations; Order Granting Approval of a 
Proposed Rule Change and Amendment No. 1 and Notice of Filing and Order 
Granting Accelerated Approval of Amendment No. 2 to the Proposed Rule 
Change by the National Association of Securities Dealers, Inc. With 
Respect to Margin Rule Amendments for Security Futures Contracts on a 
Pilot Basis

January 24, 2003.

I. Introduction

    On November 15, 2002, the National Association of Securities 
Dealers, Inc. (``NASD'') filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission'') a proposed rule change, pursuant 
to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and rule 19b-4 thereunder,\2\ to amend NASD rule 2520 
(``Margin Requirements'') to establish margin rules for security 
futures contracts. On November 22, 2002, NASD filed Amendment No. 1 to 
the proposed rule change.\3\ The proposal, as amended, was published in 
the Federal Register on December 24, 2002.\4\ The Commission received 
one comment letter on the proposed rule change.\5\ This commenter also 
submitted a comment letter on the NYSE's pilot to amend NYSE rule 431 
to establish margin requirements for security futures contracts.\6\ On 
January 15, 2003, NASD filed Amendment No.

[[Page 5318]]

2 to the proposed rule change.\7\ This order approves the proposed rule 
change, as amended, on a pilot basis until March 6, 2003.
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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.
    \4\ Securities Exchange Act Release No. 46995 (December 13, 
2002), 67 FR 78543.
    \5\ See letter from Edward J. Joyce, President and Chief 
Operating Officer, Chicago Board Options Exchange (``CBOE''), to 
Jonathan G. Katz, Secretary, Commission, dated December 20, 2002.
    \6\ See letter from Edward J. Joyce, President and Chief 
Operating Officer, CBOE, to Jonathan G. Katz, Secretary, Commission, 
dated December 9, 2002. On November 7, 2002, the Commission 
approved, on a 60-day pilot basis, a proposed rule change by the New 
York Stock Exchange, Inc. (``NYSE'') amending NYSE rule 431 
(``Margin Requirements'') to establish margin requirements for 
security futures contracts. See Securities Exchange Act Release No. 
46782 (November 7, 2002), 67 FR 69052 (November 14, 2002) (SR-NYSE-
2002-53). In January 2003, the NYSE pilot was extended for an 
additional 60 days, expiring on March 6, 2003. See Securities 
Exchange Act Release No. 47129 (January 6, 2002), 68 FR 2094 
(January 15, 2003) (SR-NYSE-2003-01).
    \7\ See letter from Gary L. Goldsholle, Associate General 
Counsel, NASD, to Katherine A. England, Assistant Director, 
Division, Commission, dated January 15, 2003 (``Amendment No. 2''). 
In Amendment No. 2, NASD requested that the Commission approve the 
proposed rule change on a pilot basis under the same terms as the 
NYSE's pilot, pending the resolution of the issues raised by 
commenters.
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II. Description of the Proposed Rule Change

    NASD is proposing to amend NASD rule 2520 (``Margin Requirements'') 
to establish margin requirements for security futures contracts 
(``SFCs''). The proposed rule change is being made to make NASD's 
margin rule consistent with the margin rules for security futures 
adopted by the SEC and the Commodity Futures Trading Commission 
(``CFTC''), and the rules adopted by the NYSE, Nasdaq-Liffe Markets, 
and One Chicago, LLC.
    The CFTC and SEC adopted customer margin requirements for SFCs 
(``SEC/CFTC Margin Regulations'') \8\ pursuant to authority delegated 
to them by the Federal Reserve Board (``FRB'') under section 7(c)(2)(B) 
of the Act.\9\ These margin regulations became effective on September 
13, 2002. NASD is proposing to conform its margin rules to these new 
requirements, and to be comparable to the NYSE's margin requirements 
under NYSE rule 431.
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    \8\ 17 CFR 242.400 through 406; 17 CFR 41.42 through 41.48.
    \9\ 15 U.S.C. 78g(c)(2)(B). As noted in the adopting release, 
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 
(15 U.S.C. 78f) 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. See Securities Exchange 
Act Release no. 46292 (August 1, 2002), 67 FR 53146 (August 14, 
2002).
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    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 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.
    NASD rule 2520(e)(6) (``Broker/Dealer Accounts'') would 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'') \10\ in computing the net capital of the 
member, in lieu of collecting margin.
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    \10\ 17 CFR 240.15c3-1.
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    NASD rule 2520(f)(11) (``Customer Margin Rules Relating to Security 
Futures'') would 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)\11\ of the Act, and rule 41.43(a)(9)\12\ 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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    \11\ 17 CFR 242.401(a)(9).
    \12\ 17 CFR 41.43(a)(9).
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    NASD rule 2520(f)(11)(B)(iii) (``Permissible Offsets'') would 
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.
    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'') would permit ``good faith'' margin 
treatment for specified hedged offset positions carried in the accounts 
noted above.\13\ NASD rule 2520(f)(11)(G)(i) 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) \14\ under 
the Act and rule 41.46(b)(2) \15\ under the CEA are satisfied.\16\
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    \13\ NASD noted that, unlike the amendments proposed by other 
SROs, on security futures, it believes that its proposed amendment 
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 the SEC/CFTC 
Margin Regulations.
    \14\ 17 CFR 242.404(b).
    \15\ 17 CFR 41.46(b)(2).
    \16\ 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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III. Summary of Comments

    As noted above, the Commission received one comment letter on the 
proposed rule change.\17\ This commenter also submitted a comment 
letter on NYSE's proposal regarding margin requirements for securities 
futures contracts.\18\ First, the commenter believes that both the NYSE 
and NASD rules on margin requirements for security futures should not 
be approved by the Commission on a permanent basis until the rules 
provide an exemption from the existing day trading provisions of NYSE 
rule 431. The commenter believes that applying the margin restrictions 
on day trading to security futures will create a disparity between 
security futures contracts that are held in a securities account and 
contracts that are held in a futures account, which is inconsistent 
with the principles of the Commodity Futures Modernization Act.
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    \17\ See supra note .
    \18\ For further details on SR-NYSE-2002-53, see id.
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    Second, the commenter would like to delete references in the 
proposed rule language to ``bona fide'' market maker or specialist 
transactions. Specifically, the commenter believes that the NYSE and 
NASD intend to determine which transactions of a ``bona fide'' market 
maker/specialist would fit within this definition. The commenter is 
concerned that NYSE and NASD may not rely on the other self-regulatory 
organizations' (``SROs'') rules regarding who is a market maker and 
that, therefore, the NYSE's and NASD's rules would not be consistent 
with the rules of these other SROs. This commenter believes that if the 
SEC approves an SRO rule regarding who as a market maker, the NYSE and 
NASD margin rules should defer to that SRO's rule in defining a market 
maker or specialist.
    In response to these substantive concerns, NASD has requested that 
its proposal be approved as a pilot under

[[Page 5319]]

the same terms as the NYSE's proposal.\19\ Under a pilot program, NASD 
will have the opportunity to consider comments it received on the 
proposal, and facilitate the trading in securities futures in 
securities accounts for those NASD members, who are not also members of 
the NYSE.
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    \19\ See supra note .
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IV. Discussion

    The Commission finds that the proposed rule change, as amended, is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
association.\20\ In particular, the Commission believes that the 
proposed rule change is consistent with the requirements of section 
15A(b)(6) of the Act,\21\ which requires, among other things, to 
promote just and equitable principles of trade and, in general, to 
protect investors and the public interest. In addition, the Commission 
believes that the proposed rule change is consistent with section 
7(c)(2)(B) of the Act,\22\ which provides, among other things, that the 
margin requirements for security futures must preserve the financial 
integrity of markets trading security futures, prevent systemic risk, 
be consistent with the margin requirements for comparable exchange-
traded options, and provides that the margin levels for security 
futures may be no lower than the lowest level of margin, exclusive of 
premium, required for any comparable exchange-traded option.
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    \20\ In approving this proposal, the Commission has considered 
its impact on efficiency, competition, and capital formation. 15 
U.S.C. 78c(f).
    \21\ 15 U.S.C. 78o-3(b)(6).
    \22\ 15 U.S.C. 78g(c)(2)(B).
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    Moreover, the Commission believes that the proposed rule change is 
generally consistent with the customer margin rules for security 
futures adopted by the Commission and the CFTC. In particular, the 
Commission notes that, consistent with rule 403 under the Act, NASD's 
proposed rules provide a minimum margin level of 20% of current market 
value for all positions in security futures carried in a securities 
account. The Commission believes that 20% is the minimum margin level 
necessary to satisfy the requirements of section 7(c)(2)(B) of the Act. 
Rule 403 under the Act \23\ also provides that a national securities 
association may set margin levels lower than 20% of the current market 
value of the security future for an offsetting position involving 
security futures and related positions, provided that an association's 
margin levels for offsetting positions meet the criteria set forth in 
section 7(c)(2)(B) of the Act. The offsets proposed by NASD are 
consistent with the strategy-based offsets permitted for comparable 
offset positions involving exchange-traded options and therefore 
consistent with section 7(c)(2)(B) of the Act.
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    \23\ 17 CFR 240.403(b)(2).
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    The Commission also believes it is consistent with the Act for the 
NASD to exclude from its margin requirements positions in SFCs carried 
in a futures account. The Commission believes that by choosing to 
exclude such positions from the scope of rule 2520, the NASD's proposal 
will make compliance by members with the regulatory requirements of 
several SROs easier.
    The NASD has asked the Commission in Amendment No. 2 to approve the 
proposed rule change on a pilot basis to accommodate the expeditious 
trading of security futures for NASD customers of broker-dealers who 
are subject to NASD margin rules. NASD also has requested that the 
Commission approve the proposed rule change on a pilot basis under the 
same terms as the NYSE's pilot, pending the resolution of the issues 
raised by commenters. The Commission believes that there is good cause 
to approve the proposed rule change, as amended, on a pilot basis until 
March 6, 2003. The Commission notes that NASD's proposed rule change is 
substantially the same as NYSE's filing on margin requirements for 
security futures. Thus, the Commission believes that it is appropriate 
to approve NASD's proposed rule change on a pilot basis to enable 
customers of broker-dealers who are subject to NASD margin rules to 
trade security futures in securities accounts without unnecessary 
delay. The Commission expects that, similar to the NYSE, NASD will file 
a proposed rule change to adopt its margin requirements for security 
futures on a permanent basis, and consider the comments it received on 
this proposal.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 2, including whether the proposed 
amendment 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 amendments that are 
filed with the Commission, and all written communications relating to 
the amendments 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 at the 
Commission's Public Reference Room. Copies of such filing also will be 
available for inspection and copying at the principal office of the 
NASD.
    All submissions should refer to File No. SR-NASD-2002-166 and 
should be submitted by February 24, 2003.

VI. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\24\ that the proposed rule change (SR-NASD-2002-166) is approved 
on a pilot basis until March 6, 2003.
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    \24\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to the delegated authority.\25\
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    \25\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 03-2484 Filed 1-31-03; 8:45 am]
BILLING CODE 8010-01-P