[Federal Register Volume 68, Number 59 (Thursday, March 27, 2003)]
[Notices]
[Pages 15015-15023]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-7311]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47550; File No. SR-NASD-2003-45]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by National 
Association of Securities Dealers, Inc. To Adopt, on a Permanent Basis, 
Margin Requirements for Security Futures Contracts Pursuant to NASD 
Rule 2520

March 20, 2003.
    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 March 19, 2003, 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. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons and to grant accelerated 
approval of the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD proposes to adopt, on a permanent basis, amendments to NASD 
Rule 2520 establishing margin requirements for security futures 
contracts (``SFCs''). The SEC originally approved these amendments on a 
pilot basis (``the Pilot'') until March 6, 2003,\3\ and thereafter 
extended the Pilot until March 20, 2003.\4\ NASD believes that the 
proposed rule change would make its margin rule consistent with margin 
rules already adopted by the SEC, the Commodity Futures Trading 
Commission (``CFTC'') and other self-regulatory organizations 
(``SROs'') regarding security futures contracts.
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    \3\ See Securities Exchange Act Release No. 47244 (January 24, 
2003), 68 FR 5317 (February 3, 2003) (SR-NASD-2002-166).
    \4\ See Securities Exchange Act Release No. 47470 (March 7, 
2003), 68 FR 12397 (March 14, 2003) (SR-NASD-2003-31).
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    Specifically, the proposed rule change would: (1) Permit customer 
margining of security futures contracts, and establish initial and 
maintenance margin requirements for security futures contracts; (2) 
allow for initial and maintenance margin levels for offsetting 
positions involving security futures contracts and related positions at 
lower levels than would be required if

[[Page 15016]]

margined separately; (3) provide for a Market Maker exclusion for 
proprietary trades of a ``Security Futures Dealer'' (``SFD'') and allow 
for ``good faith'' margin treatment for the accounts of approved 
options specialists, market makers, and other specialists; (4) provide 
definitions relative to security futures contracts for application of 
this rule; (5) provide that security futures contracts transacted in a 
futures account shall not be subject to any provisions of NASD Rule 
2520; (6) provide for money market mutual funds as defined in rule 2a-7 
\5\ under the Investment Company Act of 1940 (the ``ICA''),\6\ to be 
used to satisfy margin requirements for security futures contracts 
provided certain conditions are met; (7) require that security futures 
contracts transacted in a securities account be subject to all other 
provisions of NASD rule 2520, particularly Rule 2520(f)(8)(B) (``Day 
Trading''); and (8) permit members for which NASD is the Designated 
Examining Authority (``DEA'') to participate in the trading of security 
futures contracts.
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    \5\ 17 CFR 270.2a-7.
    \6\ 15 U.S.C. 80a et seq.
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    In addition, NASD is proposing non-substantive technical changes to 
NASD Rule 2520.\7\
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    \7\ See NASD Rule 2520(b)(2); (b)(3); (e)(7)(B); and (e)(8). 
Telephone conversation between Patricia Albrecht, Assistant General 
Counsel, NASD, and Lisa N. Jones, Attorney, Division of Market 
Regulation, Commission, dated March 18, 2003.
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    Below is the text of the proposed rule change. Proposed new 
language is italicized; 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 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 [the Association] 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.
    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'') or an amount 
sufficient to meet the maintenance margin requirements of this rule.

(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.)
    (d) No Change.

[[Page 15017]]

(e) Exceptions to Rule

    The foregoing requirements of this rule are subject to the 
following exceptions: (1) through (5) No Change.
(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 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.
    (B) No Change.
(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 [the Association] 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.
    (8) No Change.\8\
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    \8\ This provision of the rule text reflects the correction of a 
typographical error from the rule text that NASD submitted with the 
proposed rule change.
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(f) Other Provisions

    (1) through (10) No Change.

(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.

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

[[Page 15018]]

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

[[Page 15019]]

 
(17) Long (short) a basket of      Individual stock or        Threater 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                                   long security             long security
 index 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).
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    (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:
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    \9\ Two security futures contracts will be considered 
``identical'' for this purpose if they are issued by the same 
clearing agency or cleared and guaranteed by the same derivatives 
clearing organization, have identical specifications, and would 
offset each other at the clearing level.
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    (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 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 (1) a member or member organization of a 
national securities exchange or a national securities association 
registered pursuant to section 15A(a) of the Act; (2) is registered 
with such exchange or association as a security futures dealer pursuant 
to rules that are effective in accordance with section 19(b)(2) of the 
Act and, as applicable section 5c(c) of the CEA, that: (a) Requires 
such member or member organization to be registered as a floor trader 
or a floor broker with the CFTC under section 4f(a)(1) of the CEA, or 
as a dealer with the Commission under section 15(b) of the Act; (b) 
requires such member or member organization to maintain records 
sufficient to prove compliance with the rules of the exchange or 
association of which it is a member; (c) requires such member or member 
organization to hold itself out as being willing to buy and sell 
security futures for its own account on a regular and continuous basis; 
and (d) provides for disciplinary action, including revocation of such 
member's or member organization's registration as a security futures 
dealer, for such member's or member organization's failure to comply 
with rule 400 through 406 of the Act and rules 41.42 through 41.49 of 
the CEA or the rules of the exchange or association of which the 
security futures dealer is a member or member organization.
    (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

[[Page 15020]]

    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 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 market 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 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 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.
    (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 shall not be subject to any provision of this rule.

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 and is set forth in sections A, B, and C below.

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

1. Purpose

Background

    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

[[Page 15021]]

customer margin requirements for SFCs must satisfy four requirements: 
(1) They must preserve the financial integrity of markets trading SFCs; 
(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.
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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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    Subsequent to the adoption of the SEC/CFTC Margin Regulations, NASD 
filed proposed amendments to NASD rule 2520.\15\ On January 24, 2003, 
the Commission approved the amendments on a pilot basis until March 6, 
2003.\16\ On March 5, 2003, the Commission extended the Pilot until 
March 20, 2003, to allow the Pilot to permit customers to continue 
trading SFCs on an uninterrupted basis in securities accounts while 
NASD considered the comments it received on the Pilot.\17\
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    \15\ On March 6, 2003, the Commission approved a proposed rule 
change by the NYSE to adopt, on a permanent basis, margin 
requirements for security futures contracts pursuant to NYSE Rule 
431. See Securities Exchange Act Release No. 47460, 68 FR 12123 
(March 13, 2003) (SR-NYSE-2003-05).
    \16\ See supra note 3.
    \17\ See supra note 4.
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    Among the amendments approved as part of the Pilot was new NASD 
rule 2520(f)(11) (``Customer Margin Rules Relating to Security 
Futures''), which provides that SFCs transacted in a securities account 
be subject to all other provisions of NASD rule 2520, including 
2520(f)(8)(B) (``Day Trading''). Also approved as part of the Pilot 
were NASD rule 2520(f)(11)(D) (``Security Futures Dealers' Accounts''), 
rule 2520(f)(11)(E) (``Approved Options Specialists' or Market Makers' 
Accounts''), and rule 2520(f)(11)(F) (``Approved Specialists'' 
Accounts--others''). Under the Pilot, NASD rule 2520 permits ``good 
faith'' margin treatment for specified hedged offset positions carried 
in the accounts noted above.
    However, unlike the SFD rules of other SROs,\18\ The Pilot permits 
members to accord offset treatment in accounts carried for such 
specialists, market makers, and SFDs only when their activity is 
limited to bona fide specialist or market making transactions. 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.
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    \18\ See e.g., Securities Exchange Act Release No. 46555 
(September 26, 2002), 67 FR 61707 (October 1, 2002) (SR-OC-2002-01).
---------------------------------------------------------------------------

Discussion of Comments Received

    NASD received one comment letter on the Pilot from the Chicago 
Board Options Exchange, Inc. (``CBOE'').\19\ In its letter, the CBOE 
requested that the Commission not grant permanent approval of NASD's 
rule as proposed and approved on a pilot basis, unless NASD amended the 
rule to exempt SFCs from its day trading provisions and deleted 
references to the term ``bona fide'' in connection with market maker or 
specialist transactions.
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    \19\ See letter from Edward J. Joyce, President and Chief 
Operating Officer (``COO''), CBOE, to Jonathan G. Katz, Secretary, 
Commission, dated December 20, 2002. CBOE's December 20, 2002 
comment letter on NASD's Pilot is a resubmission of its December 9, 
2002 comment letter regarding the NYSE's proposed amendments to NYSE 
Rule 431 relating to margin requirements for security futures 
contracts. See Securities Exchange Act Release No. 46782 (November 
7, 2003), 67 FR 69052 (November 14, 2002) (SR-NYSE-2002-53). The 
CBOE stated that because the proposed amendments were so similar in 
nature, its comments on the NYSE's proposed amendments were 
applicable to NASD's proposed rule change. On March 6, 2003, the 
Commission approved on a permanent basis amendments to NYSE Rule 431 
to incorporate security futures contracts. Securities Exchange Act 
Release No. 47460, 68 FR 12123 (March 13, 2003) (SR-NYSE-2003-05).
---------------------------------------------------------------------------

    Under the proposed rule change, NASD's day trading margin 
requirements would apply to SFCs carried in securities accounts. The 
CBOE believes that day trading provisions should not apply to such 
accounts because it would create a disparity that the CFMA was designed 
to eliminate. In this regard, CBOE's letter states that the SEC and 
CFTC did not impose day trading margin requirements on SFCs carried in 
futures and securities accounts. The CBOE argues that since similar 
margin rules recently approved by the Commission do not impose day 
trading margin requirements on SFCs carried in futures accounts, 
permanent approval of NASD's proposed rule would lead to a regulatory 
disparity the CFMA was designed to prevent.
    NASD states that, in proposing its rule amendment on the 
application of day trading margin requirements to SFCs carried in 
securities accounts, it did not intend to create a regulatory disparity 
with other SRO rules. However, NASD notes that SRO rules can be more 
stringent than those of the Commission. While NASD is guided by the 
Commission's rules in proposing its rules, NASD has latitude to 
promulgate more stringent rules when it believes they are necessary for 
the protection of investors. In this regard, NASD believes that the 
application of day trading margin requirements of NASD rule 2520 to 
SFCs is consistent with the treatment of all securities transacted in a 
margin account under this rule. Accordingly, NASD proposes to apply 
NASD's day trading margin requirements to SFCs carried in securities 
accounts.
    The CBOE also believes that NASD should delete the term ``bona 
fide'' in connection with market maker or specialist transactions. The 
CBOE commented that NASD does not define the term ``bona fide'' nor 
does it use the term in relation to the other provisions of its margin 
rule relating to market maker and specialist transactions.
    In response to these comments, NASD is proposing to amend the rule 
text by deleting the term ``bona fide'' in connection with specialist 
or market maker transactions. In proposing such language under the 
Pilot, it was NASD's intent to permit good faith margin treatment for 
off-setting positions that were effected by specialists or market 
makers in discharging the primary responsibilities noted above in its 
original filing, rather than to permit persons other than qualified 
market makers to act in such a capacity--hence, the term ``bona fide'' 
in connection with specialist and market making transactions. Upon 
consideration, and in order to be consistent with similar rules 
proposed by other SROs, NASD will not use the term ``bona fide'' and 
instead incorporate the definition of an SFD as referenced in rule 
400(c)(2)(v) \20\ under the Act to clarify what constitutes a SFD for 
purposes of the rule. Notwithstanding this amendment, NASD reiterates 
that good faith margin treatment will be permitted only for 
transactions effected by SFDs in discharging their responsibilities and 
obligations to maintain fair and orderly markets, and to provide 
liquidity to the marketplace.
---------------------------------------------------------------------------

    \20\ 17 CFR 240.400(c)(2)(v).
---------------------------------------------------------------------------

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 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.

[[Page 15022]]

NASD believes that the proposed rule change is designed to accomplish 
these goals by permitting customers to trade SFCs in securities 
accounts.
---------------------------------------------------------------------------

    \21\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

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.

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

    NASD received written comments from the CBOE on the original 
proposed rule change that was filed with the Commission on November 15, 
2002 and amended on January 15, 2003. NASD has responded to the CBOE's 
comments and hereby amends its original rule proposal filed with the 
Commission on November 15, 2002.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change 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 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 
NASD. All submissions should refer to File No. SR-NASD-2003-45 and 
should be submitted by April 17, 2003.

IV. Commission Findings and Order Granting Accelerated Approval of a 
Proposed Rule Change

    The NASD has asked that the Commission approve the proposed rule 
change prior to the thirtieth day after publication of notice of the 
filing in the Federal Register to accommodate the continuance of 
trading of security futures in securities accounts pursuant to NASD 
rule 2520 on an uninterrupted basis after the Pilot ends on March 20, 
2003. The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities association. In 
particular, the Commission believes that the proposed rule change is 
consistent with the requirements of 15A(b)(6) of the Act,\22\ which 
requires, among other things, that the rules of NASD be designed to 
promote just and equitable principles of trade and, in general, to 
protect investors and the public interest.\23\ In addition, the 
Commission believes that the proposed rule change is consistent with 
section 7(c)(2)(B) of the Act,\24\ 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 provide 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.
---------------------------------------------------------------------------

    \22\ Id.
    \23\ In approving the proposed rule, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \24\ 15 U.S.C. 78g(c)(2)(B).
---------------------------------------------------------------------------

    The Commission believes that the 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, the rule change provides 
for 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 \25\ 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.
---------------------------------------------------------------------------

    \25\ 17 CFR 240.403(b)(2).
---------------------------------------------------------------------------

    In addition, the Commission believes it is consistent with the Act 
for 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, NASD's proposal 
will make compliance by members with the regulatory requirements of 
several SROs easier. Moreover, as proposed, NASD members will accord 
``good faith'' margin treatment to specified offsetting positions 
involving security futures, carried in a securities account for an SFD, 
consistent with the customer margin rules for security futures adopted 
by the Commission and the CFTC.
    After careful consideration of the commenter's concern about 
applying NASD's day trading margin requirements to SFCs, the Commission 
believes that it is reasonable for NASD to impose day trading margin 
requirements on its members with respect to SFCs carried in a 
securities account. As NASD noted, an SRO may adopt more stringent 
requirements than those promulgated by the Commission.
    The Commission has also carefully considered the commenter's 
concern of using the term ``bona fide'' with respect to market maker or 
specialist transactions. The Commission notes that NASD has deleted the 
term ``bona fide'' in reference to market maker or specialist 
transactions, and instead is incorporating the definition of an SFD in 
rule 400(c)(2)(v) under the Act. The Commission believes that if it 
finds, in approving an SRO's rules for SFDs, that such rules are 
consistent with the definition of SFD in rule 400(c)(2)(v), those rules 
would also be consistent with NASD rule 2520 (f)(11)(D). Therefore, the 
Commission believes this amendment should address the commenter's 
concerns that NASD not impose a higher standard on transactions by 
market maker and specialist registered pursuant to rules of another SRO 
to qualify for favorable margin treatment.
    The Commission finds good cause for approving the proposed rule 
change prior to the thirtieth day after the date of publication of 
notice of filing thereof in the Federal Register. The Commission 
believes that accelerated approval of the proposed rule change should 
enable NASD members to continue to trade SFCs in securities accounts on 
an uninterrupted basis. In addition, the Commission believes that 
granting accelerated approval to the proposed rule change should 
clarify NASD members' obligations under NASD rule 2520 with respect to 
their

[[Page 15023]]

trading in SFCs. The Commission notes it approved NASD's original 
filing as a temporary pilot to give members of the public an 
opportunity to comment on the substance of the proposed rule change 
before it requests permanent approval. The NASD has responded to the 
comments received, as described above. Accordingly, the Commission 
finds good cause, consistent with section 19(b)(2) of the Act, to 
approve the proposed rule change prior to the thirtieth day after 
publication of the notice of filing.

V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\26\ that the proposed rule change (File No. SR-NASD-2003-45) be 
approved.
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    \26\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\27\
---------------------------------------------------------------------------

    \27\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-7311 Filed 3-26-03; 8:45 am]
BILLING CODE 8010-01-P