[Federal Register Volume 68, Number 60 (Friday, March 28, 2003)]
[Notices]
[Pages 15254-15256]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-7399]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47553; File No. SR-CBOE-2003-05]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Board Options Exchange, Inc. Relating to Clearing 
Firm Prohibitions From Accepting Certain Third Party Deposits

March 21, 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 February 10, 2003, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by the CBOE. 
The CBOE filed Amendment No. 1 to the proposal on March 5, 2003. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The CBOE proposes to add a rule to Chapter 4 of its rules 
(``Business Conduct'') that would prohibit market-maker clearing firms 
from accepting certain deposits by third parties. The text of the 
proposed rule change follows:
    Additions are italicized; deletions are in [brackets].

Chicago Board Options Exchange, Incorporated

Rules
Chapter IV
Business Conduct
    Rule 4.1 through 4.20.--no change.

Third Party Deposits Prohibited

    Rule 4.21. Member organizations engaged in the business of clearing 
and carrying the accounts of options market-makers (``Clearing Firms'') 
registered to conduct business on the Exchange are subject to the 
following prohibitions:
    (1) The acceptance of a check or funds transfer for deposit into 
any broker-dealer account cleared or carried by a Clearing Firm is 
prohibited if the name on the account from which the check or transfer 
is drawn is not the same as that on the account cleared or carried by 
the Clearing Firm.
    (2) The acceptance of securities, either directly or via transfer, 
for deposit into any broker-dealer account cleared or carried by a 
Clearing Firm is prohibited if the name on the securities, or the name 
on the account from which the securities are drawn, is not the same as 
that on the account cleared or carried by the Clearing Firm.
    * * * Interpretations and Policies:
    .01 The foregoing prohibitions do not apply to checks, funds or 
securities for deposit to a market-maker's account that are drawn on a 
joint account of which the market-maker is one of the joint owners, and 
the title of the market-maker's account with the Clearing Firm 
coincides with the market-maker's designation on the joint account.
    .02 The foregoing prohibitions do not apply to checks, funds or 
securities for deposit into the account of a U.S. broker-dealer 
business entity if the depositor (i) has an ownership interest 
disclosed on Schedule A of the broker-dealer's Uniform Application for 
Broker-Dealer Registration (``Form BD''), or (ii) is a U.S. broker-
dealer and has an ownership interest disclosed on Schedule B of Form 
BD.
    .03 If immediate action is required in order for an account of a 
broker-dealer cleared and carried by a Clearing Firm to (i) establish a 
positive net liquidating equity or supplement equity when required 
based upon internal risk control procedures of the Clearing Firm, or 
(ii) achieve compliance with SEC Rule 15c3-1 (the Net Capital Rule), an 
officer or partner of a Clearing Firm may grant an exception, which 
must be in writing, with respect to any transaction prohibited by this 
Rule 4.21.
    .04 Transfers of funds or securities between two accounts cleared 
and carried by the same Clearing Firm are permitted provided that, if 
both accounts are not owned by the same person(s) or entity, the 
transfer must be authorized in writing by the owner of the account from 
which funds and/or securities would be withdrawn.
    .05 Documentation evidencing any exceptions granted pursuant to 
Interpretation and Policy .03 above, as well as documents authorizing 
transfers of funds or securities between two accounts pursuant to 
Interpretation and Policy .04 above, shall be retained by the Clearing 
Firm for at least three years, the first two years in an easily 
accessible place for examination by the Exchange. In lieu of having the 
documents easily accessible, a Clearing Firm may make and keep current 
a separate central log, index or other file through which the documents 
can be identified and retrieved.

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 CBOE 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 CBOE 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 adopt a rule that prohibits a member 
organization that is engaged in the business of clearing and carrying 
the accounts of options market-makers (a ``Clearing Firm'')\3\ from 
accepting for deposit into an account cleared or carried by the 
Clearing Firm a check or funds transfer drawn on the account of a third 
party. Under the proposed rule, Clearing Firms would be prohibited 
(with certain exceptions) from accepting a check or funds transfer if 
the name on the account from which the funds are drawn is different 
(i.e., a ``third party'') from the name on the account cleared or 
carried by the Clearing Firm. In addition to checks or funds transfers 
from third parties, the proposed rule would also prohibit (with certain 
exceptions) Clearing Firms from accepting deposits or transfers of 
securities in the name of third parties. This rule filing has been 
undertaken as a result of a recommendation by the CBOE's Financial 
Regulatory Committee.\4\
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    \3\ The proposed rule is intended to apply only to Clearing 
Firms as defined above. Broker-dealers that conduct a public 
customer business have policies and procedures that either prohibit 
acceptance of third party checks or require extensive due diligence.
    \4\ The CBOE's Financial Regulatory Committee is primarily 
comprised of representatives of market-maker clearing member 
organizations of the CBOE. The CBOE consults this committee 
primarily on issues of clearing operations, margin requirements, net 
capital requirements, and books and records requirements. The 
committee provides advice, opinions, and recommendations to the CBOE 
on rules, interpretations, and procedures.
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    The proposed rule would not prohibit a Clearing Firm from 
transferring funds and/or securities between different name accounts 
that it carries, although the proposed rule would reaffirm that

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appropriate written authorization is required for such transfers. The 
discussion herein focuses on the proposal to prohibit third party 
checks, but applies equally to funds transfers, as well as deposits and 
transfers of securities.
    Currently, there is no prohibition in the CBOE rules or any of the 
securities regulations on accepting third party checks for deposit into 
a securities account. A majority of the CBOE's Clearing Firms will 
accept the check of a third party for deposit to a market-maker 
account, unless it would be clearly inappropriate. This is done as a 
convenience to market-maker customers. These checks are made payable 
either to the market-maker or the Clearing Firm. Before accepting such 
deposits, the Clearing Firm examines the relationship of the depositor 
to the market-maker or market-making entity to gain assurance that 
there is a legitimate reason for the deposit, such as the third party 
having an ownership interest in the market-maker's business (e.g., a 
member of the Limited Liability Corporation (``LLC'') in the case of a 
market-making entity organized as an LLC).
    However, by accepting third party checks, the Clearing Firm takes a 
business risk. While Clearing Firms make a reasonable effort to confirm 
that funds deposited via a third party's check are the property of the 
market-maker or market-making entity, and the transaction exhibits no 
obvious improprieties, repercussions can arise later. Some Clearing 
Firms have, in fact, been named as defendants in legal actions taken by 
third parties who allege some type of impropriety with respect to funds 
deposited at the Clearing Firm via their check, and seek a monetary 
judgment against the firm.\5\ These actions are rare, and the 
allegations raised against the Clearing Firm are usually without merit 
and ultimately dismissed. However, the legal expenses of defending an 
arbitration claim or lawsuit are alone a significant financial risk to 
Clearing Firms.
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    \5\ In the case of a business relationship between a third party 
and a market-maker, a claim may arise due to trading losses.
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    The practice of Clearing Firms accepting third party checks most 
likely grew as a service among Clearing Firms. Clearing Firms believe 
that accepting third party checks has become uneconomical when the 
business risks are considered, and thus believe the practice should be 
ended. They argue that their market-maker customers should maintain a 
bank checking account for their market-making business. Clearing Firms 
believe that the best business practice in this regard is for Clearing 
Firms to accept checks from a market-maker's bank checking account, 
which would allow the Clearing Firm greater control over risks with 
only minor inconvenience to a market-maker. Market-makers could simply 
use their bank checking account for making deposits of third-party 
checks and issue checks or effect transfers to the Clearing Firm from 
their bank checking account. In this way, Clearing Firms need not 
provide banking services to their customers that could expose them to 
litigation risks because they are broker-dealers. The proposed rule 
would, in effect, allow a Clearing Firm to accept a check, funds 
transfer or securities transfer only if it is drawn on an account that 
is in the same person's or business entity's name as the account of 
deposit at the Clearing Firm.
    Interpretations and Policies (``I&P'') to the proposed rule would 
allow certain exceptions to the prohibitions set forth in the rule. 
Under proposed I&P .01, checks, funds or securities drawn on a joint 
account of which the market-maker is one of the joint owners are 
generally excepted from the prohibition. Under proposed I&P .02, if a 
market-maker whose account is cleared or carried by a Clearing Firm is 
not a sole proprietor (individual), but is structured as a partnership 
or corporation, the check of a third party listed as an owner on 
Schedule A or Schedule B of the market-making entity's Form BD may be 
accepted by the Clearing Firm for deposit. In order to qualify for this 
exception, an owner listed on Schedule B of Form BD must be a U.S. 
broker-dealer. Under proposed I&P .03, if a market-maker is subject to 
the Commission's Net Capital Rule, an officer or partner of the 
Clearing Firm may make a written exception to the prohibition if the 
market-maker's net capital falls below the applicable minimum. In 
addition, an officer or partner of a Clearing Firm may make a written 
exception if the equity in the market-maker's account is not sufficient 
based on the Clearing Firm's internal risk control analysis, or if net 
liquidating equity becomes negative.
    Under proposed I&P .04, transfers of funds and/or securities 
between different name accounts that are cleared and carried by the 
same Clearing Firm are permitted if the Clearing Firm obtains written 
authorization for the transfer from the owner of the account from which 
the funds and/or securities would be withdrawn. Lastly, proposed I&P 
.05 sets forth retention requirements for the Clearing Firm 
documentation evidencing exceptions and authorizations to transfer 
funds and securities between accounts.
    The CBOE believes that the uncertainty surrounding third party 
deposits justifies prohibition by rule. The CBOE further believes that 
while each Clearing Firm could make a business decision to refuse to 
accept third party checks, funds transfers and securities, a rule is 
needed to establish a uniform, safe practice.
2. Statutory Basis
    The proposed rule is intended to eliminate an unnecessary practice 
and promote a greater level of financial safety and soundness across 
Clearing Firms. As such, the CBOE believes that the proposed rule 
change is consistent with and furthers the objectives of section 
6(b)(5) of the Act,\6\ in that it is designed to promote just and 
equitable principles of trade, remove impediments to and perfect the 
mechanisms of a free and open market, and to protect investors and the 
public interest.
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    \6\ 15 U.S.C. 78(f)(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CBOE 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

    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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding, or (ii) as to 
which the CBOE consents, the Commission will:
    (A) By order approve such proposed rule change; or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing,

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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 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 filings will also be available for 
inspection and copying at the principal office of CBOE. All submissions 
should refer to File No. SR-CBOE-2003-05 and should be submitted by 
April 18, 2003.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\7\
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    \7\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-7399 Filed 3-27-03; 8:45 am]
BILLING CODE 8010-01-P