[Federal Register Volume 68, Number 79 (Thursday, April 24, 2003)]
[Notices]
[Pages 20207-20210]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-10153]



[[Page 20207]]

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47691; File No. SR-OCC-2002-10]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Proposed Rule Change Relating to Market-Maker 
Account Agreements

April 17, 2003.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on May 21, 2002, The Options 
Clearing Corporation (``OCC'') filed with the Securities and Exchange 
Commission (``Commission'') and on October 18, 2002, amended the 
proposed rule change described in Items I, II, and III below, which 
items have been prepared primarily by OCC. The Commission is publishing 
this notice to solicit comments on the proposed rule change from 
interested parties.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The proposed rule change will amend OCC's By-Laws and Rules to 
eliminate the requirement that a clearing member must obtain a 
specified form of account agreement from each market-maker for whom it 
carries an account and submit the agreement to OCC for approval. The 
proposed rule change will also add two new interpretive statements to 
Article VI, Section 3 of OCC's By-Laws to clarify the application of 
certain amendments to Article 8 and Article 9 of the Uniform Commercial 
Code to OCC clearing accounts and to clarify the application of OCC's 
lien on clearing member account positions and clearing member 
obligations.

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

    In its filing with the Commission, OCC 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. OCC has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of these 
statements.\2\
---------------------------------------------------------------------------

    \2\ The Commission has modified the text of the summaries 
prepared by OCC.
---------------------------------------------------------------------------

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

    The purpose of the proposed rule change is to amend Article VI, 
Section 3 of OCC's By-Laws and Chapter XI, Rule 1105 of OCC's Rules to 
eliminate the requirement that a clearing member must obtain and must 
submit to OCC for approval a specified form of account agreement from 
each market-maker for whom it carries an account. OCC believes that 
such submissions are no longer necessary to perfect its security 
interest in clearing members' market-maker accounts under the Uniform 
Commercial Code (``UCC'') and are administratively burdensome for OCC 
and its clearing members. In order to incorporate the changes to 
Article IV, Section 3 into its rules, OCC proposes to make conforming 
changes to Rule 1105.
    The proposed rule change also includes two interpretive statements. 
The first interpretative statement is intended to clarify the 
application to OCC clearing accounts of certain UCC amendments to 
Article 8 and to Article 9, which were adopted in 1994 and 1995. The 
other is intended to clarify that OCC's lien on positions in clearing 
member accounts extends to short security futures positions, as well as 
all other assets, and that OCC's lien secures clearing member 
obligations on long security futures positions, as well as all other 
obligations arising from the applicable account or accounts.
1. Background
    Article VI, Section 3, of OCC's By-Laws specifies the types of 
clearing accounts that a clearing member may have at OCC, including 
accounts (referred to collectively herein as ``market-maker accounts'') 
in which a clearing member may carry positions of market professionals 
such as options market-makers, JBO participants,\3\ and stock 
specialists (referred to collectively herein as ``market-makers''). 
Clearing members that maintain market-maker accounts at OCC must, 
according to the current provisions of Section 3, obtain and submit to 
OCC for approval certain agreements from each market-maker whose funds 
and positions are included in such market-maker accounts.
---------------------------------------------------------------------------

    \3\ Under Article I, Section 1 of OCC's By-Laws, a ``JBO 
participant'' is a registered broker-dealer that ``(i) maintains a 
joint back office arrangement with a clearing member pursuant to the 
requirements of Regulation T promulgated by the Board of Governors 
of the Federal Reserve System; (ii) meets the requirements 
applicable to JBO participants as specified in exchange rules; and 
(iii) consents to having his exchange transactions cleared and 
positions carried in a JBO participants account.'' Unless the 
context requires otherwise, a JBO Participant is a Market-Maker for 
purposes of OCC's By-Laws and all of OCC's Rules except for Chapter 
IV.
---------------------------------------------------------------------------

    The principal reason for requiring the filing of these agreements 
was to ensure that OCC's security interest in and setoff rights against 
long option positions and assets deposited as margin in market-maker 
Accounts would be protected under the UCC as it existed prior to the 
UCC amendments in the event of a clearing member insolvency. The 
contents of the required agreements vary depending upon the type of 
market-maker Account. In all cases, however, the agreements provide 
that OCC has: (a) A lien on positions and margin in the account as 
security for obligations of the clearing member to OCC arising in the 
account; (b) the right to net writing and purchase transactions in the 
account (i.e., to carry positions ``net''); and (c) the right to close 
out positions and apply proceeds without notice. In addition, market-
makers whose assets are carried at OCC in combined accounts with other 
market-makers are required to consent to the commingling of their 
positions with the positions of other market-makers. Because OCC's lien 
on all assets in a combined market-makers' Account covers any 
obligation arising from the commingled account, assets attributable to 
one market-maker may be used by OCC to offset obligations of the 
clearing member that are attributable to the activity of a different 
market-maker.
    OCC currently requires that a clearing member file with OCC a 
specified form of account agreement, executed by the clearing member 
and each market-maker included in the account, containing the required 
consents for the applicable type of market-maker account. OCC reviews 
the agreement and executes the agreement under the caption 
``Approved.'' The procedure is cumbersome and imposes administrative 
burdens on both clearing members and OCC staff. Moreover, OCC believes 
that there may be potential for confusion in the legal relationships 
established through these documents. Although the agreements are not 
intended to create contractual privity between OCC and the market-
maker, OCC believes it might be possible to misinterpret the agreements 
as doing so.
2. Proposed Changes
    As a result of the UCC amendments, OCC believes it is no longer 
necessary to require clearing members to file market-maker account 
agreements with OCC in order to protect OCC's security interest in and 
setoff rights against funds and positions in market-maker

[[Page 20208]]

accounts.\4\ The UCC amendments established new rules specifically 
tailored to govern the ``indirect holding system'' for securities and 
certain other investment property. Under these rules, OCC may obtain an 
automatically perfected, first-priority security interest in assets in 
market-maker accounts through provisions in OCC's By-Laws or Rules. No 
grant of a security interest from the market-maker to OCC is required.
---------------------------------------------------------------------------

    \4\ OCC did not propose to eliminate the requirement that 
clearing members file market-maker account agreements with OCC 
immediately after the adoption of the UCC amendments because that 
requirement was not inconsistent with the UCC amendments and because 
the UCC amendments were not immediately adopted in all U.S. 
jurisdictions. Because OCC is expecting an increase in Market-Maker 
account openings as a result of security futures trading, it is now 
a business priority for OCC to eliminate the requirement in order to 
relieve administrative burdens for both OCC and its clearing 
members.
---------------------------------------------------------------------------

    Under the UCC amendments, OCC and its clearing members are 
``securities intermediaries,'' \5\ and an OCC-issued option is a 
``financial asset.'' \6\ A person acquires a ``security entitlement'' 
\7\ and becomes an ``entitlement holder'' \8\ when a securities 
intermediary credits a financial asset to that person's account.\9\ 
Thus, OCC's clearing members acquire security entitlements against OCC 
when OCC credits positions to the clearing members' accounts. 
Similarly, the clearing members' customers (including market-makers) 
acquire security entitlements against the clearing member with respect 
to positions carried for the accounts of those customers on the books 
of the clearing member. In the first case, the clearing member is the 
entitlement holder, and OCC is the securities intermediary. In the 
second case, the customer (or market-maker) is the entitlement holder, 
and the clearing member is the securities intermediary. In this 
instance, the customers' security entitlement against the clearing 
member is a different item of property from the clearing member's 
security entitlement against OCC.\10\
---------------------------------------------------------------------------

    \5\ UCC 8-102(a)(14).
    \6\ UCC 8-102(a)(9)(ii) and 8-103(e).
    \7\ UCC 8-102(a)(17).
    \8\ UCC 8-102(a)(7).
    \9\ UCC 8-501(b)(1).
    \10\ Prefatory Note to UCC Article 8, Section III.C. states, 
``For purposes of Article 8 analysis, the customer's security 
entitlement against the broker or bank custodian is a different item 
of property from the security entitlement of the broker or bank 
custodian against the clearing corporation.''
---------------------------------------------------------------------------

    In order for OCC to acquire a perfected security interest in 
clearing members' security entitlements, OCC must obtain ``control'' 
over the entitlements or the ``securities account'' in which they are 
held.\11\ UCC 8-106(e) provides that the securities intermediary has 
control ``[i]f an interest in a security entitlement is granted by the 
entitlement holder to the entitlement holder's own securities 
intermediary.'' As proposed, the revised rule would state that the 
clearing member (i.e., the entitlement holder) agrees, and represents 
that it has obtained the agreement of each market-maker whose positions 
and transactions are included in the account and that OCC (i.e., the 
securities intermediary) has a lien on long positions and margin in 
each market-maker account. Consequently, OCC will have a security 
interest perfected by control in the security entitlements in each 
market-maker account whether or not it has obtained a signed agreement 
from each market-maker.
---------------------------------------------------------------------------

    \11\ UCC 9-314(a) and 9-106(a).
---------------------------------------------------------------------------

    Furthermore, OCC's security interest has priority over any 
competing interests. ``A security interest in a security entitlement or 
a securities account \12\ granted to the debtor's own securities 
intermediary has priority over any security interest granted by the 
debtor to another secured party.'' \13\
---------------------------------------------------------------------------

    \12\ UCC 8-501(a) defines ``securities account'' to mean ``an 
account to which a financial asset is or may be credited in 
accordance with an agreement under which the person maintaining the 
account undertakes to treat the person for whom the account is 
maintained as entitled to exercise the rights that comprise the 
financial asset.'' UCC 9-102(a)(14) defines ``commodity account'' as 
an account maintained by a commodity intermediary in which a 
commodity contract is carried for a commodity customer.'' Accounts 
established under Section 3 of OCC's By-Laws would ordinarily be 
``securities accounts,'' but certain accounts might be construed as 
commodity accounts or as both securities accounts and commodity 
account given that OCC may clear commodity contracts and security 
futures as well as security options. In any case, the Article 9 
rules governing perfection and priority of security interests in 
commodity accounts and assets contained therein are substantively 
identical to those governing securities accounts and assets therein 
because all are included in the UCC 9-102(a)(49) definition of 
``investment property'' to which those rules apply. To the extent 
that an account if a ``commodity account,'' OCC will fail within the 
definition of a ``commodity intermediary'' under UCC 9-102(a)(17).
    \13\ UCC 9-328(3).
---------------------------------------------------------------------------

    Because it remains the case that as between a clearing member and 
its customers (including a market-maker), the clearing member has a 
duty to obtain the customer's consent before subjecting the customer's 
securities to a security interest or taking certain other actions 
potentially affecting the customer's interests,\14\ the proposed rule 
continues to require clearing members to contain specified agreements 
from market-maker and also to require them to represent to OCC that 
such agreements have in fact been obtained. Those clearing members that 
choose to continue to use an existing form of market-maker account 
agreement will be permitted to do so, but OCC will also permit the 
agreement required under Section 3 of Article VI of its By-Laws to be 
incorporated into a clearing member's own forms of account agreements 
to the extent that the clearing member chooses to do so.
---------------------------------------------------------------------------

    \14\ See UCC 8-504(b), which states that a securities 
intermediary may not grant any security interests in a financial 
asset is it obligated to maintain on behalf of an entitlement holder 
except as otherwise agreed by the entitlement holder.
---------------------------------------------------------------------------

    OCC also proposes to add two new items to the Interpretations and 
Policies to Article VI, Section 3 of its By-Laws. The first sentence of 
proposed Interpretation .02 sets forth a representation and warranty 
that the clearing member has obtained the agreement of each person for 
whom a transaction is effected in any account of the clearing member at 
OCC pursuant to provisions of Section 3, including the security 
interest in the account that is granted by the clearing member to OCC, 
and that the inclusion of the person's transactions and positions in 
that type of account is otherwise permitted by applicable law. This 
representation would apply not only to market-maker accounts and JBO 
participant accounts \15\ but also to the firm account, pledge 
accounts, securities customer accounts, cross-margining accounts, and 
segregated futures accounts that are provided for under paragraphs (a) 
and (d) through (g) of Section 3, respectively. OCC has never required 
that a specified form of agreements be obtained by clearing members 
from persons whose transactions are included in these other types of 
accounts. Nevertheless, Rule 15c3-3 and the Commission's hypothecation 
rules, Rule 8c-1 and Rule 15c2-1, as well as certain state laws require 
that certain consents and agreements be obtained, such as consent to 
the commingling of a customer's securities with the securities of 
another customer. These comments are included in the account 
documentation normally obtained by brokers from their customers and are 
the responsibility of the broker.
---------------------------------------------------------------------------

    \15\ Under Article I, Section 1, of OCC's By-Laws a ``JBO 
participant account'' means an account established by a clearing 
member which is confined to exchange transactions cleared and 
positions carried by the clearing member on behalf of JBO 
participants for whom the clearing member has filed a JBO 
participant account agreement with OCC.
---------------------------------------------------------------------------

    The final sentence of Interpretation .02 is intended to make clear 
that the rights of OCC, including its security interest, in any account 
of the clearing member with OCC are enforceable in

[[Page 20209]]

accordance with their terms even if the clearing member fails in its 
obligations to obtain required consents or agreements from customers. 
This is consistent with the provision of UCC 8-503(e), which provides 
that an action based on an entitlement holder's property interest with 
respect to a financial asset held for its account by a securities 
intermediary, whether framed in conversion, replevin, constructive 
trust, equitable lien, or other theory, may not be asserted against any 
purchaser of the financial asset or an interest therein (which would 
include lien holders) who gives value, obtains control, and does not 
act in collusion with the securities intermediary in violating the 
securities intermediary's obligations to maintain the property for the 
entitlement holder. OCC's security interest is protected under this 
provision. \16\
---------------------------------------------------------------------------

    \16\ See also UCC 8-511(b), which provides that a claim of a 
creditor (OCC) of a securities intermediary (the failed clearing 
member) that is perfected by control has priority over the claims of 
the securities intermediary's entitlement holders.
---------------------------------------------------------------------------

    The first sentence of proposed Interpretation .03 is intended to 
clarify that OCC's lien extends to all assets in the market-maker 
accounts and JBO participant accounts. Article VI, Sections 3(b), (c), 
and (h) of OCC's By-Laws governs such accounts and uses the same 
language to describe OCC's lien's over those assets.\17\ This language 
has always been intended and understood to describe the scope of OCC's 
lien as extending to all assets in the accounts. ``Long positions'' 
were specifically referred to in Section 3 because in the case of 
options only long positions have asset value. Short option positions 
represent only a liability. However, as OCC begins clearing security 
futures, it seems prudent to clarify that OCC's lien extends to all 
positions that represent an asset in the account, including short 
futures positions, which may have asset value if the market has moved 
in their favor since the most recent mark-to-market payment. Thus, the 
first sentence of proposed Interpretation .03 clarifies that the ``long 
positions, securities, margin and other funds'' over which OCC's lien 
extends includes any ``investment property,'' as defined in Article 9 
of the UCC,\18\ including long and short positions in security futures 
as well as any other asset.
---------------------------------------------------------------------------

    \17\ Article VI, Sections 3(b), (c), and (h) contain language to 
indicate that OCC has a lien on all long positions, securities, 
margin, and other funds in such accounts.
    \18\ UCC 9-102(a)(49) defines ``investment property'' to mean a 
``security, whether certified or uncertified, security entitlement, 
securities account, commodity contract, or commodity account.''
---------------------------------------------------------------------------

    The second sentence of proposed Interpretation .03 is also 
motivated by security futures, although it more broadly clarifies that 
OCC's lien acts as security for all obligations of the clearing member 
to OCC with respect to separate or combined market-maker accounts, 
customer accounts, or segregated futures accounts. OCC uses similar 
language in Sections 3(b), (c), (e), and (f) of Article VI of OCC's By-
laws, which governs such accounts, to indicate that OCC has a lien on 
all long positions, margins, and other funds in the market-maker 
account with OCC as security for the clearing member's obligations to 
OCC in respect of all exchange transactions effected through such an 
account, short positions maintained in such an account, and exercise 
notices assigned to such an account. When OCC begins clearing security 
futures, its lien will also secure the clearing member's obligations 
with respect to long security futures positions in the account, which 
unlike long options which are always an asset may be a liability if the 
market has moved against those positions since the last mark-to-market 
payment. In order to avoid any confusion caused by reference to short 
positions but not to long positions, the proposed Interpretation .03 
clarifies that obligations to OCC with respect to all exchange 
transactions should be read broadly to encompass, where applicable, 
obligations arising from long or short positions, obligations to make 
payments or delivery under cleared contracts, and obligations with 
respect to fees and charges associated with such transactions.
    OCC has determined to clarify the language in Section 3 through the 
addition of Interpretation .03 rather than through an amendment to the 
text of Section 3 because OCC wants to avoid any possible inference 
that it is making a substantive change from the language that is 
Section 3, which language is currently used in outstanding market-maker 
account agreements.
    Changes to Rule 1105(b) are intended merely to conform to the 
changes in Article VI, Section 3. Rather than refer to the market-maker 
account agreement, the rule would now refer directly to the applicable 
provisions in Article VI, Section 3, of the By-Laws which are required 
to be incorporated into an agreement between the clearing member and 
the market-maker.
    OCC believes the proposed rule change is consistent with the 
requirements of Section 17A of the Act \19\ and the rules and 
regulations thereunder applicable to OCC because it will promote the 
prompt and accurate clearance and settlement of securities 
transactions, fosters cooperation and coordination with persons engaged 
in the clearance and settlement of securities transactions, remove 
impediments to and perfect the mechanism of a national system for the 
prompt and accurate clearance and settlement of securities 
transactions, and, in general, protect investors and the public 
interest.
---------------------------------------------------------------------------

    \19\ 15 U.S.C. 78q-1.
---------------------------------------------------------------------------

(B) Self-Regulatory Organization's Statement on Burden on Competition

    OCC does not believe that the proposed rule change would impose any 
burden on competition.

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

    Written comments were not and are not intended to be solicited with 
respect to the proposed rule change, and none have been received.

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

    Within thirty-five 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 ninety days of such date if it finds 
such longer period to be appropriate and publishes its reasons for so 
finding or (ii) as to which the self-regulatory organization consents, 
the Commission will:
    (A) By order approve such proposed rule change or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change 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. 
Comments may also be submitted electronically at the following e-mail 
address: [email protected]. All comment letters should refer to File 
No. SR-OCC-2002-10. This file number should be included on the subject 
line if e-mail is used. Copies of the

[[Page 20210]]

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 Section, 450 Fifth Street, NW., Washington, DC 20549. 
Copies of such filing also will be available for inspection and copying 
at the principal office of OCC. All submissions should refer to File 
No. SR-OCC-2002-10 and should be submitted by May 15, 2003.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\20\
---------------------------------------------------------------------------

    \20\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-10153 Filed 4-23-03; 8:45 am]
BILLING CODE 8010-01-M