[Federal Register Volume 68, Number 165 (Tuesday, August 26, 2003)]
[Notices]
[Pages 51314-51316]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-21822]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48365; File No. SR-NYSE-98-14]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Amendment Nos. 1, 2, and 3 by the New York Stock Exchange, 
Inc. Relating to Margin Requirements

August 19, 2003.

I. Introduction

    On April 28, 1998, the New York Stock Exchange, Inc. (``NYSE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Exchange Act'')\1\ and rule 19b-4 
thereunder,\2\ a proposal to amend NYSE rule 431, ``Margin 
Requirements.'' The NYSE's proposed rule change was published for 
comment in the Federal Register on August 5, 1998.\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 40278 (July 29, 
1998), 63 FR 41882.
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    The NYSE filed Amendment Nos. 1, 2, and 3 to the proposal on 
January 5, 1999, November 6, 2002, and May 12, 2003, respectively. In 
addition, on March 6, 2000, the NYSE filed an Information Memo 
(``Information Memo'') that sets forth the general requirements for the 
written risk analysis methodology that members will be required to 
maintain in connection with good faith securities transactions in 
exempt accounts. Amendment Nos. 1, 2, and 3, as well as the Information 
Memo, were published for comment in the Federal Register on July 14, 
2003.\4\
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    \4\ See Securities Exchange Act Release No. 48133 (July 7, 
2003), 68 FR 41672 (July 14, 2003) (``2003 Release'').
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    The Commission received one comment regarding the proposal,\5\ as 
initially published, and the NYSE submitted a response to that 
comment.\6\ As described more fully below, the Commission received two 
additional comment letters following the publication of the 2003 
Release.\7\ This order approves the proposed rule change, as amended.
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    \5\ See letter from Paul Saltzman, Senior Vice President and 
General Counsel, The Bond Market Association (``TBMA'') and Patricia 
Brigantic, Vice President and Senior Associate General Counsel, 
TBMA, to Jonathan Katz, Secretary, Commission, dated August 26, 1998 
(``TBMA I'').
    \6\ See letter from James E. Buck, Senior Vice President and 
Secretary, NYSE, to Michael Walinskas, Deputy Associate Director, 
Division of Market Regulation, Commission, dated April 5, 1999. TBMA 
I supported the proposal but raised questions regarding the 
definition of ``exempt account'' and the treatment of accounts that 
currently qualify as exempt but that would not satisfy the 
proposal's financial threshold for exempt accounts. The NYSE 
answered the questions raised in TBMA I in its response. TBMA I and 
the NYSE's response are described more fully in the 2003 notice, 
supra note 4.
    \7\ See letter from H. Lake Wise, Executive Vice President and 
Chief Legal Officer, Daiwa Securities America Inc., to Jonathan 
Katz, Secretary, Commission, dated August 4, 2003 (``Daiwa 
Letter''); and letter from Paul Saltzman, Executive Vice President 
and General Counsel, TBMA, to Jonathan G. Katz, Secretary, 
Commission, dated August 8, 2003 (``TBMA II'').
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II. Description of the Proposal

A. Background

    Section 7 of the Exchange Act \8\ authorizes the Board of Governors 
of the Federal Reserve System (``Federal Reserve Board'') to establish 
requirements for the purchase or carrying of securities on margin.

[[Page 51315]]

Pursuant to this authority, the Federal Reserve Board promulgated 
Regulation T,\9\ which sets minimum initial margin requirements. 
Regulation T provides that transactions in non-equity securities are 
subject to either ``good faith'' margin requirements \10\ or the level 
set by the rules of a self-regulatory organization (``SRO''), whichever 
is higher.\11\ Accordingly, the maintenance margin requirements 
established by the NYSE or another SRO set the minimum margin levels 
for non-equity securities.\12\
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    \8\ 12 U.S.C. 78(g).
    \9\ 12 CFR 220 et seq.
    \10\ Regulation T defines ``good faith'' margin as the amount of 
margin that a broker-dealer would require in exercising sound credit 
judgment.
    \11\ 12 CFR 220.12(b).
    \12\ See NYSE rule 431(c).
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    As described more fully below, the proposal amends NYSE rule 431 
to: (1) Lower the customer maintenance margin requirements for certain 
non-equity securities; and (2) permit good faith margin treatment for 
certain non-equity securities held in ``exempt accounts,'' as defined 
in the proposal.

B. Reduced Customer Maintenance Margin for Non-Equity Securities Not 
Held in Exempt Accounts

    With respect to non-equity securities that are not held in exempt 
accounts, the proposal: (1) Reduces the customer maintenance margin 
requirement for highly rated foreign sovereign debt \13\ from 20% of 
current market value to 1% to 6% of current market value, depending on 
the time to maturity; (2) reduces the customer maintenance margin 
requirement for exempted securities other than U.S. government 
obligations from 15% of current market value to 7% of current market 
value; (3) reduces the customer maintenance margin requirement for 
investment grade non-equity securities \14\ from 20% of current market 
value to 10% of current market value; and (4) establishes a customer 
maintenance margin requirement of 20% of current market value for all 
other marginable non-equity securities.\15\
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    \13\ The proposal defines ``highly rated foreign sovereign debt 
securities'' as debt securities issued or guaranteed by the 
government of a foreign country, its provinces, states or cities, or 
a supranational entity that are assigned a rating in one of the two 
top rating categories by at least one nationally recognized 
statistical rating organization. See NYSE rule 431(a)(9).
    \14\ The proposal defines ``investment grade debt'' as any debt 
securities assigned a rating in one of the top four rating 
categories by at least one nationally recognized statistical rating 
organization. See NYSE rule 431(a)(10).
    \15\ The proposal defines ``other marginable non-equity 
securities'' to include debt securities not traded on a national 
securities exchange that meet certain requirements and private pass-
through securities not guaranteed by a U.S. government agency that 
meet certain requirements. See NYSE rule 431(a)(16).
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C. Good Faith Margin Treatment for Certain Non-Equity Securities Held 
in Exempt Accounts

1. Good Faith Margin Treatment
    The proposal will permit broker-dealers to effect transactions in 
``exempt accounts'' without being required to collect either margin or 
marked to the market losses \16\ on exempted securities, mortgage-
related securities,\17\ or major foreign sovereign debt securities.\18\ 
However, a broker-dealer must take a capital charge for any uncollected 
marked to the market losses on exempt account positions in these 
securities.\19\
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    \16\ Marked to the market losses are unrealized losses on a 
position in securities resulting from a decline in the position's 
market value.
    \17\ The proposal defines ``mortgage related securities'' to 
mean securities that fall within the definition in section 3(a)(41) 
of the Exchange Act. See NYSE rule 431(a)(12).
    \18\ The proposal defines ``major foreign sovereign debt 
securities'' as debt securities issued or guaranteed by the 
government of a foreign country or supranational entity that are 
assigned a rating in the top rating category by at least one 
nationally recognized statistical rating organization. See NYSE rule 
431(a)(11).
    \19\ See NYSE rule 431(e)(2)(F).
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    For transactions in exempt accounts involving highly rated foreign 
sovereign debt \20\ and investment grade debt,\21\ the proposal 
establishes margin requirements of 0.5% and 3%, respectively.\22\ 
Although a broker-dealer is not required to collect this margin, it 
must take a capital charge for any uncollected margin and for any 
uncollected marked to the market losses.\23\
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    \20\ See supra note 13.
    \21\ See supra note 14.
    \22\ See NYSE rule 431(e)(2)(G).
    \23\ See NYSE rule 431(e)(2)(G).
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2. Limitation on Capital Charges
    The proposal limits the amount of capital charges a broker-dealer 
may take in lieu of collecting marked to the market losses.\24\ 
Specifically, a broker-dealer may not enter into transactions with 
exempt accounts that would increase the broker-dealer's capital charges 
if the broker-dealer's capital charges exceed: (1) 5% of the broker-
dealer's tentative net capital \25\ on any one account or group of 
commonly controlled accounts; or (2) 25% of the broker-dealer's 
tentative net capital on all accounts combined, unless the excess no 
longer exists on the fifth business day after it was incurred. The 
broker-dealer also must notify the NYSE that it has reached the 5% or 
25% threshold.
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    \24\ See NYSE rule 431(e)(2)(H).
    \25\ Generally, tentative net capital is a broker-dealer's net 
worth after deducting most illiquid assets but before making haircut 
deductions.
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3. Definition of Exempt Account
    The proposal defines ``exempt account'' to include the accounts of 
certain regulated entities, including banks, savings and loans, 
insurance companies, and registered investment companies. In addition, 
the proposal defines an ``exempt account'' to include any person that 
has a net worth of at least $40 million and financial assets of at 
least $45 million and who: (1) Is an issuer of registered securities; 
(2) is an issuer of securities that provides the Commission with the 
information required under rule 12g3-2(b) under the Exchange Act;\26\ 
(3) is a person with respect to which there is publicly available 
certain information required in rule 15c2-11 under the Exchange 
Act;\27\ or (4) makes available to the broker-dealer such current 
information regarding the person's ownership, business, and financial 
condition (including a current audited statement of financial 
condition, statement of income, or comparable financial reports) that 
the broker-dealer reasonably believes to be accurate, sufficient for 
the purposes of performing a risk analysis in respect of the 
person.\28\
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    \26\ 17 CFR 240.12g3-2(b).
    \27\ 17 CFR 240.15c2-11.
    \28\ See NYSE rule 431(a)(13).
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4. Written Risk Analysis Methodology
    Under the proposal, a broker-dealer must maintain a written risk 
analysis methodology for managing the credit risk associated with 
extending good faith margin on securities transactions in exempt 
accounts.\29\ The NYSE has prepared an Information Memo providing 
guidelines for the risk analysis methodology that it will distribute to 
members following approval of the proposal. The Information Memo states 
that a member's written risk analysis methodology should include the 
following:
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    \29\ See NYSE rule 431(e)(2)(H).
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    [sbull] Procedures for obtaining and reviewing the appropriate 
customer account documentation and the customer financial information 
necessary to determine exempt account status for the extension of 
credit under the rule;
    [sbull] Procedures and guidelines for the determination, review and 
approval of credit limits to customers and across all customers who 
qualify as exempt accounts under the rule;
    [sbull] Procedures and guidelines for monitoring credit risk 
exposure to the

[[Page 51316]]

organization relating to exempt account customers;
    [sbull] Procedures and guidelines for the use of stress testing of 
exempt accounts in order to monitor market risk exposure from exempt 
accounts individually and in the aggregate; and
    [sbull] Procedures providing for the regular review and testing of 
these risk management procedures by an independent unit such as 
internal audit, risk management, or other comparable group.

III. Summary of Comments

    The Commission received two comment letters following the 
publication of the 2003 Release.\30\ One commenter expressed strong 
support for the proposal.\31\ The other commenter limited its remarks 
to the provisions of the proposal affecting transactions in foreign 
sovereign debt and expressed support for those provisions.\32\ 
Specifically, this commenter maintained that NYSE rule 431 currently 
imposes high margin requirements on transactions in foreign sovereign 
debt, which the commenter believes have resulted in the exclusion of 
U.S. broker-dealers from significant segments of international bond 
markets. The commenter believed that the proposal would create more 
reasonable margin requirements for foreign sovereign debt while 
protecting U.S. broker-dealers and their customers from undue risk.
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    \30\ See Daiwa letter and TBMA II, supra note 7. As noted above, 
the Commission received a comment letter from TBMA following the 
initial publication of the proposal. See supra notes 5 and 6. TBMA I 
and the NYSE's response are described more fully in the 2003 
release, supra note 4.
    \31\ See TBMA II, supra note 7.
    \32\ See Daiwa letter, supra note 7.
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IV. Discussion

    Section 6(c)(3)(A) of the Exchange Act \33\ provides, among other 
things, that a national securities exchange may condition membership 
privileges on compliance with the exchange's own financial 
responsibility rules. Pursuant to this authority, the NYSE is 
authorized to promulgate rules governing the financial responsibility 
requirements of its members. In addition, the Commission finds that the 
proposed rule change is consistent with the Exchange Act and the rules 
and regulations thereunder applicable to a national securities 
exchange.\34\ In particular, as described above, for positions not 
maintained in exempt accounts, the proposal reduces the customer 
maintenance margin requirement for certain non-equity securities and 
establishes a customer maintenance margin requirement of 20% of current 
market value for other marginable non-equity securities. The Commission 
believes that these requirements are consistent with the risks of those 
securities.
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    \33\ 15 U.S.C. 78f(c)(3)(A).
    \34\ In approving the proposed rule change, the Commission has 
considered the proposal's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).
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    The proposal also permits the extension of good faith margin to 
certain non-equity securities held in exempt accounts. The Commission 
notes that the definition of exempt account is limited to certain 
regulated entities as well as to persons with net worth of at least $40 
million and financial assets of at least $45 million about whom certain 
information is publicly available or who make available to the broker-
dealer certain current financial information. The Commission believes 
that these requirements are important to the broker-dealer's evaluation 
of the creditworthiness of the exempt account borrower and its ability 
to make an informed decision regarding an extension of good faith 
margin to the exempt account.
    The Commission also notes that the proposal limits the amount of 
capital charges a broker-dealer may take in lieu of collecting marked 
to the market losses. Specifically, a broker-dealer may not enter into 
transactions with exempt accounts that would increase the broker-
dealer's capital charges if the broker-dealer's capital charges exceed: 
(1) 5% of the broker-dealer's tentative net capital on any one account 
or group of commonly controlled accounts; or (2) 25% of the broker-
dealer's tentative net capital on all accounts combined, unless the 
excess no longer exists on the fifth business day after it was 
incurred. In addition, the proposal requires broker-dealers to maintain 
a written risk analysis methodology for assessing the amount of good 
faith credit extended to exempt accounts and assures that a broker-
dealer has procedures for determining, approving, and monitoring 
extensions of credit to exempt accounts. The Commission believes that 
these requirements establish important safeguards to minimize potential 
risks to a broker-dealer.
    Accordingly, the Commission finds that the proposed rule change is 
consistent with section 6(b)(5) of the Exchange Act,\35\ which 
requires, among other things, that the rules of a national securities 
exchange be designed to promote just and equitable principles of trade, 
and to protect investors and the public interest.
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    \35\ 15 U.S.C. 78f(b)(5).
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V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Exchange Act,\36\ that the proposed rule change (SR-NYSE-98-14), as 
amended, is approved. 

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\37\
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    \36\ 15 U.S.C. 78s(b)(2).
    \37\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-21822 Filed 8-25-03; 8:45 am]
BILLING CODE 8010-01-P