[Federal Register Volume 68, Number 169 (Tuesday, September 2, 2003)]
[Notices]
[Pages 52259-52262]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-22229]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48407; File No. SR-NASD-00-08]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment Nos. 1 and 2 by the National Association of Securities 
Dealers, Inc. Relating to Margin Requirements

August 25, 2003.

I. Introduction

    On March 3, 2000, the National Association of Securities Dealers, 
Inc. (``NASD'') 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 NASD Rule 2520, ``Margin 
Requirements.'' The NASD's proposal was published for comment in the 
Federal Register on May 26, 2000.\3\ The Commission received one 
comment

[[Page 52260]]

letter regarding the proposal,\4\ and the NASD responded to the 
comment.\5\
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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. 42801 (May 19, 
2000), 65 FR 34240 (``2000 Release'').
    \4\ See letter from Wendy Fried, Vice President and Associate 
General Counsel, The Bond Market Association (``TBMA''), to Jonathan 
Katz, Secretary, Commission, dated June 30, 2000 (``TBMA Letter'').
    \5\ See letter from Patrice M. Gliniecki, Vice President and 
Deputy General Counsel, NASD, to Katherine A. England, Assistant 
Director, Division of Market Regulation, Commission, dated July 27, 
2000 (``NASD Letter''). The TBMA Letter, and the NASD's response, 
are discussed below.
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    The NASD filed Amendment Nos. 1 and 2 to the proposal on June 2, 
2000, and July 30, 2003, respectively. This order approves the proposed 
rule change, as amended. In addition, the Commission is publishing 
notice to solicit comments and is simultaneously approving, on an 
accelerated basis, Amendment Nos. 1 and 2.

II. Description of the Proposal

A. Background

    Section 7 of the Exchange Act \6\ 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. 
Pursuant to this authority, the Federal Reserve Board promulgated 
Regulation T,\7\ which sets minimum initial margin requirements. 
Regulation T provides that transactions in non-equity securities are 
subject to either ``good faith'' margin requirements \8\ or the level 
set by the rules of a self-regulatory organization (``SRO''), whichever 
is higher.\9\ Accordingly, the maintenance margin requirements 
established by the NASD or another SRO set the minimum margin levels 
for non-equity securities.\10\
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    \6\ 12 U.S.C. 78(g).
    \7\ 12 CFR 220 et seq.
    \8\ Regulation T defines ``good faith'' margin as the amount of 
margin that a broker-dealer would require in exercising sound credit 
judgment.
    \9\ 12 CFR 220.12(b).
    \10\ See NASD Rule 2520(c).
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    As described more fully below, the proposal amends NASD Rule 2520 
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 \11\ 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 \12\ 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.\13\
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    \11\ 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 NASD Rule 2520(a)(9).
    \12\ 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 NASD Rule 2520(a)(10).
    \13\ 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 NASD Rule 2520(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 \14\ on exempted securities, mortgage-
related securities,\15\ or major foreign sovereign debt securities.\16\ 
However, a broker-dealer must take a capital charge for any uncollected 
marked to the market losses on exempt account positions in these 
securities.\17\
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    \14\ Marked to the market losses are unrealized losses on a 
position in securities resulting from a decline in the position's 
market value.
    \15\ The proposal defines ``mortgage related securities'' to 
mean securities that fall within the definition in Section 3(a)(41) 
of the Exchange Act. See NASD Rule 2520(a)(12).
    \16\ 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 NASD Rule 
2520(a)(11).
    \17\ See NASD Rule 2520(e)(2)(F).
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    For transactions in exempt accounts involving highly rated foreign 
sovereign debt \18\ and investment grade debt,\19\ the proposal 
establishes margin requirements of 0.5% and 3%, respectively.\20\ 
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.\21\
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    \18\ See note 11, supra.
    \19\ See note 12, supra.
    \20\ See NASD Rule 2520(e)(2)(G).
    \21\ See NASD Rule 2520(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.\22\ 
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 \23\ 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 NASD that it has reached the 5% or 
25% threshold.
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    \22\ See NASD Rule 2520(e)(2)(H).
    \23\ 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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D. Amendment No. 1

    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.'' \24\ Amendment No. 1 provides a draft Notice to Members 
(``NTM'') that addresses the written risk analysis methodology that 
members must establish and maintain. Specifically, the NTM states that 
a member's written risk analysis methodology should include the 
following:
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    \24\ See NASD Rule 2520(e)(2)(H)(i).
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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 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

[[Page 52261]]

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.

E. Amendment No. 2

    Amendment No. 2 revises the proposal by modifying the definition of 
``exempt account'' in proposed NASD Rule 2520(a)(13). The proposed 
changes to proposed NASD Rule 2520(a)(13), as published in the 2000 
Release,\25\ appear below. Proposed additions are in italics; proposed 
deletions are in [brackets].
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    \25\ See note 3, supra.

2520. Margin Requirements

    (a) Definitions
    For purposes of this paragraph, the following terms shall have the 
meanings specified below:
    (1) through (12). No change.
    (13) The term ``exempt account'' means: [a member, non-member 
broker/dealer registered as a broker or dealer under the Act, 
``designated account,'' or any person having net worth of at least 
forty-five million dollars and financial assets of at least forty 
million dollars.]
    (A) a member, non-member broker/dealer registered as a broker or 
dealer under the Act, a ``designated account,'' or
    (B) any person that:
    (i) has a net worth of at least forty-five million dollars and 
financial assets of at least forty million dollars for purposes of 
subparagraphs (e)(2)(F) and (e)(2)(G), and
    (ii) either:
    a. has securities registered pursuant to Section 12 of the Act, has 
been subject to the reporting requirements of Section 13 of the Act for 
a period of at least 90 days and has filed all the reports required to 
be filed thereunder during the preceding 12 months (or such shorter 
period as it was required to file such reports), or
    b. has securities registered pursuant to the Securities Act of 
1933, has been subject to the reporting requirements of Section 15(d) 
of the Act for a period of at least 90 days and has filed all the 
reports required to be filed thereunder during the preceding 12 months 
(or such shorter period as it was required to file such reports), or
    c. if such person is not subject to Section 13 or 15(d) of the Act, 
it is a person with respect to which there is publicly available the 
information specified in paragraphs (a)(5)(i) to (xiv), inclusive, of 
Rule 15c2-11 under the Act, or
    d. furnishes information to the Securities and Exchange Commission 
as required by Rule 12g3-2(b) of the Act, or
    e. makes available to the member such current information regarding 
such person's ownership, business, operations and financial condition 
(including such person's current audited statement of financial 
condition, statement of income and statement of changes in 
stockholder's equity or comparable financial reports), as reasonably 
believed by the member to be accurate, sufficient for the purposes of 
performing a risk analysis in respect of such person.

III. Summary of Comments

    The Commission received one comment letter regarding the 
proposal.\26\ The commenter generally supported the proposal, which is 
substantially identical to a proposal by the New York Stock Exchange, 
Inc. (``NYSE'') that the Commission approved.\27\ However, the 
commenter maintained that the written risk analysis methodology 
included in the NASD's proposal was not required under the NYSE's 
proposal and was unnecessary because NASD members already are subject 
to sophisticated external and internal oversight of credit practices. 
The NASD responded by noting that the written risk analysis methodology 
was in fact proposed to be required by the NYSE.\28\
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    \26\ See TBMA Letter, supra note 4.
    \27\ See Securities Exchange Act Release No. 48365 (August 19, 
2003) (order approving File No. SR-NYSE-98-14) (``NYSE Order''). See 
also Securities Exchange Act Release Nos. 40278 (July 29, 1998), 63 
FR 41822 (August 5, 1998) (notice of File No. SR-NYSE-98-14); and 
48133 (July 7, 2003), 68 FR 41672 (July 14, 2003) (notice of 
Amendment Nos. 1, 2, and 3 to File No. SR-NYSE-98-14) (``2003 
Release'').
    \28\ See NASD Letter, supra note 5. The NYSE proposed the 
requirement that members maintain a written risk analysis 
methodology in Amendment No. 1 to its proposal, which was filed on 
January 5, 1999, and published for comment on July 14, 2003. The 
NYSE subsequently filed an Information Memo providing guidelines for 
a member's written risk analysis methodology. Amendment No. 1 to the 
NASD's proposal, set forth in Section II.D., supra, contains an NTM 
with written risk analysis methodology guidelines identical to the 
guidelines established in the NYSE's Information Memo.
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    In addition, the commenter referenced its comment letter regarding 
the NYSE's similar proposal.\29\ Specifically, the commenter requested 
clarification that: (1) the NYSE's proposed definition of ``exempt 
account'' would not supersede the existing definition of ``exempt 
account'' in NYSE Rule 431(f)(2)(D)(iv); and (2) existing extensions of 
credit to accounts that met the current requirements for exempt account 
status, but that would not meet the proposal's higher financial 
threshold for exempt accounts, would be ``grandfathered'' and 
maintained based on exempt account status even after the increased 
financial threshold became effective. In this regard, the NASD 
confirmed that the proposal's definition of ``exempt account'' does not 
replace the current definition of ``exempt account'' contained in NASD 
Rule 2520(f)(2)(D)(iv). With respect to an extension of credit to an 
account that currently qualifies as exempt but that would not qualify 
as an exempt account under the proposal, the NASD indicates that an 
account's exempt status will be determined as of the date of the 
initial extension of credit. Accordingly, accounts that meet the 
current requirements for exempt account status would be 
``grandfathered'' on their existing credit transactions, and the 
proposal's requirements for exempt account status would apply to any 
new credit transactions or ``roll-overs'' of existing credit 
extensions.
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    \29\ See letter from Paul Saltzman, Senior Vice President and 
General Counsel, TBMA, and Patricia Brigantic, Vice President and 
Senior Associate General Counsel, TBMA, to Jonathan Katz, Secretary, 
Commission, dated August 26, 1998 (``TBMA 1998 Letter''). The TBMA 
1998 Letter, and the NYSE's response, are discussed in the 2003 
Release, supra note 27. As noted in the NYSE Order, supra note 27, 
the Commission believes that the NYSE sufficiently addressed the 
questions raised in the TBMA 1998 Letter.
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IV. Discussion

    Section 15A(g)(3)(A) of the Exchange Act \30\ provides, among other 
things, that a national securities association may condition membership 
privileges on compliance with the association's own financial 
responsibility rules. Pursuant to this authority, the NASD 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 
association.\31\ 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

[[Page 52262]]

requirements are consistent with the risks of those securities.
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    \30\ 15 U.S.C. 78o-3(g)(3)(A).
    \31\ 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 15A(b)(6) of the Exchange Act,\32\ which 
requires, among other things, that the rules of a national securities 
association be designed to promote just and equitable principles of 
trade, and to protect investors and the public interest.
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    \32\ 15 U.S.C. 78o-3(b)(6).
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    The Commission finds good cause for approving Amendment Nos. 1 and 
2 to the proposal prior to the thirtieth day after the date of 
publication of notice of filing thereof in the Federal Register. 
Amendment Nos. 1 and 2 strengthen the proposal by providing guidelines 
for the written risk analysis methodology that NASD members must 
develop and maintain, and by requiring a person seeking exempt account 
status to meet specific registration and reporting requirements, or to 
provide certain current information concerning the person's ownership, 
business, operations, and financial condition. In addition, Amendment 
Nos. 1 and 2 conform the NASD's proposal to an NYSE proposal that the 
Commission approved previously.\33\ Accordingly, the Commission finds 
that there is good cause, consistent with sections 15A(b)(6) and 19(b) 
of the Exchange Act, to approve Amendment Nos. 1 and 2 on an 
accelerated basis.
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    \33\ See NYSE Order, supra note 27.
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V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 1 and 2, including whether 
Amendment Nos. 1 and 2 are consistent with the Exchange 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 number SR-NASD-00-08 and should be 
submitted by September 23, 2003.

VI. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Exchange Act,\34\ that the proposed rule change (SR-NASD-00-08), as 
amended, is approved.
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    \34\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\35\
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    \35\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-22229 Filed 8-29-03; 8:45 am]
BILLING CODE 8010-01-P