[Federal Register Volume 68, Number 188 (Monday, September 29, 2003)]
[Notices]
[Pages 56026-56029]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-24452]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48520; File No. SR-OCC-2002-10]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Granting Approval of a Proposed Rule Change Relating to Market-
Maker Account Agreements

September 22, 2003.

I. Introduction

    On May 21, 2002, The Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange Commission (``Commission'') and on 
October 18, 2002, amended proposed rule change SR-OCC-2002-10 pursuant 
to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'').\1\ Notice of the proposal was published in the Federal 
Register on April 24, 2003.\2\ No comment letters were received. For 
the reasons discussed below, the

[[Page 56027]]

Commission is granting approval of the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 47691, (April 17, 2003), 
68 FR 20207 (April 24, 2003) [File No. SR-OCC-2002-10].
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II. Description

    The purpose of the 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 a specified form of 
account agreement from each market-maker for whom it carries an account 
and must submit the agreement to OCC for approval. OCC believes that 
such submissions to OCC 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.
    The rule change also adds two new interpretive statements to 
Article VI, Section 3. Interpretation .02 clarifies the application to 
OCC clearing accounts of certain UCC amendments to Article 8 and to 
Article 9. Interpretation .03 clarifies 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 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'' 
and ``market-maker accounts''). Clearing members that maintain market-
maker accounts at OCC must, according to the current provisions of 
Article VI, 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. The principal reason for 
requiring the filing of these agreements with OCC 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 1994 UCC 
amendments in the event of a clearing member insolvency.
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    \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.
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    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.\4\ Having to 
submit each of the agreements to OCC for OCC review 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.
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    \4\ While the content of the agreements may vary by type of 
market-maker account, all agreements specify OCC's right to a lien 
on all assets in the account, the right to carry positions ``net,'' 
and the right to close out positions. 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.
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2. Proposed Changes

    Because of the UCC amendments in 1994, 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 accounts.\5\ 
The UCC amendments established new rules specifically tailored to 
govern the ``indirect holding system'' for securities and certain other 
investment property.\6\ 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.
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    \5\ 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.
    \6\ Part 5 of Article 8 of the UCC describes the core of the 
package of rights of a person who holds a security through a 
securities intermediary.
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    Under the UCC amendments, OCC and its clearing members are 
``securities intermediaries,'' \7\ and an OCC-issued option is a 
``financial asset.'' \8\ A person acquires a ``security entitlement'' 
\9\ and becomes an ``entitlement holder'' \10\ when a securities 
intermediary credits a financial asset to that person's account.\11\ 
OCC's clearing members acquire a security entitlement against OCC when 
OCC credits positions to their accounts. The clearing members' 
customers (including market-makers) acquire security entitlements 
against the clearing member with respect to positions carried for those 
customers on the books of the clearing member.
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    \7\ UCC 8-102(a)(14).
    \8\ UCC 8-102(a)(9)(ii) and 8-103(e).
    \9\ UCC 8-102(a)(17).
    \10\ UCC 8-102(a)(7).
    \11\ UCC 8-501(b)(1).
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    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.\12\ 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.''
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    \12\ UCC 9-314(a) and 9-106(a).
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    OCC's revised by-law and rule will 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 of the security entitlements in each 
market-maker account whether or not it has obtained a signed agreement 
from each market-maker. Furthermore, OCC's security interest has 
priority over any competing interests. ``A security interest in a 
security entitlement or a securities account \13\ granted to the 
debtor's own

[[Page 56028]]

securities intermediary has priority over any security interest granted 
by the debtor to another secured party.'' \14\
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    \13\ 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 is a ``commodity account,'' OCC will fall within the 
definition of a ``commodity intermediary'' under UCC 9-102(a)(17).
    \14\ UCC 9-328(3).
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    Because it remains the case that as between a clearing member and 
its customers (including market-makers), the clearing member has a duty 
to obtain each customer's consent before subjecting the customer's 
securities to a security interest or taking certain other actions 
potentially affecting the customer's interests,\15\ the rule continues 
to require clearing members to obtain specified agreements from market-
makers and 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 agreements required 
under Article VI, Section 3 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.
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    \15\ See UCC 8-504(b), which states that a securities 
intermediary may not grant any security interests in a financial 
asset it is obligated to maintain on behalf of an entitlement holder 
except as otherwise agreed by the entitlement holder.
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    OCC also will add two new items to the Interpretations and Policies 
to Article VI, Section 3. The first sentence of new Interpretation .02 
sets forth a representation and warranty from each clearing member that 
it has obtained the agreement of each person for whom a transaction is 
effected in any account of the clearing member established and 
maintained pursuant to the provisions of Section 3, including the 
granting of a security interest in the account to OCC, and that the 
inclusion of the person's transactions and positions in such account is 
in compliance with the laws, regulations, and rules applicable to the 
clearing member.
    This representation will apply to not only market-maker accounts 
and JBO participant accounts but also to firm accounts, 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. While OCC has never required that a 
specific form of agreement be obtained by clearing members from persons 
whose transactions are included in these other types of accounts, 
Commission Rule 15c3-3, Rule 8c-1, Rule 15c2-1, and the Commission's 
hypothecation rules, as well as certain state laws, where applicable, 
require that certain consents and agreements be obtained.\16\
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    \16\ For example, consent to the commingling of a customer's 
securities with the securities of another customer must be obtained. 
Such consents are normally included in the account documentation 
obtained by broker-dealers from their customers and are the 
responsibility of the broker-dealers.
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    The second sentence of new 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 accordance 
with their terms even if the clearing member fails in its obligations 
to obtain the required consents or agreements from its customers. This 
is consistent with the provisions of UCC Article 8, under which OCC's 
security interest is protected.\17\
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    \17\ UCC 8-503(e) 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. See, also, UCC 8-511(b), which provides that 
a claim of a creditor (i.e., OCC) of a securities intermediary 
(i.e., the failed clearing member) that is perfected by control has 
priority over the claims of the securities intermediary's 
entitlement holders.
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    The first sentence of new Interpretation 03 will clarify that 
pursuant to Article VI, Section 3 of OCC's By-Laws, OCC's lien extends 
to all assets in account which are ``investment property'' as defined 
under Article 9 of the UCC,\18\ including long and short positions in 
security futures and any other asset in the account. This 
interpretation is consistent with OCC's long-standing interpretation of 
Section 3 of Article VI.
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    \18\ UCC 9-102(a)(49) defines ``investment property'' to mean a 
``security, whether certificated or uncertificated, security 
entitlement, securities account, commodity contract, or commodity 
account.''
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    The second sentence of Interpretation .03 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's lien 
secures the clearing member's obligation with respect to long security 
futures positions in the account. Long security futures positions, 
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, 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.
    Changes to Rule 1105(b) are made to conform that rule to Article 
VI, Section 3. Rather than refer to the market-maker account agreement, 
the rule will now refer to the provisions in Article VI, Section 3 of 
the By-Laws which are applicable to the market-maker account.

III. Discussion

    Section 17A(b)(3)(F) of the Act requires that the rules of a 
clearing agency be designed to promote the prompt and accurate 
clearance and settlement of securities transactions and to remove 
impediments to and perfect the mechanism of a national system for the 
prompt and accurate clearance and settlement of securities 
transactions.\19\ The rule change permits OCC 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 those agreements to OCC for approval because UCC amendments 
in conjunction with requirements under federal and state law make the 
requirement redundant and unnecessary. OCC's rule change does not 
substantively alter the rights or obligations of OCC clearing members 
or their customers but rather streamlines the process by which OCC 
perfects its security interest in clearing members' market-maker 
accounts under the UCC. Accordingly, the Commission finds the rule 
change is consistent with section 17A of the Act.
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    \19\ 15 U.S.C. 78q-1(b)(3)(F).
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IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
in

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particular with the requirements of section 17A(b)(3)(F) of the Act and 
the rules and regulations thereunder. It is therefore ordered, pursuant 
to section 19(b)(2) of the Act, that the proposed rule change (File No. 
SR-OCC-2002-10) be and hereby is approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-24452 Filed 9-26-03; 8:45 am]
BILLING CODE 8010-01-P