[Federal Register Volume 69, Number 55 (Monday, March 22, 2004)]
[Notices]
[Pages 13345-13346]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-6336]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49420; File No. SR-OCC-2003-08]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Approving Proposed Rule Change Related to Delivery Settlement of 
Exercised Stock Options and Matured Stock Futures

March 16, 2004.

I. Introduction

    On August 22, 2003, The Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') 
proposed rule change SR-OCC-2003-08 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 February 13, 2004.\2\ No 
comment letters were received. For the reasons discussed below, the 
Commission is approving the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 49208 (February 9, 
2004), 69 FR 7275.
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II. Description

    OCC is restructuring its rules applicable to delivery settlement of 
exercised stock options and matured stock futures.
    The purpose of the proposed rule change is to:
    (1) Restructure OCC's Rules applicable to physical settlement of 
exercised stock options and matured stock futures to reflect that such 
settlements are normally effected through the National Securities 
Clearing Corporation (``NSCC'') (i.e., the correspondent clearing 
corporation) with broker-to-broker (``BTB'') settlement procedures as a 
backup;
    (2) Require that BTB settlements be made on a delivery-versus-
payment (``DVP'') basis at The Depository Trust Company (``DTC'') 
unless OCC directs otherwise;
    (3) Revise OCC's Rules applicable to delivery settlement effected 
on a BTB basis in order to reflect the enhanced system capabilities to 
track such settlements offered by ENCORE Release 4.0, which was 
installed on September 26, 2003; \3\
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    \3\ ENCORE Release 4.0, which includes updated systems for 
settlement of physical delivery stock options and stock futures, is 
a major installation in OCC's multiyear project to rewrite its 
clearance and settlement system.
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    (4) Revise OCC's Rules relating to buy-ins and sell-outs to 
parallel NSCC's Rules relating to buy-ins with respect to security 
balance orders; and
    (5) Revise OCC's Rule relating to protect provisions so OCC rules 
parallel NSCC's Rules relating to protect provisions with respect to 
security balance orders.
    OCC's By-Laws define an ``underlying security'' with respect to 
physically settled stock options and stock futures to mean the security 
or other asset that OCC is obligated to sell or to purchase upon 
exercise or maturity of the contract. Normally, underlying securities 
are delivered and paid for through the facilities of NSCC, but under 
certain circumstances settlement must be made on a BTB basis.\4\ If 
more than one underlying security is deliverable with respect to an 
exercised or matured contract, ENCORE Release 4.0 will treat the 
delivery of each underlying security as a separate settlement 
obligation. Payment of the aggregate purchase price for an underlying 
security will also be treated

[[Page 13346]]

as a separate settlement obligation.\5\ As is the case today, OCC will 
allocate a percentage of the exercise price or the final settlement 
price to each underlying security to be delivered.\6\
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    \4\ Such circumstances include cases when NSCC excludes an 
underlying security from its continuous net settlement system or 
when OCC suspends a clearing member with pending settlements that 
have not yet been guaranteed by NSCC.
    \5\ If the underlying security includes a cash component (e.g., 
cash in lieu amounts or the proceeds of a cash merger), the cash is 
settled through OCC's cash settlement system.
    \6\ An adjustment of a contract in response to a corporate 
action may result in more than one underlying security being 
deliverable upon exercise or maturity. OCC By-Laws, Article VI, 
section 11 and Article XIII, section 4.
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    OCC will provide clearing members with Delivery Advices indicating 
whether settlements are to be effected through NSCC or on a BTB basis. 
Delivery Advices will specify settlement information for the clearing 
member including each underlying security to be delivered or received, 
the aggregate purchase price to be received or paid, the delivery date, 
the exercise price or final settlement price, the percentage of the 
exercise price allocated to the underlying security, the contra-
clearing member to the settlement (for BTB settlements), and in the 
case of options, the activity (i.e., exercise or assignment) giving 
rise to the settlement obligation.
    OCC will normally require that BTB settlements be made on a DVP 
basis through the facilities of DTC in order to avoid the need for OCC 
to margin ``Herstatt risk'' (i.e., the risk that a party may fail to 
make delivery or payment, as the case may be, after having itself 
received payment or delivery). However, the proposed rule change 
retains provisions for BTB settlements outside of DTC to provide for 
the rare case where an underlying security may not be DTC-eligible and 
reflects the enhanced ENCORE Release 4.0 system capabilities to process 
and monitor BTB settlements. For BTB settlements, the delivering 
clearing member will enter into ENCORE the number of units of the 
underlying security delivered (up to the total delivery requirement) 
and the amount received in respect thereof. The receiving clearing 
member will enter the number of units of the underlying security 
received and the amount paid. These entries can occur at different 
times. Only if the entries match (i.e., the number of units delivered 
equals the number received or the amount received equals the amount 
paid, as the case may be) will the settlement obligation be discharged. 
In the event that the matched number of units or payment amounts is 
less than the total settlement obligation, only the deficiency will be 
treated as unsettled. An entry for which no response has been given by 
the second business day after its posting will be deemed settled 
provided that the specified delivery date has passed. Contradictory 
entries will be treated as unmatched items and will be deemed 
unsettled. All unsettled obligations will be margined.\7\ Partial 
deliveries will be permitted but only in round lots except where an 
adjustment has resulted in a unit of trading other than a round lot, in 
which case partial deliveries will also be permitted in the odd lot 
component or multiples thereof.\8\
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    \7\ The total obligation will continue to be margined until the 
installation of the margin subsystem.
    \8\ For example, where the unit of trading for an adjusted 
contract is 133 shares, a writer of three assigned calls could 
deliver in increments of 100 shares, 200 shares, 300 shares, 33 
shares, 66 shares, and/or 99 shares separately or in any combination 
up to a total of 399 shares.
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    Chapter IX of OCC's Rules sets forth the delivery and payment rules 
for stock options and stock futures. Those Rules are being restructured 
to reflect that settlement normally occurs through NSCC with BTB 
settlement as the backup. Consistent with other OCC Rule Chapters, an 
introductory section has been added to Chapter IX of the Rules. This 
introductory section sets forth OCC's authority to designate a 
settlement method with regard to exercised stock options and matured 
stock futures, OCC's general policy to effect such settlement through 
NSCC, and OCC's authority to alter a previous designation of a 
settlement method. Former Rule 913, which concerns settlements through 
NSCC, has been renumbered as Rule 901. Other conforming changes have 
been made to the Rule to reflect the general policy that settlement 
will occur through NSCC.
    Former Rules 901 through 907, which pertain to BTB settlements, 
have been renumbered as Rules 902 through 908. These Rules, along with 
Rule 909, have been modified to reflect the enhanced system for 
monitoring and tracking BTB settlements described above. Rules 910 and 
911, which concern fails to deliver and receive, respectively, and 
910A, which concerns protect procedures, have been modified to more 
closely parallel applicable provisions of NSCC's Rules. Obsolete rule 
references have been deleted, and conforming changes have been made to 
other By-Law and rule provisions as necessary.

III. Discussion

    Section 17A(b)(3)(F) of the Act requires that the rules of a 
clearing agency be designed to perfect the mechanism of a national 
system for the prompt and accurate clearance and settlement of 
securities transactions.\9\ The Commission finds that OCC's proposed 
rule change is consistent with this requirement because it will promote 
the prompt and accurate clearance and settlement of securities 
transactions by clarifying its Rules and enhancing its procedures with 
respect to the physical settlement of exercised options and matured 
security futures.
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    \9\ 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 particular section 17A 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-2003-08) be and hereby 
is approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-6336 Filed 3-19-04; 8:45 am]
BILLING CODE 8010-01-P