[Federal Register Volume 71, Number 97 (Friday, May 19, 2006)]
[Notices]
[Pages 29206-29209]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-7624]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53794; File No. SR-OCC-2005-23]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of a Proposed Rule Change Relating to the Use of 
Margin Deposit in the Event of a Clearing Member Liquidation

May 11, 2006.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on December 16, 2004, The 
Options Clearing Corporation (``OCC'') filed with the Securities and 
Exchange Commission (``Commission'') the proposed rule change as 
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 persons.
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    \1\ 15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The proposed rule change would have two complementary purposes. It 
would (1) eliminate certain unnecessary restrictions on the use of 
margin in the liquidation of a suspended Clearing Member under Chapter 
XI of the Rules and (2) ensure that other restrictions on the use of 
margin that are appropriately imposed in the By-Laws are properly 
reflected in Chapter XI of the Rules.

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),

[[Page 29207]]

and (C) below, of the most significant aspects of such statements.\2\
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    \2\ The Commission has modified parts of these statements.
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A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    Provisions in OCC's By-Laws relating to the potential use of 
securities and other margin assets in the event of a Clearing Member's 
liquidation currently restrict the use of such assets in ways not 
required under applicable laws and regulations. In addition, certain 
provisions of OCC's Rules applicable to Clearing Member liquidations do 
not fully or clearly reflect limitations imposed by the By-Laws.
    OCC is proposing to amend Chapter XI of the Rules to more precisely 
reflect appropriate limitations on the use of Clearing Member margin 
deposits and is proposing to amend provisions of the By-Laws to allow 
OCC to make use of those margin deposits to the fullest extent 
consistent with (i) applicable customer protection provisions and (ii) 
the ability of OCC and Clearing Member systems to identify margin 
assets subject to those provisions.
    Article VI, Section 3 of the By-Laws sets out a number of different 
types of accounts that a Clearing Member may establish and maintain on 
OCC's books. These accounts include firm accounts, separate market-
maker's accounts, combined market-makers' accounts, customers' 
accounts, and others. For each of these account types, Section 3 
provides that OCC shall have a lien on property in the account and 
specifies the extent of the obligations secured by the lien. For 
example, in the case of the firm lien account, Section 3(a) of Article 
VI states that ``the Corporation shall have a lien on all positions and 
on all other securities, margin and other funds in such account as 
security for all of the Clearing Member's obligations to the 
Corporation * * *.'' This language permits all of the Clearing Member's 
assets on deposit with OCC with respect to the firm account to be 
applied to any obligation of the Clearing Member to OCC regardless of 
whether that obligation arises from the firm account or any other 
account. This is appropriate in that, generally speaking, the Clearing 
Member may deposit with respect to the firm account only those assets 
that it is permitted under applicable law to treat as its own. Such 
assets include all cash not required by Rule 15c3-3\3\ to be deposited 
in a special reserve bank account for the benefit of customers and any 
securities that belong to the Clearing Member and not to its customers 
as that term is defined in Rules 15c2-1 and 8c-1 (``hypothecation 
rules'').\4\
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    \3\ 17 CFR 240.15c3-3.
    \4\ 17 CFR 240.15c2-1 and 240.8c-1.
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    The lien language applicable to assets in other types of accounts, 
however, restricts the application of margin assets to obligations of 
the Clearing Member arising from that particular account. For example, 
in the case of a combined market-makers' account other than a 
proprietary combined market-makers' account, Section 3(c) of Article VI 
states that ``the Corporation shall have a lien on all long positions, 
securities, margin and other funds in such combined Market-Maker's 
account with the Clearing Member as security for the Clearing Member's 
obligations to the Corporation in respect of all Exchange transactions 
effected through such account, short positions maintained in such 
account, and exercise notices assigned to such account * * *.'' Under 
this language, OCC's lien on margin assets deposited with respect to a 
combined market-makers' account does not secure any obligations of the 
Clearing Member other than those arising from this account.\5\
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    \5\ In some cases, however, multiple accounts of the same 
account type are treated as a single account as provided in 
Interpretation .02 following Article VI, Section 3 of the By-Laws. 
Thus, for example, if a clearing member maintains more than one 
combined market makers' account for associated market makers, those 
accounts would be treated as a single account for liquidation 
purposes. Similarly, multiple securities customers' accounts would 
be treated as a single securities customers' account for liquidation 
purposes.
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    These limitations on the use of assets in an account to obligations 
arising from the same account were adopted in order to avoid violation 
by Clearing Members of the hypothecation rules cited above.\6\ The 
rules containing these limitations, which rules are substantially 
identical to one another, provide in pertinent part that a broker or 
dealer may not permit securities carried for the account of any 
customer to be commingled with securities ``carried for any person 
other than a bona fide customer under a lien for a loan made to such 
broker or dealer.''\7\ Although it is not at all clear that this 
language should apply to OCC's lien, which is not a ``lien for a loan'' 
in the ordinary sense, OCC has historically taken the conservative view 
that it does apply and does not propose now to do otherwise.
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    \6\ The limitation is actually more restrictive than would be 
required under the hypothecation rules because OCC could lawfully 
apply assets in the account to obligations arising from the 
customers' account and any other accounts in which positions of 
securities customers as defined in the hypothecation rules are 
carried. Similarly, assets in the public customers' account could be 
applied to obligations arising from a market-maker account. As a 
matter of policy, however, OCC has maintained the separation 
continued here.
    \7\ 17 CFR 240.15c2-1(a)(2) and 240.8c-1(a)(2). The term 
customer is defined in paragraph (b)(1) of these rules not to 
include partners, officers, or directors of the broker-dealer or a 
participant in a joint account with a broker-dealer. Unlike Rule 
15c3-3, however, the hypothecation rules do not exclude broker-
dealers from the definition of customer. Accordingly, market-makers 
that do not have any of these specified relationships with their 
clearing broker must be treated as customers for purposes of the 
hypothecation rules.
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    Nevertheless, it is clear that the hypothecation rules apply only 
to ``securities carried for the account of any customer.'' Assets other 
than securities are not subject to the rule. Thus, a Clearing Member is 
not required to segregate cash received by a Clearing Member from any 
securities customer from other cash deposited by the Clearing Member 
with OCC as margin. Subject to the requirement to fund its special 
reserve bank account under Rule 15c3-3(e) and to fund a special reserve 
bank account for any proprietary account of an introducing broker 
dealer (``PAIB'') account that the broker-dealer has agreed to 
maintain, a broker-dealer may treat cash received from securities 
customers as its own. Therefore, a Clearing Member is permitted to 
deposit cash (other than cash received from commodity customers, which 
is required to be segregated under provisions of the Commodity Exchange 
Act [''CEA'']), as margin for any of its accounts at OCC without regard 
to the source of the cash. Accordingly, the lien language applicable to 
combined market-makers' accounts and certain other account types is 
overly restrictive as applied to cash and any other non-securities 
assets that might be deposited as margin in an account.\8\ OCC's lien 
could lawfully be applied to such non-securities assets to secure any 
obligation of the Clearing Member to the same extent as if the cash had 
been deposited with respect to the Clearing Member's firm lien account.
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    \8\ At present, the only other non-securities assets that may be 
deposited as margin are letters of credit (``LOCs''). LOCs are 
subject to special OCC rules in that an LOC may be secured by 
customer securities pledged by the broker-dealer to the issuer of 
the LOC. In such a situation, the LOC would be subject to the 
restrictions applicable to the securities. The broker-dealer may 
comply with those restrictions under OCC's Rules by designating the 
LOC as a ``restricted'' LOC and by specifying which account type is 
secured by the LOC.
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    It is also true that when securities other than customer securities 
are deposited with OCC as margin with respect to a customer account 
(other than a commodity customer account where securities must be 
segregated pursuant to provisions of the CEA),

[[Page 29208]]

those securities would not for that reason alone have to be treated as 
securities carried for the account of any customer, and OCC's lien 
could lawfully apply. However, there are no systems in place that allow 
OCC to distinguish between customer and non-customer securities when 
they are deposited as margin for a customer account, including a 
market-maker account. Accordingly, OCC will continue to treat all 
securities deposited as margin for any securities account other than a 
proprietary account as if the securities were customer securities for 
purposes of the hypothecation rules.
    In order to address the discrepancies described above, OCC is 
proposing to amend Article I, Section 1 of the By-Laws to define two 
different types of liens: a ``general lien'' and a ``restricted lien.'' 
Assets subject to a general lien would serve as security for all 
obligations of the Clearing Member to OCC regardless of the origin or 
nature of those obligations. The proposed rule change would also define 
a ``general lien account'' as one in which OCC has a general lien over 
all assets in the account. Thus, the firm account and any other 
proprietary account, such as a proprietary market-maker's account, 
would be a general lien account, and all general lien accounts would be 
treated as a single firm lien account in a liquidation of the Clearing 
Member. This is precisely the same result as under the present rules.
    The definition of a restricted lien would provide that assets in an 
account that are specified as subject to a restricted lien serve as 
security only for obligations arising from that particular account or 
from a specified group of accounts to which that account belongs.\9\ A 
restricted lien account would be defined as an account in which 
specified assets are subject to a restricted lien. All accounts other 
than the various types of proprietary accounts would be restricted lien 
accounts. However, not all assets in those accounts would be subject to 
a restricted lien. Cash and any other non-securities assets in a 
restricted lien account, because they are not subject to the 
restrictions of the hypothecation rules, would be subject to a general 
lien. However, an exception would be made for the securities customers' 
account and the customer lien account where all assets, including cash, 
would be subject only to a restricted lien. The reason for this 
exception is that, although these non-securities assets are not subject 
to the hypothecation rules, the provisions of Rule 15c3-3(e) and in 
particular the reserve formula used in calculating the amount of funds 
a Clearing Member is required to deposit in the special reserve bank 
account for the exclusive benefit of customers provide a debit (i.e., a 
reduction in the required deposit) reflecting ``[m]argin required and 
on deposit with [OCC] for all option contracts written or purchased in 
customer accounts.'' Given this debit in the reserve formula, it would 
appear to be inconsistent to use funds in the account as collateral for 
obligations other than those arising in such accounts. This limitation 
is reflected in the proposed rule change.
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    \9\ The reference to groups of accounts is necessary because, 
for example, a clearing member may have multiple combined market 
makers' accounts that would be liquidated as if they were a single 
account. The same would be true if a clearing member had more than 
one securities customers' account. These account groupings are 
addressed in existing Interpretation .02 following Article VI, 
Section 3 of the By-Laws.
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    In order to eliminate unnecessary restrictions on the use of non-
securities assets in certain accounts as described above, OCC proposes 
to modify the lien language appearing in the following paragraphs of 
Article VI, Section 3: paragraph (a), to the extent applicable to firm 
non-lien accounts; paragraph (b) to the extent applicable to separate 
market-maker accounts other than proprietary market-maker accounts; 
paragraph (c), to the extent applicable to combined market-makers' 
accounts other than proprietary combined market-makers' accounts; and 
paragraph (h) applicable to JBO Participants' accounts. The 
modification necessary in each case is to provide that margin assets 
deposited with respect to the applicable account and consisting of cash 
and other non-securities collateral may be applied to any obligation of 
the Clearing Member rather than only to obligations arising from that 
account. This is accomplished by subjecting securities assets in the 
accounts to a restricted lien while non-securities assets in certain of 
the account are subject to a general lien. Other changes in Article VI, 
Section 3 are non-substantive changes intended to make use of the newly 
defined terms, to improve consistency, to eliminate repetition, and to 
clarify ambiguities.\10\
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    \10\ No changes of substance are proposed to be made with 
respect to futures accounts subject to segregation requirements 
under the CEA.
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    In order to conform to the changes made in provisions of Article 
VI, Section 3(a) relating to firm non-lien accounts and in Section 3(e) 
relating to the securities customers' account, OCC is proposing to 
delete the specific lien language applicable to unsegregated long 
positions currently set forth in Rule 611. The extent of these liens 
would be set forth in the cited provisions of Article VI, Section 3.
    Notwithstanding the limitations of the existing lien language 
described above applicable to accounts other than proprietary accounts, 
these limitations are not fully reflected in the provisions of OCC's 
Rule 1104(a), which governs the creation of a liquidating settlement 
account and payments from that account in a Clearing Member 
liquidation. Rule 1104(a) presently provides, in effect, that proceeds 
from restricted letters of credit,\11\ unsegregated long positions, and 
variation payments resulting from positions in security futures in a 
public customers' account, may not be applied to obligations other than 
those arising from the public customers' account. It does not similarly 
restrict the use of proceeds of securities deposited directly as margin 
for that account even though the application of such securities to 
obligations arising out of other accounts would arguably be in 
violation of the hypothecation rules and even though such use would be 
inconsistent with OCC's restricted lien on those securities. In the 
event of a Clearing Member liquidation prior to the approval of this 
rule change, OCC would observe the limitations of the hypothecation 
rules and the lien language as it presently exists in OCC's By-Laws 
notwithstanding that those limitations are not fully reflected in Rule 
1104(a). Those limitations are fully consistent with OCC's risk 
management system in that OCC has never set margin or clearing fund 
requirements with the expectation that it would have excess collateral 
in one account that could be applied against obligations arising in 
other accounts. OCC determines its risk margin requirements on each 
Clearing Member account independently.
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    \11\ OCC is proposing to amend the definition of restricted 
letter of credit in Rule 101 in order to make it more generic. In 
current practice, restricted letters of credit are used not only for 
the securities customers' account but may also be used in a 
segregated futures account. The letter of credit must indicate on 
its face the purpose or purposes to which it may be applied.
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    Nevertheless, if in liquidating any Clearing Member account a 
shortfall occurred, it would obviously be in the interest of OCC, its 
Clearing Members, and the integrity of the clearing system if OCC were 
able to apply the margin assets that it holds to the fullest extent 
practicable without violating applicable law. In addition, the intended 
restrictions on the use of proceeds of positions and securities in the 
securities customers' account as well as in market-maker accounts and 
other restricted lien accounts as OCC is now proposing to

[[Page 29209]]

refer to them generically should be clearly stated. By making use of 
the newly defined terms general lien and restricted lien and by relying 
on the provisions of Article VI, Section 3 as proposed to be amended, 
only relatively minor amendments to the provisions of Rule 1104(a) are 
required to effectuate the dual purposes of this proposed rule change. 
Other proposed changes in Rule 1104 are intended for clarification only 
and are not substantive.
    OCC believes that the proposed rule change is consistent with the 
purposes and requirements of Section 17A of the Act because it will 
promote the prompt and accurate clearance and settlement of securities 
transactions, remove impediments to the mechanisms of a national system 
for the prompt and accurate clearance and settlement of securities 
transactions, and assure the safeguarding of securities and funds in 
the custody or control of OCC by clarifying limitations on the use of 
certain customer property in the event of a Clearing Member insolvency 
while protecting the clearing system by permitting broader use of other 
collateral deposited by Clearing Members.

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 the proposed rule change or
    (b) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

VI. 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. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml) or
     Send an e-mail to [email protected]. Please include 
File Number SR-OCC-2005-23 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-OCC-2005-23. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 Section, 100 F Street, 
NE., Washington, DC 20549. Copies of such filing also will be available 
for inspection and copying at the principal office of OCC and on OCC's 
Web site at http://www.optionsclearing.com.
    All comments received will be posted without change; the Commission 
does not edit personal identifying information from submissions. You 
should submit only information that you wish to make available 
publicly. All submissions should refer to File Number SR-OCC-2005-23 
and should be submitted on or before June 9, 2006.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. E6-7624 Filed 5-18-06; 8:45 am]
BILLING CODE 8010-01-P