[Federal Register Volume 84, Number 34 (Wednesday, February 20, 2019)]
[Notices]
[Pages 5157-5171]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-02731]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-85121; File No. SR-OCC-2015-02]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Disapproving Proposed Rule Change Concerning The Options Clearing 
Corporation's Capital Plan

February 13, 2019.

I. Introduction

    The Options Clearing Corporation (``OCC'') submitted a proposed 
rule change in January 2015 that implements a plan to significantly 
increase OCC's capitalization (``Capital Plan'' or ``Plan''). After 
being approved by the Securities and Exchange Commission 
(``Commission'' or ``SEC''),\1\ the Capital Plan is now before the 
Commission on remand from the Court of Appeals for the District of 
Columbia Circuit (``Court'' or ``D.C. Circuit'').\2\ As discussed in 
more detail below, upon further review, the Commission is disapproving 
the proposed rule change because the information before us is 
insufficient to support a finding that the Plan is consistent with the 
Securities Exchange Act of 1934 (``Exchange Act'' or ``Act'') and the 
rules and regulations thereunder.
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    \1\ Release No. 34-77112, File No. SR-OCC-2015-02 (Feb. 11, 
2016), 81 FR 8294 (Feb. 18, 2016) (``Approval Order'').
    \2\ See Susquehanna Int'l Grp., LLP v. SEC, 866 F.3d 442, 443 
(D.C. Cir. 2017) (``Susquehanna Opinion''). OCC implemented the 
Capital Plan in 2015. Neither the Commission nor the Court stayed 
the implementation of the plan on review, and the D.C. Circuit did 
not vacate the Commission's approval order on remand. The Capital 
Plan therefore has remained in effect.
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    In particular, we conclude that the Commission does not have 
sufficient information to determine that the Capital Plan was adopted 
in a manner consistent with OCC's own rules, as required by Exchange 
Act Section 19(g). OCC's By-laws require that exchanges which are not 
shareholders of OCC be promptly provided with notice of certain matters 
that the Executive Chairman of OCC considers to be of competitive 
significance to those exchanges. No such notice was given during 
consideration of the Capital Plan. Based on the information before us, 
we cannot determine whether or how the Executive Chairman concluded 
that the Capital Plan lacked competitive significance such that 
notification was not required.
    In addition, we conclude that we lack sufficient information to 
determine whether the Capital Plan imposes a burden on competition not 
necessary or appropriate in furtherance of the purposes of the Exchange 
Act, as prohibited by Section 17A(b)(3)(I) of that Act. Specifically, 
we cannot determine whether the Capital Plan, as implemented, has 
burdened competition. Nor do we have sufficient information to 
determine whether the dividend policy incorporated in the Capital Plan 
advantages the recipients of the dividends in a manner inconsistent 
with the Exchange Act.
    We recognize that the Commission previously approved this proposed 
rule change. But we did so, in significant part, in reliance upon OCC's 
representations regarding the process through which the Plan was 
negotiated and developed by OCC and its Board.\3\ The D.C. Circuit's 
Susquehanna Opinion makes clear that relying on such representations, 
without more, is insufficient. Rather, the Commission must critically 
evaluate the representations made and the conclusions drawn by OCC.\4\ 
After conducting such an analysis on remand, and after giving the 
parties the opportunity to submit additional materials to the 
Commission, we have determined that OCC has failed to meet its burden 
to demonstrate that the Capital Plan is consistent with the Exchange 
Act in at least two respects, as noted above and explained below.
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    \3\ See, e.g., Approval Order at 8301, 8302, and 8305.
    \4\ Susquehanna, 866 F.3d at 447 (``the [Commission] should have 
critically reviewed OCC's analysis or performed its own.''); id. at 
448 (``the [Commission] cannot rely on OCC's process totally 
divorced from any examination of the Plan.'').
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II. Background

    OCC is registered with the Commission as a clearing agency and, as 
such, is a self-regulatory organization (``SRO'') under the Exchange 
Act.\5\ OCC is the only clearing agency for standardized U.S. 
securities options listed on SEC-registered national securities 
exchanges (``listed options'').

[[Page 5158]]

Of the national securities exchanges on which listed options are 
traded, five are equal owners of OCC (``Stockholder Exchanges'').\6\ 
These Stockholder Exchanges are also affiliated, through various 
ownership structures, with several other national securities exchanges 
on which listed options are traded.\7\ There are three national 
securities exchanges on which listed options are traded that have no 
ownership stake in OCC (``Non-Stockholder Exchanges'').\8\
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    \5\ See 15 U.S.C. 78c(a)(26). OCC is also registered with the 
U.S. Commodity Futures Trading Commission as a derivatives clearing 
organization.
    \6\ The five owners are the Chicago Board Options Exchange, 
Inc., International Securities Exchange LLC, NASDAQ OMX PHLX, LLC, 
NYSE MKT LLC, and NYSE Arca, Inc. The NYSE exchanges are owned by a 
common parent, Intercontinental Exchange, Inc., and both NASDAQ OMX 
PHLX and the International Securities Exchange are owned by NASDAQ. 
As a result, OCC's ownership essentially consists of three entities, 
although each exchange retains one vote on the OCC Board. See The 
Options Clearing Corporation Disclosure Framework for Financial 
Market Infrastructures, https://www.theocc.com/components/docs/risk-management/pfmi-disclosures.pdf.
    \7\ As of the date of this order, CBOE operates Cboe Options 
Exchange and is owned by CBOE Global Markets, which also owns the 
entities that operate Cboe C2 Options Exchange, Cboe BZX Exchange 
(formerly known as Bats BZX Exchange), and Cboe EDGX Exchange 
(formerly known as Bats EDGX Exchange). Nasdaq, Inc. owns NASDAQ OMX 
PHLX, LLC as well as International Securities Exchange, LLC, and 
operates other options exchanges: NASDAQ BX, NASDAQ GEMX, NASDAQ 
MRX, and NASDAQ Options Market.
    \8\ References to ``Non-Stockholder Exchanges'' throughout this 
order should be understood to mean ``Non-Equity Exchanges'' as 
defined in Article VIIB of OCC's By-Laws. See OCC By-laws, Article 
VIIB Sec.  1. The Non-Stockholder Exchanges are: Miami International 
Securities Exchange, LLC, MIAX PEARL, LLC (together ``MIAX''), and 
BOX Options Exchange, LLC (``BOX''). Miami International Holdings, 
Inc. is the common owner of Miami International Securities Exchange, 
LLC and MIAX PEARL, LLC.
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    OCC clears and settles listed options trades executed on the 
Stockholder and Non-Stockholder Exchanges. OCC also has clearing 
members that clear and settle options trades for their customers 
through the exchanges, and that pay fees and receive refunds from OCC. 
In addition, OCC serves other financial markets, including the 
commodity futures, commodity options, security futures, securities 
lending, and the over-the-counter options markets. OCC provides central 
counterparty (``CCP'') clearing services for all of these markets and 
performs critical functions in the clearance and settlement process. 
OCC's role as the sole CCP for all listed options contracts in the U.S. 
makes it an integral part of the national system for clearance and 
settlement. The Financial Stability Oversight Council designated OCC as 
a systemically important financial market utility (``SIFMU'') in 
2012.\9\
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    \9\ See Financial Stability Oversight Council (``FSOC'') 2012 
Annual Report, Appendix A, https://www.treasury.gov/initiatives/fsoc/Documents/2012%20Annual%20Report.pdf (last visited February 12, 
2019).
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III. Procedural History

    On January 14, 2015, OCC filed the proposed rule change 
implementing the Capital Plan with the Commission pursuant to Section 
19(b)(1) of the Exchange Act \10\ and Rule 19b-4 thereunder.\11\ On 
January 30, 2015, the Commission published the proposed rule change for 
comment in the Federal Register.\12\ On March 6, 2015, the Division of 
Trading and Markets, for the Commission pursuant to delegated 
authority,\13\ issued an order approving the proposal (``Delegated 
Order'').\14\ The Delegated Order assessed whether the proposal was 
consistent with the requirements of the Exchange Act and the applicable 
rules and regulations thereunder, specifically finding that the Capital 
Plan was consistent with Exchange Act Sections 17A(b)(3)(A), 
17A(b)(3)(F), 17A(b)(3)(D) and 17A(b)(3)(I) and should therefore be 
approved.\15\
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    \10\ 15 U.S.C. 78s.
    \11\ 17 CFR 240.19b-4.
    \12\ Release No. 34-74136 (Jan. 26, 2015), 80 FR 5171 (Jan. 30, 
2015) (SR-OCC-2015-02) (``Notice'').
    \13\ 17 CFR 200.30-3(a)(12).
    \14\ Release No. 34-74452 (Mar. 6, 2015), 80 FR 13058 (Mar. 12, 
2015) (SR-OCC-2015-02).
    \15\ See 15 U.S.C. 78q-1(b)(3)(A); 15 U.S.C. 78q-1(b)(3)(F); 15 
U.S.C. 78q-1(b)(3)(D); 15 U.S.C. 78q-1(b)(3)(I).
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    In March 2015, BATS Global Markets, Inc. (``BATS''), BOX, KCG 
Holdings, Inc. (``KCG''), MIAX, and Susquehanna International Group, 
LLP (``SIG'') (collectively ``Petitioners'') petitioned for review of 
the Delegated Order by the Commission.\16\ On February 11, 2016, after 
a de novo review of the Capital Plan and comments received, the 
Commission issued an order setting aside the Delegated Order and 
approving the Capital Plan (``Approval Order'').\17\ In doing so, the 
Commission found the Capital Plan consistent with Exchange Act Sections 
17A(b)(3)(A), 17A(b)(3)(D), 17A(b)(3)(F), and 17A(b)(3)(I).\18\
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    \16\ See BATS Petition for Review (Mar. 16, 2015); BOX Petition 
for Review (Mar. 20, 2015); KCG Petition for Review (Mar. 20, 2015); 
MIAX Petition for Review (Mar. 20, 2015); SIG Petition for Review 
(Mar. 20, 2015).
    \17\ Release No. 34-77112, File No. SR-OCC-2015-02 (Feb. 11, 
2016), 81 FR 8294 (Feb. 18, 2016).
    \18\ See 15 U.S.C. 78q-1(b)(3)(A); 15 U.S.C. 78q-1(b)(3)(D); 15 
U.S.C. 78q-1(b)(3)(F); 15 U.S.C. 78q-1(b)(3)(I).
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    On February 12, 2016, BOX, KCG, MIAX, and SIG \19\ filed a petition 
for review in the D.C. Circuit, challenging the Commission's Approval 
Order as inconsistent with both the Exchange Act and the Administrative 
Procedure Act. On August 8, 2017, the Court issued an opinion 
concluding that the Approval Order failed to meet the standards of the 
Administrative Procedure Act and remanding the case to the Commission 
for further proceedings.\20\ In so ruling, the Court did not address 
Petitioners' arguments that the Plan was inconsistent with applicable 
provisions of the Exchange Act. Rather, the Court emphasized that the 
Commission was required under the Exchange Act either to perform an 
independent analysis of the Capital Plan or to critically evaluate 
OCC's analysis of the Plan, and found that the Commission's analysis 
relied too heavily on OCC's representations.\21\ The Court also 
described several illustrative areas where the Commission's Approval 
Order failed under the Administrative Procedure Act to adequately 
support its reasoning, including: (i) The reasonableness of the 
dividend rate under the Capital Plan; (ii) the reasonableness of the 
target capital amount established by the Capital Plan; (iii) the effect 
of the Capital Plan on net fees; (iv) the difference in treatment of 
refunds to clearing members and dividends to shareholders in certain 
circumstances under the Capital Plan; and (v) whether OCC complied with 
its own By-laws in adopting the Capital Plan.\22\
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    \19\ BATS was initially a petitioner but later withdrew.
    \20\ Susquehanna, 866 F.3d at 443.
    \21\ Id. at 446, 447.
    \22\ Id. at 448-50.
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    The Court did not vacate the Approval Order on remand, instead 
leaving the Plan in place and remanding ``to give the [Commission] an 
opportunity to properly evaluate the Plan.'' \23\ The Court determined 
not to unwind the plan at that time because ``the [Commission] may be 
able to approve the Plan once again, after conducting a proper analysis 
on remand,'' and because of assurances from the parties that, should 
the Commission disapprove the Plan, ``it will be possible to unwind the 
Plan at a later time.'' \24\ The Capital Plan therefore remained in 
effect during the pendency of the Commission's review.
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    \23\ Id. at 451.
    \24\ Id.
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    On September 14, 2017, the Commission issued an order scheduling 
the filing of statements on review of the Capital Plan (``September 
2017 Scheduling Order'').\25\ On October 13, 2017, OCC filed a post-
remand submission to the Commission in support of re-approval of the 
Capital Plan (``OCC October 2017 Post-Remand

[[Page 5159]]

Submission'').\26\ That submission included certain material submitted 
by OCC pursuant to a request for confidential treatment. Separately, 
OCC and Petitioners reached an agreement that allowed Petitioners to 
access information subject to that request, and therefore Petitioners 
generally have been able to respond to the material in their 
submissions to the Commission.\27\ On November 30, 2017, Petitioners 
(now consisting of SIG, BOX, MIAX, and Virtu) \28\ filed a post-remand 
submission to the Commission in opposition to the Capital Plan 
(``Petitioners November 2017 Post-Remand Submission'').\29\ On December 
20, 2017, OCC filed a reply to the Petitioners November 2017 Post-
Remand Submission (``OCC December 2017 Reply'').\30\ On January 10, 
2018, Petitioners filed a surreply to OCC's reply (``Petitioners 
January 2018 Surreply'').\31\
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    \25\ Release No. 34-81629, File No. SR-OCC-2015-02 (Sept. 14, 
2017), 82 FR 44239 (Sept. 21, 2017) (``September 2017 Scheduling 
Order'').
    \26\ Letter from Joseph P. Kamnik, General Counsel, OCC (Oct. 
13, 2017) (``OCC October 2017 Post-Remand Submission''). OCC's 
submission included a declaration made by Craig S. Donohue, OCC's 
Executive Chairman and Chief Executive Officer (``Donohue 
Declaration'').
    \27\ See Release No. 34-82067, File No. SR-OCC-2015-02 (Nov. 13, 
2017), 82 FR 54439, 54440 (Nov. 17, 2017) (stating that Petitioners 
represented that they have entered into a confidentiality agreement 
with OCC). As discussed below, the Commission has reviewed the 
requests for confidential treatment submitted by OCC and has 
determined to accord confidential treatment to the Confidential 
Materials. See infra note 32.
    \28\ On November 2, 2017, Virtu Financial Inc. and Virtu 
Financial LLC (together, ``Virtu'') filed a motion to substitute 
Virtu for KCG.
    \29\ Letter from David H. Thompson, Counsel for Petitioners 
Susquehanna International Group, LLP, Miami International Securities 
Exchange, LLC, BOX Options Exchange, Inc., Virtu Financial, Inc., 
and Virtu Americas, LLC (Nov. 30, 2017) (``Petitioners November 2017 
Post-Remand Submission'').
    \30\ Letter from Joseph P. Kamnik, General Counsel, OCC (Dec. 
20, 2017) (``OCC December 2017 Reply'').
    \31\ Letter from David H. Thompson, Counsel for Petitioners 
Susquehanna International Group, LLP, Miami International Securities 
Exchange, LLC, BOX Options Exchange, Inc., Virtu Financial, Inc., 
and Virtu Americas, LLC (Jan. 10, 2018) (``Petitioners January 2018 
Surreply'').
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    On August 23, 2018, OCC submitted an additional comment letter that 
included an analysis by Marc Brown of AlixPartners LLP 
(``AlixPartners'') of the reasonableness of the expected rate of return 
for the Stockholder Exchanges under the Capital Plan (``AlixPartners 
August 2018 Report''), as well as an inventory of documents and 
submissions that OCC stated were provided to the Commission during the 
course of these proceedings.\32\ On August 24, 2018, Petitioner SIG 
submitted an additional comment letter (``SIG August 2018 Post-Remand 
Letter'').\33\ On August 29, 2018, OCC submitted a response to the SIG 
August 2018 Post-Remand Letter.\34\
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    \32\ Letter from Jeffrey B. Korn, Counsel for OCC (Aug. 23, 
2018) and attached Expert Report of Marc J. Brown, CFA (Aug. 23, 
2018) (``AlixPartners August 2018 Report''). Many of the documents 
and submissions listed by OCC included requests for confidential 
treatment pursuant to 17 CFR 200.83 and the Freedom of Information 
Act (``FOIA''), 5 U.S.C. 552. See, e.g., Letter from Jeffrey B. 
Korn, Counsel for OCC (Sept. 4, 2018). For a list of materials for 
which OCC seeks confidential treatment (``Confidential Materials''), 
see AlixPartners August 2018 Report, Exhibit B. In general, OCC 
asserted that the Confidential Materials were entitled to 
confidential treatment because they contained confidential and 
proprietary information, including detailed financial information 
and proprietary commercial or financial information, the disclosure 
of which would be highly detrimental to OCC's business functions or 
would be highly likely to cause significant competitive harm to OCC. 
The Commission is not required to make public statements filed with 
the Commission in connection with a proposed rule change of a self-
regulatory organization if the Commission could withhold the 
statements from the public in accordance with the Freedom of 
Information Act (``FOIA''), 5 U.S.C. 552. The Commission has 
reviewed the documents for which OCC requests confidential treatment 
and concludes that they could be withheld from the public under the 
FOIA. FOIA Exemption 4 protects confidential commercial or financial 
information. 5 U.S.C. 552(b)(4). If, as here, the information was 
not required to be submitted, commercial or financial information is 
treated as confidential if it is not customarily disclosed to the 
public by the submitter. Critical Mass Energy Project v. NRC, 975 
F.2d 871, 879 (D.C. Cir. 1992). In its requests for confidential 
treatment, OCC stated that it has not disclosed the Confidential 
Materials to the public and there is no indication to the contrary 
in the record. Thus, the Commission has determined to accord 
confidential treatment to the Confidential Materials.
    \33\ Letter from David H. Thompson, Counsel for SIG (Aug. 24, 
2018) (``SIG August 2018 Post-Remand Letter'').
    \34\ Letter from Jeffrey B. Korn, Counsel for OCC (Aug. 29, 
2018).
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    On September 4, 2018, OCC submitted an additional comment letter 
and accompanying PowerPoint slide deck describing how, in its view, the 
Commission could reapprove the Capital Plan consistent with the D.C. 
Circuit's opinion (``OCC September 2018 Path to Re-Approval'').\35\ On 
September 21, 2018, OCC submitted a comment letter attaching a Market 
Note from Russell Rhoads, CFA of the TABB Group (``TABB September 2018 
Report'').\36\ On September 27, 2018, Petitioners submitted a comment 
letter responding to both the AlixPartners August 2018 Report and the 
OCC September 2018 Path to Re-Approval as well as reiterating 
Petitioners' view that the Commission is required by the Exchange Act 
to disapprove the Capital Plan on remand. Petitioners also attached an 
expert report from Professor Peter Easton of University of Notre Dame 
challenging the conclusions in the AlixPartners August 2018 Report 
(``Easton September 2018 Rebuttal Report'').\37\ On October 9, 2018, 
Petitioner SIG submitted a comment letter attaching another Market Note 
from Russell Rhoads, CFA of the TABB Group (Oct. 8, 2018) (``TABB 
October 2018 Follow-Up Report'').\38\ On October 15, 2018, OCC 
submitted a comment letter replying to the Easton September 2018 
Rebuttal Report and attached an expert report addressing the issues 
raised in the Easton September 2018 Rebuttal Report.\39\ In addition to 
the comments from OCC and the Petitioners, the Commission also received 
further comments pursuant to the September 2017 Scheduling Order, which 
generally support Petitioners' comments and overall opposition to the 
Capital Plan.\40\
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    \35\ Letter from Jeffrey B. Korn, Counsel for OCC (Sept. 4, 
2018) and attached slide deck The Path Forward for the Commission's 
Re-Approval of the OCC Capital Plan (``OCC September 2018 Path to 
Re-Approval'').
    \36\ Letter from Jeffrey B. Korn, Counsel for OCC (Sept. 21, 
2018) and attached Market Note from Russell Rhoads, CFA of the TABB 
Group, OCC's Capital Plan: The Value of a Bird in the Hand (Sept. 
2018) (``TABB September 2018 Report'').
    \37\ Letter from David H. Thompson, Counsel for Petitioners 
(Sept. 27, 2018) (``Petitioners September 2018 Expert Rebuttal'') 
and attached Expert Report of Professor Peter D. Easton, Ph.D. 
(Sept. 24, 2018) (``Easton September 2018 Rebuttal Report'').
    \38\ Letter from David H. Thompson, Counsel for Petitioners 
(Oct. 9, 2018).
    \39\ Letter from Jeffrey B. Korn, Counsel for OCC (Oct. 15, 
2018) (``OCC October 2018 Expert Reply'') and attached Expert Report 
of Marc J. Brown, CFA (Oct. 15, 2018) (``AlixPartners October 2018 
Reply'').
    \40\ Comments provided pursuant to the September 2017 Scheduling 
Order are available on the Commission's website at https://www.sec.gov/comments/sr-occ-2015-02/occ201502.shtml. These 
additional comments do not raise substantive issues beyond those 
raised by Petitioners. Accordingly, we consider these additional 
comments together with the submissions and comments made by OCC and 
Petitioners described above.
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IV. Description of the Plan

    In its rule filing, OCC stated that the Capital Plan was designed 
to raise additional capital in connection with its increased 
responsibilities as a SIFMU and to facilitate prompt compliance with 
certain rules that the Commission proposed in March 2014 pertaining to 
SIFMUs and others.\41\ Then-proposed Rule 17Ad-22(e)(15), which the 
Commission later adopted substantially as proposed,\42\ required, in 
part, that a covered clearing agency establish, implement, maintain and 
enforce written policies and procedures reasonably designed to 
identify, monitor, and manage its general business risk and hold 
sufficient liquid net assets funded by equity to cover potential 
general business losses so that it can continue operations and services

[[Page 5160]]

as a going concern if those losses materialize.\43\ The then-proposed 
rule also required ``a viable plan'' for raising additional equity 
should OCC's equity fall below an amount required by the Rule.\44\
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    \41\ See Notice, citing Release No. 34-71699 (Mar. 12, 2014), 79 
FR 29507 (May 22, 2014).
    \42\ See Release No. 34-78961 (Sept. 28, 2016), 81 FR 70786 
(Oct. 13, 2016).
    \43\ See Release No. 34-71699 (Mar. 12, 2014), 79 FR 29508 (May 
22, 2014); 17 CFR 240.17Ad-22(e)(15)(ii).
    \44\ See Release No. 34-71699 (Mar. 12, 2014), 79 FR 29508 (May 
22, 2014); 17 CFR 240.17Ad-22(e)(15)(iii). Specifically, the Rule, 
as adopted, requires, in part, that a covered clearing agency 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to, as applicable, maintain a viable 
plan, approved by the board of directors and updated at least 
annually, for raising additional equity should its equity fall close 
to or below the amount required by Rule 17Ad-22(e)(15)(ii).
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    OCC represented that it reviewed a range of risk scenarios and 
modeled potential losses arising from business, operational, and 
pension risks, and, based on those results, believed that it was 
appropriate to significantly increase its capital. OCC also represented 
that, after evaluating alternate sources of capital funding, including 
increasing fees or suspending refunds to clearing members, OCC's Board 
of Directors (the ``Board'') opted to approve the proposed Capital 
Plan.\45\
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    \45\ See OCC's Written Statement in Support of Affirming March 
6, 2015 Order Approving Capital Plan (October 7, 2015) (``OCC 
October 2015 Support Statement'').
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    Under the Capital Plan, OCC annually will determine a target 
capital requirement (``Target Capital Requirement'') consisting of the 
baseline amount of capital OCC believes is required as well as a buffer 
amount to offset potential losses. To assist OCC in meeting the initial 
Target Capital Requirement, the Stockholder Exchanges provided capital 
to OCC (``Capital Contribution'') upon implementation of the Plan in 
March 2015 and entered into an agreement (``Replenishment Capital 
Agreement'') to provide additional replenishment capital 
(``Replenishment Capital'') under specific circumstances, as detailed 
below. In return for this initial investment and the obligation to 
provide additional capital, the Stockholder Exchanges are eligible to 
receive dividends from OCC pursuant to an OCC internal policy 
(``Dividend Policy''). Additionally, OCC will set its fees annually to 
cover its estimated operating expenses plus a ``Business Risk Buffer'' 
pursuant to an OCC internal policy (``Fee Policy''). Finally, clearing 
members will be eligible to receive refunds annually, under certain 
circumstances, pursuant to an OCC internal policy (``Refund Policy''). 
The individual components of the Capital Plan are described in greater 
detail below.

A. Target Capital Requirement

    The Target Capital Requirement consists of: (i) A ``Baseline 
Capital Requirement'' plus (ii) a ``Target Capital Buffer.'' The 
Baseline Capital Requirement is equal to the greater of: (a) Six months 
budgeted operating expenses for the following year; (b) the maximum 
cost of the recovery scenario from OCC's recovery and wind-down plan; 
or (c) the cost to OCC of winding down operations, as set forth in its 
recovery and wind-down plan. The Target Capital Buffer is linked to 
plausible loss scenarios from business, operational, and pension risks 
and is designed to provide a significant capital cushion to offset 
potential business losses.\46\
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    \46\ OCC determined that an appropriate initial ``Target Capital 
Requirement'' was $247 million, reflecting a ``Baseline Capital 
Requirement'' of $117 million, which was equal to six-month 
projected operating expenses, plus a ``Target Capital Buffer'' of 
$130 million.
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B. Capital Contribution and Replenishment Capital Agreement

    To assist OCC in meeting the initial Target Capital Requirement, 
the Capital Plan requires OCC's Stockholder Exchanges to provide a 
Capital Contribution pursuant to their Class B Common Stock on a pro 
rata basis. When it filed the Capital Plan with the Commission, OCC 
proposed the Capital Contribution to be $150 million, and each of the 
Stockholder Exchanges contributed their pro rata share of that amount 
to OCC pursuant to the Capital Plan.\47\
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    \47\ See OCC October 2015 Support Statement.
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    In addition to the Capital Contribution, the Stockholder Exchanges 
agreed to a Replenishment Capital Agreement, under which they each 
commit to provide Replenishment Capital if OCC's total shareholders' 
equity falls below certain thresholds. The first of these thresholds--
referred to as the Hard Trigger--would be reached if OCC's 
shareholders' equity fell below 125% of the Baseline Capital 
Requirement. Upon such occurrence, the Board would determine whether to 
attempt a recovery or a wind-down of OCC's operations,\48\ or a sale or 
similar transaction, subject in each case to any necessary stockholder 
consent.\49\ OCC stated that the Hard Trigger would occur only as the 
result of a significant, unexpected event. The Hard Trigger is a sign 
that corrective action must be taken in the form of a mandatory 
Replenishment Capital call.
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    \48\ On August 23, 2018, the Commission issued a no objection to 
an advance notice and approved a proposed rule change by OCC to 
adopt a Recovery and Wind-Down Plan (``RWP'') and to implement 
enhanced tools for managing a potential recovery scenario 
(``Tools''). Release No. 34-83916 (Aug. 23, 2018), 83 FR 44076 (Aug. 
29, 2018) (SR-OCC-2017-020); Release No. 34-83927 (Aug. 23, 2018), 
83 FR 44083 (Aug. 29, 2018) (SR-OCC-2017-809); Release No. 34-83918 
(Aug. 23, 2018), 83 FR 44091 (Aug. 29, 2018) (SR-OCC-2017-021); 
Release No. 34-83928 (Aug. 23, 2018), 83 FR 44109 (Aug. 29, 2018) 
(SR-OCC-2017-810). Under the RWP, if the Board decides to wind-down 
OCC's operations, then OCC will access Replenishment Capital in the 
amount the Board determines is sufficient to fund the wind-down, 
subject to the maximum amount the Stockholder Exchanges would be 
obligated to provide under the Capital Plan (see infra note 51 and 
accompanying text). If the Board decides to attempt a recovery of 
OCC's capital and business, then OCC will access Replenishment 
Capital in the amount sufficient to return shareholders' equity to 
$20 million above the Hard Trigger, subject to the maximum amount 
the Stockholder Exchanges would be obligated to provide under the 
Capital Plan (see infra note 51).
    \49\ Article IV of OCC's Certificate of Amendment of Certificate 
of Incorporation requires the approval of a majority of the issued 
and outstanding shares of each series of Class B Common Stock, 
voting separately as a series, to authorize or consent to the sale, 
lease, or exchange of all or substantially all of the property and 
assets of the Corporation, or to authorize or consent to the 
dissolution of the corporation.
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    If the Hard Trigger is reached, under the Capital Plan, the 
Stockholder Exchanges would be obligated to provide a committed amount 
of Replenishment Capital on a pro rata basis. The provision of 
Replenishment Capital is capped at the excess of: (i) The lesser of 
either the Baseline Capital Requirement at the time of relevant funding 
or $200 million,\50\ minus (ii) outstanding Replenishment Capital 
(collectively, the ``Cap'').\51\ In exchange for any Replenishment 
Capital made under the Replenishment Capital Agreement, OCC would issue 
the Stockholder Exchanges a new class of OCC common stock (``Class C 
Common Stock'').
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    \50\ According to OCC, the $200 million takes into account 
projected growth in the Baseline Capital Requirement for the 
foreseeable future, and OCC estimated that the Baseline Capital 
Requirement would not exceed $200 million before 2022.
    \51\ For example, if the Baseline Capital Requirement is greater 
than $200 million, then the Replenishment Capital that could be 
accessed by OCC would be capped at $200 million minus any 
outstanding Replenishment Capital. Therefore, if there is no 
outstanding Replenishment Capital, OCC could access up to $200 
million. If on the other hand, the Baseline Capital Requirement is 
$100 million, then OCC could access Replenishment Capital up to $100 
million minus any Replenishment Capital outstanding.
---------------------------------------------------------------------------

    The Replenishment Capital Agreement also contains a ``Soft 
Trigger,'' which is a warning sign that OCC's capitalization has fallen 
to a level that requires action to prevent it from falling to certain 
levels that OCC deems unacceptable. The Soft Trigger is reached, under 
the Capital Plan, when

[[Page 5161]]

OCC's shareholders' equity falls below the sum of: (i) The Baseline 
Capital Requirement and (ii) 75% of the Target Capital Buffer. Upon 
such occurrence, OCC's senior management and the Board will evaluate 
options to restore the shareholders' equity to the Target Capital 
Requirement, including, but not limited to, increasing fees and/or 
decreasing expenses.
    In addition, the Board will review the Replenishment Capital 
Agreement on an annual basis. While the Replenishment Capital amount 
will increase as the Baseline Capital Requirement increases, if the 
Baseline Capital Requirement approaches or exceeds $200 million, the 
Board will review and revise the Capital Plan, as needed, to address 
potential future needs for Replenishment Capital higher than the $200 
million cap. OCC also stated that its management will monitor OCC's 
shareholders' equity to identify additional triggers or reduced capital 
levels that may require action.

C. Fee Policy, Refund Policy, and Dividend Policy

    Under the Capital Plan, OCC also implemented a Fee Policy, Refund 
Policy, and Dividend Policy designed to maintain OCC's shareholders' 
equity above the Baseline Capital Requirement. Changes to the Fee 
Policy, Refund Policy, and Dividend Policy require the affirmative vote 
of two-thirds of the directors then in office and unanimous approval by 
the holders of OCC's outstanding Class B Common Stock. Any changes are 
subject to the filing requirements of Section 19(b) of the Exchange Act 
and the rules and regulations thereunder.
1. Fee Policy
    Under the Fee Policy, OCC will set its fee structure at a level 
that will cover OCC's estimated operating expenses plus a Business Risk 
Buffer. OCC stated that the purpose of the Business Risk Buffer is to 
ensure that OCC accumulates sufficient funds to cover unexpected 
fluctuations in operating expenses, business capital needs, and 
regulatory capital requirements. Specifically, in setting fees each 
year, OCC will calculate an annual revenue target based on a forward 
twelve months expense forecast divided by the difference between one 
and the Business Risk Buffer of 25% (i.e., OCC will divide the expense 
forecast by 0.75).\52\ OCC stated that establishing the Business Risk 
Buffer at 25% would allow OCC to manage unexpected fluctuations in 
expenses or revenue.\53\
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    \52\ Put another way, the annual revenue target will be the 
forward twelve months expense forecast plus 33% of that forecast.
    \53\ For example, fees could generate less revenue than expected 
if trading volume decreases. According to OCC, because OCC's 
clearing fee schedules typically reflect different rates for 
different categories of transactions, fee projections will include 
projections of relative volume in each category. Therefore, the 
clearing fee schedule will be set to achieve the annual revenue 
target through a blended or average rate per contract, multiplied by 
total projected contract volume.
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    OCC stated that the 25% Business Risk Buffer would be lower than 
OCC's historical ten-year average buffer of 31%. OCC stated that the 
lower buffer would permit it to charge lower upfront fees to market 
participants, and thus become less reliant on refunds to clearing 
members to return any excess fees paid.\54\ In addition, by 
capitalizing OCC through shareholders' equity (i.e., the Capital 
Contribution), OCC represented that it would be positioned to charge 
lower fees that are more closely tied to its projected operating 
expenses, rather than annually generating a larger surplus to address 
business, operational, and pension risks. OCC stated that the Business 
Risk Buffer will remain at 25% as long as OCC's shareholders' equity 
remains above the Target Capital Requirement. OCC represented that it 
will review its fee schedule on a quarterly basis to manage revenues as 
close to the 25% Business Risk Buffer as possible, and, if the fee 
schedule needs to be changed to achieve the 25% Business Risk Buffer, 
OCC would file a proposed rule change with the Commission.\55\
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    \54\ OCC stated that the Capital Plan would allow OCC to refund 
approximately $40 million from 2014 fees to clearing members and to 
reduce fees in an amount to be determined by the Board. See Notice 
at 5174. On December 17, 2015, OCC issued a press release announcing 
the declaration of a refund, dividend, and fee reduction, pursuant 
to the Capital Plan. See OCC Press Release, ``OCC Declares Clearing 
Member Refund and Dividend for 2015 and Reduction of Fees under 
Approved Capital Plan,'' http://www.optionsclearing.com/about/newsroom/releases/2015/12_17.jsp (last visited February 12, 2019) 
(``OCC December 2015 Press Release''). For 2016, OCC declared a 
refund of approximately $46.6 million to clearing members and a 
dividend of approximately $25.6 million to Stockholder Exchanges. 
See OCC Press Release, ``OCC Declares Clearing Member Refund and 
Dividend for 2016,'' https://www.theocc.com/about/newsroom/releases/2017/March-28-OCC-Declares-Clearing-Member-Refund-Dividend-2016.jsp 
(last visited February 12, 2019) (``OCC March 2016 Press Release'').
    \55\ On January 20, 2016, OCC filed a proposed rule change to 
revise its Schedule of Fees, which OCC stated would lower clearing 
fees by an average of 19%. See Release No. 34-77041 (Feb. 3, 2016), 
81 FR 6917 (Feb. 9, 2016). On March 2, 2016, OCC filed a proposed 
rule change that modified its fee schedule from four tiers to two. 
See Release No. 34-77336 (Mar. 10, 2016), 81 FR 14153 (Mar. 16, 
2016). OCC stated that the fee change was revenue neutral when 
compared to its existing fee structure, but the fee change raised 
the per contract fee for trades with contracts between 500 and 
2,000, lowered the threshold for the flat per trade fee from greater 
than 2,000 to greater than 1,370 contracts, and raised the flat fee 
on such contracts from $46 to $55. On September 30, 2016, OCC filed 
a proposed rule change to revise its Schedule of Fees to implement 
an increase in clearing fees to maintain the 25% Business Risk 
Buffer. See Release No. 34-79028 (Oct. 3, 2016), 81 FR 69885 (Oct. 
7, 2016). That proposed fee change lowered the threshold for the $55 
per trade fee from 1,370 to 1,100+, and increased fees for contracts 
of 1-1,100 from $0.041 per contract to $0.050 per contract. On 
January 30, 2018, OCC filed a proposed rule change to revise its 
Schedule of Fees to implement an increase in clearing fees to 
maintain the 25% Business Risk Buffer. See Release No. 34-82596 
(Jan. 30, 2018), 83 FR 4944 (Feb. 2, 2018). On August 1, 2018, OCC 
withdrew that filing, leaving the threshold for the $55 per trade 
fee at 1,100+, and the fee for contracts of 1-1,100 at $0.050 per 
contract.
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2. Refund Policy
    Under the Refund Policy, except at a time when Replenishment 
Capital is outstanding, OCC will declare a refund to clearing members 
in December of each year using the formula set out in the Refund 
Policy. Specifically, the refund will equal 50% of the excess of: (i) 
Pre-tax income for the year in which the refund is declared over (ii) 
the sum of the following: (a) The amount of pre-tax income after the 
refund necessary to produce after-tax income for such year sufficient 
to maintain shareholders' equity at the Target Capital Requirement for 
the following year; and (b) the amount of pre-tax income after the 
refund necessary to fund any additional reserves or additional surplus 
not already included in the Target Capital Requirement.
    The Refund Policy states that OCC will declare refunds, if any, in 
December of each year, and such refunds would be paid in the following 
year after OCC issues its audited financial statements, provided that: 
(i) The payment does not result in total shareholders' equity falling 
below the Target Capital Requirement and (ii) the payment is otherwise 
permitted by Delaware law, federal laws, and regulations.\56\
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    \56\ In 2015, OCC announced a 2014 refund of $33.3 million, a 
2015 refund of $39 million, and special refund of $72 million. See 
OCC December 2015 Press Release. In 2016, OCC announced a refund of 
$46.6 million. See OCC March 2016 Press Release. In 2017, OCC 
announced a refund of $78.7 million. See OCC 2017 Annual Report at 
40, note 9; https://www.theocc.com/components/docs/about/annual-reports/occ-2017-annual-report.pdf (last visited February 12, 2019) 
(``OCC 2017 Annual Report'').
---------------------------------------------------------------------------

    OCC will not make refund payments while Replenishment Capital is 
outstanding and will resume refunds after the Replenishment Capital is 
repaid in full and the Target Capital Requirement is restored. However, 
OCC will not resume paying refunds and will recalculate how refunds are 
made if, for more than twenty-four months: (i)

[[Page 5162]]

Replenishment Capital remains outstanding or (ii) the Target Capital 
Requirement is not restored.
3. Dividend Policy
    Under the Dividend Policy, OCC will pay dividends to Stockholder 
Exchanges as consideration for their Capital Contribution and 
commitment to provide Replenishment Capital under the Replenishment 
Capital Agreement. OCC will declare dividends, if any, in December of 
each year, and such dividends would be paid in the following year after 
OCC issues its audited financial statements, provided that: (i) The 
payment does not result in total shareholders' equity falling below the 
Target Capital Requirement and (ii) the payment is otherwise permitted 
by Delaware law, federal laws, and regulations.
    Pursuant to the Dividend Policy, except at a time when 
Replenishment Capital is outstanding, OCC will declare a dividend on 
its Class B Common Stock in December of each year in aggregate equal to 
the excess of: (i) After-tax income for the year, after application of 
the Refund Policy \57\ over (ii) the sum of: (A) The amount required to 
be retained to maintain total shareholders' equity at the Target 
Capital Requirement for the following year, plus (B) the amount of any 
additional reserves or additional surplus not already included in the 
Target Capital Requirement.\58\
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    \57\ If the Refund Policy has been eliminated, the refunds shall 
be deemed to be $0.
    \58\ In 2015, OCC announced a dividend of approximately $17 
million for 2015 pursuant to the Capital Plan. See OCC December 2015 
Press Release. In 2016, OCC announced a dividend of approximately 
$25.6 million for 2016. See OCC March 2016 Press Release. In 2017, 
OCC announced a dividend of approximately $32.5 million for 2017. 
See OCC 2017 Annual Report at 32.
---------------------------------------------------------------------------

    Similar to the Refund Policy, if Replenishment Capital is 
outstanding, OCC will not pay dividends. OCC would, however, resume 
dividends after the Replenishment Capital is repaid in full and the 
Target Capital Requirement is restored through the accumulation of 
retained earnings, even if the time of repayment exceeds twenty-four 
months. In the event that refunds are not tax-deductible, OCC 
represents that it will amend the Refund Policy and Dividend Policy to 
restore the relative economic benefits between the recipients of the 
refunds and the Stockholder Exchanges to what the Capital Plan 
currently provides.

V. Discussion

    Under Section 19(b)(2)(C) of the Exchange Act, the Commission must 
approve a proposed rule change of an SRO if the Commission finds that 
the proposed rule change is consistent with the requirements of the 
Exchange Act and the applicable rules and regulations thereunder.\59\ 
If it does not make such a finding, the Commission must disapprove the 
proposed rule change.\60\ Under Rule 700(b)(3) of the Commission's 
Rules of Practice, the ``burden to demonstrate that a proposed rule 
change is consistent with the Exchange Act and the rules and 
regulations issued thereunder . . . is on the [SRO] that proposed the 
rule change.'' \61\ The description of a proposed rule change, its 
purpose and operation, its effect, and a legal analysis of its 
consistency with applicable requirements must all be sufficiently 
detailed and specific to support an affirmative Commission finding.\62\ 
Any failure of an SRO to provide the information elicited by Form 19b-4 
may result in the Commission not having a sufficient basis to make an 
affirmative finding that a proposed rule change is consistent with the 
Exchange Act and the rules and regulations issued thereunder that are 
applicable to the SRO.\63\
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    \59\ See 15 U.S.C. 78s(b)(2)(C)(i).
    \60\ 15 U.S.C. 78s(b)(2)(C)(ii).
    \61\ 17 CFR 201.700(b)(3).
    \62\ Id.
    \63\ Id.
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    The Commission is disapproving the proposed rule change 
implementing the Capital Plan because the information before us is 
insufficient to support a finding that the Plan is consistent with the 
Exchange Act. Specifically, as explained below, we find that OCC has 
failed to meet its burden to demonstrate that the Capital Plan is 
consistent with the requirements of: (1) Exchange Act Section 19(g)(1), 
and (2) Exchange Act Section 17A(b)(3)(I).
    First, Exchange Act Section 19(g)(1) states, in part, that 
``[e]very [SRO] shall comply with the provisions of this chapter, the 
rules and regulations thereunder, and its own rules. . . .'' \64\ One 
of OCC's rules--Article VIIB of its By-laws--states that Non-
Stockholder Exchanges ``will be promptly provided with information that 
the Executive Chairman considers to be of competitive significance to 
such [Non-Stockholder Exchanges] that was disclosed to Exchange 
Directors at or in connection with any meeting or action of the Board 
of Directors or any Committee of the Board of Directors.'' \65\ The By-
laws further provide that a ``requesting [Non-Stockholder Exchange] 
shall be afforded the opportunity to make presentations to the Board of 
Directors or an appropriate Committee of the Board of Directors.'' \66\ 
The Non-Stockholder Exchanges were not notified of the Capital Plan 
before its adoption, and the Commission cannot determine whether or how 
the Executive Chairman concluded that the Capital Plan lacked 
competitive significance such that notification to the Non-Stockholder 
Exchanges was not required. Thus, there are questions as to whether OCC 
complied with its By-laws and, if not, whether the proposed rule change 
is consistent with Section 19(g) of the Act. As explained further 
below, based on the information before us, the Commission is unable to 
resolve these questions.
---------------------------------------------------------------------------

    \64\ 15 U.S.C. 78s(g)(1) (emphasis added).
    \65\ OCC By-laws, Article VIIB Sec.  1.01.
    \66\ OCC By-laws, Article VIIB Sec.  1.02.
---------------------------------------------------------------------------

    Second, Petitioners have questioned whether the Plan's Dividend 
Policy is consistent with Section 17A(b)(3)(I) of the Exchange Act, 
which prohibits the rules of a clearing agency from imposing a burden 
on competition not necessary or appropriate in furtherance of the 
purposes of the Act.\67\ As explained further below, based on the 
information before us, we cannot determine whether the Plan, as 
implemented, has burdened competition. Nor do we have sufficient 
information to determine that the rate of return provided by the 
dividends under the Plan is reasonable, such that the Stockholder 
Exchanges are not unfairly advantaged in a manner inconsistent with the 
Act.
---------------------------------------------------------------------------

    \67\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------

    For these reasons, we are unable to find on the record before us 
that the Capital Plan is consistent with the Exchange Act.

A. The Commission Lacks Sufficient Information To Determine Whether OCC 
Complied With Its By-Laws in Adopting the Capital Plan

    Petitioners contend that the Capital Plan is inconsistent with 
Section 19(g) of the Exchange Act because the Capital Plan was of 
competitive significance to the Non-Stockholder Exchanges, yet OCC 
failed to notify the Non-Stockholder Exchanges of the Plan or provide 
them the opportunity to make presentations to the Board. According to 
Petitioners, OCC's actions in this regard do not comply with its By-
laws. In addressing Petitioners' contention in the Approval Order, we 
noted that we would not approve a proposed rule change of an SRO before 
the SRO had completed all actions required to be taken by its 
constitution, articles of incorporation, By-laws, rules, or 
corresponding instruments. But OCC represented that it had done so. 
Petitioners' contention also raised what

[[Page 5163]]

we viewed as the distinct question of whether, while nominally taking 
the required actions, the Board nonetheless failed to comply with its 
responsibilities under relevant corporate governance principles, but we 
concluded that the issue was ``not appropriately addressed by the 
Commission in the context of reviewing this rule filing.'' \68\
---------------------------------------------------------------------------

    \68\ Approval Order at 8305.
---------------------------------------------------------------------------

    On review, however, the D.C. Circuit found that the Commission's 
analysis regarding OCC's compliance with its By-laws gave ``short 
shrift'' to Petitioners' objection and relied too heavily on OCC's 
representation that it had completed all actions required. As a result, 
the Court instructed that ``[o]n remand, the [Commission] must resolve 
Petitioners' argument that OCC could not reasonably have considered the 
Plan to be competitively insignificant. Or, if the [Commission] 
concludes that this does not matter, it must give a reasoned 
explanation why.'' \69\
---------------------------------------------------------------------------

    \69\ Susquehanna, 866 F.3d at 450-51.
---------------------------------------------------------------------------

    On remand, OCC contends first that the Petitioners misconstrue the 
application of Section 19(g) in this context, asserting that the 
notification requirements of Article VIIB are merely ``procedural'' and 
therefore not relevant to the Commission's approval of the Capital 
Plan. OCC next contends that, even if compliance with Article VIIB were 
relevant to the Commission's approval of the Plan, its provisions do 
not apply here, both because the Executive Chairman never made an 
affirmative determination that the Capital Plan was of competitive 
significance and because there has been no showing that the Plan was of 
competitive significance. Finally, OCC asserts that even if it did not 
comply with its By-laws, any violation was harmless because Petitioners 
have had ample time and opportunity throughout the Commission review 
process to present their views on the Plan.\70\
---------------------------------------------------------------------------

    \70\ See OCC October 2017 Post-Remand Submission at 27; OCC 
September 2018 Path to Re-Approval at 49.
---------------------------------------------------------------------------

    As discussed in more detail below, the notification provisions in 
Article VIIB of OCC's By-laws serve an important role in ensuring that 
OCC meets its obligations to its participants under the Exchange Act. 
Therefore, compliance with these provisions is relevant to our 
consideration of the Capital Plan. Based on the information before us, 
however, we cannot determine whether or how the Executive Chairman 
concluded that the Capital Plan lacked competitive significance such 
that notification to the Non-Stockholder Exchanges was not required. 
Nor do we have sufficient information to ourselves determine that the 
Plan was of no competitive significance. We are therefore unable to 
find that OCC's adoption of the Plan complied with its own rules. 
Finally, we disagree with OCC's contention that violating its own By-
laws in this respect would be harmless.
1. Compliance With Article VIIB of OCC's By-Laws Is Relevant to Our 
Analysis of the Capital Plan
    OCC first asserts that Petitioners misconstrue the application of 
both Section 19(g) and the D.C. Circuit's Susquehanna Opinion in 
focusing on the merits of the Executive Chairman's determination of 
competitive significance under Article VIIB of its By-laws. According 
to OCC, the Exchange Act requires the Commission to review the 
substance of the Capital Plan, not the process by which it was adopted. 
Thus, any purported violation of a ``procedural'' By-law--as OCC 
characterizes Article VIIB--is not relevant to the Commission's 
consideration of whether to approve the Capital Plan under Section 
19(b).\71\
---------------------------------------------------------------------------

    \71\ OCC October 2017 Post-Remand Submission at 27.
---------------------------------------------------------------------------

    Petitioners counter that the By-laws are not merely procedural but 
rather provide substantive protection to the Non-Stockholder 
Exchanges.\72\ Therefore, Petitioners argue, any determination made by 
the Executive Chairman pursuant to those By-laws is subject to 
Commission review under the Exchange Act and judicial review by the 
courts.
---------------------------------------------------------------------------

    \72\ Petitioners November 2017 Post-Remand Submission at 9.
---------------------------------------------------------------------------

    We recognize that in the Approval Order we concluded that whether 
the Board complied with its governance obligations was not the focus of 
our review of the rule filing.\73\ But, in light of the D.C. Circuit's 
specific instruction, we have revisited the record and this conclusion. 
And, for the reasons discussed below, we now conclude that, in the 
context of this proposed rule filing, it is appropriate to review OCC's 
compliance with the notification provisions in Article VIIB of its By-
laws.
---------------------------------------------------------------------------

    \73\ Approval Order at 8305.
---------------------------------------------------------------------------

    As an SRO, OCC is subject to the rule filing requirements in 
Section 19(b)(1) of the Exchange Act \74\ and Rule 19b-4(c) 
thereunder.\75\ These requirements serve several important functions, 
including helping to ensure that the clearing agency's rules are 
consistent with all of the provisions of the Exchange Act and the rules 
and regulations thereunder. Exchange Act Section 19(g)(1), in turn, 
requires that an SRO comply with all of its own rules, without 
distinction as to whether those rules are procedural or otherwise.\76\ 
And Article VIIB of OCC's By-laws furthers several substantive purposes 
embodied elsewhere in the Exchange Act and the rules thereunder.
---------------------------------------------------------------------------

    \74\ 15 U.S.C. 78s(b)(1).
    \75\ 17 CFR 240.19b-4(c).
    \76\ 15 U.S.C. 78s(g)(1).
---------------------------------------------------------------------------

    In particular, Exchange Act Section 17A(b)(3)(C) requires that the 
rules of a registered clearing agency assure fair representation of its 
shareholders and participants in the selection of its directors and the 
administration of its affairs. And Rule 17Ad-22(d)(8), applicable to 
OCC at the time it adopted the Capital Plan, required OCC to establish, 
implement, maintain, and enforce written policies and procedures 
reasonably designed to have governance arrangements that, among other 
things, support the objectives of its owners and participants.\77\ The 
Commission has explained that this obligation is designed to promote 
the ability of the clearing agency to serve the interests of various 
constituents and the interests of the general public.\78\
---------------------------------------------------------------------------

    \77\ 17 CFR 240.17Ad-22(d)(8). The Commission has since adopted 
enhanced governance requirements in Rule 17Ad-22(e)(2)(vi). 17 CFR 
240.17Ad-22(e)(vi). Because OCC is a covered clearing agency, the 
governance requirements in Rule 17Ad-22(e)(2)(vi) apply to OCC while 
the requirements in Rule 17Ad-22(d)(8), applicable to OCC at the 
time it adopted the Capital Plan, no longer apply. See Rule 17Ad-
22(d), 17 CFR 240.17Ad-22(d) (``Each registered clearing agency that 
is not a covered clearing agency shall establish, implement, 
maintain and enforce written policies and procedures reasonably 
designed to, as applicable. . . .'').
    \78\ Release No. 34-68080 (Oct. 22, 2012), 77 FR 66220, 66252 
(Nov. 2, 2012).
---------------------------------------------------------------------------

    Before 2002, any new market desiring to clear options transactions 
through OCC was required to purchase common stock in OCC and execute a 
stockholders agreement, thereby becoming a Stockholder Exchange and 
obtaining representation on the Board.\79\ But in 2002, OCC sought to 
amend its By-laws and rules to permit OCC to provide clearing services 
to new options exchanges without having those exchanges become 
stockholders.\80\ Pursuant to that proposed rule change, although the 
newly created Non-Stockholder Exchanges would not have representation 
on OCC's board, the members of the Non-Stockholder Exchanges that also 
were clearing members of OCC would be ``participants'' in OCC within 
the meaning of Section 17A(b)(3)(C) of the

[[Page 5164]]

Exchange Act, and therefore would be entitled under that provision to 
fair representation in the selection of OCC's directors and the 
administration of its affairs.\81\ As participants, the Non-Stockholder 
Exchanges would also benefit from Rule 17Ad-22(d)(8)'s requirement that 
OCC's governance arrangements support their objectives.
---------------------------------------------------------------------------

    \79\ See Release No. 34-46469 (Sept. 6, 2002), 67 FR 58093 
(Sept. 13, 2002) (SR-OCC-2002-02) (``2002 By-law Amendment'').
    \80\ See id.
    \81\ Id. at 58094.
---------------------------------------------------------------------------

    OCC represented to the Commission that it would assure the fair 
representation required under Section 17A(b)(3)(C) for the new category 
of ``non-equity exchanges'' (referred to throughout this order as 
``Non-Stockholder Exchanges'') \82\ through what is now Article VIIB of 
the OCC By-laws, and in particular the requirement that:
---------------------------------------------------------------------------

    \82\ See supra note 8.

    OCC management will (1) provide non-equity exchanges with the 
opportunity to make presentations to the OCC board or the 
appropriate board committee upon request and (2) will promptly pass 
on to non-equity exchanges any information that management considers 
to be of competitive significance to such exchanges disclosed to 
exchange directors at or in connection with any meeting or action of 
the OCC board or any board committee.\83\
---------------------------------------------------------------------------

    \83\ See id. at 58094, n.6 (citing Letter from William H. Navin, 
Executive Vice President, General Counsel, and Secretary, OCC (Jul. 
8, 2002)).

This representation was essential to the Commission's decision to 
approve the 2002 By-law Amendment.\84\ The Commission concluded that 
these By-law provisions ``should help to ensure that no burden on 
competition that is not necessary or appropriate in furtherance of the 
[Exchange] Act will occur.'' \85\ And, on that basis, the Commission 
found that OCC had met its burden of demonstrating that the 2002 By-law 
Amendment was ``consistent with the requirements of Section[s] 
17A(b)(3)(C) and (I)'' of the Exchange Act.\86\
---------------------------------------------------------------------------

    \84\ Id. at 58095.
    \85\ See id. at 58095.
    \86\ See id.
---------------------------------------------------------------------------

    Given the pivotal function of Article VIIB in ensuring that OCC 
meets its obligations to the Non-Stockholder Exchanges as participants 
of OCC, the Commission does not agree with OCC's assertion that 
compliance with Article VIIB's procedures can be disregarded in the 
review of proposed rule changes under Exchange Act Section 19(b)(2)(C). 
To conclude otherwise would thwart the protection provided to OCC's 
participants by the notification provisions in these By-laws by 
depriving them of the opportunity--in appropriate circumstances--to 
influence the development of proposals of competitive significance.\87\ 
It would also limit the Commission's ability to ensure that OCC 
complies with its own rules and regulatory obligations in the first 
instance.\88\
---------------------------------------------------------------------------

    \87\ See also General Instructions for Form 19b-4, Section E, 
https://www.sec.gov/files/form19b-4.pdf (last visited February 12, 
2019) (``The Commission will not approve a proposed rule change . . 
. before the self-regulatory organization has completed all action 
required to be taken under its constitution, articles of 
incorporation, bylaws, rules, or instruments corresponding thereto 
(excluding action specified in any such instrument with respect to 
(i) compliance with the procedures of the Act or (ii) the formal 
filing of amendments pursuant to state law).'').
    \88\ The Commission has the ability under Section 19(h) of the 
Exchange Act to initiate proceedings against a clearing agency such 
as OCC for failure to comply with its own rules. But such 
proceedings cannot remedy the impact that a failure to comply with 
OCC's own rules during the process of developing proposals of 
competitive significance could have on the final result.
---------------------------------------------------------------------------

2. Article VIIB of OCC's By-Laws May Have Been Implicated by the 
Capital Plan
    OCC also contends that, even if compliance with these By-laws is 
generally relevant to proposed rule changes, Article VIIB was not 
implicated by the Capital Plan. OCC first asserts that the Executive 
Chairman has no obligation to share information with the Non-
Stockholder Exchanges unless and until he makes an ``affirmative, 
subjective'' determination that the information is of competitive 
significance, and no such determination was made here.\89\ OCC also 
states that its By-laws make clear that the Executive Chairman alone 
has the discretion to make this determination and that, in exercising 
his business judgment, he never considered the Capital Plan to be of 
competitive significance to the Non-Stockholder Exchanges.\90\
---------------------------------------------------------------------------

    \89\ OCC September 2018 Path to Re-Approval at 38.
    \90\ Donohue Declaration at para. 22; OCC October 2017 Post-
Remand Submission at 25.
---------------------------------------------------------------------------

    Petitioners, on the other hand, state that--at a minimum--the 
prompt notice requirement in the By-laws implies that the Executive 
Chairman must actually determine what information bears such 
competitive significance.\91\ They also assert that the discretionary 
authority under the By-laws does not grant the Executive Chairman an 
unconditional license to engage in arbitrary and capricious decision-
making, but rather requires that any such decision be both procedurally 
and substantively reasonable.\92\ Petitioners suggest that the 
statement by the Executive Chairman in the materials submitted by OCC 
does not establish that he actually made a determination that the Plan 
was not competitively significant and contend that OCC provided no 
evidence that the Executive Chairman made any such determination.\93\
---------------------------------------------------------------------------

    \91\ Petitioners November 2017 Post-Remand Submission at 7.
    \92\ Petitioners November 2017 Post-Remand Submission at 8.
    \93\ Id. at 7-8.
---------------------------------------------------------------------------

a. The Executive Chairman Must Consider the Issue of Competitive 
Significance and That Determination Is Reviewable
    We reject OCC's assertion that Article VIIB requires the Executive 
Chairman to notify Non-Stockholder Exchanges only if the Executive 
Chairman decides to consider whether a matter is of competitive 
significance and affirmatively determines that it is, but does not 
require the Executive Chairman to undertake such an inquiry.\94\ In our 
view, such an interpretation is inconsistent with the purpose OCC 
itself ascribed to this provision at the time it was proposed. As 
described above, OCC represented to the Commission that this provision 
would help to ensure that Non-Stockholder Exchanges were provided the 
fair representation they are entitled to as participants of OCC. The 
Commission relied on this representation in approving the By-law.\95\ 
If the Executive Chairman is not required to assess the competitive 
significance of matters coming before the Board--and can avoid 
triggering the By-law's notice requirements by merely refraining from 
such consideration--this protection is illusory.\96\
---------------------------------------------------------------------------

    \94\ OCC September 2018 Path to Re-Approval at 38.
    \95\ See 2002 By-law Amendment at 58095.
    \96\ OCC contends that, because its By-laws generally provide 
OCC's Board with authority to interpret the provisions of the By-
laws, deference must be given to the Board's interpretation of 
Article VIIB. See OCC September 2018 Path to Re-Approval at 38 
(quoting Article III, Section 8 of OCC's By-laws). The Commission 
believes, however, that there are limits to such authority and to 
the deference afforded to the Board's interpretations. OCC's Board 
does not have the authority to interpret the provisions of its By-
laws in a manner not consistent with the Exchange Act or the rules 
and regulations thereunder. Nor can the Board interpret its By-laws 
in a manner inconsistent with the purpose OCC itself ascribed to 
this provision at the time it was proposed, particularly where--as 
here--that representation formed a basis for the Commission's 
approval.
---------------------------------------------------------------------------

    We also disagree with OCC's contention that applying an 
``objective, reasonableness standard'' would ``directly conflict[ ] 
with the language of the bylaw,'' which commits the competitive 
significance determination to the sole discretion of the Executive 
Chairman.\97\ OCC's By-laws do leave the

[[Page 5165]]

determination of competitive significance to the discretion of the 
Executive Chairman. But, given the importance of the By-law provisions 
and the status of such provisions as SRO rules under Section 19(b) of 
the Exchange Act, the Commission believes that there must be a 
mechanism for ensuring that this discretion is not abused.
---------------------------------------------------------------------------

    \97\ OCC October 2017 Post-Remand Submission at 26-27 (internal 
quotation marks omitted).
---------------------------------------------------------------------------

b. The Commission Lacks Sufficient Information in the Record To 
Determine Whether OCC Complied With Article VIIB
    We conclude that the information before the Commission is 
insufficient for us to make the necessary determinations as to whether 
or how the Executive Chairman exercised his discretion under Article 
VIIB with respect to the Capital Plan.
    Although the record includes comments regarding the potential 
burden on competition of the Capital Plan, OCC has not provided any 
contemporaneous records regarding a competitive significance 
determination. Rather, the only information in the record is contained 
in an affidavit submitted in connection with OCC's October 2017 Post-
Remand Submission. In that affidavit, OCC's Executive Chairman 
declared: ``In the exercise of my business judgment, I never considered 
the Capital Plan to be of competitive significance to the Non-Equity 
Exchanges.'' \98\ In addition, OCC's October 2017 Post-Remand 
Submission included the following statement:
---------------------------------------------------------------------------

    \98\ Donohue Declaration, para. 22.

    Here, as discussed previously, the Executive Chairman, in the 
exercise of his business judgment, never determined that he 
``considers [the Capital Plan] to be of competitive significance to 
[the] Non-Equity Exchanges.'' Nor did anyone on OCC's Board ever 
suggest that the Capital Plan was of competitive significance and 
its development was required to be disclosed to non-Stockholder 
Exchanges pursuant to OCC's bylaw, despite the OCC Board's knowledge 
of the comments submitted on the record by the Petitioners to that 
effect.\99\
---------------------------------------------------------------------------

    \99\ OCC October 2017 Post-Remand Submission at 25-26 (internal 
citations omitted). We note that the Confidential Materials include 
documentation demonstrating that at least some Board members did 
raise concerns that the Capital Plan would move OCC away from its 
original industry utility model, would provide a dividend that was 
too high given the size of the investment, and/or could put upward 
pressure on fees going forward.

    These statements do not establish that the Executive Chairman gave 
consideration to the question of whether the Capital Plan was 
competitively significant prior to the adoption of the Capital Plan. 
Rather, the statement that the Executive Chairman never determined that 
he ``considers the Capital Plan to be of competitive significance to 
the Non-Equity Exchanges'' \100\ could be consistent with either of two 
things: (i) The Chairman considered the information but did not find 
that it was of competitive significance; or (ii) the Chairman did not 
consider the question of whether the information would be of 
competitive significance. Given the lack of clarity of this statement, 
and the lack of other contemporaneous records demonstrating that the 
Executive Chairman actually determined that the Capital Plan is not 
competitively significant or--if he did--the basis for that 
determination, we lack sufficient information to conclude that any 
exercise of the Executive Chairman's discretion complied with Article 
VIIB.
---------------------------------------------------------------------------

    \100\ Id. at 25 (internal punctuation omitted).
---------------------------------------------------------------------------

3. OCC's Focus on Post-Implementation Evidence of Competitive Effect Is 
Neither Justified nor Persuasive
    OCC also maintains that, regardless of what the Executive Chairman 
considered, the Capital Plan has not proven to be competitively 
significant to the Non-Stockholder Exchanges and, therefore, the Non-
Stockholder Exchanges were not in fact required to be notified under 
Article VIIB. In doing so, OCC focuses on competition between the 
Stockholder Exchanges and Non-Stockholder Exchanges for listed options 
order flow, and asserts that there is no evidence suggesting that the 
payment of dividends has altered such competition in the two years in 
which they have been paid.\101\ OCC states that there is no evidence 
that prices for execution services have been affected by the Capital 
Plan, which--in its view--indicates that there has been no competitive 
effect.\102\ Furthermore, OCC maintains that the Stockholder Exchanges' 
receipt of dividends is in exchange for their capital contributions and 
Replenishment Capital commitments, which the Non-Stockholder Exchanges 
did not make.\103\ OCC adds that, even if the Dividend Policy 
subsidizes the Stockholder Exchanges' operations by reducing expenses 
and improving profit margins--a proposition that OCC disputes--such a 
subsidy would not affect inter-exchange competition for order flow 
given the size of the market.\104\
---------------------------------------------------------------------------

    \101\ OCC October 2017 Post-Remand Submission at 19, 26.
    \102\ Id. at 20.
    \103\ Id. at 26; see also TABB September 2018 Report at 3 
(noting the existence of the ability to request payment of 
Replenishment Capital and further stating that such a request would 
likely occur ``as the result of an operational loss at OCC or a 
period of industry stress'').
    \104\ OCC October 2017 Post-Remand Submission at 20; see also 
TABB September 2018 Report at 3 (stating that the dollar amount of 
the dividend is very low relative to the annual revenues of the 
Stockholder Exchanges).
---------------------------------------------------------------------------

    Petitioners counter that moving away from OCC's historical 
operating model as an industry utility to a for-profit model that makes 
dividend payments to the Stockholder Exchanges is of obvious 
competitive significance.\105\ Petitioners assert that the Dividend 
Policy provides an advantage to the Stockholder Exchanges over the Non-
Stockholder Exchanges.\106\ Given the fierceness and intensity of the 
competition between the Stockholder Exchanges and Non-Stockholder 
Exchanges, in Petitioners' view, such an advantage is necessarily 
significant. Petitioners point to the size of the dividends paid (two 
cents or less per contract) as compared to OCC's clearing fees (up to a 
maximum of five cents per contract) to demonstrate the significance of 
the advantage.\107\ And, because they view participation in the Capital 
Plan as advantageous, Petitioners assert that the fact that only the 
Stockholder Exchanges were permitted to participate in the Capital Plan 
is, in and of itself, competitively significant.\108\ Moreover, 
Petitioners state that the structure of the Dividend Policy is such 
that the more options trades the Non-Stockholder Exchanges generate, 
the greater the dividends that the Stockholder Exchanges will 
receive.\109\
---------------------------------------------------------------------------

    \105\ Petitioners November 2017 Post-Remand Submission at 8-9.
    \106\ Id. Petitioners find support for this contention in OCC's 
assertion elsewhere in its submissions that the Dividend Policy may 
benefit end-user customers by causing the Stockholder Exchanges to 
lower prices. Id. at 17.
    \107\ Petitioners September 2018 Expert Rebuttal at 11 (citing 
OCC September 2018 Path to Re-Approval at 33); see also OCC 
September 2018 Path to Re-Approval at 33 (stating that a dividend of 
$30 million used entirely to subsidize Stockholder Exchanges' equity 
options products would result in fee decreases between 0.939 cents 
and 2.04 cents at each Exchange). Petitioners argue that such a 
subsidy would be non-trivial and cite a prior statement by OCC in 
support of a 2016 fee reduction. Petitioners September 2018 Expert 
Rebuttal at 11 (citation omitted).
    \108\ Petitioners November 2017 Post-Remand Submission at 9.
    \109\ Id. at 10; see also TABB October 2018 Follow-Up Report at 
2 (stating that the Capital Plan seems to foster incentives for OCC 
to manage its costs in a way that takes into account the related 
impacts on profits flowing back to OCC's investors).
---------------------------------------------------------------------------

    At the outset, we find that OCC's effort to narrow the analysis to 
evidence related to the effect on competition after the Capital Plan 
was implemented is neither justified nor appropriate. ``Competitive 
significance'' as used in

[[Page 5166]]

Article VIIB must be analyzed in the context of both the Commission's 
approval of Article VIIB, which was put in place to mitigate governance 
concerns stemming from the exclusion of the Non-Stockholder Exchanges 
from OCC's governance framework, as well as OCC's obligations under 
Section 17A of the Exchange Act and Rule 17Ad-22(d)--and now Rule 17Ad-
22(e)--thereunder.\110\
---------------------------------------------------------------------------

    \110\ Appropriate and clear governance arrangements are a key 
component of a registered clearing agency's regulatory obligations. 
See, e.g., 17 CFR 240.17Ad-22(d)(8) and (e)(2); see also Release No. 
34-68080 (Oct. 22, 2012), 77 FR 66219, 66252 (Nov. 2, 2012) 
(``Governance arrangements . . . play an important role in making 
sure that clearing agencies fulfill the Exchange Act requirements 
that the rules of a clearing agency be designed to protect investors 
and the public interest and to support the objectives of owners and 
participants. Similarly, governance arrangements . . . [help] 
creat[e] an oversight framework that fosters a focus on the critical 
role that risk management plays in promoting prompt and accurate 
clearance and settlement.'').
---------------------------------------------------------------------------

    Article VIIB was designed to ensure that the Non-Stockholder 
Exchanges would receive information that was of competitive 
significance and be provided an opportunity to present their views to 
the Board (and potentially influence the Board's decision with respect 
to such information), thereby ensuring that the 2002 By-law Amendment 
was consistent with Section 17A(b)(3)(C) of the Exchange Act. For 
Article VIIB to serve this purpose, the Non-Stockholder Exchanges must 
be afforded the opportunity to present their views to the Board, and 
potentially influence the Board's decision, before any relevant action 
is taken. A failure to provide that opportunity, if it was required, 
cannot be rendered meaningless by the later effects of a policy adopted 
without their ex ante participation. It is important to acknowledge, 
however, that the 2002 By-law Amendment does not place any substantive 
restrictions on the OCC Board's exercise of its business judgment. The 
Board is still free to adopt any proposal it believes is consistent 
with its By-laws, the Exchange Act, and any rules and regulations 
promulgated thereunder; it, however, must comply with OCC's own rules 
in doing so.\111\
---------------------------------------------------------------------------

    \111\ Release No. 34-46257 (Jul. 25, 2002), 67 FR 49729, 49730 
(Jul. 31, 2002) (stating that the non-equity exchanges would become 
parties to OCC's ``existing Restated Participant Exchange 
Agreement'' in the same way new participant exchanges have done in 
the past). Although OCC provides for direct Board membership only by 
those exchanges that are stockholders, it represented to the 
Commission that it would provide non-equity exchanges with 
information of competitive significance and opportunities for the 
presentation of information to OCC's Board. Id. at n. 6.
---------------------------------------------------------------------------

    Moreover, even if such after-the-fact evidence could be relevant to 
our assessment of compliance with Article VIIB, as we explain in 
greater detail below, we do not believe that competition among 
exchanges for order flow is as narrow as OCC contends.\112\ Exchanges 
can compete for order flow through a variety of activities, for 
example, by offering technological services.\113\
---------------------------------------------------------------------------

    \112\ OCC October 2017 Post-Remand Submission at 19-20 and OCC 
October 2015 Support Statement at 19-20 (focusing on the price of 
execution services).
    \113\ See discussion infra Section V.B.1.
---------------------------------------------------------------------------

    Additionally, we note that the Capital Plan changes the way in 
which OCC determines, collects, and distributes fees, refunds, and 
dividends among its participants, the Non-Stockholder Exchanges, and 
the Stockholder Exchanges. Prior to the Capital Plan, as previously 
described, OCC returned close to 100% of excess fees collected over 
annual expenses to its participants, including the Non-Stockholder 
Exchanges, and no dividends were paid to the Stockholder 
Exchanges.\114\ The Capital Plan altered this model by introducing the 
concept of annual dividend obligations to the Stockholder Exchanges, 
which are obtained by reducing the amount of refunds previously 
afforded to OCC's participants.\115\ We believe that this material 
change in the use of any excess fees that OCC collects could well have 
been considered competitively significant for OCC, its owners, and its 
participants (including the Non-Stockholder Exchanges) because those 
parties now have divergent interests in the generation, collection, and 
allocation of the excess fees.\116\ In particular, the change in the 
allocation of such funds among the parties could have the potential to 
alter their competitive positions, especially if--as Petitioners 
allege--the rate of return provided by the dividend is disproportionate 
to the investments made by the Stockholder Exchanges.
---------------------------------------------------------------------------

    \114\ See OCC 2012 Annual Report at 18 (noting that net income 
before taxes and refunds for fiscal year 2012 was $55,264,907, and 
the Board determined to return $50.1 million to its members); 
Petitioners November 2017 Post-Remand Submission at 8-9 (citing to 
materials that characterize OCC as operating under a ``zero profit'' 
operating model).
    \115\ See description of Dividend Policy, supra Section IV.C.3.
    \116\ The TABB October 2018 Follow-Up Report concludes that the 
structure of the Capital Plan affects how OCC considers the 
generation, collection, and allocation of excess fees, particularly 
in terms of how profits flow back to the Stockholder Exchanges. See 
TABB October 2018 Follow-Up Report at 2.
---------------------------------------------------------------------------

    At this time, we do not take a conclusive position regarding the 
ultimate competitive impact that this change could have, or has had, on 
competition among the Stockholder Exchanges and Non-Stockholder 
Exchanges. But, at a minimum, we believe that the potential for such an 
effect at the time the Capital Plan was under consideration was 
relevant to determining whether the Capital Plan was competitively 
significant. As a result, we cannot conclude that the lack of 
competitive significance is so obvious as to render a review of the 
Executive Chairman's determination unnecessary. And, as explained 
above, because we cannot determine whether the Executive Chairman 
considered these factors and, if so, what conclusions he drew at the 
time, we cannot determine whether he abused the discretion afforded him 
in the By-laws.
4. A Violation of Article VIIB of OCC's By-Laws Would Not Be Harmless
    Finally, OCC states that any violation of the By-laws in question 
would be harmless because Petitioners were given a full and fair 
opportunity to be heard through the notice and comment process before 
the Commission and have had ample opportunity to review and share their 
suggestions on the Capital Plan, including offering suggestions as 
recently as August 2017.\117\
---------------------------------------------------------------------------

    \117\ OCC October 2017 Post-Remand Submission at 27.
---------------------------------------------------------------------------

    The Petitioners state that the By-laws mandate that the Non-
Stockholder Exchanges have an opportunity to participate in, and 
potentially shape and influence, matters of competitive significance to 
OCC's Board before they are decided upon. In their view, the ability to 
participate in an administrative review process where the outcome is 
either an approval or disapproval is not an adequate substitute.\118\
---------------------------------------------------------------------------

    \118\ Petitioners November 2017 Post-Remand Submission at 9.
---------------------------------------------------------------------------

    For the reasons discussed more fully in Section V.A.1. above 
setting forth the important substantive protections provided to the 
Non-Stockholder Exchanges by the By-laws, we do not consider the 
failure to follow the By-laws in these circumstances to be harmless 
error. Rather, we recognize that the development process for a proposal 
such as the Capital Plan can have a significant impact on the final 
proposal presented to the Board. Thus, it is not sufficient for 
Petitioners to have been able to raise their concerns as part of the 
Commission review process only after OCC had settled on a final Capital 
Plan proposal.

[[Page 5167]]

    Accordingly, for all of the reasons discussed above, the Commission 
finds that OCC has failed to meet its burden to show that it followed 
its own rules in considering and adopting the Capital Plan, as required 
by Exchange Act Section 19(g)(1).\119\ On this basis, we are therefore 
unable to approve the proposed rule change.
---------------------------------------------------------------------------

    \119\ 15 U.S.C. 78s(g)(1).
---------------------------------------------------------------------------

B. The Commission Lacks Sufficient Information To Assess the Impact of 
the Dividend Policy on the Capital Plan's Consistency With the Exchange 
Act

    We also conclude that OCC failed to meet its burden of establishing 
that the Capital Plan is consistent with Section 17A(b)(3)(I) of the 
Exchange Act.\120\ Petitioners contend that the Capital Plan's Dividend 
Policy creates a ``subsidy'' that unfairly advantages the Stockholder 
Exchanges and therefore burdens competition in a manner neither 
necessary nor appropriate in furtherance of the purposes of the 
Act.\121\ In the Approval Order, we concluded to the contrary, finding 
that the dividends under the Plan provided reasonable compensation for 
the capital commitments made by the Stockholder Exchanges and, as a 
result, the Plan did not impose ``any costs that could be viewed as 
imposing a burden on competition not necessary or appropriate under the 
Exchange Act.'' \122\ Our finding that the rate of return the dividend 
provides to the Stockholder Exchanges was reasonable, however, was 
based on our reliance on the process used by OCC to arrive at that rate 
of return.\123\ In light of the D.C. Circuit's instruction that such 
reliance was insufficient and that the Commission may not rely on OCC's 
process divorced from an examination of the substance of the Plan,\124\ 
we have reexamined our original conclusions.
---------------------------------------------------------------------------

    \120\ 15 U.S.C. 78q-1(b)(3)(I).
    \121\ See, e.g., Petitioners September 2018 Expert Rebuttal at 
11.
    \122\ Approval Order at 8301.
    \123\ See, e.g., id. at 8300-8301.
    \124\ Susquehanna, 866 F.3d at 447-448.
---------------------------------------------------------------------------

    Upon reconsideration, we conclude that we lack sufficient 
information to make the necessary findings regarding the Plan's 
consistency with this provision of the Exchange Act. In particular, we 
cannot find--as OCC urges--that there has, in fact, been no impact on 
competition since the Plan has been implemented. Nor do we have 
sufficient information to find that the dividends under the Plan 
provide a reasonable rate of return such that they do not unfairly 
advantage the Stockholder Exchanges.
1. OCC Asserts, but Has Not Established, That There Has Been No Impact 
on Competition Since Implementation of the Capital Plan
    OCC contends that the rate of return provided by the Dividend 
Policy is only relevant to the extent that the Dividend Policy imposes 
a burden on competition not necessary or appropriate in furtherance of 
the purposes of the Exchange Act. And because, in OCC's view, there is 
no evidence that competition has been burdened or diminished as a 
result of the Dividend Policy, OCC contends that there is no need to 
analyze the rate of return.\125\ In particular, OCC states that there 
is no evidence of any change in prices for execution or exchange 
services, the introduction of new services by the Stockholder Exchanges 
as a result of the dividends they receive, or an alteration to the 
competitive behavior of the options exchanges, and therefore there is 
no need for a more detailed examination of whether the rate of return 
is reasonable.\126\ OCC also again states that as between the 
Stockholder Exchanges and Non-Stockholder Exchanges, the primary 
competition is with respect to order flow through options execution 
services, and that the dividends are insignificant when compared to the 
multi-billion-dollar market for options execution services.\127\
---------------------------------------------------------------------------

    \125\ OCC December 2017 Reply at 5.
    \126\ Id. at 6-7.
    \127\ OCC October 2017 Post-Remand Submission at 21.
---------------------------------------------------------------------------

    Petitioners, in contrast, state that the D.C. Circuit found that 
the reasonableness of the dividend rate is a central issue, and that to 
the extent the dividend rate is unreasonable, it creates a windfall to 
the Stockholder Exchanges that may inappropriately or unnecessarily 
burden competition.\128\ Petitioners further state that their 
submissions demonstrate that the dividends are, in fact, a burden on 
competition.\129\
---------------------------------------------------------------------------

    \128\ Petitioners January 2018 Surreply at 4.
    \129\ Id. at 5.
---------------------------------------------------------------------------

    The Commission agrees with OCC that the reasonableness of the rate 
of return provided by the Dividend Policy is relevant only insofar as 
it affects the analysis of the consistency of the Plan with the 
Exchange Act. But we do not believe that this obviates the need to 
assess the reasonableness of the rate of return. As explained further 
below, OCC has asserted, but not established, that implementation of 
the Dividend Policy has had no effect on competition. Nor do we have 
sufficient information to independently determine whether or to what 
extent competition has, in fact, been affected. We therefore believe 
that examination of the reasonableness of the rate of return is 
appropriate.
    In arguing that there is no evidence of an effect on competition, 
OCC asserts that (i) the only conceivably affected competition here is 
among exchanges; (ii) the competition among exchanges is principally 
for order flow; and (iii) there is no basis to expect that competition 
among exchanges for order flow has been or could be diminished because 
of the Capital Plan.\130\
---------------------------------------------------------------------------

    \130\ OCC October 2017 Post-Remand Submission at 19. In its 
Reply, OCC offered additional details that it believes support a 
conclusion that ``competition for order flow has not been affected 
in the slightest.'' OCC December 2017 Reply at 6-7.
---------------------------------------------------------------------------

    Even accepting OCC's arguments that the only conceivably affected 
competition here is among exchanges and that the competition among 
exchanges is principally for order flow, we do not agree with OCC's 
assertion that it has conclusively shown that such competition has not 
been affected by the Capital Plan.\131\ We therefore find that OCC has 
not established that competition has not been burdened. OCC itself 
concedes that the competitive balance among the options exchanges is 
dependent upon a multitude of sources, and that both Stockholder and 
Non-Stockholder Exchanges compete for order flow through a variety of 
activities.\132\ For example, exchanges can compete on the quality of 
their trade execution services by offering technological services to 
their market participants to enhance the trading process. Further, 
there are numerous ways that competition among the exchanges could be 
affected that would not necessarily manifest directly as immediately 
observable competitive behavior. For example, the Dividend Policy could 
allow the Stockholder Exchanges to lower the cost of executing options 
transactions on their exchanges (for example, by investing the dividend 
payments in more efficient order matching systems and trade processing 
systems), potentially gaining a competitive advantage over, and 
attracting options order flow from, the Non-Stockholder Exchanges. The 
Stockholder Exchanges also could use the dividends to defray the costs 
of new product listings, which, if successful, could attract options 
order flow from the Non-Stockholder Exchanges. And, while these forms 
of competition could be affected by any subsidy provided to the 
Stockholder Exchanges through the

[[Page 5168]]

Dividend Policy, we lack sufficient information to determine if there 
has been a change in these markets attributable to the Capital Plan.
---------------------------------------------------------------------------

    \131\ OCC December 2017 Reply at 6-7.
    \132\ OCC October 2015 Support Statement at 19-20.
---------------------------------------------------------------------------

    Because we cannot determine whether the Plan has had an effect on 
these aspects of competition, we cannot agree with OCC that it has 
shown an absence of a burden on competition that would obviate the need 
to assess the reasonableness of the rate of return generated by the 
Plan's Dividend Policy and its effect on competition.
2. We Do Not Have Sufficient Information To Assess the Reasonableness 
of the Rate of Return Provided by the Dividend Policy
    In asserting that the rate of return is reasonable, OCC states that 
an Ad Hoc Strategic Advisory Group (``Advisory Group'') of OCC 
directors ``negotiated an after-tax dividend that it concluded was fair 
and reasonable consideration for the Stockholder Exchanges' capital 
outlays and commitments for additional capital outlays.'' \133\ 
Specifically, in an affidavit submitted with its post-remand 
submission, OCC's Executive Chairman declared: OCC planned ``to 
calculate the dividend each year by first providing clearing members 
with a refund of 50% of OCC's earnings before tax and then issuing the 
after-tax amount of the remainder as a dividend to the Stockholder 
Exchanges'' and the ``Stockholder Exchanges represented to OCC that 
they required payment of the dividend . . . as an incentive to 
participate in the Plan.'' \134\ OCC states that the amount of 
dividends is reasonable because the dividends are necessary to 
compensate the Stockholder Exchanges for the Capital Contribution and 
Replenishment Capital Agreement.\135\ OCC also states that its Board, 
with the assistance of Oliver Wyman, Inc. and Barclays Capital, Inc. 
(``Barclays''), reviewed the risks to the Stockholder Exchanges' 
Capital Contribution and Replenishment Capital Agreement and concluded 
that the dividends were reasonable compensation for those risks.\136\
---------------------------------------------------------------------------

    \133\ OCC October 2017 Post-Remand Submission at 8. The members 
of the Advisory Group were all directors of OCC: Three clearing 
member directors, two management directors, two exchange directors, 
and two public directors. Donohue Declaration at par. 5. Craig S. 
Donohue, Executive Chairman and Chief Executive Officer of OCC, was 
one of the management directors. Id., para. 3.
    \134\ Id., paras. 17, 18.
    \135\ OCC October 2017 Post-Remand Submission at 18. See also 
TABB September 2018 Report at 3 (noting the existence of the ability 
to request payment of Replenishment Capital and further stating that 
such a request would likely occur ``as the result of an operational 
loss at OCC or a period of industry stress'').
    \136\ OCC October 2017 Post-Remand Submission at 20-21. OCC, 
however, does not explain what factors made the dividend rates 
reasonable, nor does it address the potential errors in the 
calculations that Petitioners describe. See infra note 141 and 
accompanying text.
---------------------------------------------------------------------------

    Petitioners state that the OCC October 2017 Post-Remand Submission 
fails to address the substantive reasonableness of the rate of return 
provided by the Plan's dividend provisions and instead relies on the 
process that produced the Dividend Policy.\137\ Petitioners suggest 
that this process was flawed because OCC kept the Non-Stockholder 
Exchanges out of the deliberations and because the Stockholder 
Exchanges appear to have used their veto power to obtain unreasonable 
concessions from OCC.\138\
---------------------------------------------------------------------------

    \137\ Petitioners November 2017 Post-Remand Submission at 11-12.
    \138\ Id. at 1.
---------------------------------------------------------------------------

    Petitioners also state that OCC has failed to demonstrate why it is 
reasonable to allocate roughly half of unused fees to dividends, as 
opposed to using a set percentage or a formula other than a fixed 
proportion of unused fees.\139\ Petitioners state that the resulting 
rate of dividends is unreasonably high, comparing OCC's recent 
dividends rates of 13.3% and 17.1% to the recent yield on Ten Year 
United States Treasuries (which has the same debt rating as OCC), of 
approximately 2.37%.\140\ Petitioners suggest that Barclays, in a 
presentation dated December 5, 2014, found that other capital raising 
transactions had lower rates of return that averaged 5.98%, and, 
further, that Barclays' analysis of an internal rate of return to the 
Stockholder Exchanges was flawed.\141\
---------------------------------------------------------------------------

    \139\ Id. at 3.
    \140\ Id. at 4.
    \141\ Id. at 14. According to Petitioners, the analysis was 
incorrect because it assumed that the Stockholder Exchanges would 
contribute $222 million, instead of the $150 million that they 
actually contributed, and deducted the taxes that the Stockholder 
Exchanges were expected to pay on the dividends. Petitioners state 
that applying the yearly dividends Barclays assumed OCC would pay to 
the $150 million Capital Contribution yields a dividend rate ranging 
from 16.67% to 19.93%, which is significantly higher than the 
internal rates of return estimated in Barclays' presentation for the 
Stockholder Exchanges, which were 11.7% to 13.7%. Id. at 12-14.
---------------------------------------------------------------------------

    Finally, Petitioners state that OCC failed to consider cheaper 
alternatives, such as an offer by one of the Stockholder Exchanges to 
provide OCC with capital at an 8% to 9% annual rate of return, setting 
the dividend at a predefined percentage rather than half of all excess 
fees,\142\ or obtaining the required amount of capital by retaining 
earnings.\143\ In its response to Petitioners, OCC relies on statements 
by Barclays that the terms of the Capital Plan ``provide a `reasonable 
IRR on contributed capital' and that returns would be `effectively 
capped.' '' \144\
---------------------------------------------------------------------------

    \142\ Petitioners note that Petitioner SIG has offered to 
provide OCC $150 million in capital at the rate of LIBOR + 3%. 
Petitioners November 2017 Post-Remand Submission at 15; Letter from 
David M. Pollard, Head of Strategic Planning and Special Counsel, 
Susquehanna Int'l Grp. to OCC Board of Directors (Aug. 25, 2017). On 
August 24, 2018, Petitioner SIG notified the Commission that it had 
amended this offer to $150 million at the Federal Funds Rate. SIG 
August 2018 Post-Remand Letter at 1.
    \143\ Petitioners November 2017 Post-Remand Submission at 14-15. 
See also TABB October 2018 Follow-Up Report at 2-3 (discussing 
potential alternatives not pursued by OCC).
    \144\ OCC December 2017 Reply at 4.
---------------------------------------------------------------------------

    In our view, although OCC states that the dividend rate is 
reasonable, OCC failed to provide sufficient information to support 
this conclusion. Rather, OCC submitted, pursuant to a request for 
confidential treatment, a variety of materials prepared by third-party 
consultants that OCC's Board considered in crafting and ultimately 
approving the Capital Plan.\145\ These materials largely consist of 
PowerPoint presentations prepared by these third-party consultants 
without narratives or explanations of key assumptions. OCC does not 
address all of the potential errors in these calculations alleged by 
Petitioners, or itself explain any of the assumptions used by the 
consultants in deriving their estimates.
---------------------------------------------------------------------------

    \145\ See supra note 26.
---------------------------------------------------------------------------

    For example, OCC does not explain anywhere why a pretax 50% 
division between refunds and dividends is appropriate.\146\ While OCC 
indicates that the 50% split between fees (before taxes) and dividends 
(after taxes), was arrived at through a negotiation process by the 
Advisory Group,\147\ it fails to provide any relevant substantive 
details regarding that negotiation process, nor does OCC provide any 
information or explanation as to why that particular split was chosen 
or why this division is consistent with the Exchange Act. Nor does OCC 
provide support for the disparity in treatment between dividends and 
refunds when replenishment capital has been outstanding for twenty-four 
months.\148\

[[Page 5169]]

As the D.C. Circuit made clear, trusting the process is 
insufficient.\149\ Without information sufficient to determine why a 
pretax 50% division between refunds and dividends and disparate 
treatment of refunds and dividends in the event replenishment capital 
has been outstanding for twenty-four months is appropriate, the 
Commission is unable to make determinations as to the reasonableness of 
the dividend rate and its consistency with the Act.\150\
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    \146\ Susquehanna, 866 F.3d at 447-48.
    \147\ See OCC October 2017 Post-Remand Submission at 8.
    \148\ As noted above in Section IV(C)(2) and (3), the Refund 
Policy under the Capital Plan specifies that OCC will not resume 
paying refunds and will recalculate how refunds are made if, for 
more than twenty-four months: (i) Replenishment Capital remains 
outstanding, or (ii) the Target Capital Requirement is not restored; 
however OCC would resume dividends after the Replenishment Capital 
is repaid in full and the Target Capital Requirement is restored 
through the accumulation of retained earnings, even if the time of 
repayment exceeds twenty-four months.
    \149\ See Susquehanna, 866 F.3d at 447-48 (`` `Trust the 
process' may be a reasonable slogan for the hometown basketball team 
of lead petitioner Susquehanna International Group. But the process 
alone cannot justify the dividend rate in this case.'') (internal 
citation omitted); see also id. at 448 (``More fundamentally, the 
SEC cannot rely on OCC's process totally divorced from any 
examination of the substance of the Plan . . . .'').
    \150\ In addition, while we do not reach the issue of the effect 
of the Capital Plan on fees in this order, we note that such further 
information regarding the reasonableness of the split and the 
disparity in treatment between dividends and refunds when 
replenishment capital has been outstanding for twenty-four months 
would be necessary to assess the reasonableness of the Capital 
Plan's effect on fees as well. 17 CFR 240.17Ad-22(e)(15).
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    Nor does the AlixPartners August 2018 Report, submitted by OCC, 
provide sufficient information to justify the expected rate of return. 
That report assesses the expected rate of return at the time the 
Capital Plan was being considered, concluding that the ``expected 
returns to the Stockholder Exchanges for their investment in OCC and 
the Replenishment Capital Commitment under the Capital Plan fall within 
a range of returns that is reasonable for this investment and 
commitment.'' \151\ More specifically, it concludes that the present 
value of the Stockholder Exchanges' expected returns at the time they 
agreed to make their $150 million investment in OCC were between $128.6 
million and $137.8 million. The report therefore concludes that the 
Stockholder Exchanges were not expected to receive outsized 
compensation given the risk of their investment in OCC, and thus the 
expected rate of return was not unreasonable.\152\
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    \151\ AlixPartners August 2018 Report at 5, 7, 18.
    \152\ Id. at 18.
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    The AlixPartners August 2018 Report, however, has a number of 
deficiencies that preclude the Commission from relying on it as a basis 
to conclude that the dividend rate is reasonable and therefore that the 
Dividend Policy is consistent with the Exchange Act. As an initial 
matter, the report relies on a report \153\ produced by Barclays--
including that report's estimate of dividends--as a basis of its 
analysis.\154\ It does not, however, provide any additional information 
as to the basis of those assumptions.\155\
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    \153\ Id. at 8 (``Barclays prepared several presentations for 
the Advisory Group, which ultimately resulted in a presentation to 
the OCC Board entitled ``Project Optimal: Capital Plan Discussion 
Materials,'' dated December 18, 2014 (the ``Barclays Final 
Presentation'').'').
    \154\ Id. at 8, n.27.
    \155\ Petitioners also noted the lack of any such information. 
See Petitioners September 2018 Expert Rebuttal at 9. Petitioners 
also stated that they did not have access to the specific Barclays 
report upon which the AlixPartners August 2018 Report was based. Id.
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    Moreover, the AlixPartners August 2018 Report focuses on assessing 
the estimated rate of return at the time OCC's Board voted to adopt the 
Capital Plan. But, as the report itself acknowledges, the dividends 
actually paid by OCC in 2016 and 2017 exceed those estimates.\156\ 
Other than noting the higher-than-estimated payments, the report does 
not provide any analysis of, or information regarding, the rate of 
return provided by the dividends actually paid. And, regardless of the 
reasonableness of OCC's past predictions, without such analysis or 
information of the rate of return provided by the dividends actually 
paid, we cannot assess whether the Capital Plan has proven to 
inappropriately or unnecessarily burden competition.\157\ In justifying 
its focus on what it terms this ``ex ante'' analysis, the second report 
provided by AlixPartners in October notes that the Board's approval of 
the Plan was based on these same predictive judgments.\158\ But in 
determining whether the Plan is consistent with Section 17A(b)(3)(I), 
we are not assessing the reasonableness of the Board's judgment at the 
time; \159\ rather, that provision requires us to ensure that OCC's 
rules themselves--including the Capital Plan--``do not impose a burden 
on competition not necessary or appropriate in furtherance of the 
purposes of [the Act].'' \160\ And the effect of that Plan since its 
implementation in 2015 is relevant to that determination.\161\
---------------------------------------------------------------------------

    \156\ AlixPartners August 2018 Report at 15, n.46. See also 
AlixPartners October 2018 Reply at 6, n.18 (``Moreover, I focused on 
expectations at the time of the adoption of the Capital Plan rather 
than any ex post realization.'').
    \157\ Barclays estimated (and the AlixPartners August 2018 
Report accepted) dividend payments of $25.5 million, $25 million, 
and $25.6 million in 2015, 2016, and 2017, respectively. The 
dividends actually paid in those years were $19.7 million, $25.6 
million, and $32.5 million, respectively. While the cumulative 
totals of the estimates and the actual payments are close, the 
difference between the relatively flat trend predicted and the 
actual trend of sharp increases is clear, and could be relevant to 
our analysis.
    \158\ AlixPartners October 2018 Reply at 9.
    \159\ In this respect, our analysis under Section 17A(b)(3)(I) 
differs from that under Section 19(g). As discussed above, by its 
terms, Section 19(g) requires us to ensure that OCC complies with 
its own rules, procedural and otherwise. As relevant here, that 
includes an assessment of whether the Board complied with Article 
VIIB in developing the Capital Plan. See supra 22.
    \160\ 15 U.S.C. 78q-1(b)(3)(I).
    \161\ We also note the tension between OCC's assertion here that 
the integrity of the Board's approval process obviates the need for 
the Commission to examine the effect of the Plan since 
implementation and its contention elsewhere (see supra Section 
V.B.1) that the effects of the Plan since implementation obviate the 
need to examine the Board's decision making process.
---------------------------------------------------------------------------

    The AlixPartners August 2018 Report also argues that the 
Stockholder Exchanges' investment in OCC is comparable to a private 
equity investment and cites an April 2015 paper based on a survey of 
private equity investors, which reports that private equity investors 
typically target a 22% internal rate of return on their investments on 
average (with a vast majority of target rates of return between 20% and 
25%).\162\ However, the Commission is not persuaded by this comparison 
because the April 2015 paper also suggests that private equity 
investors select investments with significant potential for 
growth,\163\ which presumably are risky investments. Indeed, the 
historical distribution of returns on private equity funds presented in 
the Easton September 2018 Rebuttal Report indicate that private equity 
investments are risky investments.\164\ These characteristics appear to 
contradict AlixPartners' own characterization of OCC as a non-profit-
maximizing firm with low growth prospects and presumably low risk.\165\
---------------------------------------------------------------------------

    \162\ AlixPartners August 2018 Report at 8.
    \163\ Gompers, Paul, Steven N. Kaplan, Vladimir Mukharlyamov, 
``What Do Private Equity Firms Say They Do?'' Harvard Business 
School, Working Paper 15-081, April 15, 2015, at 27, https://www.hbs.edu/faculty/Publication%20Files/15-081_9baffe73-8ec2-404f-9d62-ee0d825ca5b5.pdf (last visited February 12, 2019). See also 
AlixPartners October 2018 Reply at 7 (clarifying that the private 
equity investments in the sample were primarily buyout and growth 
equity investors) (citing Gompers, Paul, Steven N. Kaplan, Vladimir 
Mukharlyamov, ``What Do Private Equity Firms Say They Do? '' Harvard 
Business School, Working Paper 15-081, April 15, 2015, at 11).
    \164\ Easton September 2018 Rebuttal Report at 10-11.
    \165\ AlixPartners August 2018 Report at 13.
---------------------------------------------------------------------------

    Further, there are a number of other apparent deficiencies in the 
AlixPartners August 2018 Report, including areas where the report fails 
to provide an appropriate analysis or justification for key 
assumptions. For example, although the AlixPartners August 2018 Report 
states that it uses the Capital Asset Pricing Model

[[Page 5170]]

(``CAPM'') formula \166\ to calculate OCC's cost of equity, it appears 
that the report uses a different formula that features elements of the 
CAPM formula (risk-free rate of return; beta, a measure of an 
investment's systematic risk; and market return) as well as elements 
not in the CAPM formula (a risk premium associated with small stocks 
and a risk premium associated with an investment's unsystematic 
risk).\167\ It is therefore unclear what OCC's cost of equity would 
have been had the CAPM formula actually been used for the 
calculation.\168\ Further, even if the Commission were to assume that 
the formula in the AlixPartners August 2018 Report is a reasonable 
approach to estimate the cost of equity, because the report does not 
provide a value for the risk premium associated with unsystematic risk, 
the Commission would not be able to reproduce the cost of equity of 14% 
stated in the report.\169\
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    \166\ See William F. Sharpe, ``Capital Asset Prices: A Theory of 
Market Equilibrium under Conditions of Risk.'' The Journal of 
Finance 19(3) (1964), pp. 425-442; John Lintner, ``The Valuation of 
Risk Assets and the Selection of Risky Investments in Stock 
Portfolios and Capital Budgets.'' Review of Economics and 
Statistics. 47(1), pp. 13-37; and Eugene F. Fama and Kenneth K. 
French, ``The Capital Asset Pricing Model: Theory and Evidence.'' 
Journal of Economic Perspectives, 18(3), pp. 25-46.
    \167\ AlixPartners August 2018 Report at 9.
    \168\ We also note that Petitioners question whether the CAPM is 
an appropriate approach for calculating a cost of capital for the 
Shareholder Exchanges' equity investment in OCC. As a theoretical 
economic model, the CAPM assumes, among other things, that investors 
hold diversified portfolios. Petitioners note that this assumption 
is unlikely to hold in OCC's case because the Shareholder Exchanges 
primarily invest in assets and activities associated with the 
trading of securities, and thus their portfolios are by no means 
diversified. See Easton September 2018 Rebuttal Report at 11-12. In 
response, OCC asserts in the AlixPartners August 2018 Report that 
this argument undermines Petitioners' ``contention about the low-
risk nature of the investment'' because ``if the investor is unable 
to diversify away the unsystematic risk and is holding both 
systematic and unsystematic risk, the investment is riskier.'' Thus, 
according to OCC, ``by using only the CAPM to calculate the cost of 
equity for an investor that is undiversified, the cost of equity 
will be understated.'' See AlixPartners October 2018 Reply at 7-8.
    \169\ AlixPartners August 2018 Report at 11.
---------------------------------------------------------------------------

    As another example, the Commission has concerns regarding the 
manner in which the AlixPartners August 2018 Report estimates a beta of 
0.85, which the report uses in calculating OCC's cost of equity. 
Although the AlixPartners August 2018 Report purports to calculate a 
beta of 0.85 by averaging the beta of four ``guideline companies'' that 
the AlixPartners August 2018 Report contends have similar risk and 
return profiles as OCC, the report does not actually explain how the 
average beta of 0.85 was calculated. Specifically, it is unclear 
whether the AlixPartners August 2018 Report actually makes the 
necessary adjustments in the calculations to account for differences in 
financial leverage between OCC and the chosen guideline companies, nor 
does the AlixPartners August 2018 Report provide the inputs that 
readers of the report would need to make the adjustments 
themselves.\170\ The Commission therefore does not believe that it can 
rely on the AlixPartners August 2018 Report in determining the 
reasonableness of the rate of return provided by the Dividend Policy.
---------------------------------------------------------------------------

    \170\ One approach to adjusting for differences in financial 
leverage between the guideline companies and OCC is to remove the 
effect of financial leverage from each guideline company's beta by 
dividing that beta by (1+ (1-t) x DE), where t and DE are 
respectively, the tax rate and debt-to-equity ratio of the guideline 
company. The resulting adjusted betas of the guideline companies are 
then averaged to produce an average beta that does not exhibit 
financial leverage effects associated with guideline companies. The 
beta of OCC is calculated by multiplying the average beta by (1+ (1-
tOCC) x DEOCC), where tOCC and 
DEOCC are respectively, the tax rate and debt-to-equity 
ratio of OCC. See Robert S. Hamada, ``The Effect of the Firm's 
Capital Structure on the Systematic Risk of Common Stocks.'' The 
Journal of Finance 27(2) (1972): 435-452; Robert G. Bowman and Susan 
R. Bush, ``Using Comparable Companies to Estimate the Betas of 
Private Companies,'' Journal of Applied Finance 16(2) (2006): 71-81.
    In addition, in adjusting the present value of the Stockholder 
Exchanges' expected dividends for the lack of marketability, the 
AlixPartners August 2018 Report reviews various studies that 
quantify the appropriate level of discount to be applied to equity 
investments that lack marketability. These studies provide different 
ranges of discounts: 13% to 45%, 13% to 68%, 27% to 68%, and 35% to 
50%. The AlixPartners August 2018 Report then uses a lower discount 
of 25% and an upper discount of 30%, but other than stating that 
these discounts are conservative, the report does not explain or 
provide a justification as to why that range is appropriate here. 
See AlixPartners August 2018 Report at 13-15.
---------------------------------------------------------------------------

    Nor does the Commission believe that it can rely on the alternative 
assessment of the rate of return provided by Petitioners in the Easton 
September 2018 Rebuttal Report. Among other things, the Easton 
September 2018 Rebuttal Report concluded that the Stockholder 
Exchanges' investment in OCC is exceptionally low risk. In Professor 
Easton's view, the return and expected return on the Stockholder 
Exchanges' investment in OCC is not commensurate with the low risk 
nature of the investment. Rather, based on a number of indicia, he 
concludes that a reasonable rate of return is near five percent.\171\ 
But the Commission for the reasons discussed below is not persuaded by 
the argument that the investment made by the Stockholder Exchanges is 
an exceptionally low risk investment.\172\
---------------------------------------------------------------------------

    \171\ Easton September 2018 Rebuttal Report at 16.
    \172\ Easton September 2018 Rebuttal Report at 6.
---------------------------------------------------------------------------

    First, the Easton September 2018 Rebuttal Report compares the 
common stock investment made by the Stockholder Exchanges to the Series 
C Preferred Stock issued by the Depository Trust and Clearing 
Corporation. This comparison is problematic because preferred stock has 
a claim to a firm's cash flows that is more senior than that of common 
stock and thus preferred stock is generally less risky than common 
stock.\173\ Second, the Easton September 2018 Rebuttal Report compares 
the common stock investment made by the Stockholder Exchanges to the 
debt securities that OCC might issue. This comparison is also 
problematic because debt securities have a claim to a firm's cash flows 
that is more senior than that of either preferred stock or common 
stock, and thus debt securities are generally less risky than preferred 
stock or common stock.\174\
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    \173\ The riskiness of a preferred stock can be further reduced 
if it is cumulative, i.e., any preferred stock dividend payments 
that have been missed in the past must be paid out to the preferred 
stockholders before the issuer can pay dividends to its common 
stockholders. See also AlixPartners October 2018 Reply at 4 
(``preferred stock is different from common stock in that it 
typically has a higher priority in the capital structure'').
    \174\ The riskiness of a debt security can be further reduced by 
adding provisions to the debt agreement such as the pledging of 
collateral, provision of third-party credit guarantee, and 
incorporation of restrictive covenants to ensure that the debt 
security issuer preserves sufficient cash flows to meet interest 
payments and principal repayment. See also AlixPartners October 2018 
Reply at 2 (``Debtholders have a priority claim (above that of 
equity holders) to the company's assets if the company defaults.'').
---------------------------------------------------------------------------

    The Commission acknowledges the diversity of views presented in the 
reports, but believes that it cannot rely on the analysis of either 
report because of the concerns described above. Significantly, as noted 
above, the AlixPartners August 2018 Report is based on the Barclays 
report,\175\ and the Easton September 2018 Rebuttal Report is limited 
by the scope of the AlixPartners August 2018 Report.\176\ As a 
consequence, neither report addresses the information that is necessary 
for the Commission to evaluate the reasonableness of the rate of 
return, including an analysis of the rate of return provided by the 
dividends actually paid under the Plan or a justification of a dividend 
tied to a 50% split between fees and refunds. We therefore cannot 
determine whether the Dividend Policy, or the Plan as a whole, 
unnecessarily or inappropriately burdens competition.
---------------------------------------------------------------------------

    \175\ AlixPartners August 2018 Report at 8, n.27
    \176\ Easton September 2018 Rebuttal Report at 4.
---------------------------------------------------------------------------

    Accordingly, for the foregoing reasons, we find that OCC has failed 
to meet its burden of demonstrating that

[[Page 5171]]

the Plan is consistent with Section 17A(b)(3)(I) of the Exchange 
Act.\177\ On this independent basis, we are unable to approve the 
proposed rule change.
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    \177\ 15 U.S.C. 78q-1(b)(3)(I).
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VI. Consideration of Potential Request for Relief

    The Commission recognizes that, in operating under the Capital Plan 
since 2015, OCC has acted in reliance on the Commission's previous 
approval of the Plan. But, for the reasons discussed above, the 
Commission is now unable to find that the Capital Plan is consistent 
with the Exchange Act, and the proposed rule change is therefore 
disapproved.
    As a result of the Commission's disapproval of the proposed rule 
change today, OCC is out of compliance with Rule 17Ad-22(e)(15). 
Accordingly, OCC will be required to submit to the Commission a new or 
amended version of a capital plan in order to comply with Rule 17Ad-
22(e)(15).\178\
---------------------------------------------------------------------------

    \178\ 17 CFR 240.17Ad-22(e)(15). This order does not preclude 
OCC from revising the Capital Plan in the form of a new proposed 
rule change submission or submitting a completely new proposal to 
set a capital target and raise capital that is in compliance with 
OCC's own rules and consistent with the Exchange Act and applicable 
regulations.
    Additionally, OCC will need to submit to the Commission some 
iteration of a capital plan in order to comply with its obligations 
under Section 19(b) of the Exchange Act and Rule 19b-4 thereunder. 
15 U.S.C. 78s; 17 CFR 240.19b-4.
---------------------------------------------------------------------------

    While OCC has represented that it is possible to unwind the Capital 
Plan,\179\ the Commission acknowledges that Petitioners argued and the 
D.C. Circuit recognized that unwinding and replacing the Capital Plan 
may pose considerable logistical challenges for OCC.\180\ The 
Commission will consider any requests for exemptive or other relief 
that OCC might seek while OCC establishes a new capital plan and seeks 
to come into compliance with Rule 17Ad-22(e)(15).\181\ The Commission 
does not currently have sufficient information to understand what, if 
any, specific challenges OCC may face, and if any regulatory relief may 
be necessary, or, if so, to appropriately tailor such relief. The 
Commission would expect any such potential request for relief by OCC to 
include information sufficient for the Commission to determine whether 
the requested relief is necessary or appropriate in the public 
interest, and is consistent with the protection of investors. The 
Commission expects that any such request from OCC would likely need to 
include a detailed explanation of (i) the relief being sought, (ii) why 
the requested relief is necessary, (iii) the time period for which OCC 
is seeking relief and an explanation of its appropriateness, and (iv) 
any limitations or conditions that OCC believes would be appropriate to 
impose in connection with the requested relief.
---------------------------------------------------------------------------

    \179\ Susquehanna, 866 F.3d at 451 (``OCC assure[s] us that it 
will be possible to unwind the Plan at a later time'') (citing Oral 
Argument Transcript at 33-34, containing OCC statements at oral 
argument); OCC Opposition to Stay (D.C. Circuit Feb. 22, 2016) at 9 
(arguing that Petitioners have failed to show any irreparable harm 
in the absence of a stay).
    \180\ Susquehanna, 866 F.3d at 451; see also Petitioners 
September 2018 Expert Rebuttal at 13 (discussing alternatives to the 
current Capital Plan as well as potential Commission relief to 
manage consequences). See, e.g., OCC September 2018 Path to Re-
Approval at 51-52; TABB September 2018 Report at 4-5; see also 
Opposition of the Securities and Exchange Commission to Petitioners' 
Emergency Motion for Stay at 3, Susquehanna Int'l Grp., LLP v. SEC, 
Case No. 16-1061 (D.C. Cir.).
    \181\ Section 36 of the Exchange Act authorizes the Commission, 
by rule, regulation, or order, to exempt, either conditionally or 
unconditionally, any person, security, or transaction, or any class 
of classes of persons, securities, or transaction, from any 
provision or provisions of the Exchange Act or any rule or 
regulation thereunder, to the extent that such exemption is 
necessary or appropriate in the public interest, and is consistent 
with the protection of investors. 15 U.S.C. 78mm.
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VII. Conclusion

    It is hereby ordered that SR-OCC-2015-02 is hereby disapproved 
pursuant to section 19(b)(2) of the Exchange Act;
    It is further ordered that, in accordance with Section 23(a)(3) of 
the Exchange Act, the information for which OCC requested confidential 
treatment will not be kept in a public file because that information is 
confidential commercial and financial information that could be 
withheld from the public under FOIA Exemption 4, 5 U.S.C. 552(b)(4).

    By the Commission.
Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019-02731 Filed 2-19-19; 8:45 am]
 BILLING CODE 8011-01-P