[Federal Register Volume 68, Number 79 (Thursday, April 24, 2003)]
[Notices]
[Pages 20207-20210]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-10153]
[[Page 20207]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-47691; File No. SR-OCC-2002-10]
Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of Proposed Rule Change Relating to Market-Maker
Account Agreements
April 17, 2003.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on May 21, 2002, The Options
Clearing Corporation (``OCC'') filed with the Securities and Exchange
Commission (``Commission'') and on October 18, 2002, amended the
proposed rule change described in Items I, II, and III below, which
items have been prepared primarily by OCC. The Commission is publishing
this notice to solicit comments on the proposed rule change from
interested parties.
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\1\ 15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The proposed rule change will amend OCC's By-Laws and Rules to
eliminate the requirement that a clearing member must obtain a
specified form of account agreement from each market-maker for whom it
carries an account and submit the agreement to OCC for approval. The
proposed rule change will also add two new interpretive statements to
Article VI, Section 3 of OCC's By-Laws to clarify the application of
certain amendments to Article 8 and Article 9 of the Uniform Commercial
Code to OCC clearing accounts and to clarify the application of OCC's
lien on clearing member account positions and clearing member
obligations.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, OCC included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. OCC has prepared summaries, set forth in sections (A),
(B), and (C) below, of the most significant aspects of these
statements.\2\
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\2\ The Commission has modified the text of the summaries
prepared by OCC.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
The purpose of the proposed rule change is to amend Article VI,
Section 3 of OCC's By-Laws and Chapter XI, Rule 1105 of OCC's Rules to
eliminate the requirement that a clearing member must obtain and must
submit to OCC for approval a specified form of account agreement from
each market-maker for whom it carries an account. OCC believes that
such submissions are no longer necessary to perfect its security
interest in clearing members' market-maker accounts under the Uniform
Commercial Code (``UCC'') and are administratively burdensome for OCC
and its clearing members. In order to incorporate the changes to
Article IV, Section 3 into its rules, OCC proposes to make conforming
changes to Rule 1105.
The proposed rule change also includes two interpretive statements.
The first interpretative statement is intended to clarify the
application to OCC clearing accounts of certain UCC amendments to
Article 8 and to Article 9, which were adopted in 1994 and 1995. The
other is intended to clarify that OCC's lien on positions in clearing
member accounts extends to short security futures positions, as well as
all other assets, and that OCC's lien secures clearing member
obligations on long security futures positions, as well as all other
obligations arising from the applicable account or accounts.
1. Background
Article VI, Section 3, of OCC's By-Laws specifies the types of
clearing accounts that a clearing member may have at OCC, including
accounts (referred to collectively herein as ``market-maker accounts'')
in which a clearing member may carry positions of market professionals
such as options market-makers, JBO participants,\3\ and stock
specialists (referred to collectively herein as ``market-makers'').
Clearing members that maintain market-maker accounts at OCC must,
according to the current provisions of Section 3, obtain and submit to
OCC for approval certain agreements from each market-maker whose funds
and positions are included in such market-maker accounts.
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\3\ Under Article I, Section 1 of OCC's By-Laws, a ``JBO
participant'' is a registered broker-dealer that ``(i) maintains a
joint back office arrangement with a clearing member pursuant to the
requirements of Regulation T promulgated by the Board of Governors
of the Federal Reserve System; (ii) meets the requirements
applicable to JBO participants as specified in exchange rules; and
(iii) consents to having his exchange transactions cleared and
positions carried in a JBO participants account.'' Unless the
context requires otherwise, a JBO Participant is a Market-Maker for
purposes of OCC's By-Laws and all of OCC's Rules except for Chapter
IV.
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The principal reason for requiring the filing of these agreements
was to ensure that OCC's security interest in and setoff rights against
long option positions and assets deposited as margin in market-maker
Accounts would be protected under the UCC as it existed prior to the
UCC amendments in the event of a clearing member insolvency. The
contents of the required agreements vary depending upon the type of
market-maker Account. In all cases, however, the agreements provide
that OCC has: (a) A lien on positions and margin in the account as
security for obligations of the clearing member to OCC arising in the
account; (b) the right to net writing and purchase transactions in the
account (i.e., to carry positions ``net''); and (c) the right to close
out positions and apply proceeds without notice. In addition, market-
makers whose assets are carried at OCC in combined accounts with other
market-makers are required to consent to the commingling of their
positions with the positions of other market-makers. Because OCC's lien
on all assets in a combined market-makers' Account covers any
obligation arising from the commingled account, assets attributable to
one market-maker may be used by OCC to offset obligations of the
clearing member that are attributable to the activity of a different
market-maker.
OCC currently requires that a clearing member file with OCC a
specified form of account agreement, executed by the clearing member
and each market-maker included in the account, containing the required
consents for the applicable type of market-maker account. OCC reviews
the agreement and executes the agreement under the caption
``Approved.'' The procedure is cumbersome and imposes administrative
burdens on both clearing members and OCC staff. Moreover, OCC believes
that there may be potential for confusion in the legal relationships
established through these documents. Although the agreements are not
intended to create contractual privity between OCC and the market-
maker, OCC believes it might be possible to misinterpret the agreements
as doing so.
2. Proposed Changes
As a result of the UCC amendments, OCC believes it is no longer
necessary to require clearing members to file market-maker account
agreements with OCC in order to protect OCC's security interest in and
setoff rights against funds and positions in market-maker
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accounts.\4\ The UCC amendments established new rules specifically
tailored to govern the ``indirect holding system'' for securities and
certain other investment property. Under these rules, OCC may obtain an
automatically perfected, first-priority security interest in assets in
market-maker accounts through provisions in OCC's By-Laws or Rules. No
grant of a security interest from the market-maker to OCC is required.
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\4\ OCC did not propose to eliminate the requirement that
clearing members file market-maker account agreements with OCC
immediately after the adoption of the UCC amendments because that
requirement was not inconsistent with the UCC amendments and because
the UCC amendments were not immediately adopted in all U.S.
jurisdictions. Because OCC is expecting an increase in Market-Maker
account openings as a result of security futures trading, it is now
a business priority for OCC to eliminate the requirement in order to
relieve administrative burdens for both OCC and its clearing
members.
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Under the UCC amendments, OCC and its clearing members are
``securities intermediaries,'' \5\ and an OCC-issued option is a
``financial asset.'' \6\ A person acquires a ``security entitlement''
\7\ and becomes an ``entitlement holder'' \8\ when a securities
intermediary credits a financial asset to that person's account.\9\
Thus, OCC's clearing members acquire security entitlements against OCC
when OCC credits positions to the clearing members' accounts.
Similarly, the clearing members' customers (including market-makers)
acquire security entitlements against the clearing member with respect
to positions carried for the accounts of those customers on the books
of the clearing member. In the first case, the clearing member is the
entitlement holder, and OCC is the securities intermediary. In the
second case, the customer (or market-maker) is the entitlement holder,
and the clearing member is the securities intermediary. In this
instance, the customers' security entitlement against the clearing
member is a different item of property from the clearing member's
security entitlement against OCC.\10\
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\5\ UCC 8-102(a)(14).
\6\ UCC 8-102(a)(9)(ii) and 8-103(e).
\7\ UCC 8-102(a)(17).
\8\ UCC 8-102(a)(7).
\9\ UCC 8-501(b)(1).
\10\ Prefatory Note to UCC Article 8, Section III.C. states,
``For purposes of Article 8 analysis, the customer's security
entitlement against the broker or bank custodian is a different item
of property from the security entitlement of the broker or bank
custodian against the clearing corporation.''
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In order for OCC to acquire a perfected security interest in
clearing members' security entitlements, OCC must obtain ``control''
over the entitlements or the ``securities account'' in which they are
held.\11\ UCC 8-106(e) provides that the securities intermediary has
control ``[i]f an interest in a security entitlement is granted by the
entitlement holder to the entitlement holder's own securities
intermediary.'' As proposed, the revised rule would state that the
clearing member (i.e., the entitlement holder) agrees, and represents
that it has obtained the agreement of each market-maker whose positions
and transactions are included in the account and that OCC (i.e., the
securities intermediary) has a lien on long positions and margin in
each market-maker account. Consequently, OCC will have a security
interest perfected by control in the security entitlements in each
market-maker account whether or not it has obtained a signed agreement
from each market-maker.
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\11\ UCC 9-314(a) and 9-106(a).
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Furthermore, OCC's security interest has priority over any
competing interests. ``A security interest in a security entitlement or
a securities account \12\ granted to the debtor's own securities
intermediary has priority over any security interest granted by the
debtor to another secured party.'' \13\
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\12\ UCC 8-501(a) defines ``securities account'' to mean ``an
account to which a financial asset is or may be credited in
accordance with an agreement under which the person maintaining the
account undertakes to treat the person for whom the account is
maintained as entitled to exercise the rights that comprise the
financial asset.'' UCC 9-102(a)(14) defines ``commodity account'' as
an account maintained by a commodity intermediary in which a
commodity contract is carried for a commodity customer.'' Accounts
established under Section 3 of OCC's By-Laws would ordinarily be
``securities accounts,'' but certain accounts might be construed as
commodity accounts or as both securities accounts and commodity
account given that OCC may clear commodity contracts and security
futures as well as security options. In any case, the Article 9
rules governing perfection and priority of security interests in
commodity accounts and assets contained therein are substantively
identical to those governing securities accounts and assets therein
because all are included in the UCC 9-102(a)(49) definition of
``investment property'' to which those rules apply. To the extent
that an account if a ``commodity account,'' OCC will fail within the
definition of a ``commodity intermediary'' under UCC 9-102(a)(17).
\13\ UCC 9-328(3).
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Because it remains the case that as between a clearing member and
its customers (including a market-maker), the clearing member has a
duty to obtain the customer's consent before subjecting the customer's
securities to a security interest or taking certain other actions
potentially affecting the customer's interests,\14\ the proposed rule
continues to require clearing members to contain specified agreements
from market-maker and also to require them to represent to OCC that
such agreements have in fact been obtained. Those clearing members that
choose to continue to use an existing form of market-maker account
agreement will be permitted to do so, but OCC will also permit the
agreement required under Section 3 of Article VI of its By-Laws to be
incorporated into a clearing member's own forms of account agreements
to the extent that the clearing member chooses to do so.
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\14\ See UCC 8-504(b), which states that a securities
intermediary may not grant any security interests in a financial
asset is it obligated to maintain on behalf of an entitlement holder
except as otherwise agreed by the entitlement holder.
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OCC also proposes to add two new items to the Interpretations and
Policies to Article VI, Section 3 of its By-Laws. The first sentence of
proposed Interpretation .02 sets forth a representation and warranty
that the clearing member has obtained the agreement of each person for
whom a transaction is effected in any account of the clearing member at
OCC pursuant to provisions of Section 3, including the security
interest in the account that is granted by the clearing member to OCC,
and that the inclusion of the person's transactions and positions in
that type of account is otherwise permitted by applicable law. This
representation would apply not only to market-maker accounts and JBO
participant accounts \15\ but also to the firm account, pledge
accounts, securities customer accounts, cross-margining accounts, and
segregated futures accounts that are provided for under paragraphs (a)
and (d) through (g) of Section 3, respectively. OCC has never required
that a specified form of agreements be obtained by clearing members
from persons whose transactions are included in these other types of
accounts. Nevertheless, Rule 15c3-3 and the Commission's hypothecation
rules, Rule 8c-1 and Rule 15c2-1, as well as certain state laws require
that certain consents and agreements be obtained, such as consent to
the commingling of a customer's securities with the securities of
another customer. These comments are included in the account
documentation normally obtained by brokers from their customers and are
the responsibility of the broker.
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\15\ Under Article I, Section 1, of OCC's By-Laws a ``JBO
participant account'' means an account established by a clearing
member which is confined to exchange transactions cleared and
positions carried by the clearing member on behalf of JBO
participants for whom the clearing member has filed a JBO
participant account agreement with OCC.
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The final sentence of Interpretation .02 is intended to make clear
that the rights of OCC, including its security interest, in any account
of the clearing member with OCC are enforceable in
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accordance with their terms even if the clearing member fails in its
obligations to obtain required consents or agreements from customers.
This is consistent with the provision of UCC 8-503(e), which provides
that an action based on an entitlement holder's property interest with
respect to a financial asset held for its account by a securities
intermediary, whether framed in conversion, replevin, constructive
trust, equitable lien, or other theory, may not be asserted against any
purchaser of the financial asset or an interest therein (which would
include lien holders) who gives value, obtains control, and does not
act in collusion with the securities intermediary in violating the
securities intermediary's obligations to maintain the property for the
entitlement holder. OCC's security interest is protected under this
provision. \16\
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\16\ See also UCC 8-511(b), which provides that a claim of a
creditor (OCC) of a securities intermediary (the failed clearing
member) that is perfected by control has priority over the claims of
the securities intermediary's entitlement holders.
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The first sentence of proposed Interpretation .03 is intended to
clarify that OCC's lien extends to all assets in the market-maker
accounts and JBO participant accounts. Article VI, Sections 3(b), (c),
and (h) of OCC's By-Laws governs such accounts and uses the same
language to describe OCC's lien's over those assets.\17\ This language
has always been intended and understood to describe the scope of OCC's
lien as extending to all assets in the accounts. ``Long positions''
were specifically referred to in Section 3 because in the case of
options only long positions have asset value. Short option positions
represent only a liability. However, as OCC begins clearing security
futures, it seems prudent to clarify that OCC's lien extends to all
positions that represent an asset in the account, including short
futures positions, which may have asset value if the market has moved
in their favor since the most recent mark-to-market payment. Thus, the
first sentence of proposed Interpretation .03 clarifies that the ``long
positions, securities, margin and other funds'' over which OCC's lien
extends includes any ``investment property,'' as defined in Article 9
of the UCC,\18\ including long and short positions in security futures
as well as any other asset.
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\17\ Article VI, Sections 3(b), (c), and (h) contain language to
indicate that OCC has a lien on all long positions, securities,
margin, and other funds in such accounts.
\18\ UCC 9-102(a)(49) defines ``investment property'' to mean a
``security, whether certified or uncertified, security entitlement,
securities account, commodity contract, or commodity account.''
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The second sentence of proposed Interpretation .03 is also
motivated by security futures, although it more broadly clarifies that
OCC's lien acts as security for all obligations of the clearing member
to OCC with respect to separate or combined market-maker accounts,
customer accounts, or segregated futures accounts. OCC uses similar
language in Sections 3(b), (c), (e), and (f) of Article VI of OCC's By-
laws, which governs such accounts, to indicate that OCC has a lien on
all long positions, margins, and other funds in the market-maker
account with OCC as security for the clearing member's obligations to
OCC in respect of all exchange transactions effected through such an
account, short positions maintained in such an account, and exercise
notices assigned to such an account. When OCC begins clearing security
futures, its lien will also secure the clearing member's obligations
with respect to long security futures positions in the account, which
unlike long options which are always an asset may be a liability if the
market has moved against those positions since the last mark-to-market
payment. In order to avoid any confusion caused by reference to short
positions but not to long positions, the proposed Interpretation .03
clarifies that obligations to OCC with respect to all exchange
transactions should be read broadly to encompass, where applicable,
obligations arising from long or short positions, obligations to make
payments or delivery under cleared contracts, and obligations with
respect to fees and charges associated with such transactions.
OCC has determined to clarify the language in Section 3 through the
addition of Interpretation .03 rather than through an amendment to the
text of Section 3 because OCC wants to avoid any possible inference
that it is making a substantive change from the language that is
Section 3, which language is currently used in outstanding market-maker
account agreements.
Changes to Rule 1105(b) are intended merely to conform to the
changes in Article VI, Section 3. Rather than refer to the market-maker
account agreement, the rule would now refer directly to the applicable
provisions in Article VI, Section 3, of the By-Laws which are required
to be incorporated into an agreement between the clearing member and
the market-maker.
OCC believes the proposed rule change is consistent with the
requirements of Section 17A of the Act \19\ and the rules and
regulations thereunder applicable to OCC because it will promote the
prompt and accurate clearance and settlement of securities
transactions, fosters cooperation and coordination with persons engaged
in the clearance and settlement of securities transactions, remove
impediments to and perfect the mechanism of a national system for the
prompt and accurate clearance and settlement of securities
transactions, and, in general, protect investors and the public
interest.
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\19\ 15 U.S.C. 78q-1.
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(B) Self-Regulatory Organization's Statement on Burden on Competition
OCC does not believe that the proposed rule change would impose any
burden on competition.
(C) Self-Regulatory Organization's Statement on Comments on the
Proposed Rule Change Received From Members, Participants or Others
Written comments were not and are not intended to be solicited with
respect to the proposed rule change, and none have been received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within thirty-five days of the date of publication of this notice
in the Federal Register or within such longer period (i) as the
Commission may designate up to ninety days of such date if it finds
such longer period to be appropriate and publishes its reasons for so
finding or (ii) as to which the self-regulatory organization consents,
the Commission will:
(A) By order approve such proposed rule change or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609.
Comments may also be submitted electronically at the following e-mail
address: [email protected]. All comment letters should refer to File
No. SR-OCC-2002-10. This file number should be included on the subject
line if e-mail is used. Copies of the
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submission, all subsequent amendments, all written statements with
respect to the proposed rule change that are filed with the Commission,
and all written communications relating to the proposed rule change
between the Commission and any person, other than those that may be
withheld from the public in accordance with the provisions of 5 U.S.C.
552, will be available for inspection and copying in the Commission's
Public Reference Section, 450 Fifth Street, NW., Washington, DC 20549.
Copies of such filing also will be available for inspection and copying
at the principal office of OCC. All submissions should refer to File
No. SR-OCC-2002-10 and should be submitted by May 15, 2003.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\20\
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\20\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-10153 Filed 4-23-03; 8:45 am]
BILLING CODE 8010-01-M