GASTON SNOW

COUP4SCU.ORS AT LAW

ONE RDSRAL ITR

BOSTON ASSAvtjrr1S OZ11O-O

tt.CX 380 SAIT011 3N 617/425.400 .4 WAU STSCCT

CAS.E SASOW NCW YOSIL NCW Y0ft 00005

TLtCOPY 5171413-0035

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P5035111 $ZOMA 8005

101 CAO.W0IIiA 8EET 800 P3IICJSCO CA0.I0RNIA 84111

Investaent Cospany Act of

1940 Section .17 and Rule

17f4 thereunder

February 1989

Thomas Rarman Esquire Chief

Division of Investment Management /7

Securities and Exchange Commissio

450 Fifth Street N.W

Washigton D.C 20549 1/L

Dear Mr Harman

As counsel to Delta Government Options Corp Delta we

ask that the staff of the Division of Investment Management

the Staff confirm that it will not recommend enforcement

action to the Securities and Exchange Commission SEC with

respect to the participation of registered investment companies

funds in an overthecounter Options trading system the

System as described in this letter The options traded

through the System will be put and call option contracts issued

by Delta on certain u.s Treasury securities the Options

RMJ Options Trading Corp RMJ provides certain brokerage

services to the System participation in the System will be

limited to persons designated as prisary dealers by the Federal

Reserve Bank of New York and to Veilcapitalized and

experienced brokerdealers coasercial banks insurance

companies and other institutional investors aeeting the

financial and other requiresents established by Delta the

participants

NO-ACTION POSITIOt REQUESTED

Specifically we request the Staffs noaction position

that
GASTON SNOW

Thomas Harman Chief Counsel

February 1989

Page

an openend fund having position in Options issued

by Delta not be required to treat such Options and in

the case of writer of Options the securities or

cash and money market instruments in the case of

put used to cover such Options as illiquid for

purposes of the 10% limitation on investments by an

open_end fund in illiquid securities

Delta be treated as securities depository with

respect to funds position in Options within the

meaning of Rule 17f4 under the Investment Company Act

of 1940 the Act so that maintaining evidence of

funds Option positions in Deltas bookentry system

would not violate Section 17f of the Act

fund writing Options be permitted to deposit the

necessary initial and any additional margin directly

with Security Pacific National Trust Company New York

the Clearing Bank without violating Section 17f

of the Act and

fund its principal underwriter promoter an

affiliated person of such fund or an affiliated

person of such principal underwriter promoter or

affiliated person be permitted to simultaneously enter

Option opening closing and exercise transactions

through the System on blind broker basis without

treating such transactions as affiliated transactions

in violation of Section 17a of the Act provided

that there is no prearrangement between such parties

with respect to price or other variable Option terms

The Staff has indicated that it will no longer respond to

noaction requests on the subject referred to in paragraph

above unless novel or unique requests are presented See e.g PrudentialBache Incomevertible Plus Fund Inc pub avail

November 20 1985 We believe that the issues raised by the

operation of the System with respect to the above matters are

novel and unique The System does not present novel or unique

issues with respect to the question of whether the ongoing

obligation to make margin payments with respect to written

options maybe senior security under Section 18 of the Act

and we assume that the Staffs existing noaction position on

this issue would apply

0450g
GASTON SNOW

Thomas Harman Chief Counsel

February 1989

Page

BACKGROUND

Delta

Delta is newly formed entity which has been registered

with the SEC as clearing agency under the provisions of

Section 17A of the Securities Exchange Act of 1934 the 1934

Act File No 60024 The initial registration is for

period of 36 months which is standard for new clearing agency

registrations The noaction positions requested herein

naturally would only apply while registration under Section

l7A is in effect In addition Delta has registered the public

offering of the Options under the Securities Act of 1933

pursuant to its Registration Statement on Form Si the

Registration Statement File No 33214091 detailed

description of Delta the System and the Options is contained

in the Registration Statement Copies of the Registration

Statement and Deltas application to register as clearing

agency as amended under Section hA of the 1934 Act and the

Commissions order under Section l7A the l7A Order are

attached hereto and incorporated herein by reference Also

enclosed for your information are copies of noaction letters

issued by the Staff to Delta in connection with its clearing

agency application and to RMJ in connection with the applic

ability of certain provisions of the 1934 Act to the System

We have summarized in this letter only the details which we

believe are relevant to the analysis under the Act for purposes

of this noaction letter

The business of Delta will consist of the issuance of put

and call Options the acquisition of matching put and call

Options from Participants and the performance of its obliga

tions under the put and call Options Delta succeeds Security

Pacific National Bank SPNB and subsequently GECC Options

Corporation as the proposed issuer of the Options to be traded

in the System Originally SPNB proposed to act as the issuer

of the Options but due to certain considerations relating to

federal banking law SPNB withdrew from the role of issuer

SPNB had received certain noaction positions from the Staff

relating to the applicability of certain provisions of the 1934

Act See Security Pacific National Bank pub avail May 19

1986 and Security Pacific National Bank pub avail July 12

1985

Delta will act as the nominal issuer of all Options traded

in the System in manner similar to the role performed by the

Options Clearing Corporation the 0CC relating to exchange

traded options Specifically after Participants in the System

0450g
GASTON SNOW

Thomas Harman Chief Counsel

February 1989

Page

agree either directly with each other or through the

brokerage services provided by RMJ on the variable terms of

the Options Delta will interpose itself between the buyer and

seller Delta will act as the issuer of each put or call

Option purchased by Participant and accordingly will be the

party obligated to the holder to perform upon exercise of the

Option For each put or call Option issued by Delta Delta

contemporaneously will purchase from the other Participant in

the transaction an identical offsetting put or call Option as

the case may be so that Deltas short positions are at all

times completely offset by corresponding long positions In

this manner Delta will operate identically to the 0CC in that

it will run matched book and be fully hedged throughout the

life of each Option issued assuming that no Participant

defaults

The Options

Each Option issued by Delta relates to particular under

lying U.S Treasury securities with an aggregate principal

amount of $1 million The maximum term the expiration date

within each month of each such Option and certain of the strike

prices are standardized By standardizing certain Option

terms Delta expects to attract wider range of Participants

and to facilitate the development of more liquid trading

market for the Options in the System The variable terms of

each Option such as the premium the exercise price the

expiration month and the issue of the underlying Treasury

securities identified by maturity and coupon or yield are

negotiated between the selling and purchasing Participants

Each Option is an uncertificated security the issuance of

which is evidenced in an automated book entry system and

recorded by appropriate entries in an account maintained by

Delta for each Participant Each Participant receives daily

report evidencing the Option positions in its account and

providing certain other information relative to its account

The System

Participants may disseminate bid and ask quotations on

Options to one another on an anonymous basis through an auto

mated communications network linking video display terminals in

their respective offices Participants seeking to accept bid

or ask quotation anonymously may communicate readiness to

enter into an Options trade at quoted price by telephone to

RMJ RMJ will act as blind broker for Participants match

ing buying and selling interests in Options As an alternative

0450g
GASTON SNOW

Thomas Harman Chief Counsel

February 1989

Page

to use of RMJ as blind broker Participants are free to

communicate bid and ask quotations directly to each other

This type of communication and trading network is commonly used

for trading among government securities dealers See the 17A

Order at 18

Upon negotiation of an Option transaction the Participants

or RMJ in the case of blindbrokered trade must report the

trade directly to the Clearing Bank in order to clear the trans

action through the System The Clearing Bank will clear and

settle the purchase sale and exercise of Options traded

through the System

Each Participant writing Options will be required to

deposit margin daily to secure its obligations arising under

the Options written by such Participant The amount of margin

required will be calculated by taking into account market

considerations and the amount of the Participants short

positions offset by the amount of the Participants long

positions Additional margin may be requested if deemed

advisable in view of the market price of the Participants

short positions the size of Participants positions its

financial or operational condition or as otherwise necessary to

protect the System Delta or the public The Clearing Bank

will hold all such margin payments for the benefit of Delta

Margin account assets will be invested in overnight repurchase

agreements fully collateralized with Treasury securities with

maturity of not more than 180 days and the return on such

investments minus service fee to the Clearing Bank will be

credited to the Participants account

holder of an Option may exercise the Option by the

submission of timely exercise notice to the Clearing Bank

In addition Participants as holders or writers of Options may

liquidate their positions in offsetting closing transactions

Because holders and writers of Options are not contractually

linked to each other but instead have rights and obligations

running only to Delta the secondary market in Options does not

operate in the same manner as the secondary market in stocks

in that Options are not actually transferred from one holder or

writer to another in closing transaction Instead closing

transactions are placed and executed in the same manner as

initial purchases and sales and as result Delta provides

method for Participants to liquidate their positions which

operates identically to the method utilized by the 0CC

0450g
GASTON SNOW

Thomas Harman Chief Counsel

February 1989

Page

Operation of the System may be suspended or terminated at

any time by Delta or RMJ and may be suspended by the Clearing

Bank However such suspension or termination will not alter

the terms of any outstanding Option unless such alteration is

consented to by the Participants involved

Risks

As the nominal issuer of the Options Delta will be

obligated to perform in the event of default by the writer of

an Option To lessen this credit risk in addition to being

fully hedged Delta will impose trading limits and creditworthi

ness standards on all Participants and may impose position

limits as well As stated above Delta will also impose

initial and additional margin requirements on Options written

and the Clearing Bank will hold margin funds for the benefit of

Delta throughout the entire period between the issuance and the

termination of the Options for which the funds are deposited

The additional margin requirements are designed to ensure that

in the event of default by an Options writer Delta may close

out the position without incurring loss Each Participant

grants lien on any of its assets held by Delta and agrees to

indemnify Delta in the event the Participant defaults but no

Participant is liable for the default of any other Participant

In this respect the System differs from all other SECapproved

clearing systems which provide for some level of contributory

obligation or risk mutualization among system

participants See the 17A Order at 4344

In addition Delta will maintain credit enhancement

facility at all times at least equal to three times its maximum

potential System exposure as described more fully in the

Registration Statement At present the credit facility

consists of $100 million Letter of Credit provided by SPNB

and in the event that the Letter of Credit is exhausted

$100 million Surety Bond with maximum coverage of any

Participant equal to $20 million provided by Capital Markets

Assurance Corporation an indirect whollyowned insurance

subsidiary of Citicorp each of which shall be payable to Delta

in the event of default by one or more Participants on

certain obligations owed to Delta

LEGAL ANALYSIS

Liquidity

Guide 13 of Guidelines to Form NlA states that the usual

limit on aggregate holdings by an openend investment company

045 Og
GASTON SNOW

Thomas Harman Chief Counsel

February 1989

Page

of illiquid assets including debt securities for which there

is no established market is 10% of the value of the funds net

assets In previous noaction requests it has been recognized

that the Staff-views the absence of trading market for overthecounter OTC options on U.S Government securities as

presenting question whether the value of purchased OTC

options and the assets used as covers for written OTC

options are illiquid securities and as such are to be

included in the calculation of funds 10% limitation on

illiquid securities See e.g PrudentialBache Government

Plus Fund II pub avail August 19 1987 The Limited Term

Government Series of Drexel Series Trust pub avail March

1988 We do not believe it is appropriate or consistent with

the intent of Guide 132 to take the position that the Options

to be traded in the System are illiquid or that the value of

the cover for written Options should be included within the

category of illiquid securities for the following reasons

Specifically we believe that the System provides both an

organized and centralized OTC market for the trading of

Options and registered clearing system which is based on

operational principles that have proven quite satisfactory in

analogous securities clearing situations As result the

problems which otherwise plague the trading of OTC options

i.e the lack of an adequate method of valuation and the lack

of any secondary market are eliminated This linked market

will benefit funds that are Participants by creating forum

for the prompt pricing and trading of Options Through the

System bid and ask quotations on the Options may be entered by

Participants for opening and closing transactions simply by

accessing RMJs automated communications network on their video

display terminals and quotations entered by others can be

watched on the terminal and acted upon This aspect of the

call option is considered covered if the fund has in its

portfolio the securities which are the subject of or

deliverable upon exercise of the option put option is

considered covered if the fund maintains in segregated

account cash or high quality liquid securities with value

equal to the value of securities that such fund is

obligated to purchase under the option

No similar policy is app1icableto closedend investment

companies however certain closedend investment companies

may have adopted an analogous investment restriction For

the purpose of such restrictions we also believe such

Options should not be deemed to be illiquid

0450g
GASTON SNOW

Thomas Harman Chief Counsel

February 1989

Page

System is also critically important to funds because it assists

them in properly valuing their Option positions on daily

basis

For example if before call or put Option written by

fund is exercised the writing fund decides that it would be

desirable to terminate the Option because of occurring or

anticipated changes in interest rates the fund could seek to

close out that Option by entering blind bid on the screen

through RMJ to buy an offsetting Option or by privately

seeking another Participant for such transaction Once such

funds closing transaction is matched either through RMJ or by

direct negotiation with another Participant the funds Option

position would be liquidated the fund would not continue to be

obligated on the Option and its margin obligation with respect

to the Option would cease

The risk that the fund would not be able to cancel its

Option position by purchasing an offsetting Option does not

materially differ from the risk that fund would have with

respect to an exchangetraded option In both cases forum

exists to seek party to engage in an offsetting purchase

transaction but there is no assurance that such party will

be available at favorable price or at any price The

secondary market created by the existence of the System and the

standardization of certain terms of the Options will make any

Options written or purchased by fund relatively liquid to the

extent that other Participants are active in the System

As with any options transaction the creditworthiness of

the Participants involved is critical to the integrity of the

Options traded in the System By imposing strict financial

requirements on every Participant3 and requiring each

Participant to meet certain standards of financial responsibil

ity operational capability experience and competence as may

from time to time be prescribed in the procedures governing the

operations of the System Delta as an intermediary in every

transaction intends to reduce the likelihood that

Participant will default on its obligations to Delta However

in the event that Participant should default on its obliga

tions to satisfy the Systems premium or margin requirements

or to make delivery of or payment for the required securities

upon exercise of an Option as the case may be Delta has

Generally speaking $25 million of net capital for dealers

and $500 million of total equity for banks and insurance

companies All Participants will also have to be approved

by the issuers of the credit enhancement facility

0450g
GASTON SNOW

Thomas Barman Chief Counsel

February 1989

Page

established what it believes to be sufficient capital through

the credit enhancement facility to secure the performance of

obligations of defaulting Participant Thus the strict

financial criteria required of all Participants and the

availability of the credit enhancement facility gives Delta

strong credit base and enhances its ability to perform its

obligations to Participants The Commission has determined

for purposes of its criteria under Section 17A of the 1934 Act

that the System is adequately protected against default risk

See the 17A Order at pp 3140 6163

The one remaining risk that threatens the liquidity of the

Options to be traded in the System arises if the System is

suspended or terminated Such result could leave funds

holding Options that cannot be traded although the terms of

outstanding Options would not be altered and such Options could

be exercised according to their terms This risk is comparable

to the risk that an exchange for listed options would suspend

or terminate trading But with proper controls and financial

resources this is not significant risk from the perspective

of the illiquidity analysis Moreover Delta is confident

that in the event of suspension or termination of the System

closing and exercising transactions would still be possible

since the Participants all will be major traders of U.S

Government securities with ongoing trading needs who would

continue to be available as parties to offsetting Option

transactions

The noaction relief requested on liquidity with respect to

any fund is based upon the condition that the directors or

trustees of the fund have been advised of the risks and other

factors relevant to participation in the System and have deter

mined that such participation is in the best interest of the

fund

Custody of the Options

Section 17f of the Act requires that the securities of

management investment company be kept in the custody of

custodian bank member of national securities exchange

or such investment company However Rule 17f4 under the

Act authorizes fund or its custodian to deposit securities

owned by the fund in registered clearing agency which acts as

securities depository Securities depository is defined in

Rule 17f4 as system for the central -handling of securities

where all securities of any particular class or series of any

issuer deposited within the system are treated as fungible and

may be transferred or pledged by bookkeeping entry without

physical delivery of the securities

0450g
GASTON SNOW

Thomas Harman Chief Counsel

February 1989

Page 10

As described above Delta issues Options in uncertificated

form maintains central bookentry records of all Options

issued effects all transfers by bookentry and treats Options

of the same type or series as fungible Consequently we

believe that Delta should be treated as securities depository

for the purpose of Rule 17f4 and that such treatment is

consistent with the intent and purposes of Section 17f and

the Rule The purpose of Section 17f and the Rule is to

protect against risk of loss of the assets of fund and to

facilitate the wadvantages inherentw in the use of depository

or bookentry systems which eliminate the necessity of

physically holding certificate as evidence of ownership of

security Treating Delta as securities depository is

consistent with the intent of Section 17f and the Rule in

that the System adequately protects the deposited securities

against the risk of loss Specifically the safeguards

proposed under the System to protect fund assets are as follows

Delta establishes separate account for each

Participants Options and provides each Participant

with daily position report evidencing the ownership

of its Options

Each Participant must file certified list of

signatures of its representatives who are authorized

to sign on its behalf In addition each Participant

must file all supporting powers of attorney

resolutions or other documents granting such authority

Each Participant must have representative available

at designated office on every business day to take

any and all actions necessary for conducting business

through the System and

Each Participant must provide certified copies of the

power of attorney or investment management agreement

granting authority to such funds investment manager

to act on its behalf

We believe these safeguards are consistent with the

requirements of the Act and with prior SEC positions relating

to the custody of securities that are issued in uncertificated

form Most notably in Institutional Equity Fund pub avail

January 27 1984 the SEC indicatedit would not recommend

enforcement action where stock index put options issued by the

0CC in uncertificated form to fund were maintained in the

bookentry system at the 0CC Accordingly because the service

provided by Delta is very similar if not identical in this

0450g
GASTON SNOW

Thomas Harman Chief Counsel

February 1989

Page 11

respect to the service provided by the 0CC Delta should be

treated as securities depository with respect to the Options

within the meaning of Rule 17f4 and funds should be able to

maintain assets in Deltas bookentry system without violating

Section 17f of the Act

Custody of Margin Deposits

Section 17f of the Act as stated above requires that

the securities and other assets of fund be maintained in the

custody of qualified bank custodian member of national

securities exchange or the fund The Clearing Bank which

holds margin payments for the benefit of Delta to secure the

obligations of writing Participants is an entity authorized

under Section 17f to act as custodian of funds assets

However it is presently contemplated that the Clearing Bank

would expressly hold funds margin payments solely for the

benefit of Delta and not in dual capacity as the funds

subcustodian

When entering Option transactions through the System

fund writing an Option must deposit initial and additional

margin with the Clearing Bank for the benefit of Delta The

initial margin is usually equal to small percentage of the

value of the securities underlying the Option Initial margin

is not borrowing but represents good faith deposit by

fund on the Option it has written securing its performance as

required upon exercise of the Option Subsequent payments

called additional margin are calculated daily over the life of

the Option The daily calculation of additional margin is

based upon the estimated cost to liquidate Participants

written short Option positions less the proceeds from

Participants long purchased Option positions taking into

account reasonably anticipated adverse price changes in the

underlying Treasury securities plus additional economic

factors relevant to the financial condition of the System or

the Participant

Margin requirements that exist in connection with the

writing of Options through the System do not exist for the

benefit of the writing Participant Instead such margin

deposits are essential for the protection of the System Delta

and other Participants in the event that writer of an Option

defaults on its obligations So lohg as the Option has not

expired been exercised or terminated by means of closing

transaction the fund has no right to any assets deposited as

margin except for those assets which may be refunded as

0450g
GASTON SNOW

Thomas Harman Chief Counsel

February 1989

Page 12

result of favorable variation in the value of the Option.4

Because the fund has no right to the assets held as margin

until the Option is exercised terminates or expires such

assets should not be considered fund assets and therefore

should not have to be maintained in the custody of an entity

specified in Section 17f of the Act

Furthermore the fact that fund has right to have

deposited margin refunded under certain circumstances does not

render such margin an asset of the fund Rather funds

interest in the cash or securities used to satisfy its margin

requirement is cut off and replaced by the funds interest in

the Option it has written The right to have deposited margin

refunded is embodied in the Option itself These rights are

governed by the System rules and procedures which are subject

to SEC review and approval under Section l7A of the 1934 Act

Because the Option is maintained in Deltas bookentry system

the Option and the rights arising under it are properly

protected as permitted by Rule 17f4 assuming that the Staff

takes the noaction position requested above with respect to

custody of the Options

This analysis is analogous to the position taken by the

Department of Labor DOL with respect to the assets of

employee benefit plans invested in futures contracts DOL

Opinion No 8249A In its opinion the DOL found that margin

deposits with respect to futures contracts were essential for

the protection of all investors and participants in the

commodity futures market Therefore such margin could not be

considered to be benefit accruing exclusively to an employee

benefit plan nor could it be considered plan asset The DOL

analysis is economically accurate and we recommend its

adoption by the Staff for this particular request

Finally the margin is held accounted for invested and

returned to Participants when appropriate by the Clearing

Bank which is national bank subject to regulation by the

Office of the Conptrol.er of the Currency and subject to

Such assets are returned plus any other amounts owed to

the Participant such as premiums for Options written or

exercise sale proceeds net of other liabilities of the

fund to Delta such as premiums or service fees owed on

the next business day which is consistent with the Staffs

noaction position taken in Putnam Option Income Trust II

pub avail September 23 1985 daily net settlement

system of this type is efficient and typical for

contemporary clearing systems

045 Og
GASTON SNOW

Thomas flarrnan Chief Counsel

February 1989

Page 13

indirect SEC control through its contractual relationship with

Delta as facilities manager for registered clearing agency

See the 17A Order at pp 2528

We are familiar with the staffs noaction position

expressed in the -Putnam letter cited above and in series of

other similar noaction letters These letters conclude in

essence that initial margin for listed options and futures

transactions is fund asset which must be held by the funds

custodian but in the name of and subject to the right of the

broker or futures commission merchant to reach the initial

margin upon default by the fund These letters also

contemplate that variation margin may be paid to and held by

the broker or futures commission merchant since such payments

represent money actually owed by the Fund to such broker or

futures commission merchant We believe however that the

situation presented in this letter has important factual

distinctions which are described below Even if the Staff does

not agree with our conclusion that funds margin payments are

not fund assets we believe that the purposes of Section 17f

of the Act will be entirely served if the Clearing Bank is

permitted to hold the margin payments

In the traditional margin situation described in the Putnam

letter the alternative to retention by the fund custodian

would have been to have the broker or futures commission

merchant hold the margin Considering that many of these

entities may have relatively low capitalization and are exposed

to significant market and trading risks as well as to

extensive obligations for the financial protection of the

relevant clearing corporation i.e risk mutualization as

noted above the risk of loss of funds margin payments made

use of the funds custodian bank the clearly preferable

alternative In the case of the System however the fund will

be the direct participant without interposition of broker

and the holder of the margin assets will be an experienced

national bank and trust company which is qualified to serve as

fund custodian Furthermore the funds which will be

Participants in the System will be responsible only for their

own obligations unlike brokers or futures commission merchants

participating directly in other clearing systems which are

liable for obligations of the clearing system This direct

participation adds another component of risk that such

participants could become insolvent and the funds would be

unable to recover their margin deposits Deltas ability to

perform its obligations in the event of default as noted

above is supported by the credit enhancement facility rather

than by the credit of its Participants The funds margin

045 Og
GASTON SNOW

Thomas Harman Chief Counsel

February 1989

Page 14

account in the System would be as safe and well protected as

the interests of the funds in the Putnam and other noaction

letters referred to above

We therefore would request the Staffs noaction position

permitting the Clearing Bank to have custody of margin payments

as described herein even if the Staff views the initial or

additional margin as an asset of the fund

Affiliated Transactions Under Section 17a

Section 17a of the Act generally prohibits any affiliated

person or promoter of or principal underwriter for an investment

company or any affiliated person of such person promoter or

principal underwriter acting as principal from knowingly

purchasing from or selling to such investment company securities

or other property This section was included in the Act largely

to protect shareholders from the potential abuses inherent in an

investment companys purchase or sale transaction with party

who has both the ability and the pecuniary incentive to

influence the actions of the investment company Hearings on

S.3580 Before Subcomrn of the Senate Comm on Banking and

Currency 76th Cong 3d Sess 17 1940 To the extent that

fund and its principal underwriter an affiliated person of

the fund and/or an affiliated person of such principal under

writer or affiliated person are each Participants in the

System it might well be argued that the fund could not directly

negotiate transaction in Options traded in the System with

any such affiliate without violating Section 17a of the Act

notwithstanding the interpositioning of Delta as the contra

party to each Participant since the price and other terms

would have been established by the Participants However in

situations where RMJ serves as blind broker for Options

traded in the System and the fund and the affiliated person

independently enter bona fide quotations through RMJ with no

prearrangement as to price or other Option terms it would not

be possible for any of the abovementioned persons to knowingly

buy from or sell Options on basis that offends the policy

underlying Section 17a of the Act

As stated above Delta is the contraparty to each

Participant For each Option issued by Delta Delta

contemporaneously will purchase from writing Participant

matching Option Although Participnts -could be matched by

Delta with an affiliated fund or other affiliated person that

happened to be seeking quotations simultaneously through RMJ

such transactions are matched not for the purpose of estab

lishing permanent parties to the transaction but rather as

0450g
GASTON SNOW

Thomas Harman Chief Counsel

February 1989

Page 15

means of relieving Delta of risk by allowing it to purchase an

offsetting Option for every Option it issues Similarly in

instances where Participant exercises an Option Delta would

exercise the corresponding open Option position whether or not

the writer of that Option has any affiliation with the exercis

ing Participant If there is more than one corresponding open

Option position Delta may in turn exercise matching Option

on random basis from third party that may also be affiliated

with the exercising Participant Moreover if the purchaser or

writer of an Option decides to enter into closing transaction

such transaction may be matched by Delta with third party that

also could be an affiliated person Because Delta will inter

pose itself in each transaction Participants executing trades

will be in privity of contract solely with Delta and may look

only to Delta to perform the obligations arising under the terms

of an Option Thus there is technically no transaction in

violation of Section 17a Provided that all such trans

actions in Options traded through the System are entered without

prearrangement and consummated on blind broker basis the

policy behind Section 17a will not be violated In all of the

foregoing examples an affiliated party will not be in

position to influence the actions of fund Participant because

such affiliated party will not know the identity of the other

party to the transaction Therefore such transactions should

not be deemed to be affiliated transactions in violation of

Section 17a of the Act

We also believe that investment companies dealing with

other affiliated investment companies participating in the

System would not violate Section 17a if they deal directly

with each other pursuant to the guidelines of Rule l7a7 under

the Act or through RMJ as described above

We therefore respectfully request that the Staff confirm

that it will not recommend enforcement action to the SEC with

respect to the matters discussed above under NoAction

Position Requested

If further clarification or amplification of any of the

facts or issues discussed in this letter is required please

contact the undersigned or Michael Richman of this office

You may also wish to confer with Jonathan Kallman Esq of the

Division of Market Regulation who 1.s quite familiar with the

0450g
GASTON SNOW

Thomas Harman Chief Counsel

February 1989

Page 16

System Deltas registration under Section hA of the 1934 Act

and the noaction letters on issues under the 1934 Act referred

to above

PLC/h rb

Enclosures

cc Jonathan Kahlman Esq

Division of Market Regulation

Very

0450g
J1JL217989

Our Ref No 89-66-CC

Delta Government

RESPONSE OF THE OFFICE OF CHIEF COUNSEL Options Corp

DIVISION OF INVESTMENT MANAGEMENT File No 132-3

Your letter of February 1989 requests our assurance that

we would not recommend that the Commission take any enforcement

action under the Investment Company Act of 1940 1940 Act if

registered investment companies participate in an overthe

counter options trading system System in the manner

described in your letter .2/ You specifically request that

fund having position in options issued by Delta

registered clearing agency not be required to include such

options and in the case of writer of options the

securities or cash and money market instruments in the case

of put used to cover such options in the ten percent

limitation on investments by an open-end fund in illiquid

securities

Delta be treated as securities depository within the

meaning of Rule 17f-4 under the 1940 Act with respect to

funds position in options so that maintaining evidence of

funds option positions in Deltas bookentry system would

not violate Section 17f of the 1940 Act

fund writing options be permitted to deposit the

necessary initial and any additional margin directly with

Security Pacific National Trust Company the Clearing

Bank without violating Section 17f of the 1940 Act and

fund its principal underwriter promoter an

affiliated person of such fund or an affiliated person of

such principal underwriter promoter or affiliated person

be permitted to simultaneously enter option opening closing

and exercise transactions through the System on blind

broker basis without treating such transactions as

affiliated transactions in violation of Section 17a of the

1940 Act

First you believe that it is appropriate and consistent

with the intent of Guide 13 of the Guidelines to Form N-lA to

The options traded through the System will be put and call

option contracts issued by Delta Government Options Corp Delta on certain U.S Treasury securities

2/ As your letter states certain closedend investment

companies may have adopted analogous investment

restrictions

1/ Guide 13 to Form N-lA the registration form for open-end

continued..
take the position that the options in the System are liquid and

that the value of purchased options as veil as the assets used as

cover for written options should not be included within the

category of illiquid securities We cannot agree While the

System provides forum for the trading of options on U.S

Treasury securities on the basis of the facts in your letter we

are unable to conclude that such forum is either established

or provides liquid market Indeed you state that the

secondary market created by the System and the standardization of

certain option terms will make options written or purchased by

fund relatively liquid to the extent that other Participants are

active in the System

Second you believe that Delta should be treated as

securities depository for the purpose of Rule t7f-4 under the

194 Act and that such treatment is consistent with the intent of

Section 17f and the Rule if As support for this you cite

Institutional Equity Fund pub avail Feb 27 1984 and

assert that Deltas bookentry system is very similar if not

identical to the OCCs system We cannot agree While your

letter states that Delta issues options in uncertificated form

maintains central bookentry records of all options issued

effects all transfers by book-entry and treats options of the

.continued

investment companies in relevant part states the staffs

position that the usual limit on aggregate holdings by

openend companies of illiquid assets including debt

securities for which there is no established market is 10

percent of the value of its net assets emphasis added

In Investment Company Act Rel No 7221 June 1972 the

staff included restricted securities interests in real

estate and commodities futures contracts as other

investments to be considered when determining the ten

percent limitation on illiquid investments See generally

Investment Company Act Rel No 5847 Oct 21 1969

Commission sets forth the ten percent limitation on

restricted securities and other assets not having readily

available market quotations

4/ Rule 17f-4 defines securities depository as system for

the central handling of securities where all securities of

any particular class or series of any issuer deposited

within the system are treated as fungible and may be

transferred or pledaed by bookkeeping entry without physical

delivery of securities emphasis added

In Institutional Equity the staff granted no-action relief

to fund to permit its bank custodian to maintain stock

index put options owned by the fund at the Options Clearing

Corp 0CC through clearing member of the 0CC
same type or series as fungible your letter does not state that

options within the System can be pledged as required by paragraph

of the Rule

Third we are unable to agree that funds margin payments

are not assets of fund and thus need not be maintained in

manner that complies with Section 17f Nor can we agree

with your alternative assertion that the purposes of Section

17f of the 1940 Act will be entirely served if the Clearing

Bank is permitted to hold the margin payments Particularly we

note that your letter does not state in whose name the margin

payments would be held j. Deltas or funds or if held in

funds name under what circumstances Delta would have access

to such payments

Finally we would not recommend that the Commission take any

enforcement action under Section 17a of the 1940 Act in

situations where RNJ Options Trading Corp RNJ registered

brokerdealer serves as blind broker as described in your

letter for options traded in the System provided the fund and

any affiliated person independently enter bona fide quotations

through RNJ with no pre-arrangement as to price or other option

terms Because this response is based on the facts and

representations made in your letter you should note that any

Institutional Equity Fund letter where counsel

represented that the 0CC can effect the transfer or pledge

of stock index options by book-entry

21 g.g Putnam Option Income Trust II pub avail Sept

23 1985

However on the basis of the facts provided in your letter

we are unable to agree with your belief that investment

companies may rely on Rule 17a-7 under the 1940 Act For

example paragraph of the Rule prevents an investment

company from relying on the Rule with respect to

transactions in securities for which market quotations are

not readily available See Investment Company Act Rel No

11676 March 10 1981 adopting amendments to Rule 17a7

Moreover subparagraphs -3 do not appear to apply

to the System and it is not clear to us that investment

companies would be able to satisfy subparagraph of

Rule 17a-7 Subparagraph contemplates that fund

would solicit from disinterested third parties

sufficient number of bid and offer prices for the options to

be purchased or sold to allow the current market price to

approximate the actual value of the option in the secondary

market See Principal Preservation Tax-Exempt Fund Inc

Principal Preservation TaxExempt Portfolios Inc pub avail Dec 1986
different facts or conditions may require different conclusion

Further this response only expresses the Divisions position on

enforcement action and does not purport to express any legal

conclusions on the questions presented

coJ_p PUi

Carol Peebles

Attorney