Delta Government Options Corp

127 John Street New York N.Y 10038

212 742-0270

Company Act of

tion 17 and Rule

Thomas Harman Esquire Chief Counsel

Division of Investment Management

Securities and Exchange Commission

450 Fifth Street N.W

Washington D.C 20549

RE Delta Government Options Corp Supplementary

NoAction Request to your Reference No 8966-CC

File No 1323

Dear Mr Harman

Counsel to Delta Government Options Corp Delta1

requested by letter dated February 1989 that the staff of the

Division of Investment Management take four noaction positions

with respect to participation by registered investment companies in

Deltas over-the-counter options trading system the No-Action

Request In letter dated July 21 1989 your Reference No

89-66-CC File No 132-3 you declined to take noaction position

on three of the four issues presented and took noaction

position on portion of the fourth issue the No-Action Reply

In subsequent telephone discussion between you and

certain members of your staff and our counsel you suggested that

additional information might be relevant to further consideration

of two of the three issues on which you declined to take

noaction position

Accordingly Delta hereby requests that you consider the

following as supplementary submission with respect to the

No-Action Request The defined terms used in this letter have the

same meaning as set forth in the No-Action Request
Thomas Harman Esquire

August 27 1990

Page

Delta as Securities Depository

The No-Action Request requested that Delta be treated as

securities depository for purposes of Rule 17f-4 under the Act

The No-Action Reply declined to grant such relief on the basis that

it was not apparent that options within the System can be pledged

as required by Rule 17f4

Further to the telephone discussion on the subject Delta

represents to you that options within the System may be pledged

subject to satisfaction of requirements consistent with the

integrity of the System although for the practical reasons

discussed below Delta expects that such pledges will be relatively

infrequent Delta also believes that registered investment

companies would have no conceivable reason to pledge open option

positions

The operating procedures governing the System are set

forth in the Procedures of the Over-the-Counter Options Trading

System the Procedures which have been approved by the

Commission under Section 19b of the 1934 Act and which may not

be amended without such approval The basis upon which

Participant may enter into option transactions on the System and

the Participants rights with respect to transferability of options

on the System are set forth in Section 211 of the Procedures

which provides

Each participant shall effect Option Contracts as

principal for its own account and not on behalf of

customers or other persons No Option Contract

issued by the Issuer i.e Delta shall be

transferred or pledged by Participant except in

accordance with the Procedures or with the prior

written consent of the Issuer the Issuer shall

have no obligation to register any purported

transfer or pledge in violation of this Section

211 and any such purported transfer or pledge

shall be ineffective as against the Issuer

emphasis added

It is plain that the Procedures do not prohibit pledges

and that pledges are contemplated but are subject to appropriate

controls if the pledge is to be recorded in the System in favor of

the pledgee which would give the pledgee rights as Participant

in the System pledge can occur even without such record right

being created At present there are no specific provisions in the

Procedures to govern pledges since such pledges would be likely

only under somewhat unusual and specialized circumstances in which
Thomas Harman Esquire

August 27 1990

Page

both the pledgor and pledgee would be sophisticated institutional

parties with specific needs and objectives relative to the pledge

which would have to be reconciled with the needs and objectives of

the System Delta will develop pledge procedures in which the

pledge will be recognized by the System to be consistent with such

needs and objectives once they have been identified by

participant For example Delta understands that one Participant

which is government securities dealer may want to develop pledge

procedures to support its bank borrowings to finance long hedge

positions The procedures for such pledge would best be worked

out in the context of an actual proposed transaction rather than

as an abstract proposition

Delta believes that under the Procedures as currently

stated it could approve certain types of pledge arrangements which

have no impact on and do not need to be recognized as matter of

record on the System For example in the case noted above if the

dealer granted lender bank the right in the event of default to

require the dealer to exercise or close profitable long option

position and remit proceeds to the bank net of other obligations

to the System Delta believes that it could properly recognize such

instructions at the time of the transaction under the System The

banks interest would not necessarily be perfected however and

might be challenged by third party creditor of the dealer To

differentiate however if the dealer wished to grant an ongoing

perfected record security interest in all of its positions on the

System to the bank number of controls and procedures might have

to be developed to protect the System while serving the commercial

needs of the dealer and bank and in such case an amendment to the

Procedures under Section 19b of the 1934 Act would be warranted

The Staff should take into account that the value of

derivative instruments such as options are seldom realized by

transfer or pledge Options have limited life and are subject to

significant price volatility during that life with price being

driven both by intrinsic values based upon the exercise price and

the price of the underlying security and by the time remaining

until expiration of the option Favorable price movements are

realized by executing closing transactions or in the case of long

option positions the holder may alternatively exercise the option

Short option positions appear to have no asset that could be

pledged since the holder has premium and the obligation to

deliver the underlying security

The central point to be made for purposes of Section

17f of the Act however is that investment companies can pledge

their options under the System subject to appropriate System

safeguards if the pledgees interest is to appear of record on the
Thomas Harman Esquire

August 27 1990

Page

System but it is extremely unlikely if not inconceivable that

they would have occasion to do so As experience with other option

clearing corporations indicates the typical and most economically

efficient way for an investment company to realize value on an

option position is closing transaction or exercise An

investment company would pledge assets only against permitted

borrowings which typically would only be for temporary or

emergency purposes or in some cases for investment leverage In

either case the stable source of the collateral in form suitable

for pledging by an investment company lies in its portfolio

securities Investment companies do not engage in dealer trading

financing and would have no occasion to pledge an option position

Deposit of Margin and Cover

Participant in Deltas System that is registered

investment company will be permitted to deposit margin or cover for

options it writes with Delta by causing the same to be transferred

to an account at such investment companys custodian in an account

in the name of Delta or Deltas clearing bank provided that Delta

or Deltas clearing bank will be permitted to withdraw the

deposited margin or cover only upon the investment companys

default on the option contract The investment company would be

expected to receive excess margin or return of cover daily but

occasionally may not receive the same until the next business day

Staff of the Division of Investment Management have in

the past stated it would not recommend any enforcement action to

the Commission under Section 17f if margin or cover were

deposited in the manner specified in the preceding paragraph or

ii excess margin or cover were temporarily retained overnight or

over weekends in such account Putnam Option Income Trust II pub

avail Sept 23 1985 and supporting letters cited therein

Requested Relief

Based upon the information discussed above Delta

requests your advice that the Division of Investment Management

would not recommend enforcement action under Section 17f of the

Investment Company Act of 1940 as amemded if registered
Thomas Harmari Esquire

August 27 1990

Page

investment companies utilize Delta as securities depository for

purposes of Rule 17f-4 and deposit margin or cover for options

contracts as described herein

Very truly yours

David Maloy

President

DM dro

/SEC-TSH
SEP 19

Our Ref No 90451-CC

Delta Government

RESPONSE OF THE OFFICE OF CHIEF COUNSEL Options Corp

DIVISION OF INVESTMENT MANAGEMENT File No 132-3

Your letter of August 27 1990 requests our assurance that

we would not recommend that the Commission take any enforcement

action if registered investment companies utilize Delta

Government Options Corp Delta as securities depository

under Rule 17f-4 of the Investment Company Act of 1940 1940 Act or deposit margin or cover for options at the

investment companys custodian in an account in Deltas name or

in the name of Deltas clearing bank without violating Section

17f of the 1940 Act

With respect to whether Delta qualifies as securities

depository under Rule 17f-4 we note that 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 You state

that under the systems current procedures Delta believes that

it can approve certain types of pledge arrangements that do not

need to be recognized as matter of record on the system

You further state that Delta will develop pledge procedures that

will be recognized by the system consistent with the needs and

objectives of the system and participants

With respect to the deposit of margin or cover in compliance

with Section 17f you state that registered investment

company will be permitted to deposit margin or cover for options

its writes with Delta by transferring the appropriate amount to

the investment companys custodian held in an account in Deltas

name or in the name of its clearing bank provided that Delta or

its clearing bank will be permitted to withdraw the deposited

Rule l7f4 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 pledged by bookkeeping entry without physical

delivery of securities

21 See Delta Government Options Corp pub avail July 21

1989

In general the operating procedures governing the system

provide that an option contract issued by Delta may be

pledged by participant in accordance with the procedures

or with Deltas prior written consent The Commission

approved the operating procedures governing Deltas system

under Section 19b of the Securities Exchange Act of 1934

The Commission would also have to approve any amendments of

the procedures
margin or cover only upon an investment companys default on an

option contract Further an investment company would be

expected to receive excess margin or return of cover daily but

occasionally not until the next business day jI

On the basis of the facts and representations in your letter

of August 27 1990 and your letter of February 1989 we

would not recommend that the Commission take any enforcement

action under Section 17f of the 1940 Act or Rule 17f-4

thereunder if registered investment companies proceed as

described in your letter of August 27th Because this response

is made on the basis of your facts and representations you

should note that any different facts or representations might

require different conclusion Moreover this response only

expresses the Divisions position on enforcement action and does

not purport to express any legal conclusions on the questions

presented

Carol Peebles

Acting Special Counsel

jI See generally Putnam Option Income Trust II pub avail

Sept 23 1985 overnight retention of excess margin by

funds futures commission merchant does not violate Section

17f of the 1940 Act