61884 Federal Register / Vol. 69, No. 203 / Thursday, October 21, 2004 / Notices 

12 17 CFR 200.30–3(a)(12).

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

3Reference to subparagraph (b)(3)(viii) as 

unchanged was added pursuant to telephone 

conversion between Gary Goldsholle, Office of 

General counsel, Regulatory Policy and Oversight, 

NASD, and Ira Brandriss, Division of Market 

Regulation, Commission, on October 14, 2004.

4See Securities Exchange Act Release No. 47307 

(February 3, 2003), 68 FR 6977 (February 11, 2003) 

(SR–NASD–2002–134); Securities Exchange Act 

Release No. 40932 (Jan 11, 1999), 64 FR 2930 

(January 19, 1999) (SR–NASD –98–92); Securities 

Exchange Act Release No. 40087 (June 12, 1998), 63 

FR 33746 (June 19, 1998), (SR–NASD –98–23); 

Securities Exchange Act Release No. 39771 (March 

19, 1998), 63 FR 14743 (March 26, 1998) (SR–NASD 

–98–15).

2004–33 and should be submitted on or 

before November 12, 2004.

For the Commission, by the Division of 

Market Regulation, pursuant to delegated 

authority. 12

Margaret H. McFarland, 

Deputy Secretary.

[FR Doc. E4–2739 Filed 10–20–04; 8:45 am] 

BILLING CODE 8010–01–P

SECURITIES AND EXCHANGE 

COMMISSION 

[Release No. 34–50539; File No. SR–NASD–

2004–153] 

Self-Regulatory Organizations; Notice 

of Filing of Proposed Rule Change by 

National Association of Securities 

Dealers, Inc. Relating to a Conditional 

Exemption From Stock Option Position 

Limits for OTC Derivatives Dealers 

October 14, 2004. 

Pursuant to section 19(b)(1) of the 

Securities Act of 1934 (‘‘Act’’) 1 and 

Rule 19b–4 thereunder,2 notice is 

hereby given that on October 12, 2004, 

the National Association of Securities 

Dealers, Inc. (‘‘NASD’’) filed with the 

Securities and Exchange Commission 

(‘‘Commission’’) the proposed rule 

change as described in items I, II, and 

III below, which items have been 

prepared by NASD. The Commission is 

publishing this notice to solicit 

comments on the proposed rule change 

from interested persons.

I. Self-Regulatory Organization’s 

Statement of the Terms of Substance of 

the Proposed Rule Change 

NASD is proposed to amend NASD 

Rule 2860 to provide an exemption from 

stock options position limits for OTC 

Derivatives Dealers provided that 

certain conditions have been satisfied. 

Below is the text of the proposed rule 

change. Proposed new language is in 

italics; proposed deletions are in 

brackets.

* * * * *

2800. SPECIAL PRODUCTS

* * * * *

2860. Options

(a) No Change. 

(b) Requirements

(1) No Change. 

(2) Definitions

(A) through (Q) No Change. 

(R) Delta Neutral—The term ‘‘delta 

neutral’’ described a stock options 

position that has been hedged, in 

accordance with an SEC-approved 

pricing model, with a portfolio of 

instruments relating to the same 

underlying stock to offset the risk that 

the value of the options position will 

change with changes in the price of the 

stock underlying the options position.

Current (R) through (FF) Renumbered 

as (S) through (GG). 

(HH) Net Delta—The term ‘‘net delta’’

means the number of shares that must 

be maintained (either long or short) to 

offset the risk that the value of a stock 

options position will change with 

changes in the price of the stock 

underlying the options position.

Current (GG) through (BBB) 

Renumbered as (II) through (DDD). 

(3) Position Limits

(A) Stock Options—Except in highly 

unusual circumstances, and with the 

prior written approval of NASD 

pursuant to the Rule 9600 Series for 

good cause shown in each instance, no 

member shall effect for any account in 

which such member has an interest, or 

for the account of any partner, officer, 

director or employee thereof, or for the 

account of any customer, non-member 

broker, or non-member dealer, an 

opening transaction through Nasdaq, the 

over-the-counter market or on any 

exchange in a stock option contract of 

any class of stock options if the member 

has reason to believe that as a result of 

such transaction the member or partner, 

officer, director or employee thereof, or 

customer, non-member broker, or nonmember dealer, would, acting along or 

in concert with others, directly or 

indirectly, hold or control or be 

obligated in respect of an aggregate 

equity options position in excess of:

(i) through (vi) No Change. 

(vii) Equity Options Hedge 

Exemptions 

a. No Change. 

b. Delta Hedging Exemption for OTC 

Derivatives Dealer A stock options 

position of an OTC Derivatives Dealer 

(as that term is defined in Rule 3b–12 

under the Act) affiliated with a member, 

in standardized or conventional options 

that is delta neutral, shall be exempt 

from position limits under this rule if 

the following conditions are satisfied:

1. The member has obtained a written 

representation from its affiliated OTC 

Derivatives Dealer that such entity is 

hedging its stock options positions in 

accordance with its internal risk 

management control systems and 

pricing models approved by the SEC 

pursuant to Rules 15c3–1(a)(5) and 

15c3–1f under the Act and that if it 

ceases to hedge stock options positions 

in accordance with such systems and 

models, that it will provide immediate 

written notice to the member.

2. The member must report in 

accordance with the paragraph (b)(5), 

all stock options positions (including 

those that are delta neutral) of 200 or 

more contracts (whether long or short) 

on the same side of the market covering 

the same underlying stock that are 

effected by the member.

3. Any stock options position of an 

OTC Derivatives Dealer that is not delta 

neutral shall be subject to position 

limits in accordance with this section 

(subject, however, to the availability of 

other exemptions). For these purpose, 

only the option contract equivalent of 

the net delta of such positions is subject 

to position limits. The options contract 

equivalent of the net delta is the net 

delta divided by 100.

(viii) No change.3

(B) through (D) No Change. 

(4) through (24) No Change.

* * * * *

II. Self-Regulatory Organization’s 

Statement of the Purpose of, and 

statutory Basis for, the Proposed Rule 

Change 

In its filing with the Commission, 

NASD included statements concerning 

the purpose of, and basis for, the 

proposed rule change and discussed any 

comments it had received on the 

proposed rule change. The text of these 

statements may be examined at the 

places specified in Item IV below. 

NASD has prepared summaries, set 

forth in sections A, B, and C below, of 

the most significant aspects of such 

statements. 

A. Self-Regulatory Organization’s 

Statement of the Purpose of, and 

Statutory Basis for, the Proposed Rule 

Change 

1. Purpose 

Over the past several years, NASD has 

increased in absolute terms the size of 

the options position and exercise limits 

as well as the size and scope of available 

exemptions for ‘‘hedged’’ positions.4

These increases, however, have 

generally required a one-to-one hedge 

(e.g., one stock option contract must be 

Federal Register / Vol. 69, No. 203 / Thursday, October 21, 2004 / Notices 61885

5For example, an option with a delta of .5 will 

move $0.50 for every $1.00 move in the underlying 

stock.

6Securities Exchange Act Release No. 40594 (Oct. 

23, 1998), 63 FR 59362 (Nov. 3, 1998) (SEC File No. 

S7–30–97) (‘‘OTC Derivatives Dealer release’’).

7 17 CFR 240.15a–1.

8OTC Derivatives Dealer release, supra note 6, at 

63 FR 59380.

9 Id.

10The proposed rule change does not expressly 

amend NASD’s options exercise limits in NASD 

Rule 2860(b)(4) because such exercise limits apply 

only to the extent NASD Rule 2860(b)(3) imposes 

position limits. Thus, as delta neutral positions of 

an OTC Derivatives Dealer would be exempt from 

position limits under the proposed rule change, 

such positions also would be exempt from exercise 

limits. See NASD Notice to Members 94–46 at 2 

(‘‘* * * exercise limits correspond to position 

limits, such that investors in options classes on the 

same side of the market are allowed to exercise 

* * * only the number of options contracts set 

forth as the applicable position limit for those 

options classes.’’). Similarly, for positions held by 

an OTC Derivatives Dealer that are not delta 

neutral, only the option contract equivalent of the 

net delta of such positions would be subject to 

exercise limits. 11 15 U.S.C. 78o–3(b)(6).

hedged by one-hundred shares of stock). 

In practice, however, many firms and 

customers do not hedge their options 

positions in this way. Rather, these 

firms engage in what is known as ‘‘delta 

hedging,’’ which varies the number of 

shares of stock used to hedge an options 

position based upon the relative 

sensitivity of the value of the option 

contract to a change in the price of the 

underlying stock.5 Delta hedging is a 

widely accepted risk management tool.

In 1998, the Commission approved 

rules allowing U.S. securities firms to 

establish a separately capitalized entity 

to engage in dealer activities in eligible 

over-the-counter (‘‘OTC’’) derivative 

instruments.6 This separately 

capitalized entity, known as an OTC 

Derivatives Dealer, receives preferential 

capital treatment and is exempt from 

self-regulatory organization (‘‘SRO’’) 

membership. In general, however, most 

transactions of an OTC Derivatives 

Dealer (including stock options 

transactions) must be effected through 

its fully regulated broker-dealer affiliate, 

except to the extent otherwise permitted 

by Rule 15a–1 under the Act.7 Thus, 

SRO rules, including stock, options 

position and exercise limits, continue to 

apply to transactions where a member 

must effect the transaction between the 

OTC Derivatives Dealer and the 

counterparty. As a consequence, the 

application of these position and 

exercise limits often deters parties from 

entering into transactions they 

otherwise would seek to conduct with 

an OTC Derivatives Dealer in the 

absence of such limits. Indeed, the 

Commission recognized this issue at the 

time it approved rules applicable to 

OTC Derivatives Dealers.8 Specifically, 

the Commission encouraged NASD to 

revise its rules to recognize as ‘‘hedged’’

those option positions of an OTC 

Derivatives Dealer that are hedged on a 

‘‘delta neutral basis’’ (i.e., the position is 

delta neutral or fully hedged with regard 

to the risk that the price of the stock 

underlying the options position might 

change).9

In June 2003, NASD received a 

request on behalf of several member 

firms affiliated with OTC Derivatives 

Dealers to amend its rule imposing stock 

options position and exercise limits so 

that it applied only to a stock options 

position’s net delta.10

NASD believes that the rigor of the 

OTC Derivatives Dealer approval 

process and the ongoing oversight by 

the Commission staff provides an 

appropriate basis for exempting delta 

neutral positions in stock options at 

such entities from position limits. The 

proposed rule change would exempt 

from NASD Rule 2860 delta neutral 

stock options positions of an OTC 

Derivatives Dealer and would provide 

that only the option contract equivalent 

of the net delta of a stock options 

position is subject to position limits 

provided that the member satisfies three 

conditions. 

The first condition would require a 

member to receive a written 

representation from its affiliated OTC 

Derivatives Dealer stating that the OTC 

Derivatives Dealer is hedging its stock 

options positions in accordance with 

risk management and pricing models 

approved by the Commission. This 

written representation would enable 

NASD to identify those firms that will 

be relying on the delta hedging 

exemption on behalf of their OTC 

Derivatives Dealer affiliates and would 

be required to be maintained in 

accordance with the recordkeeping 

provisions of NASD Rule 3110. 

The second condition would require 

that the member must report stock 

options positions of the OTC Derivatives 

Dealer, including those that are delta 

neutral, in accordance with NASD Rule 

2860(b)(5). These reports would inform 

NASD of the OTC Derivatives Dealer’s 

aggregate stock options positions and 

permit NASD to conduct surveillance 

for market manipulation, insider 

trading, and other trading abuses. 

The third condition would provide 

that any stock options position that is 

not delta neutral must remain subject to 

position and, by extension, exercise 

limits (subject, however, to the 

availability of other exemptions). An 

OTC Derivatives Dealer generally 

employs delta hedging as part of its risk 

management program, but it is 

nevertheless possible that an OTC 

Derivatives Dealer may maintain some 

positions that are not fully hedged, so 

long as the entity as a whole meets the 

conditions imposed by the Commission. 

In such cases, only the option contract 

equivalent of the ‘‘net delta’’ of any such 

stock options positions, which is the net 

delta divided by 100, would be subject 

to position limits. This calculation of an 

options contract equivalent conforms to 

existing NASD Rule 2860(b)(2)(JJ), 

which provides that, for purposes of 

subparagraphs (3) through (12) of NASD 

Rule 2860(b), a stock option overlying 

more or less than 100 shares ‘‘shall be 

deemed to constitute as many option 

contracts as that other number of shares 

divided by 100 (e.g., an option to buy 

or sell five hundred shares of common 

stocks shall be considered as five option 

contracts).’’

It is important to note that, for 

purposes of the proposed rule change, 

only financial instruments relating to 

the stock underlying a stock options 

position could be included in any 

determination of a stock options 

position’s net delta or whether the stock 

options position is delta neutral. For 

example, warrants granting the right to 

purchase Microsoft stock might be used 

to offset the risk associated with a 

position in Microsoft puts granting the 

holder the right to sell Microsoft stock. 

However, for purposes of the proposed 

rule change, a position in Microsoft 

calls granting the holder the right to 

purchase Microsoft stock may not be 

hedged by puts (or any other financial 

instrument) overlying any security other 

than Microsoft stock. 

NASD will announce the effective 

date of the proposed rule change in a 

Notice to Members to be published no 

later than 60 days following 

Commission approval. The effective 

date will be no later than 30 days 

following publication of the Notice to 

Members announcing Commission 

approval. 

2. Statutory Basis 

NASD believes that the proposed rule 

change is consistent with the provisions 

of section 15A(b)(6) of the Act,11 which 

requires, among other things, that NASD 

rules must be designed to prevent 

fraudulent and manipulative acts and 

practices, to promote just and equitable 

principles of trade, and, in general, to 

protect investors and the public interest. 

NASD believes that it is appropriate, 

subject to certain conditions, to exempt 

stock options positions of OTC 

61886 Federal Register / Vol. 69, No. 203 / Thursday, October 21, 2004 / Notices 

12OTC Derivatives Dealer release, supra note 6, 

at 63 FR 59380.

13 17 CFR 200.30–3(a)(12).

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

3See letter from Edward Knight, Executive Vice 

President, Nasdaq, to Katherine England, Assistant 

Director, Division of Market Regulation 

(‘‘Division’’), Commission, dated September 29, 

2004 (‘‘Amendment No. 1’’). In Amendment No. 1, 

Nasdaq clarified the description of the proposed 

rule change and provided rationale for its request 

to waive the 30-day operative delay for the 

proposed rule change.

4See Amendment No. 1, note 3 supra.

5The proposed rule change is marked to show 

changes from the rule as it appears in the electronic 

NASD Manual available at http://www.nasdr.com as 

well as SR–NASD–2004–76 filed on an immediately 

effective basis on May 5, 2004. See Securities 

Exchange Act Release No. 50074 (July 23, 2004), 69 

FR 45866 (July 30, 2004).

Derivatives Dealers from position limits 

and require that only the option contract 

equivalent of the net delta of a stock 

options position be subject to position 

limits. Moreover, NASD’s proposed rule 

change would implement an approach 

that the Commission encouraged NASD 

to adopt at the time the Commission 

approved the regulatory model for OTC 

Derivatives Dealers.12

B. Self-Regulatory Organization’s 

Statement on Burden on Competition 

NASD does not believe that the 

proposed rule change could result in 

any burden on competition that is not 

necessary or appropriate in furtherance 

of the purposes of the Act, as amended. 

C. Self-Regulatory Organization’s 

Statement on Comments on the 

Proposed Rule Change Received From 

Members, Participants, or Others 

Written comments were neither 

solicited nor received. 

III. Date of Effectiveness of the 

Proposed Rule Change and Timing for 

Commission Action 

Within 35 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 

90 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 NASD 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. 

Comments may be submitted by any of 

the following methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/

rules/sro.shtml); or 

• Send an e-mail to rulecomments@sec.gov. Please include File 

Number SR–NASD–2004–153 on the 

subject line. 

Paper Comments 

• Send paper comments in triplicate 

to Jonathan G. Katz, Secretary, 

Securities and Exchange Commission, 

450 Fifth Street, NW., Washington, DC 

20549–0609. 

All submissions should refer to File 

Number SR–NASD–2004–153. This file 

number should be included on the 

subject line if e-mail is used. To help the 

Commission process and review your 

comments more efficiently, please use 

only one method. The Commission will 

post all comments on the Commission’s 

Internet Web site (http://www.sec.gov/

rules/sro.shtml). Copies of the 

submission, all subsequent 

amendments, all written statements 

with respect to the proposed rule 

change that are filed with the 

Commission, and all written 

communications relating to the 

proposed rule change between the 

Commission and any person, other than 

those that may be withheld from the 

public in accordance with the 

provisions of 5 U.S.C. 552, will be 

available for inspection and copying in 

the Commission’s Public Reference 

Section, 450 Fifth Street, NW., 

Washington, DC 20549. Copies of such 

filing also will be available for 

inspection and copying at the principal 

office of NASD. All comments received 

will be posted without change; the 

Commission does not edit personal 

identifying information from 

submissions. You should submit only 

information that you wish to make 

publicly available. All submissions 

should refer to File Number SR–NASD–

2004–153 and should be submitted on 

or before November 12, 2004.

For the Commission, by the Division of 

Market Regulation, pursuant to delegated 

authority.13

Margaret H. McFarland, 

Deputy Secretary.

[FR Doc. 04–23558 Filed 10–20–04; 8:45 am] 

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE 

COMMISSION 

[Release No. 34–50537; File No. SR–NASD–

2004–143] 

Self-Regulatory Organizations; Notice 

of Filing and Immediate Effectiveness 

of Proposed Rule Change, and 

Amendment No. 1 thereto, by National 

Association of Securities Dealers, Inc. 

Relating to Attributable Summary 

Orders in the Nasdaq Market Center 

October 14, 2004. 

Pursuant to section 19(b)(1) of the 

Securities Exchange Act of 1934 

(‘‘Act’’),1 and Rule 19b–4 thereunder,2

notice is hereby given that on 

September 24, 2004, the National 

Association of Securities Dealers, Inc. 

(‘‘NASD’’), through its subsidiary, The 

Nasdaq Stock Market, Inc. (‘‘Nasdaq’’), 

filed with the Securities and Exchange 

Commission (‘‘Commission’’) the 

proposed rule change as described in 

items I, II, and III below, which items 

have been prepared by Nasdaq. On 

October 4, 2004, Nasdaq filed 

Amendment No. 1 to the proposed rule 

change.3 The Commission is publishing 

this notice to solicit comments on the 

proposed rule change from interested 

persons.

I. Self-Regulatory Organization’s 

Statement of the Terms of the Substance 

of the Proposed Rule Change 

Nasdaq is filing a proposed rule 

change with the Commission to provide 

Order Delivery electronic 

communication networks (‘‘ECNs’’) in 

the Nasdaq Market Center the ability to 

enter attributable Summary Orders—an 

order type that rejects back to the 

entering party if the order would lock or 

cross the best bid or best offer displayed 

in the Nasdaq Market Center.4 The text 

of the proposed rule change is below. 

Proposed deletions are in brackets.5

* * * * *

4700. Nasdaq Market Center—

Execution Services 

4701. Definitions 

Unless stated otherwise, the terms 

described below shall have the 

following meaning: 

(a)—(nn) No Change. 

(oo) The term ‘‘Summary’’ shall mean, 

for priced limit orders so designated, 

that if an order is marketable upon 

receipt by the Nasdaq Market Center, it 

shall be rejected and returned to the 

entering party. Summary Orders may 

only be entered by Order-Delivery 

ECNs. [Summary Orders may only be 

designated as Non-Attributable Orders.] 

(pp)–(uu) No Change.

* * * * *