[Federal Register Volume 65, Number 103 (Friday, May 26, 2000)]
[Notices]
[Pages 34240-34244]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-13260]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42801; File No. SR-NASD-00-08]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc., 
Relating to Margin Rule Amendments for Non-Equity Securities and Exempt 
Accounts

May 19, 2000.
    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 March 3, 2000, the National Association of Securities Dealers, Inc. 
(``NASD'' or ``Association''), through its wholly-owned subsidiary, 
NASD Regulation, Inc. (``NASD Regulation'') filed with the Securities 
and Exchange Commission (``SEC'' or ``Commission'') the proposed rule 
change as described in Items I, II, and III below, which Items have 
been prepared by NASD Regulation. The Commission is publishing this 
notice to solicit comments on the proposed rule change from interested 
persons.
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    \1\15 U.S.C. 78s(b)(1).
    \2\17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    NASD Regulation is proposing to amend Rule 2520 to revise the 
margin requirements relating to non-equity securities and exempt 
accounts. Proposed new language is in italics; proposed deletions are 
in brackets.
* * * * *

2520. Margin Requirements

    (a) Definitions
    For purposes of this paragraph, the following terms shall have the 
meanings specified below:
    (a)(1) through (a)(3) No change
    (4) The term ``designated account'' means the account of: [a bank, 
trust company, insurance company,

[[Page 34241]]

investment trust, state or political subdivision thereof, charitable or 
nonprofit educational institution regulated under the laws of the 
United States or any state, or pension or profit sharing plan subject 
to ERISA or of any agency of the United States or of a state or a 
political subdivision thereof.]
    (A) a bank (as defined in Section 3(a)(6) of the Act),
    (B) a savings association (as defined in Section 3(b) of the 
Federal Deposit Insurance Act), the deposits of which are insured by 
the Federal Deposit Insurance Corporation,
    (C) an insurance company (as defined in Section 2(a)(17) of the 
Investment Company Act of 1940),
    (D) an investment company registered with the Securities and 
Exchange Commission (SEC) under the Investment Company Act,
    (E) a state or political subdivision thereof, or
    (F) a pension or profit sharing plan subject to Employee Retirement 
Income Security Act (ERISA) or of an agency of the United States or of 
a state or a political subdivision thereof.
    (a)(5) through (a)(8) No Change
    (9) The term ``highly rated foreign sovereign debt securities'' 
means any debt securities (including major foreign sovereign debt 
securities) issued or guaranteed by the government of a foreign 
country, its provinces, state or cities, or a supranational entity, if 
at the time of the extension of credit the issue, the issuer or 
guarantor, or any other outstanding obligation of the issuer or 
guarantor ranked junior to or on a parity with the issue or the 
guarantee is assigned a rating (implicitly or explicitly) in one of the 
top two rating categories by at least one nationally ranked statistical 
rating organization.
    (10) The term ``investment grade debt securities'' means any debt 
securities (including those issued by the government of a foreign 
country, its provinces, states or cities, or a supranational entity), 
if at the time of the extension of credit the issue, the issuer or 
guarantor, or any other outstanding obligation of the issuer or 
guarantor ranked junior to or on a parity with the issue or the 
guarantee is assigned a rating (implicitly or explicitly) in one of the 
top four rating categories by at least one nationally recognized 
statistical rating organization.
    (11) The term ``major foreign sovereign debt'' means any debt 
securities issued or guaranteed by the government of a foreign country 
or a supranational entity, if at the time of the extension of credit 
the issue, the issuer or guarantor, or any other outstanding obligation 
of the issuer or guarantor ranked junior to or on a parity with the 
issue or the guarantee is assigned a rating (implicitly or explicitly) 
in the top rating category by at least one nationally recognized 
statistical rating organization.
    (12) The term ``mortgage related securities'' means securities 
falling within the definition in Section 3(a)(41) of the Act.
    (13) The term ``exempt account'' means a member, non-member broker/
dealer registered as a broker or dealer under the Act, ``designated 
account,'' or any person having a net worth of at least forty-five 
million dollars and financial assets of at least forty-million dollars.
    (14) The term ``non-equity securities'' means any securities other 
than equity securities as defined in Section 3(a)(11) of the Act.
    (15) The term ``listed non-equity securities'' means any non-equity 
securities that: (A) are listed on a national securities exchange; or 
(B) have unlisted trading privileges on a national securities exchange.
    (16) The term ``other marginable non-equity securities'' means:
    (A) Any debt securities not traded on a national securities 
exchange meeting all of the following requirements:
    (i) At the time of the original issue, a principal amount of not 
less than $25,000,000 of the issue was outstanding;
    (ii) The issue was registered under Section 5 of the Securities Act 
of 1933 and the issuer either files periodic reports pursuant to 
Section 13(a) or 15(d) of the Act or is an insurance company which 
meets all of the conditions specified in Section 12(g)(2)(G) of the 
Act; and
    (iii) At the time of the extensions of credit, the creditor has a 
reasonable basis for believing that the issuer is not in default on 
interest or principal payments; or
    (B) Any private pass-through securities (not guaranteed by any 
agency of the U.S. government) meeting all of the following 
requirements:
    (i) An aggregate principal amount of not less than $25,000,000 
(which may be issued in series) was issued pursuant to a registration 
statement filed with the SEC under Section 5 of the Securities Act of 
1933;
    (ii) Current reports relating to the issue have been filed with the 
SEC; and
    (iii) At the time of the credit extension, the creditor has a 
reasonable basis for believing that mortgage interest, principal 
payments and other distributions are being passed through as required 
and that the servicing agent is meeting its material obligations under 
the terms of the offering.
    (b)(1) through (e)(1) No change
    (e)(2) Exempted Securities, [Marginable Corporate Debt Securities] 
Non-equity Securities and Baskets
(A) Obligations of the United States and Highly Rated Foreign Sovereign 
Debt Securities
    On net ``long'' or net ``short'' positions in obligations 
(including zero coupon bonds, i.e., bonds with coupons detached or non-
interest bearing bonds) issued or guaranteed as to principal or 
interest by the United States Government or [issued or guaranteed] by 
corporations in which the United States has a direct or indirect 
interest as shall be designated for exemption by the Secretary of the 
Treasury, or in obligations that are highly rated foreign sovereign 
debt securities, the margin to be maintained shall be the percentage of 
the current market value of such obligations as specified in the 
applicable category below:

(i) Less than one year to maturity--1 percent
(ii) One year but less than three years to maturity--2 percent
(iii) Three years but less than five years to maturity--3 percent
(iv) Five years but less than ten years to maturity--4 percent
(v) Ten years but less than twenty years to maturity--5 percent[, or]
(vi) Twenty years or more to maturity--6 percent

    Notwithstanding the above, on zero coupon bonds with five years or 
more to maturity the margin to be maintained shall not be less than 3 
percent of the principal amount of the obligation.
    When such obligations other than United States Treasury bills are 
due to mature in thirty calendar days or less, a member, at its 
discretion, may permit the customer to substitute another such 
obligation for the maturing obligation and use the margin held on the 
maturing obligation to reduce the margin required on the new 
obligation, provided the customer has given the member irrevocable 
instructions to redeem the maturing obligation.
(B) All Other Exempted Securities
    On any positions in exempted securities other than obligations of 
the United States, the margin to be maintained shall be [15]7 percent 
of the current market value [or 7 percent of the principal amount of 
such obligation, whichever amount is greater].

[[Page 34242]]

(C) [Non-Convertible Corporate Debt] Non-Equity Securities
    On any positions in [non-convertible corporate debt] non-equity 
securities, [which are listed or traded on a registered national 
securities exchange or qualify as an ``OTC margin bond,'' as defined in 
Section 220.2(t) of Regulation T of the Board of Governors of the 
Federal Reserve System], the margin to be maintained (except where a 
lesser requirement is imposed by other provisions of this Rule) shall 
be]:
    (i) 10 percent of the current market value in the case of 
investment grade debt securities; and
    (ii) 20 percent of the current market value or 7 percent of the 
principal amount, whichever amount is greater, in the case of all other 
listed non-equity securities, and all other marginable non-equity 
securities as defined in paragraph (a)(16) of this Rule [except on 
mortgage related securities as defined in Section 3(a)(41) of the Act 
the margin to be maintained for an exempt account shall be 5 percent of 
the current market value. For purposes of this subparagraph, an exempt 
account shall be defined as a member, non-member broker/dealer, 
``designated account'' or any person having net tangible assets of at 
least sixteen million dollars.]
(D) and (E) No Change
(F) [Cash] Transactions With [Customers] Exempt Accounts Involving 
Certain ``Good Faith'' Securities
    [When a customer purchases an issued exempted security from or 
through a member in a cash account, full payment shall be made 
promptly. If, however, delivery or payment therefor is not made 
promptly after the trade date, a deposit shall be required as if it 
were a margin transaction, unless it is a transaction with a 
``designated account.'']
    On any position resulting from a transaction [in issued] involving 
exempted securities, mortgage related securities, or major foreign 
soveriegn debt securities [made for a member, or a non-member broker/
dealer, or] made for or with [a ``designated''] an ``exempt account,'' 
no margin need be required and any marked to the market loss on such 
position need not be [marked to the market] collected. However, [where 
such position is not marked to the market, an amount equal to the loss 
at the market in such position] the amount of any uncollected marked to 
the market loss shall be [charged against] deducted in computing the 
member's net capital as provided in SEC Rule 15c3-1, subject to the 
limits provided in paragraph (e)(2)(H) below.
    (G) Transactions With Exempt Accounts Involving Highly Rated 
Foreign Sovereign Debt Securities and Investment Grade Debt Securities
    On any position resulting from a transaction made for or with an 
``exempt account'' (other than a position subject to paragraph 
(e)(2)(F), the margin to be maintained on highly rated foreign 
sovereign debt and investment grade debt securities shall be, in lieu 
of any greater requirements imposed under this Rule, (i) 0.5 percent of 
current market value in the case of highly rated foreign sovereign debt 
securities, and (ii) 3 percent of current market value in the case of 
all other investment grade debt securities. The member need not collect 
any such margin, provided the amount equal to the margin required shall 
be deducted in computing the member's net capital as provided in SEC 
Rule 15c3-1, subject to the limits provided in paragraph (e)(2)(H) 
below.
    (H) Limits on Net Capital Deductions for Exempt Accounts
    (i) Member organizations shall maintain a written risk analysis 
methodology for assessing the amount of credit extended to exempt 
accounts pursuant to paragraphs (e)(2)(F) and (e)(2)(G) which shall be 
made available to the Association upon request.
    (ii) In the event that the deductions of securities positions from 
net capital deductions taken by a member as a result of marked to the 
market losses incurred under paragraphs (e)(2)(F) and (e)(2)(G) 
(exclusive of the percentage requirements established thereunder) 
exceed:
    a. on any one account or group of commonly controlled accounts, 5 
percent of the member's tentative net capital, or
    b. on all accounts combined, 25 percent of the member's tentative 
net capital,
    and, such excess exists on the fifth business day after it was 
incurred, the member shall give prompt written notice to the 
Association and shall not enter into any new transaction(s) subject to 
the provisions of paragraphs (e)(2)(F) or (e)(2)(G) that would result 
in an increase in the amount of such excess under, as applicable, 
subparagraph a. or b. above.
* * * * *

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 Regulation 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. NASD Regulation 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
    NASD Regulation is proposing amendments to Rule 2520 to revise the 
margin requirements for certain non-equity securities and to expand the 
types of non-equity securities eligible for exempt account treatment. 
Currently, Regulation T \3\ of the FRB, which establishes initial 
margin reqirements, provides that transactions in non-equity securities 
are subject to ``good faith'' requirements \4\ when effected in a 
margin account. Securities that are transacted in a ``good faith'' 
account are not subject to Regulation T margin requirements, \5\ but 
are subject to the margin required by the creditor in ``good faith'' or 
the percentage set by the regulatory authority where the trade occurs, 
whichever is greater. As a result, the margin requirements of NASD Rule 
2520 apply to non-equity positions maintained in customers' accounts 
and are important in providing ongoing safety and soundness levels. In 
this regard, NASD Regulation believes that the proposed rule change 
provides for margin requirements for non-equity securities that are 
commensurate with the risks associated with positions in such 
securities held by customers.
    In addition, NASD Regulation is proposing several changes with 
regard to exempt accounts. Specifically, the proposed rule change will 
modify the definition of ``exempt account,'' including increasing the 
financial threshold for a customer to be considered an exempt account, 
and will revise margin requirements for exempt account transactions 
involving mortgage-related securities, major

[[Page 34243]]

foreign sovereign debt securities, highly rated foreign debt securities 
and other investment grade debt securities.
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    \3\ 12 CFR 220. The Board of Governors of the Federal Reseve 
System (``FRB'') issued Regulation T pursuant to Section 7(c) of the 
Act.
    \4\ The term ``good faith'' in this context generally means that 
such transactions are subject to the requirements of the applicable 
self-reguatory organizaiton and that such requirements shall be 
applicable for initial and maintenance margin purposes.
    \5\ In 1998, amendments to Regulation T established ``good 
faith'' accounts, which can be used for transactions in non-equity 
securities in lieu of a margin or cash account. See Board of 
Governors of the Federal Reserve Docket Nos. R-0923, and R-0944 
(January 8, 1998), 63 FR 2706 (January 16, 1998).
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    Non-Equity Securities NASD Regulation believes that the proposed 
rule change will provide for margin requirements on non-equity 
securities that are commensurate with the risks associated with 
positions in such securities held by customers. Under the proposed rule 
change, the margin requirements for highly rated foreign sovereign debt 
securities will be the amounts specified in NASD Rule 2520 for U.S. 
debt securities.\6\ In addtition, the posposed rule change will reduce 
the margin requirement for exempted securities \7\ other than U.S. debt 
securities from 15 percent to 7 percent of the current market value, 
and reduce the margin requirement for investment grade debt securities, 
including investment grade debt securities issued by the government of 
a foreign country, from 20 percent to 10 percent of the current market 
value. The margin requirement for all other marginable non-equity 
securities will remain at the greater of 20 percent of the current 
market value or 7 percent of the principal amount. The proposed rule 
change will result in margin requirements for investment grade debt 
securities and exempted securities other than U.S. debt securities that 
are comparable to the highest haircut percentages under the SEC's net 
capital rule \8\ for proprietary positions in similar securities.
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    \6\ The margin required for U.S. government obligations under 
NASD Rule 2520 varies according to the length of time to maturity.
    \7\ NASD Rule 2520(a)(6) provides that exempted securities have 
the meaning provided in Section 3(a)(12) of the Act.
    \8\ See SEC Rule 15c3-1.
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    Exempt Accounts. Currently, NASD Rule 2520 contains margin 
requirements specifically addressing transactions by exempt accounts in 
exempted securities and mortgage-related securities. These requirements 
are lower than those applicable to transactions in such securities 
effected in accounts other than exempt accounts. The proposed rule 
change will define ``exempt account'' as a member organization, non-
member broker/dealer registered as a broker or dealer pursuant to the 
Act or ``designated account,'' \9\ and will increase the financial 
threshold for a person to be considered an exempt account to require a 
net worth of at least $45 million and financial assets of $40 million.
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    \9\ NASD Regulation proposes to revise the definition of 
``designated account.'' Specifically, the proposal defines 
``designated account'' to mean the account of: (1) a bank, as 
defined in Section 3(a)(6) of the Act; (2) a savings association, as 
defined in Section 3(b) of the Federal Deposit Insurance Act, the 
deposits of which are insured by the Federal Deposit Insurance 
Corporation; (3) an insurance company, as defined in Section 
2(a)(17) of the Investment Company Act of 1940; (4) an investment 
company registered with the SEC under the Investment Company Act of 
1940; (5) a state or a political subdivision thereof; or (6) a 
pension or profit sharing plan subject to ERISA or of an agency of 
the United States or of a state or a political subdivision thereof.
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    The proposed rule change also will provide lower margin 
requirements for exempt account transactions in highly rated foreign 
sovereign debt, investment grade foreign sovereign debt, and other 
investment grade non-equity securities. According to NASD Regulation, 
the proposed rule change recognizes both the quality of the securities 
as well as the creditworthiness of the customer and, as such, is 
intended to maintain reasonable safety and soundness standards. For 
transactions in these types of securities by exempt accounts, members 
will be required either to collect margin equal to the marked to market 
losses and any percentage requirements under the rule or to take a net 
capital charge, subject to the limits provided in proposed NASD Rule 
2520(e)(2)(H). Under the proposed rule change, the percentage 
requirements will be 3 percent of current market value for all 
investment grade corporate debt and for foreign sovereign debt in the 
lower two investment grade categories and 0.5 percent of current market 
value for foreign sovereign debt in the second highest investment grade 
category (i.e., highly rated foreign sovereign debt securities). These 
terms are also defined in the proposed rule change.
    For major foreign sovereign debt securities and mortgage-related 
securities in exempt accounts, the proposed rule change provides the 
same margin treatment for these securities as U.S. Government 
securities in exempt accounts, in that no margin will be required and 
marked to the market losses need not be collected, subject to the 
limits proposed in NASD Rule 2520(e)(2)(H).
    Proposed NASD Rule 2520(e)(2)(H) will also limit the amount of any 
uncollected marked to market losses which are being deducted from a 
member's net capital to 5 percent for each exempt account and 25 
percent for all exempt accounts combined. When marked to market losses 
exceeding these limits continue to exist on the fifth business day 
after they were incurred, the member will be required to provide the 
Association with written notification and will be prohibited from 
entering into any new transactions that would increase the amount of 
the excess.
    Other Provisions. The proposed rule change will provide new 
definitional provisions, which, among other things, will define the 
following types of non-equity securities: highly rated foreign 
sovereign debt securities; investment grade debt securities; major 
foreign sovereign debt securities; listed non-equity securities; and 
other marginable non-equity securities. The defined terms categorize 
certain types of non-equity securities for purposes of prescribing the 
applicable margin requirements. In addition, the proposed rule change 
will require that, as good business practice and for safety and 
soundness considerations, members maintain written procedures for 
assessing credit extended to exempt accounts.
2. Statutory Basis
    NASD Regulation believes that the proposed rule change is 
consistent with the provisions of section 15A(b)(6) \10\ of the Act 
which requires, among other things, that the Association's 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 Regulation believes 
that the proposed rule change will promote the safety and soundness of 
member firms and is consistent with the rules and regulations of the 
FRB for the purpose of preventing the excess use of credit for the 
purchase or carrying of securities.
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    \10\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD Regulation does not believe that the proposed rule change will 
result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act.

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

[[Page 34244]]

(ii) as to which the NASD consents, the Commission will:
    A. By order approve the proposed rule change, or
    B. Institute proceedings to determine whether the proposed rule 
chane 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, N.W., Washington, D.C. 20549-
0609. 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 at the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to File No. SR-NASD-00-08 and should 
be submitted by June 16, 2000.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority. \11\
Margaret H. McFarland,
Deputy Secretary.
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    \11\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 00-13260 Filed 5-25-00; 8:45 am]
BILLING CODE 8010-01-M