File No. SR-OCC-2005-17

Page 15 of 18

(d) The right of setoff is enforceable at law.
Condition (a) will clearly be satisfied; rights and obligations with respect to transactions in
options are, as a result of contract novation, bilateral between OCC and each of its Clearing
Members. Condition (b) will be satisfied upon the adoption of Section 26, which constitutes a
netting agreement by which OCC and the Clearing Member are bound. A Clearing Member, as
the reporting party, will thus have a right of setoff against OCC to the extent set forth in new
Section 26. We may presume that condition (c) will be met in that a Clearing Member would
presumably intend to apply setoff to the maximum extent possible in the event of a liquidation of
OCC. Condition (d) will require an opinion of counsel, and Section 26 is intended to support an

appropriate opinion.

Discussion of Specific Provisions of Section

The text of proposed new Section 26 of Article VI of the By-Laws is largely self-
explanatory in light of the foregoing discussion of its purpose. A few comments may
nevertheless be helpful.

Section 26(a) allows OCC, if it should ever give notice of its insolvency, to set a
Termination Time that is later that the time at which the notice is given. This leaves open at least
the theoretical possibility that, if there are trading days or hours left between the time the notice
is given and the Termination Time, market participants could attempt to engage in closing
transactions at prices determined in the market to avoid being subject to a forced liquidation at
prices fixed by OCC.

Section 26 generally provides for netting within and not across different accounts,

with specific exceptions set forth in Section 26(d). Where a Clearing Member carries both


File No. SR-OCC-2005-17

Page 6 of 18

customers of the Clearing Member and held for distribution to the persons entitled thereto
in accordance with applicable law.

(4) A net asset position in the segregated futures account shall not be netted
against a net liability in any other account and shall be segregated and identified as
property of the futures customers of the Clearing Member and held for distribution to the
persons entitled thereto in accordance with applicable law.

(5) A net asset position in the internal non-proprietary cross-margining account
shall not be netted against a net liability in any other account and shall be segregated and
identified as property of the futures customers of the Clearing Member and held for
distribution to the persons entitled thereto in accordance with applicable law.

The result of all permitted netting shall be the total net asset position or total net liability position
of the Clearing Member with respect to its positions in cleared contracts and stock loan and
borrow positions with the Corporation before application of margin assets as provided in
paragraph (e) hereof.

(e) Application of Cash Margin Assets. Any restricted margin deposited by a Clearing
Member in the form of cash shall be applied to the reduction of any net liability in the account or
accounts of the Clearing Member to which such margin may be applied in accordance with the
applicable restrictions, and the Clearing Member’s total net liability position shall be reduced
accordingly. The Clearing Member’s total net liability position shall be further reduced by the
amount of unrestricted cash margin deposited by the Clearing Member in respect of all of its
accounts other than segregated futures accounts and X-M accounts. The resulting net amount
shall be the Clearing Member’s total net asset position or total net liability position (as the case
may be) after application of cash margin assets. As used in this Section 26, the term “restricted
margin” means any margin asset, whether in the form of cash, securities or a letter of credit, the
use of which is limited to specified obligations of the Clearing Member either under the By-
Laws and Rules, by any other agreement between the Corporation and the Clearing Member or
by applicable law.

(f) Liquidation Settlement.

(1) The Corporation shall designate a liquidation settlement date, which shall be
no earlier than the business day following the Termination Date.

(2) Any obligations of a Clearing Member to the Corporation, and any
obligations of the Corporation to the Clearing Member, not included in the foregoing
determination of the Clearing Member’s total net asset position or total net liability
position shall be reduced by netting to a single amount owed by the Clearing Member to
the Corporation or by the Corporation to the Clearing Member. The resulting net amount
shall be netted with the Clearing Member’s total net asset position or total net liability
position, as the case may be, to obtain a Net Settlement Amount.


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Chapter XI of OCC’s mules provides in considerable detail for liquidation of the
accounts of an insolvent Clearing Member, including provisions for close-out netting of the
Clearing Member’s obligations against its assets to the extent permitted by customer protection
tules under the Securities Exchange Act of 1934 (the “Exchange Act”) and the Commodity
Exchange Act (the “CEA”). However, OCC’s rules do not presently contain any provisions that
specifically permit close-out netting in the event of an insolvency of OCC. Indeed, an OCC
insolvency has always been considered so unlikely that OCC’s rules do not contain any
provisions whatever contemplating such an event. Management does not believe that an OCC
insolvency has become any more likely. On the contrary, OCC’s long track record of safe
operation and continually improved methods of risk management suggest that such an event is
more remote than ever. Nevertheless, the Basle Netting Standards make it desirable for OCC to
put in place such a netting provision in order to allow Clearing Members subject to regulations
adopting these standards to achieve more beneficial capital treatment.

OCC does not believe that a close-out netting rule would directly affect a Clearing
Member’s net capital computation under SEC Rule 15c3-1. However, OCC believes that enough
Clearing Members are or may be affected by the Basle Capital Accord standards through their
ownership by entities regulated as banks or bank holding companies to make the proposed
adoption of a netting rule desirable for that reason alone. In addition, as noted below, OCC
believes that a close-out netting rule would also clarify proper accounting treatment of

obligations among OCC and its Clearing Members.


File No. SR-OCC-2005-17

Page 8 of 18

entitled thereto under applicable law, as appropriate, at such time as the Corporation has
determined (1) that it has been fully reimbursed for losses and expenses arising from any of the
circumstances detailed in Article VIII, Section S(a) and, subject to the restriction set forth
therein, Section 5(b); and (2) that it is extremely unlikely that the Corporation will incur
additional losses and expenses reimbursable from the Clearing Fund.

(j) Interpretation in Relation to FDICIA. The Corporation intends that certain provisions
of this Section 26 be interpreted in relation to certain terms (identified by quotation marks) that
are defined in the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”),
as amended, as follows:

(1) The Corporation is a “‘clearing organization.”

(2) An obligation of a Clearing Member to make a payment to the Corporation,
or of the Corporation to make a payment to a Clearing Member, subject to a netting
agreement, is a “covered clearing obligation” and a “covered contractual payment
obligation.”

(3) An entitlement of a Clearing Member to receive a payment from the
Corporation, or of the Corporation to receive a payment from a Clearing Member, subject
to a netting contract, is a “covered contractual payment entitlement.”

(4) The Corporation is a “member,” and each Clearing Member is a “member.”

(5) The amount by which the covered contractual payment entitlements of a
Clearing Member or the Corporation exceed the covered contractual payment obligations
of such Clearing Member or the Corporation after netting under a netting contract is its
“net entitlement.”

(6) The amount by which the covered contractual payment obligations of a
Clearing Member or the Corporation exceed the covered contractual payment
entitlements of such Clearing Member or the Corporation after netting under a netting
contract is its “net obligation.”

(7) The By-Laws and Rules of the Corporation, including this Section 26, are a
“netting contract.”

(k) Cross-Margining Agreements. If an event of insolvency of the type referred to in
paragraph (a) of this Section 26 occurs, the Corporation shall immediately seek to exercise its
authority under each Participating CCO Agreement to which it is a party to cause the immediate
liquidation of all assets and liabilities in all X-M accounts of Clearing Members subject to such
agreements and to reduce such account to a single net obligation to or from the Clearing Member
or Pair of Affiliated Clearing Members to be settled in accordance with the terms of the
applicable Participating CCO Agreement.


File No. SR-OCC-2005-17

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(3) If a Clearing Member has a positive Net Settlement Amount, it has a claim
against the Corporation for the value of that amount on the termination date and, as a
general unsecured creditor of the Corporation, may file a claim for the amount thereof in
the Corporation’s bankruptcy case.

(4) Ifa Clearing Member has a negative Net Settlement Amount after application
of available cash margin as described above, it shall pay the value of such position to the
Corporation on the liquidation settlement date. If the Clearing Member fails to pay the
full amount of any negative Net Settlement Amount on the liquidation settlement date,
the provisions of paragraph (g) hereof shall apply.

(g) Failure of Clearing Member to Pay Net Settlement Amount. If a Clearing Member
fails to pay any Net Settlement Amount to the Corporation when due, the Corporation shall
liquidate all non-cash margin deposits as needed and shall apply the proceeds thereof to reduce
the deficit; provided, however, that if the issuer of a letter of credit shall agree in writing to
extend the irrevocability of its commitment thereunder in a manner satisfactory to the
Corporation, the Corporation may, in lieu of demanding immediate payment of the face amount
of the letter of credit, but reserving its right to do so, demand only such amounts as it may from
time to time deem necessary to meet anticipated disbursements. Proceeds of any restricted
margin deposited by a Clearing Member in the form of cash shall be applied to the reduction of
any net liability arising from the account or accounts of the Clearing Member to which such
margin may be applied in accordance with the applicable restrictions. If any portion of the Net
Settlement Amount remains unsatisfied after application of margin deposits, the Corporation
shall seek to satisfy the remaining deficit as follows: (i) first, apply the Clearing Member’s
clearing fund contribution (including any amounts obtained from the Clearing Member in
satisfaction of its obligation to make good on any charges against its Clearing Fund
contribution); and (ii) second, make a pro rata charge against the Clearing Fund contributions of
other Clearing Members in accordance with the By-Laws and Rules.

(h) Disposition of Remaining Margin Deposits. If the Clearing Member is solvent and
has not been suspended pursuant to Chapter 11 of the Rules, then any remaining restricted or
unrestricted margin deposited by the Clearing Member and remaining after all permissible
applications provided for above, shall be released to the Clearing Member to be treated and dealt
with by the Clearing Member in accordance with applicable law. If the Clearing Member has
been suspended by the Corporation pursuant to Chapter 11, then any restricted margin deposited
by a Clearing Member and remaining after application of restricted margin to the full extent
provided above shall be segregated to the extent required and held by the Corporation under an
appropriate designation for distribution to the persons entitled thereto in accordance with
applicable law. Any unrestricted margin remaining shall be held for distribution to the persons
entitled thereto under applicable law.

(i) Clearing Fund. Any unused portion of a Clearing Member’s Clearing Fund
contribution shall be returned to the Clearing Member or held for distribution to the persons


File No. SR-OCC-2005-17

Page 10 of 18

bank. The absence of a “netting agreement” that would apply in an insolvency of OCC can
cause the minimum capital requirement applicable to such a parent company and its subsidiaries
on a consolidated basis to be substantially larger than it would otherwise be. In the absence of a
netting agreement, applicable banking regulations generally prohibit offsetting the Clearing
Member’s obligations to OCC on short positions in options and other obligations against the
Clearing Member’s credit exposure to OCC in respect of long options positions and other
obligations to the Clearing Member.

It is OCC’s understanding that the capital rules applicable to most banks,
following guidelines under the Basle Capital Accord relating to bilateral netting (the “Basle
Netting Standards”), require that an enforceable netting agreement be in place in order for
mutual obligations between a Clearing Member that is a bank affiliate and a counterparty, such
as OCC, to be treated on a net basis. The policy behind this requirement is to ensure that
obligations that are treated on a net basis for capital purposes can actually be offset against one
another in the event of the failure of the counterparty. In the absence of an enforceable netting
agreement, there is concern that the representative of the failed counterparty (i.e., OCC, in this
scenario) might be able to “cherry pick” under applicable insolvency law by assuming the benefit
of contracts representing an asset to the bankruptcy estate while rejecting contracts representing
a liability, forcing the non-defaulting counterparty (i.e., the Clearing Member) to perform in full
on its liabilities while sharing with other unsecured creditors in any amounts available for
distribution from the bankruptcy estate to satisfy its claims. An enforceable netting agreement
providing for so-called “close-out netting” in the event of an insolvency of OCC would avoid

this potential result, permitting the Clearing Member to receive more favorable capital treatment.


File No. SR-OCC-2005-17

st 3 FY i 24 Page 2 of 18

ween ArT

GFULGr ie

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 19b-4

Proposed Rule Change

by

THE OPTIONS CLEARING CORPORATION

Pursuant to Rule 19b-4 under the
Securities Exchange Act of 1934


File No. SR-OCC-2005-17

Page 13 of 18

Overview of Proposed Rule Change

The proposed rule change would consist of a single new Section 26 of Article VI
of OCC’s By-Laws. Consistent with the requirements of the Basle Netting Standards, the netting
provision would be applicable in the event that OCC fails to perform its obligations with respect
to cleared contracts as the result of defaults by OCC in performing its obligations under its rules,
or as the result of bankruptcy, a liquidation of OCC or similar circumstances. The proposed rule
is drafted in such a way that it would only be triggered by an event that disabled OCC from
rendering full performance under cleared contracts when due. The rule would not be triggered
by any delay in performance that is permitted under OCC’s rules.

The proposed rule provides that, when a triggering event occurs, rights and
obligations within and between accounts of each Clearing Member will be netted to the same
extent as if the Clearing Member had been suspended and its accounts were being liquidated
under Chapter XI of the Rules. This is an appropriate result in that those rules generally provide
for the netting of assets against liabilities to the extent permitted under applicable law, including
the customer protection rules referred to above. Assets remaining after all legally permissible
offsets would be returned to the Clearing Member entitled to them, and the Clearing Member
would remain obligated to OCC only to the extent of any remaining net liabilities following such
permitted offsets.

Tf close-out netting were ever required because of the insolvency of OCC, it
seems likely that there would be no market available in which to liquidate positions in cleared
contracts through market transactions. Accordingly, the proposed rule contains a provision for

valuation of open cleared contracts based upon market values of underlying interests and


File No. SR-OCC-2005-17

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The Basle Netting Standards

The Basle Netting Standards provide that a bank! may net transactions subject to
any legally valid form of bilateral netting, including netting of bilateral obligations arising from
novation, if the bank satisfies its national supervisor that it has a netting contract with the
counterparty which creates a single legal obligation, covering all included transactions, such that
the bank would have either a claim to receive or obligation to pay only the net sum of the
positive and negative mark-to-market values of included individual transactions in the event a
counterparty fails to perform due to any . . . default, bankruptcy, liquidation or similar
circumstances.

The Basle Netting Standards also require that the bank have certain “written and
reasoned legal opinions that, in the event of a legal challenge, the relevant courts and
administrative authorities would find the bank’s exposure to be the net amount. The national
supervisor must be satisfied that the netting is enforceable under the laws of each relevant
jurisdiction. The proposed netting rule is intended to support such an opinion.

The Basle standards have been incorporated in applicable bank regulatory laws or
regulations in various jurisdictions. For example, the substance of this standard appears in
Article 12f of the Swiss Banking Ordinance. It has also been incorporated into the capital

guidelines for various U.S. financial institutions.”

' These same standards are also applied to bank holding companies.

? See, e.g., Regulations of the Office of the Comptroller of the Currency applicable to national banks set forth at 12
C.F.R. Part 3, Appendix A (adopted July 1, 2002), section (3)(b)(5)(ii)(B).


File No. SR-OCC-2005-17

Page 9 of 18

(1) Clearing Member Suspensions; Charges Against the Clearing Fund. In the event that
a Clearing Member is suspended by the Corporation pursuant to Chapter 11 of the Rules after a
notice has been given by the Corporation pursuant to paragraph (a) of this Section 26 or prior to
the time when the Corporation has completed the liquidation of a previously suspended Clearing
Member’s accounts as provided in Chapter 11, the Corporation shall liquidate, or continue to
liquidate, the Clearing Member’s accounts as provided in Chapter 11 to the extent practicable
and not inconsistent with this Section 26; and any amounts owing between the Corporation and
the Clearing Member as a result of such actions shall be included in determining the Clearing
Member’s Net Settlement Amount under this Section 26. If the Corporation suffers a loss as the
result of such a Clearing Member liquidation pursuant to Chapter 11 or from any other cause that
is chargeable against the Clearing Fund in accordance with the By-Laws and Rules, whether
such loss occurs before or after the Corporation gives a notice under this paragraph (a), such loss
shall be chargeable against the Clearing Fund as and to the extent provided in the By-Laws and
Rules notwithstanding the giving of such notice, and any obligations of Clearing Members
resulting from a pro rata charge to the Clearing Fund, including any obligation to make good any
deficiency in the Clearing Member’s Clearing Fund contribution as the result of a pro rata
charge, shall also be included in determining the Clearing Member’s Net Settlement Amount.

Item 2. Procedures of the Self-Regulatory Organization

The proposed rule change was approved by the Board of Directors of OCC at a
meeting held on July 27; 2004.

Questions regarding the proposed rule change should be addressed to Jean

Cawley, First Vice-President and Deputy General Counsel, at (312) 322-6269.

Item 3. Self-Regulatory Organization’s Statement of the Purpose of, and
Statutory Basis for, the Proposed Action

Background

OCC has been asked by several of its Clearing Members to consider adopting a
tule that would allow for close-out netting of obligations running between OCC and Clearing
Members in the event of an OCC insolvency. Such a rule can reduce applicable capital

requirements for a Clearing Member’s parent company where the parent is a U.S. or non-U.S.


File No. SR-OCC-2005-17

Page 5 of 18

(2) quotations from leading dealers in the underlying interest, setting forth the
price (which may be a dealing price or an indicative price) that the quoting dealer would
charge or pay for a specified quantity of the underlying interest; and

(3) relevant historical and current market data for the relevant market, provided
by reputable outside sources or generated internally.

(4) values derived from theoretical pricing models using available prices for the
underlying interest or a related interest and other relevant data.
Amounts stated in a currency other than U.S. Dollars shall be converted to U.S. Dollars at the
current rate of exchange, as determined by the Corporation. A position having a positive close-
out value shall be an “asset position” and a position having a negative close-out value shall be a
“liability position.”

(c) Netting Within Accounts. The Corporation shall net the close-out values of positions
in each account of each Clearing Member to determine the net asset position or net liability
position in each account as follows:

(1) Aggregate the close-out values of all asset positions (excluding segregated
long option positions in a securities customers’ account or firm non-lien account),
aggregate the (negative) close-out values of all liability positions, and net the aggregate
asset position against the aggregate liability position.

(2) The aggregate close-out value of segregated long option positions in a
securities customers’ account or firm non-lien account shall be identified as constituting
the property of the securities customers of the Clearing Member and held for distribution
to the persons entitled thereto in accordance with applicable law.

(d) Netting Across Accounts. The Corporation shall determine the total net asset position
or the total net liability of the Clearing Member by netting across the Clearing Member’s
accounts as follows:

(1) A net asset position in the firm account, a proprietary Market-Makers’
account or any other proprietary account (other than a proprietary X-M account) may be
netted against a net liability in any other account.

(2) A net liability in a firm account, proprietary Market-Makers’ account or any
proprietary account may be netted against a net asset position in any other proprietary
account (except a proprietary X-M account).

(3) A net asset position in a combined non-proprietary Market-Makers’ account
or a separate non-proprietary Market-Maker’s account shall not be netted against a net
liability position in any other account and shall be identified as the property of securities


File No. SR-OCC-2005-17

Page 16 of 18

proprietary and customer accounts, netting across accounts could be a violation of Rule 15c3-3
and other customer protection rules of the SEC. In addition, CEA segregation rules require
separate segregation of customer funds of futures customers. Accordingly, netting across futures
segregated funds accounts and other accounts is also generally prohibited. Otherwise, the
provisions of Section 26(d) are intended to maximize netting where consistent with customer
protection rules. While securities market makers and specialists are generally not customers
within the meaning of Rule 15c3-3, they are ordinarily “customers” within the meaning of the
SEC’s hypothecation rules cited above. OCC has historically not permitted setoff between
market-maker accounts and the customers’ account in which positions of other securities

customers are carried. This separation has been preserved in Section 26(d)(3).

Item 4. Self-Regulatory Organization’s Statement on Burden on Competition

OCC does not believe that the proposed rule change would impose any burden on

competition.

Item 5. Self-Regulatory Organization’s Statement on Comments on the Proposed
Rule Change Received from Members, Participant Exchanges, or Others

Written comments were not and are not intended to be solicited with respect to the

proposed rule change, and none has been received.



File No. SR-OCC-2005-17

Page 18 of 18

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, The Options Clearing
Corporation has duly caused this filing to be signed on its behalf by the undersigned thereunto

duly authorized.

THE OPTIONS CLEARING CORPORATION

Lf
i) 4 +

By: ; ie

William H. Navin
Executive Vice-President and
General Counsel


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Page 4 of 18

SECTION 26. (a) Insolvency of the Corporation. If the Corporation determines that it is
insolvent or commences a voluntary case under Chapter 7 of the U.S. Bankruptcy Code (the
“Code”), or if an involuntary case under Chapter 7 of the Code is commenced against the
Corporation and is not dismissed within 30 days, the Corporation or its representative shall
promptly notify the Securities and Exchange Commission, the Commodity Futures Trading
Commission, the Clearing: Members, any clearing organizations with which the Corporation has
cross-margining or cross-guarantee arrangements, and all Exchanges, futures markets and
security futures markets for which the Corporation clears Exchange transactions. Such notice
shall state the nature of the event that has occurred, that effective as of a specified time on a
specified date (the “Termination Time”) the Corporation will accept no more Exchange
transactions for clearing, and that all pending transactions, positions in cleared contracts and
stock loan and borrow positions remaining in all accounts of all Clearing Members at the
Termination Time will be valued as of the Termination Time and liquidated in accordance with
this Section 26 of the By-Laws. Such liquidated positions shall be netted to the maximum extent
permitted by law and the By-Laws and Rules, and settlement of the net amounts shall be effected
in the manner provided by this Section 26 in satisfaction of all obligations owing between the
Corporation and Clearing Members in respect of such positions. The provisions of this Section
26, other than paragraph (k) below, shall not apply to the disposition of assets and liabilities in
any X-M account provided for in Article VI, Section 24 of the By-Laws. From and after the
Termination Time the rights of Clearing Members against the Corporation shall be limited to
those set forth in this Section 26 and applicable bankruptcy law. In the event that a Clearing
Member is suspended by the Corporation pursuant to Chapter 11 of the Rules or the Corporation
suffers a loss from any cause that is chargeable against the Clearing Fund in accordance with the
By-Laws and Rules, whether such suspension or loss occurs before or after the Corporation gives
a notice under this paragraph (a), the provisions of paragraph (1) below shall apply.

(b) Valuation. The Corporation shall fix a U.S. dollar amount (the “close-out value”) to
be paid to or received from the Corporation with respect to each short or long position in cleared
contracts and each stock loan and borrow position in each account of each Clearing Member. In
fixing close-out values, the Corporation shall exercise its discretion, acting in good faith and in a
commercially reasonable manner, in adopting methods of valuation expected to produce
reasonably accurate substitutes for the values that would have been obtained from the relevant
market if it were operating normally, including but not limited to the use of pricing models to
determine a value for a cleared contract based on the market price of the underlying interest or
the market prices of its components. In determining a close-out amount, the Corporation may
consider any information that it deems relevant, including, but not limited to, any of the
following:

(1) prices for underlying interests in recent transactions, as reported by the
market or markets for such interests;


File No. SR-OCC-2005-17

Page 3 of 18

Item 1. Text of the Proposed Rule Change

In order to permit certain of its Clearing Members to take advantage of more
favorable net capital requirements applicable to contractual obligations to counterparties with
which the Clearing Member has an enforceable netting agreement, The Options Clearing
Corporation (“OCC” or the “‘Corporation”) proposes to amend its By-Laws and Rules to provide
for close-out netting procedures to be followed in the highly unlikely event that OCC were to
become insolvent. The procedures include notifying the Clearing Members and other interested
persons and carrying out an orderly and efficient liquidation of outstanding cleared contracts,
making maximum use of netting under the protection of Title IV of the Federal Deposit
Insurance Corporation Improvement Act of 1991 (“FDICIA”) and applicable provisions of the
U.S. Bankruptcy Code.

The proposed rule change will add a new Section 26 in Article VI of the By-
Laws. Because this section is entirely new, underlining ordinarily used to mark textual additions
has been omitted to facilitate readability.

THE OPTIONS CLEARING CORPORATION
BY-LAWS
ke *
ARTICLE VI
Clearance of Exchange Transactions

x Ok Ok

Close-Out Netting


File No. SR-OCC-2005-17

Page 14 of 18

provides a reasonable means for OCC to fix all necessary values of assets and liabilities for

purposes of the netting. Valuations would be based upon available market information.

FIN 39: Offsetting of Amounts Related to Certain Contracts

In addition to the potential benefit of the proposed rule with respect to Clearing
Member’s capital requirements under the Basle Accord standards, OCC believes that the
proposed rule should also clarify proper accounting treatment of mutual obligations running
between OCC and its Clearing Members. OCC’s Clearing Members most commonly prepare
their financial statements using generally accepted accounting principles (“GAAP”). In March
1992 the Federal Accounting Standards Board (“FASB”) issued an interpretation of APB
Opinion No. 10 and FASB Statement No. 105 that responds to certain questions relating to the
circumstances in which assets and liabilities may be treated as offsetting in financial statements.
APB Opinion No. 10 says the following: “it is a general principle of accounting that the
offsetting of assets and liabilities in the balance sheet is improper except where a right of setoff
exists.” FIN 39 provides a definition of a right of setoff and a statement of the conditions under
which a right of setoff exists. The definition is as follows: “A right of setoff is a debtor’s legal
right, by contract or otherwise, to discharge all or a portion of the debt owed to another party by
applying against the debt an amount that the other party owes to the debtor.” The four conditions
under which a right of setoff exists are as follows:
(a) Each of two parties owes the other determinable amounts. [Emphasis in original.]
(b) The reporting party has the right to set off the amount owed with the amount
owed by the other party.

(c) The reporting party intends to set off.


File No. SR-OCC-2005-17

Page 17 of 18

Item 6. Extension of Time Period for Commission Action

OCC does not consent to an extension of the time period specified in Section

19(b)(2) of the Act.
Item 7. Basis for Summary Effectiveness Pursuant to Section 19(b)(3) or for

Accelerated Effectiveness Pursuant to Section 19(b)(2)

Summary effectiveness and accelerated effectiveness are not sought.

Item 8. Proposed Rule Change Based on Rules of Another Regulatory
Organization or of the Commission

The proposed rule change is not based on a rule of another self regulatory

organization or of the Commission.

Item 9. Exhibits

Exhibit | Completed notice of the proposed rule change for

publication in the Federal Register