Federal Register / Vol. 61, No. 97 / Friday, May 17, 1996 / Notices 24993

20 15 U.S.C. § 78o–4.

1 15 U.S.C. 78s(b)(1) (1988).

2Securities Exchange Act Release No. 36930

(March 6, 1996), 61 FR 10051.

3When a market maker, either alone or acting in

concert with other market makers, takes net streetside trading positions (i.e., non-retail trading with

other broker-dealers) that constitute a

disproportionately large percentage of the total net

street-side buys or net street-side sells in any issue

(i.e., the market maker dominates one side of the

market in the issue), the risk of default by that

market maker can increase.

4However, to the extent that market makers’ net

street-side trading positions in dominated issues

result from legitimate customer orders, the potential

adverse impact on the financial viability of a

settling member and the potential for increased

exposure to NSCC could be mitigated. So long as

the customer orders are legitimate, the risks

associated with such positions are borne among the

individual accounts of the market maker’s

customers and not concentrated solely in the

proprietary accounts of the market maker.

5NSCC Rule 1 defines a ‘‘settling member’’ to

include any NSCC member, non-clearing member

and, except where a contrary intent is expressed in

NSCC’s rules, a special representative.

6Class A Surveillance permits NSCC, among

other things, to increase a settling members clearing

fund requirement by an amount equal to (i) up to

5% of the settling member’s CNS long fail positions,

plus (ii) up to 5% of the settling member’s short fail

positions, plus (iii) 2.5% or at NSCC’s discretion up

to 5% of the settling member’s average non-CNS

and non-mutual fund services debits, plus (iv) 2.5%

of the settling member’s average non-CNS and nonmutual fund services credits. NSCC Rules and

Procedures, Addendum B, IV(C).

7However, the mere fact that a market maker has

a large customer base may not necessarily constitute

the necessary mitigating circumstances especially if

the customers are retail and/or the market maker

has a history of customer complaints or other

adverse regulatory or disciplinary actions. Refer

also to note 4.

based fee structure and work with

market participants to address the issues

raised by this concept. In developing its

fees the Commission encourages the

MSRB to continue to build a consensus

among market participants on how best

to allocate the burden of funding the

MSRB operations.

V. Conclusion

The Commission finds that the

proposed rule change is consistent with

the requirements of the Act and the

rules and regulations thereunder

applicable to the Municipal Securities

Rulemaking Board and, in particular,

with the requirements of Section 15B of

the Act.20 Specifically, the Commission

believes the proposal is consistent with

the requirements of Section 15B(b)(2)(J)

that the MSRB’s rules be designed,

among other things, to provide that each

municipal securities broker and each

municipal securities dealer shall pay to

the MSRB such reasonable fees and

charges as may be necessary or

appropriate to defray the costs and

expenses of operating and

administrating the Board.

It is therefore ordered, pursuant to

Section 19(b)(2) of the Act, that the

proposed rule change (SR–MSRB–95–

13) is approved.

By the Commission.

Dated: May 10, 1996.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 96–12384 Filed 5–16–96; 8:45 am]

BILLING CODE 8010–01–M

[Release No. 34–37202; File No. SR–NSCC–

95–17]

Self-Regulatory Organizations;

National Securities Clearing

Corporation; Order Temporarily

Approving a Proposed Rule Change to

Establish Additional Procedures for

Placing Settling Members on Class A

Surveillance and Collecting Clearing

Fund and Other Collateral Deposits

From Settling Members

May 10, 1996.

On December 20, 1995, the National

Securities Clearing Corporation

(‘‘NSCC’’) filed with the Securities and

Exchange Commission (‘‘Commission’’)

a proposed rule change (File No. SR–

NSCC–95–17) pursuant to Section

19(b)(1) of the Securities Exchange Act

of 1934 (‘‘Act’’) to establish additional

procedures for placing settling members

on Class A Surveillance and collecting

clearing fund and other collateral

deposits from settling members.1 Notice

of the proposal was published in the

Federal Register on March 12, 1996.2

No comment letter were received. For

the reasons discussed below, the

Commission is temporarily approving

the proposed rule change through May

31, 1997.

I. Description of the Proposal

NSCC’s Board of Directors has

determined that under certain

circumstances settling members who

clear securities transactions for over-thecounter (‘‘OTC’’) market makers or who

themselves engage in OTC market

making can have their financial viability

materially impacted by such business.3

Furthermore, if these settling members

dominate one side of the market in their

street-side trading positions, either

directly by participating in OTC market

making or indirectly by clearing

transactions for OTC market makers,

NSCC believes that the risk of default by

the settling member increases.4 In turn,

this could potentially increase NSCC’s

exposure because NSCC is obligated to

complete defaulting settling members’

unsettled trades once NSCC’s trade

guarantee attaches.

The problem is magnified if one or

more additional risk factors are present.

These additional risk factors can

include, without limitation:

(1) Concentrated short selling in

dominated issues;

(2) Undue concentration of securities

held in inventory by market maker(s) for

dominated issues;

(3) Dominated issues also being IPOs

less than six months past initial

issuance particularly when the current

value of the issue is significantly

different from its initial sales price or

there is undue concentration of

inventory in the managing

underwriter(s); and

(4) Clearing positions of market

makers in dominated issues away from

their primary clearing brokers.

Rule 15, Section 3 of NSCC’s rules

currently provides that any settling

member 5 shall furnish to NSCC such

adequate assurances of its financial

responsibility and operational capability

as NSCC may at any time or from time

to time deem necessary or advisable in

order to protect NSCC. Section 4 of Rule

15 states that such adequate assurances

may include, but are not be limited to,

increased clearing fund deposits of

settling members. Furthermore, Section

III.B.1.o. of Addendum B to NSCC’s

rules sets forth the guidelines for

determining when NSCC may place a

broker-dealer settling member on Class

A surveillance status.6 Pursuant to these

guidelines, NSCC may place a brokerdealer settling member on Class A

surveillance if there is any condition

which could materially impact the

operational or financial viability of the

settling member which increases or

potentially may increase exposure to

NSCC.

In order for NSCC to reduce its

potential exposure from the OTC market

making activity described above, NSCC

is adding Addendum O to its rules and

procedures. Addendum O will permit

NSCC to place settling members on

Class A surveillance if they clear for or

are themselves OTC market makers and

(i) they do not have sufficient capital or

access to capital to support either

potential increases in market making

activity in dominated OTC issues or (ii)

there is the presence of the additional

risk factors described above. At its

discretion, NSCC may elect not to place

settling members on Class A

surveillance if it has obtained sufficient

assurances that a high degree of

mitigating circumstances exist.7

Furthermore, NSCC is adopting an

interim collateralization policy which

will allow NSCC in its discretion to

require settling members placed on

Class A surveillance that clear for or are

themselves OTC market makers to meet
24994 Federal Register / Vol. 61, No. 97 / Friday, May 17, 1996 / Notices

8 Domination will be determined according to

criteria specified by NSCC from time to time.

9The term ‘‘same-day funds’’ refers to payment in

funds that are immediately available and generally

are transferred by electronic means.

10 In determining net unsettled trading positions,

NSCC in its discretion under certain circumstances

may elect to take into account offsetting pending

confirmed ID transactions only if such transactions

also have been affirmed. Moreover, NSCC may

decline to consider any ID transaction if it has

reason to believe that the institutional counterparty

may not or cannot settle such transaction.

11 15 U.S.C. 78q–1 (1988).

12For example, if a clearing member’s excess net

capital is $100,000 and the value of its OTC market

making activities is $125,000, the rule change

permits NSCC to require the clearing member to

deposit an additional $25,000. However, if the

clearing member’s OTC market making activity

includes short positions, the rule change will

permit NSCC to collect more than $25,000.

13From time to time, NSCC will determine in its

discretion what such higher threshold shall be.

14NSCC Procedure XV contains the formulae

usually employed to calculated clearing members’

clearing fund requirements.

15Supra note 10.

16Supra note 14.

the following special collateralization

requirements:

(1) To the extent that the sum of the

absolute dollar values of any such

settling members’ net unsettled trading

positions in all securities dominated 8

by a market maker exceeds such market

maker’s excess net capital, NSCC can

require the settling member to deposit

with NSCC at such times and in such

manner as NSCC may designate,

including an immediate deposit of

same-day funds the amount by which

the value of the net unsettled trading

positions exceed the market maker’s

excess net capital.9 In determining the

size of net unsettled trading positions,

NSCC may take into account offsetting

pending (i.e., non-fail) institutional

delivery (‘‘ID’’) transactions that have

been confirmed and when NSCC deems

appropriate, affirmed,10 through the ID

system of a clearing agency registered

under Section 17A of the Act

(‘‘registered clearing agency’’).11 In

addition, if a market maker’s net

unsettled trading positions in

dominated issues are cleared by one or

more other settling members, including

any settling member on Class A

surveillance, NSCC will have the

discretion for purposes of calculating

the special collateral deposit of treating

those positions as if they were all

cleared by a settling member on Class A

surveillance.

(2) To the extent that the unsettled

positions referred to in paragraph (1)

above are short (i.e., net sells), NSCC in

its discretion may collect more than 100

percent of the amount by which the sum

of the absolute dollar values of the net

unsettled trading positions of any such

settling member in all the securities

dominated by a market maker exceeds

the market maker’s excess net capital.12

In lieu of cash collateral, NSCC may

require or accept a book-entry delivery

of securities to NSCC sufficient to cover

such short position.

(3) NSCC will reserve the right at all

times to accept alternative arrangements

for its protection in any of the above

situations. NSCC may require special

collateral deposits with respect to

trading positions in issues dominated by

a market maker even when the value of

those positions do not exceed the

market maker’s excess net capital. NSCC

also may choose to forego collecting

such special collateral even when the

value of those positions exceed the

market maker’s excess net capital but do

not exceed some higher threshold.13

NSCC will make these determinations

based on the specific situation and

depending upon, among other things,

the presence or absence of additional

risk factors or mitigating circumstances.

The special collateralization

requirements described above are

interim measures for settling members

on Class A surveillance which will be

in effect until NSCC has gained enough

experience in surveillance of OTC

market maker trading activities to

impose permanent special

collateralization requirements.

Additionally, if there is concentrated

short selling in dominated issues, NSCC

will maintain its right to collect special

collateral deposits from the settling

members clearing the short sales

without regard to their surveillance

status. Special collateral collected from

any settling member pursuant to the

above procedures will be in addition to

the settling member’s clearing fund

deposit computed in accordance with

the formulae set forth in NSCC

Procedure XV or in accordance with the

alternative method set forth below.

Because NSCC believes that its

settling members on Class A

surveillance present a higher than

normal risk of default and insolvency,

NSCC is proposing that such settling

members’ clearing fund deposits be

based on the close-out risk presented by

their unsettled positions in NSCC’s

systems. Therefore, pursuant to Rule 15

as expressed under Addendum O, NSCC

will have the discretion to compute the

continuous net settlement (‘‘CNS’’)

component of the clearing fund

requirement for any settling member on

Class A surveillance in accordance with

the following alternative method rather

than the formulae to calculate clearing

fund set forth in NSCC Procedure XV.14

(1) NSCC may calculate on a daily or

periodic basis the volatility of any such

settling member’s net unsettled trading

positions in CNS eligible issues (‘‘net

CNS trading positions’’). Such positions

shall be determined after taking into

account offsetting pending (i.e., nonfail) ID transactions that have been

confirmed and, when NSCC deems

appropriate, affirmed 15 through the ID

system of a registered clearing agency.

Such calculation will be made in

accordance with the Capital Asset

Pricing Model or any other generally

accepted portfolio volatility model,

including without limitation, any

margining formula employed by any

other registered clearing agency

provided, however, that not less than

two standard deviations’ volatility shall

be calculated under any model chosen.

Such calculation will be made utilizing

such assumptions and based on such

historical data as NSCC deems

reasonable and shall cover such range of

historical volatility as NSCC from time

to time deems appropriate. If such

volatility is calculated on a periodic

basis, it may be expressed as a

percentage of the sum of the absolute

values of the firm’s net CNS trading

positions. Any such calculations,

whether expressed as a dollar value or

percentage, may be rounded as NSCC

deems appropriate.

(2) NSCC shall have the discretion to

exclude from the above calculations net

CNS trading positions in classes of

securities whose volatility is (i) less

amenable to statistical analysis such as

OTC bulletin board or pink sheet issues

or issues trading below a designated

dollar threshold (e.g., five dollars) or (ii)

amenable to generally accepted

statistical analysis only in a complex

manner (e.g., municipal or corporate

bonds). The amount of clearing fund

required with respect to net CNS trading

positions in such issues shall be

determined by multiplying the absolute

value of such positions by a percentage

designated by NSCC, which percentage

may vary depending on such factors as

NSCC deems relevant.

(3) The amounts calculated in

accordance with the immediately

preceding two numbered paragraphs

will be substituted for the amount

calculated in accordance with paragraph

(1)(c) of Sections A.I.(a), A.II.(a) and

A.II.(b) of NSCC’s Procedure XV.16 In

addition, NSCC may in its discretion

reduce or eliminate the amount

calculated in accordance with paragraph

(1)(a) of Procedure XV.

(4) NSCC in its discretion also may

calculate the total clearing fund

requirement of any settling member on
Federal Register / Vol. 61, No. 97 / Friday, May 17, 1996 / Notices 24995

17 15 U.S.C. § 78q–1(b)(3)(F) (1988). 18 17 CFR 200.30–3(a)(12) (1995).

1 15 U.S.C. 78s(b)(1) (1988).

2Letter from James C. Yong, First Vice President

and General Counsel, OCC, to Jerry W. Carpenter,

Assistant Director, Division of Market Regulation

(‘‘Division’’), Commission (February 5, 1996).

3Securities Exchange Act Release No. 36960

(March 13, 1996), 61 FR 11458.

4Letter from James C. Yong, First Vice President

and General Counsel, OCC, to Jerry W. Carpenter,

Assistant Director, Division, Commission (March

19, 1996).

5The Commission has modified the text of the

summaries submitted by OCC.

a daily basis instead of a twenty-day

rolling average basis and may collect

deficiencies at such times and in such

manner as specified by NSCC from time

to time, including immediate collection

of same-day funds.

Nothing in the foregoing rule change

will limit NSCC’s discretion with

respect to placing settling members on

Class A surveillance or requiring

settling members to furnish adequate

assurance of financial responsibility or

operational capability as set forth in

NSCC’s rules and procedures.

II. Discussion

Section 17A(b)(3)(F) of the Act 17

requires that the rules of a clearing

agency be designed to assure the

safeguarding of securities and funds

which are in the custody or control of

the clearing agency and generally to

protect investors and the public interest.

The Commission believes the proposed

rule change is consistent with NSCC’s

obligations under the Act because it will

allow NSCC to take particular action to

protect itself, its members, and investors

in situations where settling members

pose an increased risk because of their

involvement in OTC market making.

Under the proposal, NSCC will have

the authority with respect to settling

members who participate in OTC

market making activities or clear for

correspondents that engage in such

activity (1) to place such members on

Class A surveillance, (2) to require such

members to post additional collateral

with NSCC, and (3) to calculate an

alternative clearing fund requirement

for such members when additional risk

factors are present. Collectively, the

higher level of surveillance, the

additional level of collateralization, and

the alternative clearing fund

requirements should help to ameliorate

NSCC’s exposure which in turn should

assist NSCC in fulfilling its obligations

under the Act to safeguard securities

and funds for which it has control of, is

responsible for and, generally, to protect

investors and the public interest.

The Commission is temporarily

approving the proposed rule change

through May 31, 1997, so that NSCC can

gain additional experience in the

surveillance of OTC market makers and

the risks posed by clearing such activity.

NSCC also will be able to gain

experience with the additional

collateralization requirements and

alternative clearing formula

requirements for settling members

subject to Class A surveillance prior to

permanent imposition of these

requirements. Temporary approval also

will afford both the Commission and

NSCC an opportunity to observe

whether the additional collateralization

and alternative clearing fund

requirements adequately protect NSCC,

its members, and investors from the

expected risks of participating in and

clearing OTC market maker activity and

whether adjustments to the procedures

are necessary. Prior to filing a proposed

rule change seeking permanent approval

of the procedures set forth in this

temporary approval order, NSCC shall

present to the Commission a more

detailed report of its findings regarding

the adequacy of the controls and

discussing any changes to be made to

the procedures. During the temporary

approval period, NSCC will from time to

time apprise the Commission on the

operation of the additional

collateralization requirements to enable

the Commission to monitor the

implementation of such requirements.

III. Conclusion

On the basis of the foregoing, the

Commission finds that the proposal is

consistent with the requirements of the

Act and in particular with the

requirements of Section 17A of the Act

and the rules and regulations

thereunder.

It is therefore ordered, pursuant to

Section 19(b)(2) of the Act, that the

proposed rule change (File No. SR–

NSCC–95–17) be, and hereby is,

approved on a temporary basis through

May 31, 1997.

For the Commission by the Division of

Market Regulation, pursuant to delegated

authority.18

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 96–12471 Filed 5–16–96; 8:45 am]

BILLING CODE 8010–01–M

[Release No. 34–37203; File No. SR–OCC–

95–20]

Self-Regulatory Organizations; The

Options Clearing Corporation; Notice

of Filing of an Amendment to a

Proposed Rule Change Relating to the

Issuance, Clearance, and Settlement of

Buy-Write Options Unitary Derivatives

May 10, 1996.

On December 27, 1995, The Options

Clearing Corporation (‘‘OCC’’) filed with

the Securities and Exchange

Commission (‘‘Commission’’) a

proposed rule change (File No. SR–

OCC–95–20) pursuant to Section

19(b)(1) of the Securities Exchange Act

of 1934 (‘‘Act’’) relating to the issuance,

clearance, and settlement of Buy-Write

Options Unitary Derivatives

(‘‘BOUND’’).1 On February 5, 1996, OCC

filed Amendment No. 1 to the proposed

rule change.2 Notice of the proposed

rule change, as amended, was published

in the Federal Register on March 20,

1996.3 On March 20, 1996, OCC filed

Amendment No. 2.4 Amendment No. 2

is described in Items I, II, and III below,

which items have been prepared

primarily by OCC. The Commission is

publishing this notice to solicit

comments on the proposed rule change,

as amended, from interested persons.

I. Self-Regulatory Organization’s

Statement of the Terms of Substance of

the Proposed Rule Change

The purpose of Amendment No. 2 to

the proposed rule change is to add a

provision to Article XXIV, Section 6 of

OCC’s By-Laws to specify that the

closing price for the underlying security

of a BOUND is conclusively presumed

to be accurate and shall be final for

purposes of determining settlement

rights and obligations with respect to

that BOUND.

II. Self-Regulatory Organization’s

Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule

Change

In its filing with the Commission,

OCC included statements concerning

the purpose of and basis for the

proposed rule change and discussed any

comments that it received on the

proposed rule change. The text of these

statements may be examined at the

places specified in Item IV below. OCC

has prepared summaries, set forth in

sections (A), (B), and (C) below, of the

most significant aspects of such

statements.5

(A) Self-Regulatory Organization’s

Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule

Change

The purpose of Amendment No. 2 to

the proposed rule change is to add a

provision to Article XXIV, Section 6 of

OCC’s By-Laws to specify that the