Document ID: SEC-2007-1761-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: Options Clearing Corp.
Posted Date: 2007-12-27T05:00Z

[Federal Register: December 27, 2007 (Volume 72, Number 247)]
[Notices]               
[Page 73401-73404]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr27de07-110]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-56991; File No. SR-OCC-2007-15]

 
Self-Regulatory Organizations; the Options Clearing Corporation; 
Notice of Filing and Immediate Effectiveness of a Proposed Rule Change 
Relating to Cleared Contracts Carried in a Proprietary Account

December 19, 2007.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on October 23, 2007, the 
Options Clearing Corporation (``OCC'') 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 
primarily by OCC. OCC filed the proposed rule change pursuant to 
section 19(b)(3)(A)(i) of the Act \2\ and Rule 19b-4(f)(1) \3\ 
thereunder so that the proposal was effective upon filing with the 
Commission. 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\ 15 U.S.C. 78s-1(b)(3)(A)(i).
    \3\ 17 CFR 240.19b-4(f)(1).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The proposed rule change would clarify that existing provisions of 
OCC's By-laws and Rules constitute a ``cross-margining or similar 
arrangement'' for purposes of the United States Bankruptcy Code with 
respect to cleared contracts carried in any proprietary account at OCC 
to the extent that commodity contracts and securities contracts are 
permitted to be carried in such account.

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 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.\4\
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    \4\ The Commission has modified parts of these statements.

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[[Page 73402]]

(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    The purpose of the proposed rule change is to add Interpretation 
and Policy .02 to section 3 of Article VI of OCC's By-laws to clarify 
that OCC's existing By-laws and Rules constitute ``a cross-margining 
agreement or similar arrangement'' for purposes of the United States 
Bankruptcy Code with respect to cleared contracts carried in any 
proprietary account at OCC to the extent that commodity futures and 
futures options (collectively ``commodity contracts'') are permitted to 
be carried in such account along with securities options and other 
securities (collectively ``securities contracts'').\5\ Where such 
positions are permitted to be so commingled, margin is calculated under 
Chapter VI of OCC's Rules based on the net risk of all such cleared 
contracts whether they are securities contracts or commodity contracts. 
``Proprietary accounts'' within the scope of Interpretation and Policy 
.02 include (i) a firm account, (ii) a separate market-maker's account 
for which the market-maker is a clearing member or a proprietary 
market-maker trading for his own account, (iii) a combined market-
maker's account confined to the exchange transactions of market-makers 
who are clearing members or proprietary market-makers trading for their 
own accounts, (iv) an OCC proprietary X-M account, or (v) a proprietary 
futures professional account. Under OCC's By-laws, all such proprietary 
accounts must be confined to the transactions of the clearing member 
itself and of such other persons as are not required to be treated as 
``customers'' of the clearing member either under the definition in 
Commodity Futures Trading Commission (``CFTC'') Regulation 1.3(k) \6\ 
or under Commission Rules 8c-1,\7\ 15c2-1,\8\ or 15c3-3,\9\ or 
Commission staff interpretations or no-action letters thereunder.\10\
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    \5\ Security futures carried in a proprietary account would be 
considered to be both securities contracts and commodity contracts 
for purposes of this rule filing.
    \6\ 17 CFR 1.3(k).
    \7\ 17 CFR 240.8c-1.
    \8\ 17 CFR 240.15c2-1.
    \9\ 17 CFR 240.15c3-3.
    \10\ Article VI, Section 3(a) of OCC's By-laws provides that a 
``firm account * * * shall be confined to (i) the Exchange 
transactions in cleared securities other than security futures of 
such Clearing Member's non-customers [which is defined in terms of 
rules under the Securities Exchange Act of 1934], (ii) the Exchange 
transactions in (x) futures other than security futures and (y) 
futures options of persons whose transactions are not required to be 
treated as the transactions of futures customers, and (iii) the 
Exchange transactions in security futures of persons whose 
transactions are not required to be treated as the transactions 
either of securities customers or of futures customers.'' The term 
``futures customer'' is defined in Article I of OCC's By-Laws as ``a 
person whose positions are carried by a futures commission merchant 
* * * in a futures account required to be segregated under Section 
4d of the Commodity Exchange Act and regulations of the Commodity 
Futures Trading Commission thereunder.'' Article VI, Section 3(c) 
provides that a proprietary combined market-makers' account is 
confined to transactions of ``proprietary Market-Makers,'' which is 
defined to include ``any participant, as such, in an account that is 
not required to be segregated under Section 4d of the Commodity 
Exchange Act.'' A ``separate Market-Maker's account'' under Section 
3(b) is similarly limited to a ``proprietary Market-Maker.'' An 
``OCC Proprietary X-M account (together with the corresponding 
proprietary X-M account at a participating futures clearing 
organization)'' is defined in the applicable cross-margining 
agreements to be an account of a person whose account is a 
``proprietary account'' within the meaning of Section 1.3(y) of CFTC 
regulations. Finally, a ``proprietary futures professional account'' 
is defined in Article I of the By-laws to be an account of a futures 
professional that is not a futures customer. Accordingly, all of 
these accounts are defined in terms that exclude any person whose 
property is required to be segregated under Section 4d of the CEA. 
Moreover, a futures commission merchant is itself obligated to carry 
the positions of futures customers in CFTC segregated accounts and 
would be in violation of that obligation by carrying them in any 
account at OCC that is not such an account.
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    Section 4d of the Commodity Exchange Act (``CEA'') \11\ and CFTC 
regulations thereunder require that futures and futures options traded 
on a ``designated contract market'' and carried for the account of a 
``customer'' as defined in CFTC Regulation 1.3(k) must be segregated by 
the carrying futures commission merchant (``FCM'') from funds or 
positions that are ``proprietary'' to the carrying FCM. Although 
Section 4d and the CFTC regulations permit the property of separate 
customers of the same FCM to be commingled at the clearinghouse in 
segregated customer accounts, CFTC Regulation 1.22 provides that 
``[c]ustomer funds shall not be used to carry trades or positions of 
the same commodity and/or option customer other than in commodities or 
commodity options traded through the facilities of a [CFTC-designated] 
contract market.'' \12\ Accordingly, OCC carries trades and positions 
of commodity customers in separate segregated funds accounts in 
compliance with the CFTC's regulations and except in accordance with 
specific cross-margining orders of the CFTC does not commingle these 
funds with the funds of securities options customers.
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    \11\ 7 U.S.C. 6d.
    \12\ 17 CFR 1.22.
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    However, Section 4d and the cited regulations do not apply to 
accounts that are ``proprietary'' within the meaning of CFTC Regulation 
1.3(y).\13\ There is no prohibition against commingling of proprietary 
funds of an FCM relating to its futures activities with other 
proprietary funds of the same FCM at the clearinghouse level. 
Accordingly, a clearing member may maintain both securities contracts 
and commodity contracts in any proprietary account to the extent that 
such inclusion is otherwise consistent with the purposes of the 
account. The result is that clearing level margin requirements 
applicable to any such proprietary account are determined under OCC 
Rule 601 based upon the net liquidating value of all positions carried 
in the account. Therefore, the margin that would otherwise be required 
on positions in securities contracts may be reduced by offsetting 
positions in commodity contracts and vice versa.
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    \13\ 17 CFR 1.3(y).
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    Section 561(b)(2)(A) of the United States Bankruptcy Code 
(``Code'') \14\ contains certain prohibitions against the offset by a 
party of obligations to a ``debtor'' (i.e., a person subject to a 
bankruptcy proceeding under the Code) arising under or in connection 
with a commodity contract as defined under section 761(4) of the Code 
\15\ against any claim arising under or in connection with other 
instruments including securities contracts ``except to the extent that 
the party has positive net equity in its commodity accounts at the 
debtor.'' Section 561(b)(2)(B) of the Code contains a similar 
prohibition against such offsets applicable to ``another commodity 
broker'' having an obligation to the debtor arising under or in 
connection with a commodity contract entered into on behalf of a 
``customer of the debtor.'' \16\ The legislative history of these 
provisions states, ``Subsections 561(b)(2)(A) and (b)(2)(B) limit the 
depletion of assets available for distribution to customers of 
commodity brokers.'' \17\
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    \14\ 11 U.S.C. 561(b)(2)(A).
    \15\ 11 U.S.C. 761(4). This very broad ``commodity contracts'' 
definition should include commodity futures and futures options and 
may include security futures as well.
    \16\ 11 U.S.C. 561(b)(2)(B).
    \17\ H.R. Rep. No. 109-31, part 1 at 132 (April 8, 2005).
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    OCC recently adopted a ``close-out netting'' rule, set forth in 
section 27 of Article VI of OCC's By-laws.\18\ Section 27 is intended 
to allow clearing members to calculate their credit exposure to OCC on 
a net basis for balance sheet and regulatory capital purposes to the 
extent consistent with

[[Page 73403]]

customer protection rules under the Act and the CEA. Paragraph (d) of 
section 27 effectively permits netting of assets and liabilities within 
proprietary accounts without limitation as to whether the assets and 
liabilities in the account arise from securities contracts or commodity 
contracts. Absent an applicable exception, the prohibition in section 
561(b)(2)(A) could be interpreted to limit such netting and make it 
unenforceable to the extent that there are both securities contracts 
and commodity contracts in such accounts.\19\ However, an exception to 
the prohibition in section 561(b)(2)(A) and section 561(b)(2)(B) was 
created for cross-margining arrangements, and that exception is 
applicable to the close-out netting provided for in section 27 of 
Article VI of OCC's By-laws insofar as such netting permits the offset 
of commodity contracts against securities contracts in proprietary 
accounts.
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    \18\ Securities Exchange Act Release No. 56069 (July 13, 2007), 
72 FR 39869 (July 20, 2007) (File No. SR-OCC-2006-19).
    \19\ Section 561(b)(2)(B) should not apply to close-out netting 
in the event of an insolvency of OCC. Section 561(b)(2)(B) would 
appear to provide in effect that a clearing member may not net an 
obligation to OCC arising from a commodity contract entered into on 
behalf of a ``customer of the debtor'' against amounts owed by OCC 
to the clearing member arising under a securities contract or other 
contracts other than commodity contracts. Because OCC would be the 
debtor, the term ``customer of the debtor'' would appear to refer to 
a customer of OCC. OCC does not believe that a clearing member would 
likely be deemed to have entered into any commodity contract on 
behalf of any party that would also be deemed to be a customer of 
OCC for purposes of this provision, and we therefore believe that 
Section 561(b)(2)(B) should not be interpreted as limiting the 
enforceability of any provisions of Section 27 of Article VI of 
OCC's By-laws. In any event, however, Section 561(b)(2)(B) would be 
overridden by the exception in Section 561(b)(3)(A) as set forth in 
the proposed Interpretation and Policy.
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    Section 561(b)(3)(A) of the Code provides that ``no provision of 
[Section 561(b)(2)(A) or (B)] shall prohibit the offset of claims and 
obligations that arise under a cross-margining agreement or similar 
arrangement that has been submitted to the [CFTC] under paragraph (1) 
or (2) of section 5c(c) of the [CEA] and has not been abrogated or 
rendered ineffective by the [CFTC].'' All of OCC's By-laws and Rules 
have been submitted under Paragraph (1) or (2) of section 5c(c) of the 
CEA, and none has been abrogated or rendered ineffective by the CFTC. 
As commonly understood, a ``cross-margining agreement'' includes an 
arrangement under which commodity contracts and securities contracts 
are margined together as a single portfolio.\20\ This is precisely what 
takes place under OCC By-laws and Rules and its Rule 601 in particular 
in all proprietary accounts to the extent that they contain both 
securities contracts and commodity contracts.
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    \20\ Securities Exchange Act Release No. 26153 (October 3, 
1988), 53 FR 39561 (October 3, 1988) (File No. SR-OCC-86-17) 
approving the first cross-margining program between OCC and its 
commodity clearing affiliate, The Intermarket Clearing Corporation 
(``ICC''). CFTC approval of that cross-margining program was 
memorialized in a letter from Jean A. Webb, Secretary, to George S. 
Hender, President, ICC (June 1, 1988).
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    The original cross-margining program, which was initiated between 
OCC and ICC in 1988, was limited to proprietary accounts.\21\ In 
connection with its approval, the Commission stated that ``it appears 
that no statutory, Commission or CFTC rule changes are required to 
implement a cross-margining system for proprietary accounts.'' OCC rule 
changes were necessary in 1988 in order to implement proprietary cross-
margining because OCC and ICC were separate clearing organizations and 
needed to have special arrangements between them in order to combine 
securities contracts cleared by OCC and commodity contracts cleared by 
ICC for margin purposes. However, when OCC itself registered as a 
derivatives clearing organization under the CEA, cross-margining in 
proprietary accounts was an automatic consequence of that dual 
registration. Of course, a rule filing was necessary in order to 
combine customer positions in security contracts and commodity 
contracts for margin purposes even where OCC clears both the commodity 
contracts and the securities contracts. Accordingly, OCC submitted 
appropriate rule filings to both the Commission and the CFTC and 
received the necessary approval to create an internal cross-margining 
program for non-proprietary market professionals.\22\ In the case of 
proprietary cross-margining, however, no such approval is required, and 
this rule filing is being submitted simply in order to clarify OCC's 
interpretation of its existing rules.
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    \21\ Securities Exchange Act Release No. 26153.
    \22\ The proposed rule change adopted By-Law Article VI, Section 
25. Securities Exchange Act Release No. 50509 (Oct. 8, 2004), 69 FR 
61289 (October 15, 2004) (File No. SR-OCC-2004-10) and CFTC order 
issued November 5, 2004.
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    Since its approval of the first cross-margining program in 
1988,\23\ the Commission has repeatedly expressed its support for such 
programs and has found that they are consistent with the Act and in 
particular with section 17A of the Act. Indeed, there has been wide 
support for cross-margining systems over many years. For example, the 
Report of the Presidential Task Force on Market Mechanisms (``Brady 
Report'') noted that the absence of an effective cross-margining system 
for futures and securities options markets contributed to payment 
strains in October 1987. Accordingly, the Brady Report recommended that 
cross-margining be allowed in order to permit market participants with 
an investment in futures to receive credit for a hedged investment in 
stocks or options.\24\ The President's Working Group on Financial 
Markets in its Interim Report concurred recommending that the 
Commission and CFTC not only approve the OCC/ICC cross-margining 
program but facilitate cross-margining among other clearing 
agencies.\25\
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    \23\ Securities Exchange Act Release No. 26153.
    \24\ Brady Report at 66 (January 1988).
    \25\ Interim Report of the President's Working Group on 
Financial Markets, Appendix D at 11 (May 1988).
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    The Commission has previously found that cross-margining programs 
are consistent with clearing agency responsibilities under section 17A 
of the Act. In so finding, the Commission noted that cross-margining 
programs reduce the risk that a clearing member would become insolvent 
in a distressed market and the corresponding risk that one insolvency 
could lead to multiple insolvencies in a ripple effect and that they 
therefore enhance the security of the clearing system.\26\
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    \26\ Securities Exchange Act Release No. 32708 (August 2, 1993) 
58 FR 42586 (August 10, 1993) (File No. SR-OCC-93-13).
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    The proposed rule change is not inconsistent with the rules of OCC 
including any rule proposed to be amended.

(B) Self-Regulatory Organization's Statement on Burden on Competition

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

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants, or Others

    Written comments were not and are not intended to be solicited with 
respect to the proposed rule change, and none have been received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action
    The foregoing rule change has become effective pursuant to section 
19(b)(3)(A)(i) of the Act \27\ and Rule 19b-4(f)(1) \28\ promulgated 
thereunder because the proposal constitutes an interpretation with 
respect to the meaning, administration, or enforcement of an existing 
rule of

[[Page 73404]]

OCC.\29\ At any time within sixty days of the filing of the proposed 
rule change, the Commission may summarily abrogate such rule change if 
it appears to the Commission that such action is necessary or 
appropriate in the public interest, for the protection of investors, or 
otherwise in furtherance of the purposes of the Act.
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    \27\ 15 U.S.C. 78s(b)(3)(A)(i).
    \28\ 17 CFR 240.19b-4(f)(1).
    \29\ The Commission neither makes any findings nor expresses any 
opinion with respect to OCC's representations and interpretations 
regarding the application of the Bankruptcy Code.
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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 rule-comments@sec.gov. Please include 

File Number SR-OCC-2007-15 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-OCC-2007-15. 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 Room, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of OCC. 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 available publicly. All 
submissions should refer to File Number SR-OCC-2007-15 and should be 
submitted on or before January 17, 2008.

    For the Commission by the Division of Trading and Markets, 
pursuant to delegated authority.\30\
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    \30\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E7-24984 Filed 12-26-07; 8:45 am]

BILLING CODE 8011-01-P