Document ID: SEC-2007-0414-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: National Association of Securities Dealers, Inc.
Posted Date: 2007-03-20T04:00Z

[Federal Register: March 20, 2007 (Volume 72, Number 53)]
[Notices]               
[Page 13149-13155]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr20mr07-101]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-55471; File No. SR-NASD-2007-013]

 
Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Notice of Filing and Immediate Effectiveness of Proposed 
Rule Change Relating to Portfolio Margin

March 14, 2007.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'' or ``Exchange Act'') \1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on February 12, 2007, the National Association of 
Securities Dealers, Inc. (``NASD'') filed with the Securities and 
Exchange Commission (``Commission'') the proposed rule change as 
described in Items I, II, and III below, which Items have been prepared 
by NASD. NASD has filed the proposed rule as a ``non-controversial'' 
rule change pursuant to Section 19(b)(3)(A) of the Act \3\ and Rule 
19b-4(f)(6) thereunder,\4\ which renders it 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\ 17 CFR 240.19b-4.
    \3\ 15 U.S.C. 78s(b)(3)(A).
    \4\ 17 CFR 240.19b-4(f)(6).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD proposes to amend NASD Rule 2520 to permit members to margin 
certain products according to a prescribed portfolio margin methodology 
on a pilot basis. NASD further proposes to amend NASD Rule 2860 to 
require that a disclosure statement and written acknowledgement for use 
with the proposed portfolio margin program be furnished to customers 
using a portfolio margin account.
    Below is the text of the proposed rule change. Proposed new rule 
language is in italics.
* * * * *
2520. Margin Requirements
    (a) through (f) No Change.
    (g) Portfolio Margin
    As an alternative to the ``strategy-based'' margin requirements set 
forth in paragraphs (a) through (f) of this Rule, members may elect to 
apply the portfolio margin requirements set forth in this paragraph (g) 
to all margin equity securities,1 listed options, security 
futures products (as defined in Section 3(a)(56) of the Exchange Act), 
unlisted derivatives, warrants, index warrants and related instruments, 
provided that the requirements of paragraph (g)(6)(B)(i) of this Rule 
are met.
    In addition, a member, provided that it is a Futures Commission 
Merchant (``FCM'') and is either a clearing member of a futures 
clearing organization or has an affiliate that is a clearing member of 
a futures clearing organization, is permitted under this paragraph (g) 
to combine an eligible participant's related instruments as defined in 
paragraph (g)(2)(D), with listed index options, unlisted derivatives, 
options on exchange traded funds (``ETF''), index warrants and 
underlying instruments and compute a margin requirement for such 
combined products on a portfolio margin basis.
    The portfolio margin provisions of this Rule shall not apply to 
Individual Retirement Accounts (``IRAs'').
    (1) Monitoring.--Members must monitor the risk of portfolio margin 
accounts and maintain a comprehensive written risk analysis methodology 
for assessing the potential risk to the member's capital over a 
specified range of possible market movements of positions maintained in 
such accounts. The risk analysis methodology shall specify the 
computations to be made, the frequency of computations, the records to 
be reviewed and maintained, and the person(s) within the organization 
responsible for the risk function. This risk analysis methodology must 
be filed with NASD, or the member's designated examining authority 
(``DEA'') if other than NASD, and submitted to the Commission prior to 
the implementation of portfolio margining. In performing the risk 
analysis of portfolio margin accounts required by this Rule, each 
member shall include in the written risk analysis methodology 
procedures and guidelines for:
    (A) obtaining and reviewing the appropriate account documentation 
and financial information necessary for assessing the amount of credit 
to be extended to eligible participants;
    (B) the determination, review and approval of credit limits to each 
eligible participant, and across all eligible participants, utilizing a 
portfolio margin account;
    (C) monitoring credit risk exposure to the member from portfolio 
margin accounts, on both an intra-day and end of day basis, including 
the type, scope and frequency of reporting to senior management;
    (D) the use of stress testing of portfolio margin accounts in order 
to monitor market risk exposure from individual accounts and in the 
aggregate;
    (E) the regular review and testing of these risk analysis 
procedures by an independent unit such as internal audit or other 
comparable group;
    (F) managing the impact of credit extended related to portfolio 
margin accounts on the member's overall risk exposure;
    (G) the appropriate response by management when limits on credit 
extensions related to portfolio margin accounts have been exceeded; and
    (H) determining the need to collect additional margin from a 
particular eligible participant, including whether that determination 
was based upon the creditworthiness of the participant and/or the risk 
of the eligible product.
    Moreover, management must periodically review, in accordance with 
written procedures, the member's credit extension activities for 
consistency with these guidelines. Management must periodically 
determine if the data necessary to apply this paragraph (g) is 
accessible on a timely basis and information systems are available to 
adequately capture, monitor, analyze and report relevant data.
    (2) Definitions.--For purposes of this paragraph (g), the following 
terms shall have the meanings specified below:

[[Page 13150]]

    (A) The term ``listed option'' means any equity-based or equity 
index-based option traded on a registered national securities exchange 
or automated facility of a registered national securities association.
    (B) The term ``portfolio'' means any eligible product, as defined 
in paragraph (g)(6)(B)(i), grouped with its underlying instruments and 
related instruments.
    (C) The term ``product group'' means two or more portfolios of the 
same type (see table in paragraph (g)(2)(F)below) for which it has been 
determined by SEC Rule 15c3-1a that a percentage of offsetting profits 
may be applied to losses at the same valuation point.
    (D) The term ``related instrument'' within a security class or 
product group means broad-based index futures and options on broad-
based index futures covering the same underlying instrument. The term 
``related instrument'' does not include security futures products.
    (E) The term ``security class'' refers to all listed options, 
security futures products, unlisted derivatives, and related 
instruments covering the same underlying instrument and the underlying 
instrument itself.
    (F) The term ``theoretical gains and losses'' means the gain and 
loss in the value of individual eligible products and related 
instruments at ten equidistant intervals (valuation points) ranging 
from an assumed movement (both up and down) in the current market value 
of the underlying instrument. The magnitude of the valuation point 
range shall be as follows:

------------------------------------------------------------------------
                                             Up/down market move (high &
              Portfolio type                    low valuation points)
------------------------------------------------------------------------
High Capitalization, Broad-based Market     +6% / -8%
 Index 2.
Non-High Capitalization, Broad-based        10%
 Market Index 3.
Any other eligible product that is, or is    15%
 based on, an equity security or a narrow-
 based index.
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    (G) The term ``underlying instrument'' means a security or security 
index upon which any listed option, unlisted derivative, security 
future, or broad-based index future is based.
    (H) The term ``unlisted derivative'' means any equity-based or 
equity index-based unlisted option, forward contract, or security-based 
swap that can be valued by a theoretical pricing model approved by the 
Commission.
    (3) Approved Theoretical Pricing Models.--Theoretical pricing 
models must be approved by the Commission.
    (4) Eligible Participants.--The application of the portfolio margin 
provisions of this paragraph (g) is limited to the following:
    (A) any broker or dealer registered pursuant to Section 15 of the 
Exchange Act;
    (B) any member of a national futures exchange to the extent that 
listed index options, unlisted derivatives, options on ETFs, index 
warrants or underlying instruments hedge the member's index futures; 
and
    (C) any person or entity not included in paragraphs (g)(4)(A) and 
(g)(4)(B) above approved for uncovered options and, if transactions in 
security futures are to be included in the account, approval for such 
transactions is also required. However, an eligible participant under 
this paragraph (g)(4)(C) may not establish or maintain positions in 
unlisted derivatives unless minimum equity of at least five million 
dollars is established and maintained with the member. For purposes of 
this minimum equity requirement, all securities and futures accounts 
carried by the member for the same eligible participant may be combined 
provided ownership across the accounts is identical. A guarantee 
pursuant to paragraph (f)(4) of this Rule is not permitted for purposes 
of the minimum equity requirement.
    (5) Opening of Accounts
    (A) Members must notify and receive approval from NASD, or the 
member's DEA if other than NASD, prior to establishing a portfolio 
margin methodology for eligible participants.
    (B) Only eligible participants that have been approved to engage in 
uncovered short option contracts pursuant to NASD Rule 2860, or the 
rules of the member's DEA if other than NASD, are permitted to utilize 
a portfolio margin account.
    (C) On or before the date of the initial transaction in a portfolio 
margin account, a member shall:
    (i) furnish the eligible participant with a special written 
disclosure statement describing the nature and risks of portfolio 
margining which includes an acknowledgement for all portfolio margin 
account owners to sign, attesting that they have read and understood 
the disclosure statement, and agree to the terms under which a 
portfolio margin account is provided (see NASD Rule 2860(c)); and
    (ii) obtain the signed acknowledgement noted above from the 
eligible participant and record the date of receipt. (6) Establishing 
Account and Eligible Positions.
    (A) For purposes of applying the portfolio margin requirements 
prescribed in this paragraph (g), members are to establish and utilize 
a specific securities margin account, or sub-account of a margin 
account, clearly identified as a portfolio margin account that is 
separate from any other securities account carried for an eligible 
participant.
    A margin deficit in the portfolio margin account of an eligible 
participant may not be considered as satisfied by excess equity in 
another account. Funds and/or securities must be transferred to the 
deficient account and a written record created and maintained. However, 
if a portfolio margin account is carried as a sub-account of a margin 
account, excess equity in the margin account (determined in accordance 
with the rules applicable to a margin account other than a portfolio 
margin account) may be used to satisfy a margin deficit in the 
portfolio margin sub-account without having to transfer any funds and/
or securities.
    (B) Eligible Products
    (i) For eligible participants as described in paragraphs (g)(4)(A) 
through (g)(4)(C), a transaction in, or transfer of, an eligible 
product may be effected in the portfolio margin account. Eligible 
products under this paragraph (g) consist of:
    (a) a margin equity security (including a foreign equity security 
and option on a foreign equity security, provided the foreign equity 
security is deemed to have a ``ready market'' under SEC Rule 15c3-1 or 
a ``no-action'' position issued thereunder, and a control or restricted 
security, provided the security has met the requirements in a manner 
consistent with SEC Rule 144 or a Commission ``no-action'' position 
issued thereunder, sufficient enough to permit the sale of the 
security, upon exercise or assignment of any listed option or unlisted 
derivative written or held against it, without restriction);
    (b) a listed option on an equity security or index of equity 
securities;
    (c) a security futures product;
    (d) an unlisted derivative on an equity security or index of equity 
securities;
    (e) a warrant on an equity security or index of equity securities; 
and
    (d) a related instrument as defined in paragraph (g)(2)(D).
    (7) Margin Required.--The amount of margin required under this 
paragraph (g) for each portfolio shall be the greater of:

[[Page 13151]]

    (A) the amount for any of the ten equidistant valuation points 
representing the largest theoretical loss as calculated pursuant to 
paragraph (g)(8) below; or
    (B) for eligible participants as described in paragraph (g)(4)(A) 
through (g)(4)(C), $.375 for each listed option, unlisted derivative, 
security future product, and related instrument, multiplied by the 
contract's or instrument's multiplier, not to exceed the market value 
in the case of long contracts in eligible products.
    (C) Account guarantees pursuant to paragraph (f)(4) of this Rule 
are not permitted for purposes of meeting margin requirements.
    (D) Positions other than those listed in Paragraph (g)(6)(B)(i) 
above are not eligible for portfolio margin treatment. However, 
positions not eligible for portfolio margin treatment (except for 
ineligible related instruments) may be carried in a portfolio margin 
account, provided the member has the ability to apply the applicable 
strategy-based margin requirements promulgated under this Rule. Shares 
of a money market mutual fund may be carried in a portfolio margin 
account, also subject to the applicable strategy-based margin 
requirement under this Rule provided that:
    (i) the customer waives any right to redeem shares without the 
member's consent;
    (ii) the member (or, if the shares are deposited with a clearing 
organization, the clearing organization) obtains the right to redeem 
shares in cash upon request;
    (iii) the fund agrees to satisfy any conditions necessary or 
appropriate to ensure that the shares may be redeemed in cash, promptly 
upon request; and
    (iv) the member complies with the requirements of Section 11(d)(1) 
of the Exchange Act and SEC Rule 11d1-2 thereunder.
    (8) Method of Calculation
    (A) Long and short positions in eligible products, including 
underlying instruments and related instruments, are to be grouped by 
security class; each security class group being a ``portfolio.'' Each 
portfolio is categorized as one of the portfolio types specified in 
paragraph (g)(2)(F) above, as applicable.
    (B) For each portfolio, theoretical gains and losses are calculated 
for each position as specified in paragraph (g)(2)(F) above. For 
purposes of determining the theoretical gains and losses at each 
valuation point, members shall obtain and utilize the theoretical 
values of eligible products as described in this paragraph (g) rendered 
by an approved theoretical pricing model.
    (C) Offsets. Within each portfolio, theoretical gains and losses 
may be netted fully at each valuation point. Offsets between portfolios 
within the eligible product groups, as described in paragraph 
(g)(2)(F), may then be applied as permitted by SEC Rule 15c3-1a.
    (D) After applying the offsets above, the sum of the greatest loss 
from each portfolio is computed to arrive at the total margin required 
for the account (subject to the per contract minimum).
    (E) In addition, if a security that is convertible, exchangeable, 
or exercisable into a security that is an underlying instrument 
requires the payment of money or would result in a loss if converted, 
exchanged, or exercised at the time when the security is deemed an 
underlying instrument, the full amount of the conversion loss is 
required.
    (9) Portfolio Margin Minimum Equity Deficiency
    (A) If, as of the close of business, the equity in the portfolio 
margin account of an eligible participant as described in paragraph 
(g)(4)(C), declines below the five million dollar minimum equity 
required, if applicable, and is not restored to at least five million 
dollars within three business days by a deposit of funds and/or 
securities or through favorable market action, members are prohibited 
from accepting new opening orders beginning on the fourth business day, 
except that new opening orders entered for the purpose of reducing 
market risk may be accepted if the result would be to lower margin 
requirements. This prohibition shall remain in effect until,
    (i) equity of five million dollars is established, or
    (ii) all unlisted derivatives are liquidated or transferred from 
the portfolio margin account to the appropriate securities account.
    (B) Members will not be permitted to deduct any portfolio margin 
minimum equity deficiency amount from Net Capital in lieu of collecting 
the minimum equity required.
    (10) Portfolio Margin Deficiency
    (A) If, as of the close of business, the equity in the portfolio 
margin account of an eligible participant, as described in paragraph 
(g)(4)(A) through (g)(4)(C), is less than the margin required, the 
eligible participant may deposit additional funds and/or securities or 
establish a hedge to meet the margin requirement within three business 
days. After the three business day period, members are prohibited from 
accepting new opening orders, except that new opening orders entered 
for the purpose of reducing market risk may be accepted if the result 
would be to lower margin requirements. In the event an eligible 
participant fails to hedge existing positions or deposit additional 
funds and/or securities in an amount sufficient to eliminate any margin 
deficiency after three business days, the member must liquidate 
positions in an amount sufficient to, at a minimum, lower the total 
margin required to an amount less than or equal to the account equity.
    (B) If the portfolio margin deficiency is not met by the close of 
business on the next business day after the business day on which such 
deficiency arises, members will be required to deduct the amount of the 
deficiency from Net Capital until such time the deficiency is satisfied 
or positions are liquidated pursuant to paragraph (g)(10)(A) above.
    (C) Members will not be permitted to deduct any portfolio margin 
deficiency amount from Net Capital in lieu of collecting the margin 
required.
    (D) NASD, or the member's DEA if other than NASD, may grant 
additional time for an eligible participant to meet a portfolio margin 
deficiency upon written request, which is expected to be granted in 
extraordinary circumstances only.
    (E) Notwithstanding the provisions of subparagraph (B) above, 
members should not permit an eligible participant to make a practice of 
meeting a portfolio margin deficiency by liquidation. Members must have 
procedures in place to identify accounts that periodically liquidate 
positions to eliminate margin deficiencies, and the member is expected 
to take appropriate action when warranted. Liquidation to eliminate 
margin deficiencies that are caused solely by adverse price movements 
may be disregarded.
    (11) Determination of Value for Margin Purposes.--For the purposes 
of this paragraph (g), all eligible products shall be valued at current 
market prices. Account equity for the purposes of paragraphs (g)(9)(A) 
and (g)(10)(A) shall be calculated separately for each portfolio margin 
account by adding the current market value of all long positions, 
subtracting current market value of all short positions, and adding the 
credit (or subtracting the debit) balance in the account.
    (12) Net Capital Treatment of Portfolio Margin Accounts
    (A) No member that requires margin in any portfolio account 
pursuant to paragraph (g) of this Rule shall permit the aggregate 
portfolio margin requirements to exceed ten times its Net Capital for 
any period exceeding three business days. The member shall, beginning 
on the fourth business day,

[[Page 13152]]

cease opening new portfolio margin accounts until compliance is 
achieved.
    (B) If, at any time, a member's aggregate portfolio margin 
requirements exceed ten times its Net Capital, the member shall 
immediately transmit telegraphic or facsimile notice of such deficiency 
to the principal office of the Commission in Washington, D.C., the 
district or regional office of the Commission for the district or 
region in which the member maintains its principal place of business; 
and to NASD, or the member's DEA if other than NASD. Notice to NASD 
shall be in such form as NASD may prescribe.
    (13) Day Trading Requirements.--The day trading restrictions 
promulgated under paragraph (f)(8)(B) of this Rule shall not apply to 
portfolio margin accounts that establish and maintain at least five 
million dollars in equity, provided that a member has the ability to 
monitor the intra-day risk associated with day trading. Portfolio 
margin accounts that do not establish and maintain at least five 
million dollars in equity will be subject to the day trading 
restrictions under paragraph (f)(8)(B) of this Rule, provided the 
member has the ability to apply the applicable day trading requirement 
under this Rule. However, if the position or positions day traded were 
part of a hedge strategy, the day trading restrictions will not apply. 
A ``hedge strategy'' for purposes of this Rule means a transaction or a 
series of transactions that reduces or offsets a material portion of 
the risk in a portfolio. Members are expected to monitor these 
portfolio margin accounts to detect and prevent circumvention of the 
day trading requirements.
    (14) Requirements to Liquidate
    (A) A member is required immediately either to liquidate, or 
transfer to another broker-dealer eligible to carry portfolio margin 
accounts, all portfolio margin accounts with positions in related 
instruments if the member is:
    (i) insolvent as defined in section 101 of title 11 of the United 
States Code, or is unable to meet its obligations as they mature;
    (ii) the subject of a proceeding pending in any court or before any 
agency of the United States or any State in which a receiver, trustee, 
or liquidator for such debtor has been appointed;
    (iii) not in compliance with applicable requirements under the 
Exchange Act or rules of the Commission or any self-regulatory 
organization with respect to financial responsibility or hypothecation 
of eligible participant's securities; or
    (iv) unable to make such computations as may be necessary to 
establish compliance with such financial responsibility or 
hypothecation rules.
    (B) Nothing in this paragraph (g)(14) shall be construed as 
limiting or restricting in any way the exercise of any right of a 
registered clearing agency to liquidate or cause the liquidation of 
positions in accordance with its by-laws and rules.
    (15) Members must ensure that portfolio accounts are in compliance 
with Rule 2860.

----------------

    \1\ For purposes of this paragraph (g) of the Rule, the term 
``margin equity security'' utilizes the definition at Section 220.2 
of Regulation T of the Board of Governors of the Federal Reserve 
System.
    \2\ In accordance with paragraph (b)(1)(i)(B) of SEC Rule 15c3-
1a (Appendix A to SEC Rule 15c3-1), 17 CFR 240.15c3-1a(b)(1)(i)(B).
    \3\ See footnote 2.
* * * * *
2860. Options
    (a) through (b) No Change.
    (c) Portfolio Margining Disclosure Statement and Acknowledgement
    The special written disclosure statement describing the nature and 
risks of portfolio margining, and acknowledgement for an eligible 
participant signature, required by Rule 2520(g)(5)(C) shall be in a 
format prescribed by NASD or in a format developed by the member, 
provided it contains substantially similar information as in the 
prescribed NASD format and has received the prior written approval of 
NASD.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NASD included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. NASD has prepared summaries, set forth in sections A, B, 
and C below, of the most significant aspects of such statements.

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

1. Purpose
    Background. Section 7(a) of the Act \5\ authorizes the Board of 
Governors of the Federal Reserve System to prescribe the rules and 
regulations regarding credit that may be extended by broker-dealers on 
securities to their customers as set forth in Regulation T. Currently, 
Rule 2520 (Margin Requirements) prescribes minimum maintenance margin 
requirements for customer accounts held by members based on position or 
strategy-based margin requirements. This methodology applies prescribed 
margin percentage requirements to each security position and/or 
strategy, either long or short, held in a customer's account.
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    \5\ 15 U.S.C. 78g.
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    The Board of Governors of the Federal Reserve System in its 
amendments to Regulation T in 1998 permitted self-regulatory 
organizations to implement portfolio margin rules, subject to 
Commission approval.\6\ Accordingly, NASD is filing the proposed rule 
change to allow members to extend a portfolio margin methodology to 
eligible participants as an alternative to the current margin 
requirements.
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    \6\ See Federal Reserve System, ``Securities Credit 
Transactions; Borrowing by Broker and Dealers''; Regulations G, T, U 
and X; Dockets Nos. R-0905, R-0923 and R-0944, 63 FR 2806 (January 
16, 1998).
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    As further detailed herein, the proposed rule change would amend 
NASD Rule 2520 on a pilot basis to allow members, subject to specified 
conditions, to elect to apply a portfolio margin methodology to all 
margin equity securities,\7\ listed options, security futures 
products,\8\ unlisted derivatives,\9\ warrants, index warrants, and 
related instruments.\10\ In addition, a member, provided that it is a 
futures commission merchant (``FCM'') and is either a clearing member 
of a futures clearing organization or has an affiliate that is a 
clearing member of a futures clearing organization, would be permitted 
to combine an eligible participant's related instruments with listed 
index options, unlisted derivatives, options on exchange traded funds 
(``ETF''), index warrants, and underlying instruments \11\ and compute 
a margin requirement for such combined products on a portfolio margin 
basis.
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    \7\ For purposes of the rule, the term ``margin equity 
security'' uses the definition at Section 220.2 of Regulation T of 
the Board of Governors of the Federal Reserve System.
    \8\ For purposes of the rule, ``security futures product'' uses 
the definition at Section 3(a)(56) of the Act.
    \9\ For purposes of the rule, the term ``unlisted derivatives'' 
is defined in Rule 2520(g)(2)(H).
    \10\ For purposes of the rule, the term ``related instrument'' 
is defined in Rule 2520(g)(2)(D).
    \11\ For purposes of the rule, the term ``underlying 
instrument'' is defined in Rule 2520(g)(2)(G).
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    The proposed rule change is substantially similar to recent margin

[[Page 13153]]

rule amendments by the New York Stock Exchange (``NYSE'') and the 
Chicago Board Options Exchange (``CBOE''), which were approved by the 
Commission.\12\ Consistent with the NYSE and CBOE programs, the 
proposed rule change would be available as a pilot beginning on April 
2, 2007 and ending on July 31, 2007, unless the Commission approves an 
extension of the pilot or adoption of the program on a permanent basis.
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    \12\ See Securities Exchange Act Release No. 54918 (December 12, 
2006), 71 FR 75790 (December 18, 2006) (SR-NYSE-2006-13, relating to 
further amendments to the NYSE's portfolio margin pilot program); 
Securities Exchange Act Release No. 54125 (July 11, 2006), 71 FR 
40766 (July 18, 2006) (SR-NYSE-2005-93, relating to amendments to 
the NYSE's portfolio margin pilot program); Securities Exchange Act 
Release No. 52031 (July 14, 2005), 70 FR 42130 (July 21, 2005) (SR-
NYSE-2002-19, relating to the NYSE's original portfolio margin 
pilot). See also Securities Exchange Act Release No. 54919 (December 
12, 2006), 71 FR 75781 (December 18, 2006) (SR-CBOE-2006-014, 
relating to amendments to the CBOE's portfolio margin pilot); 
Securities Exchange Act Release No. 52032 (July 14, 2005), 70 FR 
42118 (July 21, 2005) (SR-CBOE-2002-03, relating to the CBOE's 
original portfolio margin pilot).
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    Portfolio Margin. Portfolio margining is a margin methodology that 
sets margin requirements for an account based on the greatest projected 
net loss of all positions in a product class or group \13\ using 
computer modeling to perform risk analysis using multiple pricing 
scenarios. These scenarios are designed to measure the theoretical loss 
of the positions given changes in both the underlying price and implied 
volatility inputs to the model. Accordingly, the margin required is 
based on the greatest loss that would be incurred in a portfolio if the 
value of its components move up or down by a predetermined amount.
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    \13\ Products would be grouped into a single portfolio that is 
based on the same index or issuer.
---------------------------------------------------------------------------

    Margin Calculation. Under the proposed rule change, a gain or loss 
on each position in the portfolio would be calculated on each of ten 
equidistant points along a range representing a potential percentage 
increase and decrease in the value of the instrument or underlying 
instrument in the case of a derivative product. For portfolios of only 
highly capitalized broad-based indexes, the range would be between a 
market increase of 6% and a decrease of 8%. For non-highly capitalized 
broad-based indexes the range would be +/-10%. For portfolios of equity 
options, narrow-based index options and/or security futures, the risk-
array for computing the portfolio margin requirement would be up/down 
market moves of +/-15%.
    Options having the same underlying security (or index in the case 
of an index option), the underlying security itself, and any related 
futures, options on futures or security futures products could be 
combined as a portfolio for purposes of computing a portfolio margin 
requirement. The Commission approved theoretical options pricing model 
would be used to derive position values at each valuation point for the 
purpose of determining the gain or loss.\14\ The gains and losses are 
netted to derive a potential portfolio gain or loss for the point. The 
margin requirement for the portfolio is the amount of the greatest loss 
among the calculation points. Certain portfolios would be allowed 
offsets such that, at the same valuation point, a gain in one portfolio 
may reduce or offset the loss in another portfolio. The amount of 
offset allowed between portfolios would be the same as permitted under 
SEC Rule 15c3-1a for computing a broker-dealer's net capital. The 
margin requirement for each portfolio would then be added together to 
calculate the total margin requirement for the portfolio margin 
account.
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    \14\ Currently, the only model that is approved by the 
Commission is The Options Clearing Corporation's Theoretical 
Intermarket Margining System (TIMS).
---------------------------------------------------------------------------

    In addition, the proposed rule change prescribes a minimum margin 
requirement of $.375 for each listed option, unlisted derivative, 
security futures product, and related instrument multiplied by the 
contract or instrument's multiplier. This minimum amount of margin 
ensures that a certain level of margin is required from the customer in 
the event that the greatest loss among the valuation points is a de 
minimis amount.
    Generally, a customer benefits from portfolio margining in that 
margin requirements calculated on net position risk are generally lower 
than strategy-based margin methodologies currently in place. In 
permitting margin computation based on actual net risk, members would 
no longer be required to compute a margin requirement for each 
individual position or strategy in a customer's account.
    Monitoring and Risk Management. However, as a pre-condition to 
permitting portfolio margining, the member would be required to 
establish comprehensive written risk analysis methodology to assess the 
potential risk to the member's capital over a specified range of 
possible market movements. In performing the risk analysis, the member 
would be required to include in the written risk analysis methodology 
procedures and guidelines for (1) obtaining and reviewing account 
documentation and financial information to assess the amount of credit 
to be extended to eligible participants; (2) the determination, review, 
and approval of credit limits to each eligible participant, and across 
all eligible participants, utilizing a portfolio margin account; (3) 
monitoring credit risk exposure to the member's capital, on both a 
intra-day and end of day basis, including the type, scope and frequency 
of reporting to senior management; (4) the use of stress testing of 
portfolio margin accounts in order to monitor market risk exposure from 
individual accounts and in the aggregate; (5) the regular review and 
testing of the procedures by an independent unit; (6) managing the 
impact of credit extended related to portfolio margin accounts on the 
member's overall risk exposure; (7) the appropriate response by 
management when credit extensions have been exceeded; and (8) 
determining when additional margin may need to be collected.
    Members would be required to periodically review their credit 
extension activities for consistency with their guidelines and 
determine if the data necessary to apply portfolio margining is 
accessible on a timely basis and information systems are available to 
adequately capture, monitor, analyze and report relevant data. The risk 
analysis methodology must be filed with NASD, or the member's 
designated examining authority (``DEA'') if other than NASD, and 
submitted to the Commission prior to implementation of portfolio 
margining. The proposed rule change also requires members to notify and 
receive approval from NASD or the member's DEA if other than NASD, 
prior to establishing a portfolio margin methodology for eligible 
participants.
    Eligible Participants. The proposed rule change would permit the 
following persons to engage in portfolio margining: (1) Any broker or 
dealer registered pursuant to Section 15 of the Act; (2) any member of 
a national futures exchange to the extent that listed index options, 
unlisted derivatives, options on ETFs, index warrants or underlying 
instruments hedge the member's index futures; and (3) any person 
approved to engage in uncovered option contracts, and if security 
futures are to be included in the account, approval for such 
transactions is also required. However, an eligible participant under 
category (3) may not establish or maintain positions in unlisted 
derivatives unless minimum equity of at least five million dollars is 
established and maintained with the member. If the account of a 
participant subject to the five million dollar

[[Page 13154]]

requirement falls below such minimum requirement, it must be restored 
within three business days. A member would be prohibited from accepting 
new opening orders beginning on the fourth business day, except for new 
opening orders entered solely for the purpose of reducing market risk, 
where the result would be to lower margin requirements.
    Margin Deficiencies. Under the proposed rule change, participants 
would be required to satisfy a margin deficiency in a portfolio margin 
account within three business days by the deposit of additional funds 
and/or securities or by the establishment of a hedge that would reduce 
margin requirements. In the event the deficiency is not satisfied after 
three business days, the member must liquidate positions to eliminate 
the deficiency. A member would be required to deduct from its net 
capital the amount of any margin deficiency not satisfied by the close 
of business on the next business day after the business day on which 
the deficiency arises and continuing until the deficiency is satisfied. 
Members should not permit an eligible participant to make a practice of 
meeting a portfolio margin deficiency by liquidation and would be 
required to identify accounts that periodically liquidate positions to 
eliminate margin deficiencies.
    Establishing Account. Members would be permitted to use a specific 
securities margin account or a sub-account of a margin account clearly 
identified as a portfolio margin account. The account must be separate 
from any other securities account. In the event a portfolio margin 
account is a subaccount of a regular margin account, a member would be 
allowed to use excess equity in the regular margin account to meet a 
margin deficiency in the portfolio margin account. In addition, 
securities, including money market funds, that are not eligible for 
portfolio margin treatment would be allowed to be carried in a 
portfolio margin account for their collateral value, subject to the 
margin requirement applicable in a regular securities margin account.
    Day Trading. The day trading restrictions in Rule 2520 would not 
apply to portfolio margin accounts that establish and maintain at least 
five million dollars in equity, provided that a member has the ability 
to monitor the intra-day risk associated with day trading. Portfolio 
margin accounts that do not establish and maintain at least five 
million dollars in equity would otherwise be subject to the day trading 
restrictions. However, if the position or positions day traded were 
part of a hedge strategy, the day trading restrictions would not apply. 
A ``hedge strategy'' for purposes of the rule means a transaction or a 
series of transactions that reduces or offsets a material portion of 
the risk in a portfolio. Members would be expected to monitor portfolio 
accounts to detect and prevent circumvention of the day trading 
requirements.
    Net Capital Treatment. The proposed rule change would provide that 
the aggregate portfolio margin and maintenance requirements may not 
exceed ten times the member's net capital, as computed under SEC Rule 
15c3-1. This requirement places a ceiling on the amount of portfolio 
margin a broker-dealer can extend to its customers.
    Disclosure Document. NASD Rule 2860(b)(11) prescribes requirements 
for the delivery of options disclosure documents concerning the opening 
of customer accounts. Under the proposed rule change, members would be 
required to provide every portfolio margin customer with a written risk 
disclosure statement at or prior to the initial transaction in a 
portfolio margin account. The disclosure would be in a format 
prescribed by NASD or in a format developed by the member, provided it 
contains substantially similar information as in the prescribed NASD 
format and has received the prior written approval of NASD. NASD will 
issue a Notice to Members to set forth the language required in the 
written disclosure statement.
    NASD has filed the proposed rule change for immediate 
effectiveness. As noted above, the proposed rule change would establish 
a pilot program that would begin on April 2, 2007 and end on July 31, 
2007 to conform to the time periods of the similar portfolio margin 
pilot programs of the NYSE and CBOE.\15\
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    \15\ See supra note 12.
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2. Statutory Basis
    NASD believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\16\ which requires, among 
other things, that NASD rules be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. NASD believes that the proposed rule change will 
better align the margin requirements with actual risk.
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    \16\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD 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

    The foregoing proposed rule change is subject to Section 
19(b)(3)(A)(iii) of the Act \17\ and Rule 19b-4(f)(6) \18\ because the 
proposal: (i) Does not significantly affect the protection of investors 
or the public interest; (ii) does not impose any significant burden on 
competition; and (iii) does not become operative prior to 30 days after 
the date of filing or such shorter time as the Commission may designate 
if consistent with the protection of investors and the public interest; 
provided that NASD has given the Commission notice of its intent to 
file the proposed rule change, along with a brief description and text 
of the proposed rule change, or such shorter time as designated by the 
Commission.\19\
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    \17\ 15 U.S.C. 78s(b)(3)(A)(iii).
    \18\ 17 CFR 240.19b-4(f)(6).
    \19\ NASD has satisfied the five day pre-filing requirement.
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    At any time within 60 days of the filing of such 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.

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-NASD-2007-013 on the subject line.

[[Page 13155]]

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-NASD-2007-013. 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. Copies of such 
filing also will be available for inspection and copying at the 
principal office of NASD. All comments received will be posted without 
change; the Commission does not edit personal identifying information 
from submissions. You should submit only information that you wish to 
make available publicly. All submissions should refer to File Number 
SR-NASD-2007-013 and should be submitted on or before April 10, 2007.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-4973 Filed 3-19-07; 8:45 am]

BILLING CODE 8010-01-P