Document ID: SEC-2007-1689-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2007-12-12T05:00Z

[Federal Register: December 12, 2007 (Volume 72, Number 238)]
[Notices]               
[Page 70627-70628]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr12de07-87]                         

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SECURITIES AND EXCHANGE COMMISSION

Release No. 34-56916; File No. SR-NASD-2007-044]

 
Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc. (n/k/a Financial Industry Regulatory Authority Inc.); 
Order Granting Approval of Proposed Rule Change, as Modified by 
Amendment No. 1 Thereto, To Expand the Class of Entities Permitted To 
Use the Delta Hedging Exemption From Equity Options Position Limits

 December 6, 2007.
    On June 29, 2007, the National Association of Securities Dealers, 
Inc. (``NASD'') (n/k/a Financial Industry Regulatory Authority, Inc.) 
filed with the Securities and Exchange Commission (``Commission''), 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'')\1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to 
amend Rule 2860 to expand the class of entities permitted to use the 
delta hedging exemption from equity options position limits.\3\ The 
Commission published the proposed rule change for comment in the 
Federal Register on August 13, 2007.\4\ On October 15, 2007, FINRA 
filed Amendment No. 1 to the proposed rule change.\5\ The Commission 
received one comment letter on the proposed rule change.\6\ This order 
approves the proposed rule change as modified by Amendment No. 1.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ On July 26, 2007, the Commission approved a proposed rule 
change filed by NASD to amend NASD's Certificate of Incorporation to 
reflect its name change to Financial Industry Regulatory Authority 
Inc., or FINRA, in connection with the consolidation of the member 
firm regulatory functions of NASD and NYSE Regulation, Inc. See 
Securities Exchange Act Release No. 56146 (July 26, 2007), 72 FR 
42190 (August 1, 2007).
    \4\ See Securities Exchange Act Release No. 56207 (August 6, 
2007), 72 FR 45284.
    \5\ In Amendment No. 1, FINRA made technical revisions to the 
proposal. This is a technical amendment and is not subject to notice 
and comment. In Amendment No. 1, FINRA noted that the effective date 
of the proposal will be February 1, 2008, or such later date as may 
be necessary to ensure completion of the required technology changes 
by the Options Clearing Corporation and the Securities Industry 
Automation Corporation.
    \6\ See letter to Nancy M. Morris, Secretary, Commission, from 
John R. Vitha, Esq., Chairman, Derivative Products Committee, 
Securities Industry and Financial Markets Association, dated 
September 25, 2007. The commenter supported the proposed rule 
change.
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    In 2004, the Commission approved amendments to Rule 2860 that 
provide a delta hedging exemption from stock

[[Page 70628]]

options position and exercise limits \7\ for positions held by 
affiliates of FINRA members approved by the Commission as ``OTC 
derivatives dealers.'' \8\ Under the proposal, FINRA would expand 
eligibility for its delta hedging exemption beyond OTC derivatives 
dealers by allowing members and certain non-member affiliates \9\ to 
rely on this exemption if its position in standardized and/or 
conventional equity options is delta neutral under a ``Permitted 
Pricing Model.'' \10\ The options contract equivalent of the net delta 
\11\ of a hedged options position still would be subject to the 
position limits in Rule 2860 (subject to the availability of any other 
position limit exemptions).\12\ A member that intends to employ, or 
whose non-member affiliate intends to employ, this exemption would be 
required to provide a written certification to FINRA stating that the 
member and/or its affiliate will use a Permitted Pricing Model, and 
that if an affiliate ceases to hedge stock options positions in 
accordance with such systems and models, it will provide immediate 
written notice to the member.\13\ Furthermore, any member or designated 
aggregation unit would be required to report any aggregate position of 
200 or more contracts on the same side of the market and the options 
contract equivalent of the net delta of a position representing 200 or 
more contracts.\14\ In addition, the options positions of a non-member 
relying on this exemption would be required to be carried by a member 
with which it is affiliated.\15\
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    \7\ The proposed rule change does not expressly amend FINRA's 
options exercise limits in Rule 2860(b)(4) because such exercise 
limits apply only to the extent Rule 2860(b)(3) imposes position 
limits. Thus, as delta neutral positions would be exempt from 
position limits under the proposed rule change, such positions also 
would be exempt from exercise limits. See NASD Notice to Members 94-
46 (June 1994) at 2 (``* * * exercise limits correspond to position 
limits, such that investors in options classes on the same side of 
the market are allowed to exercise * * * only the number of options 
contracts set forth as the applicable position limit for those 
options classes.''). Similarly, for positions held that are not 
delta neutral, only the option contract equivalent of the net delta 
of such positions would be subject to exercise limits.
    \8\ See Securities Exchange Act Release No. 50748 (November 29, 
2004), 69 FR 70485 (December 6, 2004) (SR-NASD-2004-153).
    \9\ The Commission notes that only those non-member affiliates 
identified in the definition of ``Permitted Pricing Model'' would be 
eligible to rely on the delta hedging exemption. See infra note 10.
    \10\ ``Permitted Pricing Model'' for purposes of this exemption 
would be a pricing model used by: (1) A member or its affiliate 
subject to consolidated supervision by the Commission pursuant to 
Appendix E of Rule 15c3-1 under the Act (i.e., a consolidated 
supervised entity or ``CSE''); (2) a financial holding company 
(``FHC'') or a company treated as an FHC under the Bank Holding 
Company Act of 1956, or its affiliate subject to consolidated 
holding company group supervision; (3) a Commission registered OTC 
derivatives dealer; (4) a national bank under the National Bank Act; 
and (5) a member, or non-member affiliate (that is part of a CSE or 
FHC), using a pricing model maintained and operated by the Options 
Clearing Corporation. See proposed Rule 2860(b)(3)(A)(vii)(b)(1).
    \11\ ``Net delta'' would be defined to mean ``the number of 
shares that must be maintained (either long or short) to offset the 
risk that the value of an equity options position will change with 
incremental changes in the price of the security underlying the 
options position.'' See proposed changes to Rule 2860(b)(2)(GG).
    ``Options Contract Equivalent of the Net Delta'' would be 
defined to mean the net delta divided by the number of shares 
underlying the options contract. See proposed Rule 2860(b)(2)(LL).
    \12\ See proposed Rule 2860(b)(3)(A)(vii)(b). The Commission 
notes that Rule 2860(b)(3)(A)(vii) provides for multiple, 
independent hedge exemptions. Of course, to the extent that a 
position is used to hedge for the purpose of one exemption from 
position limit requirements, such as the delta hedge exemption, such 
position cannot be used to take advantage of another exemption from 
position limit requirements.
    \13\ See proposed Rule 2860(b)(3)(A)(vii)(b)(3).
    \14\ See proposed Rule 2860(b)(3)(A)(vii)(b)(4).
    \15\ See proposed Rule 2860(b)(3)(A)(vii)(b)(3).
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    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder that are applicable to a national securities 
association.\16\ In particular, the Commission believes that the 
proposed rule change is consistent with Section 15A(b)(6) of the 
Act,\17\ which requires, among other things, that FINRA rules be 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, to remove impediments 
to and perfect the mechanism of a free and open market and a national 
market system, and, in general, to protect investors and the public 
interest. The Commission has previously stated its support for 
recognizing options positions hedged on a delta neutral basis as 
properly exempted from position limits.\18\
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    \16\ In approving this rule, the Commission notes that it has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \17\ 15 U.S.C. 78o-3(b)(6).
    \18\ See Securities Exchange Act Release No. 40594 (October 23, 
1998), 63 FR 59362, 59380 (November 3, 1998) (File No. S7-30-97) 
(adopting rules relating to OTC derivatives dealers).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\19\ that the proposed rule change (SR-NASD-2007-044), as modified 
by Amendment No. 1, be, and it hereby is, approved.
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    \19\ 15 U.S.C. 78s(b)(2).
    \20\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets 
pursuant to delegated authority.\20\
Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E7-24044 Filed 12-11-07; 8:45 am]

BILLING CODE 8011-01-P