[Federal Register: September 29, 2003 (Volume 68, Number 188)]
[Notices]
[Page 56026-56029]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr29se03-141]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-48520; File No. SR-OCC-2002-10]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Granting Approval of a Proposed Rule Change Relating to Market-
Maker Account Agreements
September 22, 2003.
I. Introduction
On May 21, 2002, The Options Clearing Corporation (``OCC'') filed
with the Securities and Exchange Commission (``Commission'') and on
October 18, 2002, amended proposed rule change SR-OCC-2002-10 pursuant
to section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'').\1\ Notice of the proposal was published in the Federal
Register on April 24, 2003.\2\ No comment letters were received. For
the reasons discussed below, the
[[Page 56027]]
Commission is granting approval of the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ Securities Exchange Act Release No. 47691, (April 17, 2003),
68 FR 20207 (April 24, 2003) [File No. SR-OCC-2002-10].
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II. Description
The purpose of the rule change is to amend Article VI, Section 3 of
OCC's By-Laws and Chapter XI, Rule 1105 of OCC's Rules to eliminate the
requirement that a clearing member must obtain a specified form of
account agreement from each market-maker for whom it carries an account
and must submit the agreement to OCC for approval. OCC believes that
such submissions to OCC are no longer necessary to perfect its security
interest in clearing members' market-maker accounts under the Uniform
Commercial Code (``UCC'') and are administratively burdensome for OCC
and its clearing members.
The rule change also adds two new interpretive statements to
Article VI, Section 3. Interpretation .02 clarifies the application to
OCC clearing accounts of certain UCC amendments to Article 8 and to
Article 9. Interpretation .03 clarifies that OCC's lien on positions in
clearing member accounts extends to short security futures positions,
as well as all other assets, and that OCC's lien secures clearing
member obligations on long security futures positions, as well as all
other obligations arising from the applicable account or accounts.
1. Background
Article VI, Section 3, of OCC's By-Laws specifies the types of
clearing accounts that a clearing member may have at OCC, including
accounts in which a clearing member may carry positions of market
professionals such as options market-makers, JBO participants,\3\ and
stock specialists (referred to collectively herein as ``market-makers''
and ``market-maker accounts''). Clearing members that maintain market-
maker accounts at OCC must, according to the current provisions of
Article VI, Section 3, obtain and submit to OCC for approval certain
agreements from each market-maker whose funds and positions are
included in such market-maker accounts. The principal reason for
requiring the filing of these agreements with OCC was to ensure that
OCC's security interest in and setoff rights against long option
positions and assets deposited as margin in market-maker accounts would
be protected under the UCC as it existed prior to the 1994 UCC
amendments in the event of a clearing member insolvency.
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\3\ Under Article I, Section 1 of OCC's By-Laws, a ``JBO
participant'' is a registered broker-dealer that ``(i) maintains a
joint back office arrangement with a clearing member pursuant to the
requirements of Regulation T promulgated by the Board of Governors
of the Federal Reserve System; (ii) meets the requirements
applicable to JBO participants as specified in exchange rules; and
(iii) consents to having his exchange transactions cleared and
positions carried in a JBO participants account.'' Unless the
context requires otherwise, a JBO participant is a market-maker for
purposes of OCC's By-Laws and all of OCC's Rules except for Chapter
IV.
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OCC currently requires that a clearing member file with OCC a
specified form of account agreement, executed by the clearing member
and each market-maker included in the account, containing the required
consents for the applicable type of market-maker account.\4\ Having to
submit each of the agreements to OCC for OCC review is cumbersome and
imposes administrative burdens on both clearing members and OCC staff.
Moreover, OCC believes that there may be potential for confusion in the
legal relationships established through these documents. Although the
agreements are not intended to create contractual privity between OCC
and the market-maker, OCC believes it might be possible to misinterpret
the agreements as doing so.
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\4\ While the content of the agreements may vary by type of
market-maker account, all agreements specify OCC's right to a lien
on all assets in the account, the right to carry positions ``net,''
and the right to close out positions. Market-makers whose assets are
carried at OCC in combined accounts with other market-makers are
required to consent to the commingling of their positions with the
positions of other market-makers. Because OCC's lien on all assets
in a combined market-makers' account covers any obligation arising
from the commingled account, assets attributable to one market-maker
may be used by OCC to offset obligations of the clearing member that
are attributable to the activity of a different market-maker.
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2. Proposed Changes
Because of the UCC amendments in 1994, OCC believes it is no longer
necessary to require clearing members to file market-maker account
agreements with OCC in order to protect OCC's security interest in and
setoff rights against funds and positions in market-maker accounts.\5\
The UCC amendments established new rules specifically tailored to
govern the ``indirect holding system'' for securities and certain other
investment property.\6\ Under these rules, OCC may obtain an
automatically perfected, first-priority security interest in assets in
market-maker accounts through provisions in OCC's By-Laws or Rules. No
grant of a security interest from the market-maker to OCC is required.
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\5\ OCC did not propose to eliminate the requirement that
clearing members file market-maker account agreements with OCC
immediately after the adoption of the UCC amendments because that
requirement was not inconsistent with the UCC amendments and because
the UCC amendments were not immediately adopted in all U.S.
jurisdictions. Because OCC is expecting an increase in market-maker
account openings as a result of security futures trading, it is now
a business priority for OCC to eliminate the requirement in order to
relieve administrative burdens for both OCC and its clearing
members.
\6\ Part 5 of Article 8 of the UCC describes the core of the
package of rights of a person who holds a security through a
securities intermediary.
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Under the UCC amendments, OCC and its clearing members are
``securities intermediaries,'' \7\ and an OCC-issued option is a
``financial asset.'' \8\ A person acquires a ``security entitlement''
\9\ and becomes an ``entitlement holder'' \10\ when a securities
intermediary credits a financial asset to that person's account.\11\
OCC's clearing members acquire a security entitlement against OCC when
OCC credits positions to their accounts. The clearing members'
customers (including market-makers) acquire security entitlements
against the clearing member with respect to positions carried for those
customers on the books of the clearing member.
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\7\ UCC 8-102(a)(14).
\8\ UCC 8-102(a)(9)(ii) and 8-103(e).
\9\ UCC 8-102(a)(17).
\10\ UCC 8-102(a)(7).
\11\ UCC 8-501(b)(1).
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In order for OCC to acquire a perfected security interest in
clearing members' security entitlements, OCC must obtain ``control''
over the entitlements or the ``securities account'' in which they are
held.\12\ UCC 8-106(e) provides that the securities intermediary has
control ``[i]f an interest in a security entitlement is granted by the
entitlement holder to the entitlement holder's own securities
intermediary.''
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\12\ UCC 9-314(a) and 9-106(a).
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OCC's revised by-law and rule will state that the clearing member
(i.e., the entitlement holder) agrees and represents that it has
obtained the agreement of each market-maker whose positions and
transactions are included in the account and that OCC (i.e., the
securities intermediary) has a lien on long positions and margin in
each market-maker account. Consequently, OCC will have a security
interest perfected by control of the security entitlements in each
market-maker account whether or not it has obtained a signed agreement
from each market-maker. Furthermore, OCC's security interest has
priority over any competing interests. ``A security interest in a
security entitlement or a securities account \13\ granted to the
debtor's own
[[Page 56028]]
securities intermediary has priority over any security interest granted
by the debtor to another secured party.'' \14\
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\13\ UCC 8-501(a) defines ``securities account'' to mean ``an
account to which a financial asset is or may be credited in
accordance with an agreement under which the person maintaining the
account undertakes to treat the person for whom the account is
maintained as entitled to exercise the rights that comprise the
financial asset.'' UCC 9-102(a)(14) defines ``commodity account'' as
an account maintained by a commodity intermediary in which a
commodity contract is carried for a commodity customer.'' Accounts
established under Section 3 of OCC's By-Laws would ordinarily be
``securities accounts,'' but certain accounts might be construed as
commodity accounts or as both securities accounts and commodity
account given that OCC may clear commodity contracts and security
futures as well as security options. In any case, the Article 9
rules governing perfection and priority of security interests in
commodity accounts and assets contained therein are substantively
identical to those governing securities accounts and assets therein
because all are included in the UCC 9-102(a)(49) definition of
``investment property'' to which those rules apply. To the extent
that an account is a ``commodity account,'' OCC will fall within the
definition of a ``commodity intermediary'' under UCC 9-102(a)(17).
\14\ UCC 9-328(3).
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Because it remains the case that as between a clearing member and
its customers (including market-makers), the clearing member has a duty
to obtain each customer's consent before subjecting the customer's
securities to a security interest or taking certain other actions
potentially affecting the customer's interests,\15\ the rule continues
to require clearing members to obtain specified agreements from market-
makers and to require them to represent to OCC that such agreements
have in fact been obtained. Those clearing members that choose to
continue to use an existing form of market-maker account agreement will
be permitted to do so, but OCC will also permit the agreements required
under Article VI, Section 3 of its By-Laws to be incorporated into a
clearing member's own forms of account agreements to the extent that
the clearing member chooses to do so.
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\15\ See UCC 8-504(b), which states that a securities
intermediary may not grant any security interests in a financial
asset it is obligated to maintain on behalf of an entitlement holder
except as otherwise agreed by the entitlement holder.
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OCC also will add two new items to the Interpretations and Policies
to Article VI, Section 3. The first sentence of new Interpretation .02
sets forth a representation and warranty from each clearing member that
it has obtained the agreement of each person for whom a transaction is
effected in any account of the clearing member established and
maintained pursuant to the provisions of Section 3, including the
granting of a security interest in the account to OCC, and that the
inclusion of the person's transactions and positions in such account is
in compliance with the laws, regulations, and rules applicable to the
clearing member.
This representation will apply to not only market-maker accounts
and JBO participant accounts but also to firm accounts, pledge
accounts, securities customer accounts, cross margining accounts, and
segregated futures accounts that are provided for under paragraphs (a)
and (d) through (g) of Section 3. While OCC has never required that a
specific form of agreement be obtained by clearing members from persons
whose transactions are included in these other types of accounts,
Commission Rule 15c3-3, Rule 8c-1, Rule 15c2-1, and the Commission's
hypothecation rules, as well as certain state laws, where applicable,
require that certain consents and agreements be obtained.\16\
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\16\ For example, consent to the commingling of a customer's
securities with the securities of another customer must be obtained.
Such consents are normally included in the account documentation
obtained by broker-dealers from their customers and are the
responsibility of the broker-dealers.
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The second sentence of new Interpretation .02 is intended to make
clear that the rights of OCC, including its security interest, in any
account of the clearing member with OCC are enforceable in accordance
with their terms even if the clearing member fails in its obligations
to obtain the required consents or agreements from its customers. This
is consistent with the provisions of UCC Article 8, under which OCC's
security interest is protected.\17\
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\17\ UCC 8-503(e) provides that an action based on an
entitlement holder's property interest with respect to a financial
asset held for its account by a securities intermediary, whether
framed in conversion, replevin, constructive trust, equitable lien,
or other theory, may not be asserted against any purchaser of the
financial asset or an interest therein (which would include lien
holders) who gives value, obtains control, and does not act in
collusion with the securities intermediary in violating the
securities intermediary's obligations to maintain the property for
the entitlement holder. See, also, UCC 8-511(b), which provides that
a claim of a creditor (i.e., OCC) of a securities intermediary
(i.e., the failed clearing member) that is perfected by control has
priority over the claims of the securities intermediary's
entitlement holders.
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The first sentence of new Interpretation 03 will clarify that
pursuant to Article VI, Section 3 of OCC's By-Laws, OCC's lien extends
to all assets in account which are ``investment property'' as defined
under Article 9 of the UCC,\18\ including long and short positions in
security futures and any other asset in the account. This
interpretation is consistent with OCC's long-standing interpretation of
Section 3 of Article VI.
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\18\ UCC 9-102(a)(49) defines ``investment property'' to mean a
``security, whether certificated or uncertificated, security
entitlement, securities account, commodity contract, or commodity
account.''
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The second sentence of Interpretation .03 more broadly clarifies
that OCC's lien acts as security for all obligations of the clearing
member to OCC with respect to separate or combined market-maker
accounts, customer accounts, or segregated futures accounts. OCC's lien
secures the clearing member's obligation with respect to long security
futures positions in the account. Long security futures positions,
unlike long options which are always an asset, may be a liability if
the market has moved against those positions since the last mark-to-
market payment. In order to avoid any confusion caused by reference to
short positions but not to long positions, Interpretation .03 clarifies
that obligations to OCC with respect to all exchange transactions
should be read broadly to encompass, where applicable, obligations
arising from long or short positions, obligations to make payments or
delivery under cleared contracts, and obligations with respect to fees
and charges associated with such transactions.
Changes to Rule 1105(b) are made to conform that rule to Article
VI, Section 3. Rather than refer to the market-maker account agreement,
the rule will now refer to the provisions in Article VI, Section 3 of
the By-Laws which are applicable to the market-maker account.
III. Discussion
Section 17A(b)(3)(F) of the Act requires that the rules of a
clearing agency be designed to promote the prompt and accurate
clearance and settlement of securities transactions and to remove
impediments to and perfect the mechanism of a national system for the
prompt and accurate clearance and settlement of securities
transactions.\19\ The rule change permits OCC to eliminate the
requirement that a clearing member must obtain a specified form of
account agreement from each market-maker for whom it carries an account
and submit those agreements to OCC for approval because UCC amendments
in conjunction with requirements under federal and state law make the
requirement redundant and unnecessary. OCC's rule change does not
substantively alter the rights or obligations of OCC clearing members
or their customers but rather streamlines the process by which OCC
perfects its security interest in clearing members' market-maker
accounts under the UCC. Accordingly, the Commission finds the rule
change is consistent with section 17A of the Act.
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\19\ 15 U.S.C. 78q-1(b)(3)(F).
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IV. Conclusion
On the basis of the foregoing, the Commission finds that the
proposed rule change is consistent with the requirements of the Act and
in
[[Page 56029]]
particular with the requirements of section 17A(b)(3)(F) 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-OCC-2002-10) be and hereby is approved.
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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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-24452 Filed 9-26-03; 8:45 am]
BILLING CODE 8010-01-P