[Federal Register: September 2, 2003 (Volume 68, Number 169)]
[Notices]
[Page 52259-52262]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr02se03-149]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-48407; File No. SR-NASD-00-08]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval of
Amendment Nos. 1 and 2 by the National Association of Securities
Dealers, Inc. Relating to Margin Requirements
August 25, 2003.
I. Introduction
On March 3, 2000, the National Association of Securities Dealers,
Inc. (``NASD'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to section 19(b)(1) of the
Securities Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposal to amend NASD Rule 2520, ``Margin
Requirements.'' The NASD's proposal was published for comment in the
Federal Register on May 26, 2000.\3\ The Commission received one
comment
[[Page 52260]]
letter regarding the proposal,\4\ and the NASD responded to the
comment.\5\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 42801 (May 19,
2000), 65 FR 34240 (``2000 Release'').
\4\ See letter from Wendy Fried, Vice President and Associate
General Counsel, The Bond Market Association (``TBMA''), to Jonathan
Katz, Secretary, Commission, dated June 30, 2000 (``TBMA Letter'').
\5\ See letter from Patrice M. Gliniecki, Vice President and
Deputy General Counsel, NASD, to Katherine A. England, Assistant
Director, Division of Market Regulation, Commission, dated July 27,
2000 (``NASD Letter''). The TBMA Letter, and the NASD's response,
are discussed below.
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The NASD filed Amendment Nos. 1 and 2 to the proposal on June 2,
2000, and July 30, 2003, respectively. This order approves the proposed
rule change, as amended. In addition, the Commission is publishing
notice to solicit comments and is simultaneously approving, on an
accelerated basis, Amendment Nos. 1 and 2.
II. Description of the Proposal
A. Background
Section 7 of the Exchange Act \6\ authorizes the Board of Governors
of the Federal Reserve System (``Federal Reserve Board'') to establish
requirements for the purchase or carrying of securities on margin.
Pursuant to this authority, the Federal Reserve Board promulgated
Regulation T,\7\ which sets minimum initial margin requirements.
Regulation T provides that transactions in non-equity securities are
subject to either ``good faith'' margin requirements \8\ or the level
set by the rules of a self-regulatory organization (``SRO''), whichever
is higher.\9\ Accordingly, the maintenance margin requirements
established by the NASD or another SRO set the minimum margin levels
for non-equity securities.\10\
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\6\ 12 U.S.C. 78(g).
\7\ 12 CFR 220 et seq.
\8\ Regulation T defines ``good faith'' margin as the amount of
margin that a broker-dealer would require in exercising sound credit
judgment.
\9\ 12 CFR 220.12(b).
\10\ See NASD Rule 2520(c).
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As described more fully below, the proposal amends NASD Rule 2520
to: (1) lower the customer maintenance margin requirements for certain
non-equity securities; and (2) permit good faith margin treatment for
certain non-equity securities held in ``exempt accounts,'' as defined
in the proposal.
B. Reduced Customer Maintenance Margin for Non-Equity Securities Not
Held in Exempt Accounts
With respect to non-equity securities that are not held in exempt
accounts, the proposal: (1) Reduces the customer maintenance margin
requirement for highly rated foreign sovereign debt \11\ from 20% of
current market value to 1% to 6% of current market value, depending on
the time to maturity; (2) reduces the customer maintenance margin
requirement for exempted securities other than U.S. government
obligations from 15% of current market value to 7% of current market
value; (3) reduces the customer maintenance margin requirement for
investment grade non-equity securities \12\ from 20% of current market
value to 10% of current market value; and (4) establishes a customer
maintenance margin requirement of 20% of current market value for all
other marginable non-equity securities.\13\
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\11\ The proposal defines ``highly rated foreign sovereign debt
securities'' as debt securities issued or guaranteed by the
government of a foreign country, its provinces, states or cities, or
a supranational entity that are assigned a rating in one of the two
top rating categories by at least one nationally recognized
statistical rating organization. See NASD Rule 2520(a)(9).
\12\ The proposal defines ``investment grade debt'' as any debt
securities assigned a rating in one of the top four rating
categories by at least one nationally recognized statistical rating
organization. See NASD Rule 2520(a)(10).
\13\ The proposal defines ``other marginable non-equity
securities'' to include debt securities not traded on a national
securities exchange that meet certain requirements and private pass-
through securities not guaranteed by a U.S. government agency that
meet certain requirements. See NASD Rule 2520(a)(16).
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C. Good Faith Margin Treatment for Certain Non-Equity Securities Held
in Exempt Accounts
1. Good Faith Margin Treatment
The proposal will permit broker-dealers to effect transactions in
``exempt accounts'' without being required to collect either margin or
marked to the market losses \14\ on exempted securities, mortgage-
related securities,\15\ or major foreign sovereign debt securities.\16\
However, a broker-dealer must take a capital charge for any uncollected
marked to the market losses on exempt account positions in these
securities.\17\
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\14\ Marked to the market losses are unrealized losses on a
position in securities resulting from a decline in the position's
market value.
\15\ The proposal defines ``mortgage related securities'' to
mean securities that fall within the definition in Section 3(a)(41)
of the Exchange Act. See NASD Rule 2520(a)(12).
\16\ The proposal defines ``major foreign sovereign debt
securities'' as debt securities issued or guaranteed by the
government of a foreign country or supranational entity that are
assigned a rating in the top rating category by at least one
nationally recognized statistical rating organization. See NASD Rule
2520(a)(11).
\17\ See NASD Rule 2520(e)(2)(F).
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For transactions in exempt accounts involving highly rated foreign
sovereign debt \18\ and investment grade debt,\19\ the proposal
establishes margin requirements of 0.5% and 3%, respectively.\20\
Although a broker-dealer is not required to collect this margin, it
must take a capital charge for any uncollected margin and for any
uncollected marked to the market losses.\21\
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\18\ See note 11, supra.
\19\ See note 12, supra.
\20\ See NASD Rule 2520(e)(2)(G).
\21\ See NASD Rule 2520(e)(2)(G).
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2. Limitation on Capital Charges
The proposal limits the amount of capital charges a broker-dealer
may take in lieu of collecting marked to the market losses.\22\
Specifically, a broker-dealer may not enter into transactions with
exempt accounts that would increase the broker-dealer's capital charges
if the broker-dealer's capital charges exceed: (1) 5 % of the broker-
dealer's tentative net capital \23\ on any one account or group of
commonly controlled accounts; or (2) 25% of the broker-dealer's
tentative net capital on all accounts combined, unless the excess no
longer exists on the fifth business day after it was incurred. The
broker-dealer also must notify the NASD that it has reached the 5% or
25% threshold.
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\22\ See NASD Rule 2520(e)(2)(H).
\23\ Generally, tentative net capital is a broker-dealer's net
worth after deducting most illiquid assets but before making haircut
deductions.
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D. Amendment No. 1
Under the proposal, a broker-dealer must maintain a written risk
analysis methodology for managing the credit risk associated with
extending good faith margin on securities transactions in ``exempt
accounts.'' \24\ Amendment No. 1 provides a draft Notice to Members
(``NTM'') that addresses the written risk analysis methodology that
members must establish and maintain. Specifically, the NTM states that
a member's written risk analysis methodology should include the
following:
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\24\ See NASD Rule 2520(e)(2)(H)(i).
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[sbull] Procedures for obtaining and reviewing the appropriate
customer account documentation and the customer financial information
necessary to determine exempt account status for the extension of
credit under the Rule;
[sbull] Procedures and guidelines for the determination, review and
approval of credit limits to customers and across all customers who
qualify as exempt accounts under the Rule;
[sbull] Procedures and guidelines for monitoring credit risk
exposure to the organization relating to exempt account customers;
[sbull] Procedures and guidelines for the use of stress testing of
exempt accounts in order to monitor market risk exposure
[[Page 52261]]
from exempt accounts individually and in the aggregate; and
[sbull] Procedures providing for the regular review and testing of
these risk management procedures by an independent unit such as
internal audit, risk management, or other comparable group.
E. Amendment No. 2
Amendment No. 2 revises the proposal by modifying the definition of
``exempt account'' in proposed NASD Rule 2520(a)(13). The proposed
changes to proposed NASD Rule 2520(a)(13), as published in the 2000
Release,\25\ appear below. Proposed additions are in italics; proposed
deletions are in [brackets].
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\25\ See note 3, supra.
2520. Margin Requirements
(a) Definitions
For purposes of this paragraph, the following terms shall have the
meanings specified below:
(1) through (12). No change.
(13) The term ``exempt account'' means: [a member, non-member
broker/dealer registered as a broker or dealer under the Act,
``designated account,'' or any person having net worth of at least
forty-five million dollars and financial assets of at least forty
million dollars.]
(A) a member, non-member broker/dealer registered as a broker or
dealer under the Act, a ``designated account,'' or
(B) any person that:
(i) has a net worth of at least forty-five million dollars and
financial assets of at least forty million dollars for purposes of
subparagraphs (e)(2)(F) and (e)(2)(G), and
(ii) either:
a. has securities registered pursuant to Section 12 of the Act, has
been subject to the reporting requirements of Section 13 of the Act for
a period of at least 90 days and has filed all the reports required to
be filed thereunder during the preceding 12 months (or such shorter
period as it was required to file such reports), or
b. has securities registered pursuant to the Securities Act of
1933, has been subject to the reporting requirements of Section 15(d)
of the Act for a period of at least 90 days and has filed all the
reports required to be filed thereunder during the preceding 12 months
(or such shorter period as it was required to file such reports), or
c. if such person is not subject to Section 13 or 15(d) of the Act,
it is a person with respect to which there is publicly available the
information specified in paragraphs (a)(5)(i) to (xiv), inclusive, of
Rule 15c2-11 under the Act, or
d. furnishes information to the Securities and Exchange Commission
as required by Rule 12g3-2(b) of the Act, or
e. makes available to the member such current information regarding
such person's ownership, business, operations and financial condition
(including such person's current audited statement of financial
condition, statement of income and statement of changes in
stockholder's equity or comparable financial reports), as reasonably
believed by the member to be accurate, sufficient for the purposes of
performing a risk analysis in respect of such person.
III. Summary of Comments
The Commission received one comment letter regarding the
proposal.\26\ The commenter generally supported the proposal, which is
substantially identical to a proposal by the New York Stock Exchange,
Inc. (``NYSE'') that the Commission approved.\27\ However, the
commenter maintained that the written risk analysis methodology
included in the NASD's proposal was not required under the NYSE's
proposal and was unnecessary because NASD members already are subject
to sophisticated external and internal oversight of credit practices.
The NASD responded by noting that the written risk analysis methodology
was in fact proposed to be required by the NYSE.\28\
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\26\ See TBMA Letter, supra note 4.
\27\ See Securities Exchange Act Release No. 48365 (August 19,
2003) (order approving File No. SR-NYSE-98-14) (``NYSE Order''). See
also Securities Exchange Act Release Nos. 40278 (July 29, 1998), 63
FR 41822 (August 5, 1998) (notice of File No. SR-NYSE-98-14); and
48133 (July 7, 2003), 68 FR 41672 (July 14, 2003) (notice of
Amendment Nos. 1, 2, and 3 to File No. SR-NYSE-98-14) (``2003
Release'').
\28\ See NASD Letter, supra note 5. The NYSE proposed the
requirement that members maintain a written risk analysis
methodology in Amendment No. 1 to its proposal, which was filed on
January 5, 1999, and published for comment on July 14, 2003. The
NYSE subsequently filed an Information Memo providing guidelines for
a member's written risk analysis methodology. Amendment No. 1 to the
NASD's proposal, set forth in Section II.D., supra, contains an NTM
with written risk analysis methodology guidelines identical to the
guidelines established in the NYSE's Information Memo.
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In addition, the commenter referenced its comment letter regarding
the NYSE's similar proposal.\29\ Specifically, the commenter requested
clarification that: (1) the NYSE's proposed definition of ``exempt
account'' would not supersede the existing definition of ``exempt
account'' in NYSE Rule 431(f)(2)(D)(iv); and (2) existing extensions of
credit to accounts that met the current requirements for exempt account
status, but that would not meet the proposal's higher financial
threshold for exempt accounts, would be ``grandfathered'' and
maintained based on exempt account status even after the increased
financial threshold became effective. In this regard, the NASD
confirmed that the proposal's definition of ``exempt account'' does not
replace the current definition of ``exempt account'' contained in NASD
Rule 2520(f)(2)(D)(iv). With respect to an extension of credit to an
account that currently qualifies as exempt but that would not qualify
as an exempt account under the proposal, the NASD indicates that an
account's exempt status will be determined as of the date of the
initial extension of credit. Accordingly, accounts that meet the
current requirements for exempt account status would be
``grandfathered'' on their existing credit transactions, and the
proposal's requirements for exempt account status would apply to any
new credit transactions or ``roll-overs'' of existing credit
extensions.
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\29\ See letter from Paul Saltzman, Senior Vice President and
General Counsel, TBMA, and Patricia Brigantic, Vice President and
Senior Associate General Counsel, TBMA, to Jonathan Katz, Secretary,
Commission, dated August 26, 1998 (``TBMA 1998 Letter''). The TBMA
1998 Letter, and the NYSE's response, are discussed in the 2003
Release, supra note 27. As noted in the NYSE Order, supra note 27,
the Commission believes that the NYSE sufficiently addressed the
questions raised in the TBMA 1998 Letter.
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IV. Discussion
Section 15A(g)(3)(A) of the Exchange Act \30\ provides, among other
things, that a national securities association may condition membership
privileges on compliance with the association's own financial
responsibility rules. Pursuant to this authority, the NASD is
authorized to promulgate rules governing the financial responsibility
requirements of its members. In addition, the Commission finds that the
proposed rule change is consistent with the Exchange Act and the rules
and regulations thereunder applicable to a national securities
association.\31\ In particular, as described above, for positions not
maintained in exempt accounts, the proposal reduces the customer
maintenance margin requirement for certain non-equity securities and
establishes a customer maintenance margin requirement of 20% of current
market value for other marginable non-equity securities. The Commission
believes that these
[[Page 52262]]
requirements are consistent with the risks of those securities.
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\30\ 15 U.S.C. 78o-3(g)(3)(A).
\31\ In approving the proposed rule change, the Commission has
considered the proposal's impact on efficiency, competition, and
capital formation. 15 U.S.C. 78c(f).
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The proposal also permits the extension of good faith margin to
certain non-equity securities held in exempt accounts. The Commission
notes that the definition of exempt account is limited to certain
regulated entities as well as to persons with net worth of at least $40
million and financial assets of at least $45 million about whom certain
information is publicly available or who make available to the broker-
dealer certain current financial information. The Commission believes
that these requirements are important to the broker-dealer's evaluation
of the creditworthiness of the exempt account borrower and its ability
to make an informed decision regarding an extension of good faith
margin to the exempt account.
The Commission also notes that the proposal limits the amount of
capital charges a broker-dealer may take in lieu of collecting marked
to the market losses. Specifically, a broker-dealer may not enter into
transactions with exempt accounts that would increase the broker-
dealer's capital charges if the broker-dealer's capital charges exceed:
(1) 5% of the broker-dealer's tentative net capital on any one account
or group of commonly controlled accounts; or (2) 25% of the broker-
dealer's tentative net capital on all accounts combined, unless the
excess no longer exists on the fifth business day after it was
incurred. In addition, the proposal requires broker-dealers to maintain
a written risk analysis methodology for assessing the amount of good
faith credit extended to exempt accounts and assures that a broker-
dealer has procedures for determining, approving, and monitoring
extensions of credit to exempt accounts. The Commission believes that
these requirements establish important safeguards to minimize potential
risks to a broker-dealer.
Accordingly, the Commission finds that the proposed rule change is
consistent with section 15A(b)(6) of the Exchange Act,\32\ which
requires, among other things, that the rules of a national securities
association be designed to promote just and equitable principles of
trade, and to protect investors and the public interest.
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\32\ 15 U.S.C. 78o-3(b)(6).
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The Commission finds good cause for approving Amendment Nos. 1 and
2 to the proposal prior to the thirtieth day after the date of
publication of notice of filing thereof in the Federal Register.
Amendment Nos. 1 and 2 strengthen the proposal by providing guidelines
for the written risk analysis methodology that NASD members must
develop and maintain, and by requiring a person seeking exempt account
status to meet specific registration and reporting requirements, or to
provide certain current information concerning the person's ownership,
business, operations, and financial condition. In addition, Amendment
Nos. 1 and 2 conform the NASD's proposal to an NYSE proposal that the
Commission approved previously.\33\ Accordingly, the Commission finds
that there is good cause, consistent with sections 15A(b)(6) and 19(b)
of the Exchange Act, to approve Amendment Nos. 1 and 2 on an
accelerated basis.
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\33\ See NYSE Order, supra note 27.
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V. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning Amendment Nos. 1 and 2, including whether
Amendment Nos. 1 and 2 are consistent with the Exchange Act. Persons
making written submissions should file six copies thereof with the
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW.,
Washington, DC 20549-0609. 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 will also be available for
inspection and copying at the principal office of the NASD. All
submissions should refer to file number SR-NASD-00-08 and should be
submitted by September 23, 2003.
VI. Conclusion
It is therefore ordered, pursuant to section 19(b)(2) of the
Exchange Act,\34\ that the proposed rule change (SR-NASD-00-08), as
amended, is approved.
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\34\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\35\
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\35\ 17 CFR 200.30-3(a)(12).
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-22229 Filed 8-29-03; 8:45 am]
BILLING CODE 8010-01-P