Federal Register / Vol. 69, No. 247 / Monday, December 27, 2004 / Notices 77287

general, to protect investors and the securities, and this rule change will For the Commission, by the Division of public interest.14 The Commission improve NASD’s ability to achieve this Market Regulation, pursuant to delegated believes that the proposed rule change objective. authority.20 Margaret H. McFarland, is consistent with the provisions of the NASD’s proposal would also strike Act noted above because it will subparagraph (7)(B) from Rule 2830(k). Deputy Secretary. strengthen NASD’s rules against quid This provision of NASD’s rules has [FR Doc. E4–3806 Filed 12–23–04; 8:45 am] pro quo arrangements between NASD heretofore allowed NASD members to BILLING CODE 8010–01–P members and investment companies distribute shares of investment whereby investment companies companies that, pursuant to a disclosed compensate broker-dealers for policy, consider sales of their shares by SECURITIES AND EXCHANGE promotion of their shares with broker-dealers as a factor when selecting COMMISSION brokerage commissions (or similar broker-dealers for the execution of transaction-related remuneration), [Release No. 34–50885; File No. SR–NYSE– transactions for a fund. NASD’s 2002–19] which are paid out of fund assets. The proposal would add new subparagraph Commission has noted that such (k)(2) to NASD Rule 2830. This Self-Regulatory Organizations; Notice practices pose significant conflicts of subparagraph will now explicitly state of Filing of Proposed Rule Change and interest and may be harmful to fund that members are not permitted to sell Amendment Nos. 1 and 2 Thereto by shareholders, as well as potential the shares of investment companies that the New York Stock Exchange, Inc. purchasers of fund shares, in that they the member knows or has reason to Relating to Customer Portfolio and may induce broker-dealers ‘‘to know engages in such practices. The Cross-Margining Requirements recommend funds that best compensate Commission believes that elimination of December 20, 2004. the broker rather than funds that meet subparagraph (k)(7)(B) of Rule 2830 15 the customer’s investment needs.’’ should strengthen investor protection Pursuant to Section 19(b)(1) of the The addition of new subparagraph because it removes a possible incentive Securities Exchange Act of 1934 (k)(2) to Rule 2830 would clarify that no 1 2 for brokers to recommend investments (‘‘Act’’), and Rule 19b–4 thereunder, member may sell the shares of, or act as based on their own financial interests, notice is hereby given that on June 21, an underwriter for, an investment rather than the best interests of their 2004, the New York Stock Exchange, company if the member knows, or has customers. Inc. (‘‘NYSE’’ or ‘‘Exchange’’) filed with reason to know, that such investment the Securities and Exchange company, or an investment adviser or Finally, the Commission notes that, Commission (‘‘Commission’’ or ‘‘SEC’’) principal underwriter of the company, under subparagraph (8)(A) of Rule Amendment No. 2 3 to the proposed rule has a written or oral agreement or 2830(k),17 NASD members may still sell change as described in Items I, II, and understanding whereby the investment the shares of an investment company III below, which Items have been company directs, or is expected to that directs fund portfolio transactions prepared by the Exchange. The NYSE direct, portfolio securities transactions to the member, so long as the other submitted the original proposed rule (or any commission, markup or other provisions of the rule are satisfied. The change to the Commission on May 13, remuneration resulting from any such Commission believes that this existing 2002 (‘‘Original Filing’’). On August 21, transaction) to a broker-dealer in provision of the rule makes clear that an 2002, the NYSE filed Amendment No. 1 consideration for the promotion or sale NASD member may continue to to the proposed rule change.4 The of shares issued by the company or any distribute the shares of investment proposed rule change and Amendment other registered investment company. companies for which the member No. 1 were published in the Federal As NASD noted in its description of the executes investment portfolio Register on October 8, 2002.5 The proposed rule change,16 this transactions, where the member’s sales Commission received three comment requirement will differ from that in efforts are not connected to any letters in response to proposed rule existing subparagraph (k)(1) of the rule arrangements for the direction of change.6 The NYSE is proposing because ‘‘the broker-dealer’s intent to brokerage commissions in exchange for favor or disfavor a particular fund distribution. In this regard, the 20 17 CFR 200.30–3(a)(12). would not be relevant.’’ Rather, the new Commission notes that NASD Rule 3010 1 15 U.S.C. 78s(b)(1). provision will require NASD members requires NASD members to establish 2 17 CFR 240.19b–4. to refrain from distributing the shares of and maintain a supervisory system for 3 See letter from Darla C. Stuckey, Corporate registered representatives and Secretary, NYSE, to Michael A. Macchiaroli, an investment company in any case Associate Director, Division of Market Regulation where the member knows, or has reason associated persons that is reasonably (‘‘Division’’), Commission, dated June 17, 2004 to know, of the investment company’s designed to achieve compliance with (‘‘Amendment No. 2’’). participation in such an arrangement. applicable securities laws and 4 See letter from Mary Yeager, Assistant Secretary, regulations and with the NASD’s rules. NYSE, to T.R. Lazo, Senior Special Counsel, The Commission believes that this Division of Market Regulation, Commission, dated amendment of NASD’s rules is IV. Conclusion August 20, 2002 (‘‘Amendment No. 1’’). In consistent with the protection of Amendment No. 1, the NYSE made technical investors because it will clarify that It is therefore ordered, pursuant to corrections to its proposed rule language to 18 eliminate any inconsistencies between its proposal broker-dealers may not enter into such Section 19(b)(2) of the Act that the and the Chicago Board Options Exchange, Inc.’s quid pro quo distribution arrangements. proposed rule change (SR–NASD–2004– (‘‘CBOE’’) proposal pursuant to the Rule 431 One important purpose of Rule 2830(k) 027), as amended, be, and hereby is, Committee’s (‘‘Committee’’) recommendations. See is to help eliminate conflicts of interest approved.19 Securities Exchange Act Release No. 45630 (March 22, 2002), 67 FR 15263 (March 29, 2002) (File No. in the sale of investment company SR–CBOE–2002–03) (‘‘CBOE Proposal’’). 17 Previously designated as Rule 2830(k)(7)(A). 5 See Securities Exchange Act Release No. 46576 14 15 U.S.C. 78o–3(b)(6). 18 15 U.S.C. 78s(b)(2). (October 1, 2002), 67 FR 62843 (October 8, 2002). 15 Prohibition on the Use of Brokerage 19 In approving this proposed rule change, the 6 See letter from R. Allan Martin, President, Auric Commissions to Finance Distribution, note 10, Commission notes that it has considered the Trading Enterprises, Inc., to Secretary, Commission, supra, 69 FR 54728 at 54729–54730. proposed rule’s impact on efficiency, competition, dated October 9, 2002 (‘‘Martin Auric Letter’’); 16 See Notice, 69 FR 64609, 64610 n. 5. and capital formation. 15 U.S.C. 78c(f). Continued

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Amendment No. 2 for the purpose of listed, broad-based U.S. index options, grouped with their underlying eliminating inconsistencies between the index warrants and underlying instruments and related instruments. proposed NYSE and CBOE rules,7 and instruments and compute a margin (D) The term ‘‘option series’’ relates to to incorporate certain substantive requirement (‘‘cross margin’’) on a listed options and means all option amendments requested by Commission portfolio margin basis. Member contracts of the same type (either a call staff. The Commission is publishing this organizations must confine cross- or a put) and exercise style, covering the notice to solicit comments on the margin positions to a portfolio margin same underlying instrument with the proposed rule change, as amended, from account dedicated exclusively to cross- same exercise price, expiration date, interested persons. margining. and number of underlying units. (E) The term ‘‘related instrument’’ I. Self-Regulatory Organization’s The portfolio margin and cross- margining provisions of this Rule shall within an option class or product group Statement of the Terms of Substance of means futures contracts and options on the Proposed Rule Change not apply to Individual Retirement Accounts (‘‘IRAs’’). futures contracts covering the same The Exchange proposes to amend (1) Member organizations will be underlying instrument. NYSE Rule 431 to permit self-clearing expected to monitor the risk of portfolio (F) The term ‘‘underlying instrument’’ members and member organizations to margin accounts and maintain a written means long and short positions in an margin listed, broad-based, market risk analysis methodology for assessing exchange traded fund or other fund index options, index warrants and the potential risk to the member product registered under the Investment related exchange-traded funds according organization’s capital over a specified Company Act of 1940, that holds the to a prescribed portfolio margin range of possible market movements of same securities, and in the same methodology relating to a portfolio positions maintained in such accounts. proportion, as contained in a broad- margin account of a registered broker- The risk analysis methodology shall based index on which options are listed. dealer, any affiliate of a self-clearing specify the computations to be made, The term underlying instrument shall member or member organization, certain the frequency of computations, the not be deemed to include, futures qualified members of a national futures records to be reviewed and maintained, contracts, options on futures contracts, exchange, and any other person or and the position(s) within the underlying stock baskets, or unlisted entity that maintains account equity of organization responsible for the risk instruments. at least $5 million. function. This risk analysis (G) The term ‘‘product group’’ means The Exchange further proposes to methodology shall be made available to two or more portfolios of the same type amend NYSE Rule 726 to require that a the Exchange upon request. In (see sub-paragraph (g)(2)(H) below) for disclosure statement and written performing the risk analysis of portfolio which it has been determined by Rule acknowledgement for use with the margin accounts required by this Rule, 15c3–1a under the Securities Exchange proposed portfolio margining and cross- each member organization shall include Act of 1934 that a percentage of margining changes be furnished to the following in the written risk analysis offsetting profits may be applied to customers. The text of the proposed rule methodology: losses at the same valuation point. change is below. Additions are in (A) Procedures and guidelines for the (H) The term ‘‘theoretical gains and italics. Deletions are in brackets. determination, review and approval of losses’’ means the gain and loss in the * * * * * credit limits to each customer, and value of individual option series and related instruments at 10 equidistant Margin Requirements across all customers, utilizing a portfolio margin account. intervals (valuation points) ranging from an assumed movement (both up and Rule 431. (a) through (f) unchanged. (B) Procedures and guidelines for down) in the current market value of the Portfolio Margin and Cross-Margin for monitoring credit risk exposure to the underlying instrument. The magnitude Index Options member organization, including intra- of the valuation point range shall be as day credit risk, related to portfolio (g) As an alternative to the ‘‘strategy’’ follows: based margin requirements set forth in margin accounts. paragraphs (a) through (f) of this Rule, (C) Procedures and guidelines for the Up/down mar- use of stress testing of portfolio margin member organizations may elect margin Portfolio type ket move (high for listed, broad-based U.S. index accounts in order to monitor market risk & low valu- ation points) options, index warrants and underlying exposure from individual accounts and in the aggregate. instruments (as defined below) in Non-High Capitalization, +/¥10% accordance with the portfolio margin (D) Procedures providing for the Broad-based U.S. Market requirements set forth in this Rule. regular review and testing of these risk Index Option 8. In addition, member organizations, analysis procedures by an independent High Capitalization, Broad- +6%/¥8% provided they are a Futures Commission unit such as internal audit or other based U.S. Market Index Merchant (‘‘FCM’’) and are either a comparable group. Option 9. (2) Definitions.—For purposes of this clearing member of a futures clearing 8 In accordance with sub-paragraph organization or have an affiliate that is paragraph (g), the following terms shall (b)(1)(i)(B) of Rule 15c3–1a (Appendix A to a clearing member of a futures clearing have the meanings specified below: Rule 15c3–1) under the Securities Exchange organization, are permitted under this (A) The term ‘‘listed option’’ shall Act of 1934, 17 CFR 240.15c3–1a(b)(1)(i)(B). 9 See footnote above. section to combine a customer’s related mean any option traded on a registered instruments (as defined below) and national securities exchange or (3) Approved Theoretical Pricing automated facility of a registered Models.—Theoretical pricing models Phupinder S. Gill, Managing Director and President, national securities association. must be approved by a Designated Chicago Mercantile Exchange Inc., to Jonathan G. (B) The term ‘‘options class’’ refers to Examining Authority and reviewed by Katz, Secretary, Commission, dated October 21, all options contracts covering the same the Securities and Exchange 2002 (‘‘Gill CBOE Letter’’); and E-mail from Mike Ianni, Private Investor to [email protected], underlying instrument. Commission (‘‘The Commission’’) in dated November 7, 2002 (‘‘Ianni E-mail’’). (C) The term ‘‘portfolio’’ means order to qualify. Currently, the 7 See supra note 4. options of the same options class theoretical model utilized by The

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Options Clearing Corporation (‘‘The paragraph (g), member organizations (B) Cross-Margin Account—Eligible OCC’’) is the only model qualified are to establish and utilize a specific Positions pursuant to The Commission’s Net securities margin account, or sub- (i) A transaction in, or transfer of, a Capital Rule. All member organizations account of a margin account, clearly related instrument may be effected in participating in the pilot program shall identified as a portfolio margin account the cross margin account provided a obtain their theoretical values from The that is separate from any other position in an offsetting listed, U.S. OCC. securities account carried for a broad-based index option, index (4) Eligible Participants.—The customer. warrant or underlying instrument is in application of the portfolio margin (2) Cross-Margin Account. For the account or is established in the provisions of this paragraph (g), purposes of combining related account on the same day. including cross-margining, is limited to instruments and listed, broad-based (ii) If the listed, U.S. broad-based the following: U.S. index options, index warrants and index option, index warrant or (A) any broker or dealer registered underlying instruments and applying underlying instrument position pursuant to Section 15 of the Securities the portfolio margin requirements offsetting a related instrument ceases to Exchange Act of 1934; members are to establish and utilize a exist and is not replaced within ten (B) any affiliate of a self-clearing portfolio margin account, clearly business days, the related instrument member organization; identified as a cross-margin account, position must be transferred to a futures (C) any member of a national futures that is separate from any other account and margined accordingly. exchange to the extent that listed index securities account or portfolio margin Member organizations will be expected options hedge the member’s index account carried for a customer. to monitor cross-margin accounts for futures; and A margin deficit in either the portfolio possible abuse of this provision. (D) any other person or entity not margin account or the cross-margin (iii) In the event that fully paid for included in (4)(A) through (4)(C) above account of a customer may not be long options and/or index warrants that has or establishes, and maintains, considered as satisfied by excess equity (securities) are the only positions equity of at least 5 million dollars. For in the other account. Funds and/or contained within a cross-margin purposes of this equity requirement, all securities must be transferred to the account, such long positions must be securities and futures accounts carried deficient account and a written record transferred to a securities account other by the member organization for the created and maintained. than a portfolio margin account or cross same customer may be combined (A) Portfolio Margin Account— margin account within 10 business provided ownership across the accounts Eligible Positions days, subject to the margin required, is identical. A guarantee pursuant to (i) A transaction in, or transfer of, a unless the status of the account changes paragraph (f)(4) of this Rule is not listed, broad-based U.S. index option or such that it is no longer composed solely permitted for purposes of the minimum index warrant may be effected in the of fully paid for long options and/or equity requirement. portfolio margin account. index warrants. (5) Opening of Accounts. (7) Initial and Maintenance Margin (ii) A transaction in, or transfer of, an (A) Only customers that have been Required.— The amount of margin underlying instrument may be effected approved for options transactions and required under this paragraph (g) for in the portfolio margin account approved to engage in uncovered short each portfolio shall be the greater of: option contracts pursuant to Exchange provided a position in an offsetting (A) the amount for any of the 10 Rule 721, are permitted to utilize a listed, broad-based U.S. index option or equidistant valuation points portfolio margin account. index warrant is in the account or is representing the largest theoretical loss (B) On or before the date of the initial established in the account on the same as calculated pursuant to paragraph transaction in a portfolio margin day. (g)(8) below, or account, a member organization shall: (iii) If, in the portfolio margin (B) $.375 for each listed index option (i) furnish the customer with a special account, the listed, broad-based U.S. and related instrument multiplied by written disclosure statement describing index option or index warrant position the contract’s or instrument’s multiplier, the nature and risks of portfolio offsetting an underlying instrument not to exceed the market value in the margining and cross-margining which position ceases to exist and is not case of long positions in listed options includes an acknowledgement for all replaced within ten business days, the and options on futures contracts. portfolio margin account owners to sign, underlying instrument position must be (C) Account guarantees pursuant to and an additional acknowledgement for transferred to a regular margin account, paragraph (f)(4) of this Rule are not owners that also engage in cross- subject to initial Regulation T margin permitted for purposes of meeting initial margining to sign, attesting that they and margined according to the other and maintenance margin requirements. have read and understood the provisions of this Rule. Member (8) Method of Calculation. disclosure statement, and agree to the organizations will be expected to (A) Long and short positions in listed terms under which a portfolio margin monitor portfolio margin accounts for options, underlying instruments and account and the cross-margin account possible abuse of this provision. related instruments are to be grouped by respectively, are provided (see Exchange (iv) In the event that fully paid for option class; each option class group Rule 726 (d)), and long options and /or index warrants are being a ‘‘portfolio’’. Each portfolio is (ii) obtain the signed the only positions contained within a categorized as one of the portfolio types acknowledgement(s) noted above from portfolio margin account, such long specified in sub-paragraph (g)(2)(H) the customer (both of which are positions must be transferred to a above. required for cross-margining customers) securities account other than a portfolio (B) For each portfolio, theoretical and record the date of receipt. margin account or cross ‘‘margin gains and losses are calculated for each (6) Establishing Account and Eligible account within 10 business days, subject position as specified in sub-paragraph Positions to the margin required, unless the status (g)(2)(H) above. For purposes of (1) Portfolio Margin Account. For of the account changes such that it is no determining the theoretical gains and purposes of applying the portfolio longer composed solely of fully paid for losses at each valuation point, member margin requirements provided in this long options and/or index warrants. organizations shall obtain and utilize

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the theoretical value of a listed index amount less than or equal to account responsibility or hypothecation of option, underlying instrument or related equity. Paragraph (f)(7) of this Rule— customer’s securities; or instrument rendered by a theoretical Practice of Meeting Regulation T Margin (iv) Unable to make such pricing model that, in accordance with Calls by Liquidation Prohibited shall not computations as may be necessary to sub-paragraph (b)(1)(i)(B) of Rule 15c3– apply to portfolio margin accounts. establish compliance with such 1a under the Securities Exchange Act of However, member organizations will be financial responsibility or 1934, qualifies for purposes of expected to monitor portfolio margin hypothecation rules. determining the amount to be deducted and cross-margin accounts for possible (B) Nothing in this paragraph (14) in computing net capital under a abuse of this provision. shall be construed as limiting or portfolio based methodology. (12) Net Capital Treatment of restricting in any way the exercise of (C) Offsets. Within each portfolio, Portfolio Margin and Cross Margin any right of a registered clearing agency theoretical gains and losses may be Accounts. to liquidate or cause the liquidation of netted fully at each valuation point. (A) No member organization that positions in accordance with its by-laws Offsets between portfolios within the requires margin in any customer and rules. High Capitalization, Broad-based Index account pursuant to paragraph (g) of * * * * * Option product group and the Non-High this Rule shall permit gross customer Capitalization, Broad-based Index Delivery of Options Disclosure portfolio margin requirements to exceed Document and Prospectus Option product group may then be 1,000 percent of its net capital for any applied as permitted by Rule 15c3–1a period exceeding three business days. Rule 726 (a) through (c) unchanged. under the Securities Exchange Act of The member organization shall, Portfolio Margining and Cross- 1934. beginning on the fourth business day, (D) After applying the Offsets above, Margining Disclosure Statement and cease opening new portfolio margin the sum of the greatest loss from each Acknowledgement accounts until compliance is achieved. portfolio is computed to arrive at the (d) The special written disclosure (B) If, at any time, a member total margin required for the account statement describing the nature and organization’s gross customer portfolio (subject to the per contract minimum). risks of portfolio margining and cross- (9) Equity Deficiency.—If, at any time, margin requirements exceed 1,000 margining, and acknowledgement for equity declines below the 5 million percent of its net capital, the member customer signature, required by Rule dollar minimum required under sub- organization shall immediately transmit 431(g)(5)(B) shall be in a format paragraph (4)(D) of this paragraph (g) telegraphic or facsimile notice of such prescribed by the Exchange or in a and is not restored to at least 5 million deficiency to the Securities and format developed by the member dollars within three (3) business days Exchange Commission, 450 Fifth Street organization, provided it contains (T+3) by a deposit of funds and/or NW, Washington, DC, 20549; to the substantially similar information as in securities; member organizations are district or regional office of the the prescribed Exchange format and has prohibited from accepting opening Securities and Exchange Commission received the prior written approval of orders starting on T+4, except that for the district or region in which the the Exchange. opening orders entered for the purpose member organization maintains its Sample Portfolio Margining and Cross- of hedging existing positions may be principal place of business; and to its Margining Risk Disclosure Statement to accepted if the result would be to lower Designated Examining Authority. (13) Day Trading Requirements.—The Satisfy Requirements of Exchange Rule margin requirements. This prohibition 431(g) shall remain in effect until equity of 5 requirements of sub-paragraph (f)(8)(B) million dollars is established. of this Rule—Day-Trading shall not Overview of Portfolio Margining (10) Determination of Value for apply to portfolio margin accounts 1. Portfolio margining is a margin Margin Purposes.—For the purposes of including cross margin accounts. methodology that sets margin this paragraph (g), all listed index (14) Cross Margin Accounts— requirements for an account based on options and related instrument Requirements to Liquidate the greatest projected net loss of all positions shall be valued at current (A) A member is required immediately positions in a ‘‘product class’’ or market prices. Account equity for the either to liquidate, or transfer to another ‘‘product group’’ as determined by an purposes of this paragraph (g) shall be broker-dealer eligible to carry cross- options pricing model using multiple calculated separately for each portfolio margin accounts, all customer cross- pricing scenarios. These pricing margin account by adding the current margin accounts that contain positions scenarios are designed to measure the market value of all long positions, in futures and/or options on futures if theoretical loss of the positions given subtracting the current market value of the member is: changes in both the underlying price all short positions, and adding the (i) Insolvent as defined in section 101 and implied volatility inputs to the credit (or subtracting the debit) balance of title 11 of the United States Code, or model. Portfolio margining is currently in the account. is unable to meet its obligations as they limited to product classes and groups of (11) Additional Margin.—If at any mature; index products relating to broad-based time, the equity in any portfolio margin (ii) The subject of a proceeding market indexes. account is less than the margin pending in any court or before any 2. The goal of portfolio margining is required, the customer may deposit agency of the United States or any State to set levels of margin that more additional margin or establish a hedge in which a receiver, trustee, or precisely reflects actual net risk. The to meet the margin requirement within liquidator for such debtor has been customer benefits from portfolio one business day (T+1). In the event a appointed; margining in that margin requirements customer fails to hedge existing (iii) Not in compliance with calculated on net risk are generally positions or deposit additional margin applicable requirements under the lower than alternative ‘‘position’’ or within one business day, the member Securities Exchange Act of 1934 or rules ‘‘strategy’’ based methodologies for organization must liquidate positions in of the Securities and Exchange determining margin requirements. an amount sufficient to, at a minimum, Commission or any self-regulatory Lower margin requirements allow the lower the total margin required to an organization with respect to financial customer more leverage in an account.

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Customers Eligible for Portfolio of the third business day will result in sophisticated mathematical calculations Margining a prohibition on entering any opening and theoretical values that must be 3. To be eligible for portfolio orders, with the exception of opening calculated from market data, it may be margining, customers (other than orders that hedge existing positions, more difficult for customers to predict broker-dealers and certain non-broker- beginning on the fourth business day the size of future margin calls in a and continuing until such time as the dealer affiliates of the carrying broker- portfolio margin account. This is minimum equity requirement is dealer) must meet the basic standards particularly true in the case of satisfied. customers who do not have access to for having an options account that is 8. A position in an exchange traded approved for uncovered writing and specialized software necessary to make index fund or other eligible fund such calculations or who do not receive must have and maintain at all times product may not be established in a account net equity of not less than $5 theoretical values calculated and portfolio margin account unless there distributed periodically by The Options million, aggregated across all accounts exists, or there is established on the under identical ownership at the Clearing Corporation. same day, an offsetting position in 13. For the reasons noted above, a clearing broker. The identical ownership securities options, or other eligible requirement excludes accounts held by customer that carries long options securities. Exchange traded index funds positions in a portfolio margin account the same customer in different and/or other eligible funds will be capacities (e.g., as a trustee and as an could, under certain circumstances, be transferred out of the portfolio margin less likely to recover the full value of individual) and accounts where account and into a regular securities ownership is overlapping but not those positions in the event of the account subject to initial Regulation T insolvency of the carrying broker. identical (e.g., individual accounts and and NYSE Rule 431 margin if the joint accounts). 14. Trading of securities index offsetting securities options, other products in a portfolio margin account Positions Eligible for a Portfolio Margin eligible securities and/or related is generally subject to all the risks of Account instruments no longer remain in the trading those same products in a regular account for ten business days. securities margin account. Customers 4. All positions in broad-based U.S. 9. When a broker-dealer carries a market index options and index should be thoroughly familiar with the regular cash account or margin account risk disclosure materials applicable to warrants listed on a national securities for a customer, the broker-dealer is exchange, and exchange traded funds those products, including the booklet limited by rules of the Securities and entitled Characteristics and Risks of and other products registered under the Exchange Commission and of The Investment Company Act of 1940 that Standardized Options. Options Clearing Corporation (‘‘OCC’’) 15. Customers should consult with are managed to track the same index to the extent to which the broker-dealer that underlies permitted index options, their tax advisers to be certain that they may permit OCC to have a lien against are familiar with the tax treatment of are eligible for a portfolio margin long option positions in those accounts. account. transactions in securities index In contrast, OCC will have a lien against products. Special Rules for Portfolio Margin all long option positions that are carried 16. The descriptions in this disclosure Accounts by a broker-dealer in a portfolio margin statement relating to eligibility account, and this could, under certain requirements for portfolio margin 5. A portfolio margin account may be circumstances, result in greater losses to either a separate account or a sub- accounts, and minimum equity and a customer having long option positions margin requirements for those accounts, account of a customer’s regular margin in such an account in the event of the account. In the case of a sub-account, are minimums imposed under Exchange insolvency of the customer’s broker. rules. Time frames within which margin equity in the regular account will be Accordingly, to the extent that a available to satisfy any margin and equity calls must be met are customer does not borrow against long maximums imposed under Exchange requirement in the portfolio margin sub- option positions in a portfolio margin account without transfer to the sub- rules. Broker-dealers may impose their account or have margin requirements in own more stringent requirements. account. the account against which the long 6. A portfolio margin account or sub- option can be credited, there is no Overview of Cross-Margining account will be subject to a minimum advantage to carrying the long options margin requirement of $.375 multiplied 17. With cross-margining, index in a portfolio margin account and the futures and options on index futures are by the index multiplier for every option customer should consider carrying them contract or index warrant carried long combined with offsetting positions in in an account other than a portfolio securities index options and underlying or short in the account. No minimum margin account. margin is required in the case of eligible instruments, for the purpose of exchange traded funds or other eligible Special Risks of Portfolio Margin computing a margin requirement based fund products. Accounts on the net risk. This generally produces lower margin requirements than if the 7. Margin calls in the portfolio margin 10. Portfolio margining generally related instruments 10 and securities account or sub-account, regardless of permits greater leverage in an account, products are viewed separately, thus whether due to new commitments or the and greater leverage creates greater providing more leverage in the account. effect of adverse market moves on losses in the event of adverse market 18. Cross-margining must be done in existing positions, must be met within movements. one business day. Any shortfall in 11. Because the time limit for meeting a portfolio margin account type. A aggregate net equity across accounts margin calls is shorter than in a regular separate portfolio margin account must must be met within three business days. margin account, there is increased risk be established exclusively for cross- Failure to meet a margin call when due that a customer’s portfolio margin margining. will result in immediate liquidation of account will be liquidated involuntarily, 10 For purposes of this Rule, the term ‘‘related positions to the extent necessary to possibly causing losses to the customer. instruments,’’ within an option class or product reduce the margin requirement. Failure 12. Because portfolio margin means futures contracts, and options on futures to meet an equity call prior to the end requirements are determined using contracts covering the same underlying instrument.

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19. When index futures and options the futures account to be Commodity Exchange Act and the rules on futures are combined with offsetting undermargined, a margin call will be of the CFTC adopted pursuant to the positions in index options and issued or positions will be liquidated to Commodity Exchange Act. underlying instruments in a dedicated the extent necessary to eliminate the 34. Trading of index options and account, and a portfolio margining deficit. futures contracts in a cross-margin methodology is applied to them, cross- 28. Customers participating in cross- account is generally subject to all the margining is achieved. margining will be required to sign an risks of trading those same products in agreement acknowledging that their a futures account or a regular securities Customers Eligible for Cross-Margining positions and property in the cross- margin account. Customers should be 20. The eligibility requirements for margin account will be subject to the thoroughly familiar with the risk cross-margining are generally the same customer protection provisions of Rule disclosure materials applicable to those as for portfolio margining, and any 15c3–3 under the Securities Exchange products, including the booklet entitled customer eligible for portfolio margining Act of 1934 and the Securities Investor Characteristics and Risks of is eligible for cross-margining. Protection Act, and will not be subject Standardized Options and the risk 21. Members of futures exchanges on to the provisions of the Commodity disclosure document required by the which cross-margining eligible index Exchange Act, including segregation of CFTC to be delivered to futures contracts are traded are also permitted funds. customers. Because this disclosure to carry positions in cross-margin 29. According to the rules of the statement does not disclose the risks accounts without regard to the exchanges, a broker dealer is required to and other significant aspects of trading minimum aggregate account equity. immediately liquidate, or, if feasible, in futures and options, customers transfer to another broker-dealer eligible should review those materials carefully Positions Eligible for Cross-Margining to carry cross-margin accounts, all before trading in a cross-margin 22. All securities products eligible for customer cross-margin accounts that account. portfolio margining are also eligible for contain positions in futures and/or 35. Customers should bear in mind cross-margining. options on futures in the event that the that the discrepancies in the cash flow 23. All broad-based U.S. listed market carrying broker-dealer becomes characteristics of futures and certain index futures and options on index insolvent. options are still present even when those futures traded on a designated contract 30. In signing the agreement referred products are carried together in a cross market subject to the jurisdiction of the to in paragraph 28 above, a customer margin account. Both futures and Commodity Futures Trading also acknowledges that a cross-margin options contracts are generally marked Commission (‘‘CFTC’’) are eligible for account that contains positions in to the market at least once each cross-margining. futures and/or options on futures will be business day, but the marks may take immediately liquidated, or, if feasible, place with different frequency and at Special Rules for Cross-Margining transferred to another broker-dealer different times within the day. When a 24. Cross-margining must be eligible to carry cross-margin accounts, futures contract is marked to the conducted in a portfolio margin account in the event that the carrying broker- market, the gain or loss is immediately type. A separate portfolio margin dealer becomes insolvent. credited to or debited from, respectively, account must be established exclusively the customer’s account in cash. While for cross-margining. A cross margin Special Risks of Cross-Margining an increase in the value of a long option account is a securities account, and 31. Cross-margining must be contract may increase the equity in the must be maintained separate from all conducted in a portfolio margin account account, the gain is not realized until other securities account. type. Generally, cross-margining and the the option is sold or exercised. 25. Cross-margining is automatically portfolio margining methodology both Accordingly, a customer may be accomplished with the portfolio contribute to provide greater leverage required to deposit cash in the account margining methodology. Cross-margin than a regular margin account, and in order to meet a variation payment on positions are subject to the same greater leverage creates greater losses in a futures contract even though the minimum margin requirement for every the event of adverse market movements. customer is in a hedged position and contract, including futures contracts. 32. Since cross-margining must be has experienced a corresponding (but 26. Margin calls arising in cross- conducted in a portfolio margin account yet unrealized) gain on a long option. margin account, and any shortfall in type, the time required for meeting Alternatively, a customer who is in a aggregate net equity across accounts, margin calls is shorter than in a regular hedged position and would otherwise be must be satisfied within the same securities margin account and may be entitled to receive a variation payment timeframe, and subject to the same shorter than the time ordinarily required on a futures contract may find that the consequences, as in a portfolio margin by a futures commission merchant for cash is required to be held in the account. meeting margin calls in a futures account as margin collateral on an 27. A position in a futures product account. Consequently, there is offsetting option position. may not be established in a cross- increased risk that a customer’s cross- 36. Customers should consult with margin account unless there exists, or margin positions will be liquidated their tax advisers to be certain that they there is established on the same day, an involuntarily, causing possible loss to are familiar with the tax treatment of offsetting position in securities options the customer. transactions in index products, and/or other eligible securities. Related 33. As noted above, cross margin including tax consequences of trading instruments will be transferred out of accounts are securities accounts and are strategies involving both futures and the cross margin account and into a subject to the customer protections set- option contracts. futures account if, for more than ten forth in Rule 15c3–3 under the 37. The descriptions in this disclosure business days and for any reason, the Securities Exchange Act of 1934 and the statement relating to eligibility offsetting securities options and/or other Securities Investor Protection Act. requirements for cross-margining, and eligible securities no longer remain in Cross-margin positions are not subject minimum equity and margin the account. If the transfer of related to the customer protection rules under requirements for cross margin accounts, instruments to a futures account causes the segregation provisions of the are minimums imposed under Exchange

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rules. Time frames within which margin positions that do not operate to offset The Options Clearing Corporation to and equity calls must be met are your aggregate indebtedness and have a lien on long positions. This maximums imposed under Exchange thereby reduce your margin requirement exception is outlined in a separate rules. The broker-dealer carrying a you receive no benefit from carrying acknowledgement form that must be customer’s portfolio margin account, those positions in your portfolio-margin signed prior to or concurrent with this including any cross-margin account, account or cross-margin account and form. Additionally, the Securities may impose its own more stringent incur the additional risk of OCC’s lien Investor Protection Corporation requirements. on your long option position(s). (‘‘SIPC’’) insures customer accounts * * * * * By signing below the customer affirms against the financial insolvency of a that the customer has read and broker-dealer in the amount of up to Sample Portfolio Margining and Cross- understood the foregoing disclosure $500,000 to protect against the loss of Margining Acknowledgements statement and acknowledges and agrees registered securities and cash Acknowledgement for Customers that long option positions in portfolio- maintained in the account for Utilizing a Portfolio Margin Account margining accounts, and cross- purchasing securities or as proceeds —Cross-Margining and Non-Cross- margining accounts, will be exempted from selling securities (although the Margining— from certain customer protection rules limit on cash claims is $100,000). of the Securities and Exchange According to the rules of the exchanges, Rule 15c3–3 under the Securities Commission as described above and will a broker-dealer is required to Exchange Act of 1934 requires that a be subject to a lien by the Options immediately liquidate, or, if feasible, broker or dealer promptly obtain and Clearing Corporation without regard to transfer to another broker-dealer eligible maintain physical possession or control such rules. to carry cross-margin accounts, all of all fully-paid securities and excess Customer Name: llllllllll customer cross margin accounts that margin securities of a customer. Fully- contain positions in futures and/or paid securities are securities carried in By: llllllllllllllll (Signature/title) options on futures in the event that the a cash account and margin equity carrying broker-dealer becomes llllllllllllllll securities carried in a margin or special Date: insolvent. account (other than a cash account) that Acknowledgement for Customers have been fully paid for. Excess margin By signing below the customer affirms Engaged in Cross-Margining securities are a customer’s margin that the customer has read and securities having a market value in As disclosed above, futures contracts understood the foregoing disclosure excess of 140% of the total of the debit and other property carried in customer statement and acknowledges and agrees balances in the customer’s non-cash accounts with Futures Commission that: (1) Positions and property in cross- accounts. For the purposes of Rule Merchants (‘‘FCM’’) are normally subject margining accounts, will not be subject 15c3–3, securities held subject to a lien to special protection afforded under the to the customer protection rules under to secure obligations of the broker- customer segregation provisions of the the customer segregation provisions of dealer are not within the broker-dealer’s Commodity Exchange Act (‘‘CEA’’) and the Commodity Exchange Act and the physical possession or control. The the rules of the Commodity Futures rules of the Commodity Futures Trading Commission staff has taken the position Trading Commission adopted pursuant Commission adopted pursuant to the that all long option positions in a to the CEA. These rules require that CEA and (2) cross-margining accounts customer’s portfolio-margining account customer funds be segregated from the that contain positions in futures and/or (including any cross-margin account) accounts of financial intermediaries and options on futures will be immediately may be subject to such a lien by OCC be accounted for separately. However, liquidated, or if feasible, transferred to and will not be deemed fully-paid or they do not provide for, and regular another broker-dealer eligible to carry excess margin securities under Rule futures accounts do not enjoy the cross-margin accounts in the event that 15c3–3. benefit of, insurance protecting the carrying broker-dealer becomes The hypothecation rules under the customer accounts against loss in the insolvent. Securities Exchange Act of 1934 (Rules event of the insolvency of the Customer Name: llllllllll 8c–1 and 15c2–1), prohibit broker- intermediary carrying the accounts. By: llllllllllllllll dealers from permitting the As discussed above, cross-margining hypothecation of customer securities in must be conducted in a portfolio margin (Signature/title) a manner that allows those securities to account, dedicated exclusively to cross Date: llllllllllllllll be subject to any lien or liens in an margining and cross margin accounts * * * * * amount that exceeds the customer’s are not treated as a futures account with aggregate indebtedness. However, all an FCM. Instead, cross margin accounts I. Self-Regulatory Organization’s long option positions in a portfolio- are treated as securities accounts Statement of the Purpose of, and margining account (including any cross- carried with broker-dealers. As such, Statutory Basis for, the Proposed Rule margining account) will be subject to cross margin accounts are covered by Change OCC’s lien, including any positions that Rule 15c3–3 under the Securities In its filing with the Commission, the exceed the customer’s aggregate Exchange Act of 1934, which protects Exchange included statements indebtedness. The Commission staff has customer accounts. Rule 15c3–3, among concerning the purpose of and basis for taken a position that would allow other things, requires a broker-dealer to the proposed rule change and discussed customers to carry positions in maintain physical possession or control any comments it received on the portfolio-margining accounts, (including of all fully-paid and excess margin proposed rule change. The text of these any cross-margining account) even securities and maintain a special statements may be examined at the when those positions exceed the reserve account for the benefit of their places specified in Item IV below. The customer’s aggregate indebtedness. customers. However, with regard to Exchange has prepared summaries, set Accordingly, within a portfolio margin cross margin accounts, there is an forth in Sections A, B, and C below, of account or cross-margin account, to the exception to the possession or control the most significant aspects of such extent that you have long option requirement of Rule 15c3–3 that permits statements.

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A. Self-Regulatory Organization’s account, thus providing a cross-margin capability. In a portfolio margin account Statement of the Purpose of, and capability. The Exchange proposes to that is used exclusively for cross- Statutory Basis for, the Proposed Rule introduce the amendments as a two-year margining, separate portfolios may be Change pilot program that would be available established containing index options, on a voluntary basis to member index warrants and exchange-traded 1. Purpose organizations. funds structured to replicate the a. Background Portfolio margining is a margin composition of the index underlying a NYSE Rule 431 generally prescribes methodology that sets margin particular portfolio, as well as related minimum maintenance margin requirements for an account based on index futures and options on such requirements for customer accounts the greatest projected net loss of all futures. held at members and member positions in a product class or group as To determine theoretical gains and organizations. In April 1996, the determined by the Commission- losses, and resulting margin Exchange established the Committee to approved options pricing model using requirements, the same portfolio margin assess the adequacy of NYSE Rule 431 multiple pricing scenarios. These computation procedure will be applied on an ongoing basis, review margin scenarios are designed to measure the to a portfolio margin account that is requirements, and make theoretical loss of the positions given identified as a cross-margin account. The liquidation/transfer requirement recommendations for change. A number changes in both the underlying price and implied volatility inputs to the set forth in Amendment No. 2 of proposed amendments resulting from model. Accordingly, the margin necessitates that cross-margin positions the Committee’s recommendations have required is based on the greatest loss be carried in a separate account, been approved by the Exchange’s Board that would be incurred in a portfolio if whereas the Original Proposal and of Directors since the Committee was the value of its components move up or Amendment No. 1 permitted cross- established. Similarly, the proposed down by a predetermined amount. margin positions to either be combined amendments discussed below have been The Exchange represents that the in the same account with other portfolio recommended by the Committee and purpose and benefit of portfolio margin positions, or carried in a have been adopted by the Exchange in 11 margining is to efficiently set levels of separate cross-margin account. this proposal, as amended. The margin that more precisely reflect actual Amendment No. 2 also proposes Exchange represents that the proposed net risk of all positions in the account. changes to numerous sections of Rule portfolio margin and cross-margin rules A customer benefits from portfolio 431 to remove references to the ability have been developed in conjunction margining in that margin requirements to co-mingle cross-margin positions with the CBOE, The Options Clearing calculated on net position risk are along with all other portfolio margin Corporation, the American Stock generally lower than strategy-based positions. Exchange LLC, the Board of Trade of the margin methodologies currently in Another change in Amendment No. 2 City of Chicago, Inc., the Chicago place. In permitting margin computation is the incorporation of a provision, as Mercantile Exchange Inc., and the based on actual net risk, members and requested by Commission staff, that National Association of Securities member organizations will no longer be requires liquidation or transfer of cross- Dealers, Inc. required to compute a margin margin accounts in the event that a The Exchange filed Amendment No. 2 requirement for each individual carrying broker-dealer becomes for the purpose of eliminating position or strategy in a customer’s insolvent. This requirement would inconsistencies between the proposed account. provide for Securities Investor 12 NYSE and CBOE rules, and to However, as a pre-condition to Protection Corporation (‘‘SIPC’’) incorporate certain substantive permitting portfolio margining, the coverage of futures and options on amendments requested by Commission member or member organization would futures in a securities account because staff. be required to establish procedures and such instruments would be viewed as b. Portfolio Margin guidelines to monitor credit risk to the converted to cash in the event of a firm member or member organization’s insolvency. The Exchange proposes to amend capital, including intra-day credit risk, NYSE Rule 431 to expand the scope of and stress testing of portfolio margin d. Disclosure Document and Customer its margin rule by providing a portfolio accounts. Further, members and Attestation margin methodology for listed, broad- member organizations would have to Exchange Rule 726 prescribes based market index options, index establish procedures for regular review requirements for the delivery of options warrants and related exchange-traded and testing of these required risk disclosure documents concerning the funds. The Exchange believes that the analysis procedures. opening of customer accounts. As proposed amendments would allow proposed by the Exchange, members c. Cross-Margining Capability clearing members and member and member organizations would be organizations to extend a portfolio Amendment No. 2 requires a clearing required to provide every portfolio margin methodology to eligible member or member organization to margin customer with a written risk customers as an alternative to the establish a separate portfolio margin disclosure statement at or prior to the current strategy-based margin account (securities margin account) initial opening of a portfolio margin requirements. The Exchange further exclusively for cross-margining.13 In account. The disclosure statement is believes that the proposed rule also this regard, related index futures and divided into two sections, one dealing would allow broad-based market index options on such futures would be with portfolio margining, and the other futures and options on such futures to carried in a separate cross-margin with cross-margining. be included in a portfolio margin account, thus affording a cross-margin The statement would disclose the risk and operation of portfolio margin 11 Many aspects of the proposed rule change are 13 The Original Proposal and Amendment No. 1 accounts, including cross-margining, similar to the CBOE’s proposed rule change to permitted cross-margin positions to either be permit customer portfolio margining and cross- combined in the same account with other portfolio and the differences between portfolio margining. See CBOE Proposal, supra note 4. margin positions, or carried in a separate cross- margin and strategy-based margin 12 See CBOE Proposal, supra note 4. margin account. requirements. The disclosure statement

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would also address who is eligible to mechanism of a free and open market All submissions should refer to File open a portfolio margin account, the and a national market system, and, in Number SR–NYSE–2002–19. This file instruments that are allowed, and when general, to protect investors and the number should be included on the deposits to meet margin and minimum public interest. In addition, the subject line if e-mail is used. To help the equity are required. Exchange believes that Section 6(b)(5) of Commission process and review your Included within the portfolio margin the Act 16 requires that the rules of an comments more efficiently, please use section of the disclosure statement exchange foster cooperation and only one method. The Commission will would be a list of certain of the risks coordination with persons engaged in post all comments on the Commission’s unique to portfolio margin accounts, regulating transactions in securities. Internet Web site (http://www.sec.gov/ such as: Increased leverage; shorter time rules/sro.shtml). Copies of the for meeting margin; involuntary B. Self-Regulatory Organization’s submission, all subsequent liquidation if margin not received; Statement on Burden on Competition amendments, all written statements inability to calculate future margin The Exchange does not believe that with respect to the proposed rule requirements because of the data and the proposed rule change will impose change that are filed with the calculations required; and that long any burden on competition that is not Commission, and all written positions are subject to a lien. The risks necessary or appropriate in the communications relating to the and operation of a cross-margin feature furtherance of the purposes of the Act. proposed rule change between the are delineated in the cross-margin Commission and any person, other than section of the disclosure statement, and C. Self-Regulatory Organization’s those that may be withheld from the a list of certain of the risks associated Statement on Comments on the public in accordance with the with cross-margining will be included Proposed Rule Change Received From provisions of 5 U.S.C. 552, will be as well. Members, Participants, or Others available for inspection and copying in In addition, at or prior to the time a No written comments were either the Commission’s Public Reference portfolio margin account is initially solicited or received. Section, 450 Fifth Street, NW., opened, members and member Washington, DC 20549. Copies of such III. Date of Effectiveness of the organizations would be required to filing also will be available for Proposed Rule Change and Timing for obtain a signed acknowledgement inspection and copying at the principal Commission Action regarding certain implications of office of the NYSE. All comments portfolio margining (e.g., treatment Within 35 days of the date of received will be posted without change; under SEC Rules 8c–1, 15c2–1 and publication of this notice in the Federal the Commission does not edit personal 15c3–3 under the Act) from the Register or within such longer period (i) identifying information from customer. Further, prior to providing as the Commission may designate up to submissions. You should submit only cross-margining, members and member 90 days of such date if it finds such information that you wish to make organizations would be required to longer period to be appropriate and available publicly. All submissions obtain a second signed customer publishes its reasons for so finding or should refer to File Number SR–NYSE– acknowledgement relative to the (ii) as to which the Exchange consents, 2002–19 and should be submitted on or segregation treatment for futures the Commission will: before January 18, 2005. contracts and SIPC coverage. (A) By order approve such proposed For the Commission, by the Division of Amendment No. 2 reflects changes to rule change, as amended, or Market Regulation, pursuant to delegated the risk disclosure statement and (B) Institute proceedings to determine authority.17 acknowledgement forms to reflect whether the proposed rule change Margaret H. McFarland, proposed amendments to the rule should be disapproved. Deputy Secretary. language concerning separation of cross- [FR Doc. 04–28183 Filed 12–23–04; 8:45 am] margining from all other portfolio IV. Solicitation of Comments BILLING CODE 8010–01–P margining. The acknowledgement form Interested persons are invited to in Amendment No. 2 will require that submit written data, views, and by signing the cross-margin agreement, arguments concerning the foregoing, SECURITIES AND EXCHANGE the signer acknowledges that all including whether the proposed rule COMMISSION positions carried in a cross-margin change is consistent with the Act. account will be immediately liquidated Comments may be submitted by any of [Release No.34–50877; File No. SR–Phlx– or transferred to another broker-dealer the following methods: 2004–90] eligible to carry cross-margin accounts Electronic Comments Self-Regulatory Organizations; Notice in the event that the carrying broker- of Filing of Proposed Rule Change by • Use the Commission’s Internet dealer becomes insolvent. the Philadelphia Stock Exchange, Inc. comment form (http://www.sec.gov/ Relating to Remote Streaming Quote 2. Statutory Basis rules/sro.shtml); or Traders The Exchange believes the proposed • Send an e-mail to rule- rule change, as amended, is consistent [email protected]. Please include File December 17, 2004. with Section 6(b) of the Act 14 in Number SR–NYSE–2002–19 on the Pursuant to Section 19(b)(1) of the general, and furthers the objectives of subject line. Securities Exchange Act of 1934 Section 6(b)(5) of the Act 15 in 1 2 Paper Comments (‘‘Act’’) , and Rule 19b–4 thereunder, particular, because it is designed to notice is hereby given that on December prevent fraudulent and manipulative • Send paper comments in triplicate 9, 2004, the Philadelphia Stock acts and practices, to promote just and to Jonathan G. Katz, Secretary, Exchange, Inc. (‘‘Phlx’’ or ‘‘Exchange’’) equitable principles of trade, to remove Securities and Exchange Commission, filed with the Securities and Exchange impediments to and perfect the 450 Fifth Street, NW., Washington, DC 20549–0609. 17 17 CFR 200.30–3(a)(12). 14 15 U.S.C. 78f(b). 1 15 U.S.C. 78s(b)(1). 15 15 U.S.C. 78f(b)(5). 16 15 U.S.C. 78f(b)(5). 2 17 CFR 240.19–4.

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