Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the American Stock Exchange LLC Relating to Margin and Net Capital Requirements for Members and Clearing Members Participating in Joint Back Office Arrangements

[Federal Register Volume 64, Number 224 (Monday, November 22, 1999)]
[Notices]
[Pages 63834-63836]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-30319]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42129; File No. SR-Amex-99-26]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the American Stock Exchange LLC Relating to Margin and Net 
Capital Requirements for Members and Clearing Members Participating in 
Joint Back Office Arrangements

November 10, 1999.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on July 16, 1999, the American Stock Exchange LLC (``Amex'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II and III below, which Items have been prepared by the 
Exchange. The Commission is publishing this notice to solicit comments 
on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Amex proposes to amend Exchange Rule 462, ``Minimum Margins,'' 
to establish margin and net capital requirements for Amex members and 
clearing members participating in joint back office (``JBO'') 
arrangements. The test of the proposed rule change is available at the 
Exchange and at the Commission.

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

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

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

1. Purpose
    The Exchange proposes to revise Exchange Rule 462 to establish 
margin and net capital requirements for JBO participants \3\ and 
clearing members. JBO arrangements permit a participating broker-dealer 
to be deemed self-clearing \4\ for margin purposes and entitle the 
participating broker-dealer to receive credit on a good faith margin 
basis.\5\
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    \3\ The proposed rule change would apply to Amex members and 
member organizations that participate in JBO arrangements with JBO 
clearing members (``JBO participants'').
    \4\ Under the proposal, JBO participants would not be considered 
self-clearing for any purpose other than for the extension of credit 
under Exchange Rule 462, as revised, or under the comparable rules 
of another self-regulatory organization.
    \5\ ``Good faith'' with respect to margin means, ``the amount of 
margin which a creditor would require in exercising sound credit 
judgment.'' See 12 CFR 220.2.
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    In a 1996 release discussing amendments to Regulation T,\6\ the 
Board of Governors of the Federal Reserve System (``FRB'') placed its 
reliance on the authority of self-regulatory organizations (``SROs'') 
to ensure the reasonableness of JBO arrangements.\7\ When the 
Regulation T provision that permits JBO arrangements was first adopted, 
the FRB assumed there would be a reasonable relationship between the 
good faith credit a JBO clearing member extended to a JBO participant 
and the participant's ownership interest in the clearing member. 
Consequently, the FRB did not establish any explicit requirement for 
the amount of ownership that each JBO participant should have in the 
JBO clearing member. However, because Regulation T does not provide a 
precise ownership standard,\8\ good faith credit has been extended to 
some ``owners'' that hold merely a nominal interest in a JBO clearing 
member.
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    \6\ Regulation T is entitled ``Credit by Brokers and Dealers.'' 
The FRB issued Regulation T pursuant to Section 7(a) of the Act. See 
12 CFR 220, et seq.
    \7\ See Board of Governors of the Federal Reserve System Docket 
No. R-0772 (April 26, 1996), 61 FR 20386 (May 6, 1996).
    \8\ Section 220.7(c) of Regulation T only requires that a JBO 
clearing firm be ``a clearing and servicing broker or dealer owned 
jointly or individually by other [broker-dealers].'' 12 CFR 
220.7(c).
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    In conjunction with other SROs and representatives from the 
securities industry, the Exchange seeks to establish prudent ownership 
standards for JBO participants and clearing members. These standards 
would permit the extension of good faith credit to clearing member 
``owners'' only when the owners maintain meaningful assets on deposit 
with the JBO clearing member, and the clearing member maintains 
sufficient net capital and risk control procedures to carry the JBO 
accounts.
    a. Requirements for JBO Participants. Under the proposal, each JBO 
participant would be required to be a registered broker-dealer subject 
to the net capital requirements prescribed by Commission Rule 15c3-1 
(``Rule 15c3-1'').\9\ JBO participants could not claim the net capital 
exemption available to option market makers under Commission Rule 15c3-
1(b)(1).\10\ Instead, JBO participants would be required to deposit and 
maintain minimum account equity of $1 million and would be subject to 
Financial and Operational Combined Uniform Single Report (``FOCUS'') 
filings and certified audits. If the equity in a JBO participant's 
account fell below $1 million, the JBO clearing firm would be

[[Page 63835]]

required to issue a margin call for additional funds or securities to 
be satisfied within five business days. Additionally, each JBO 
participant would be required to satisfy the ownership standards 
established by the JBO clearing member. To ensure that adequate 
procedures existed for complying with these requirements, JBO 
participants would be required to employ or have access to qualified 
Series 27 principal.\11\
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    \9\ 17 CFR 240.15c3-1.
    \10\ 17 CFR 240.15c3-1(b)(1).
    \11\ The Commission notes that certain broker-dealers subject to 
Rule 15c3-1(a)(2) (i.e., broker-dealers that carry customer accounts 
and broker-dealers that introduce customer accounts and receive 
securities) are eligible for an exemption from NASD Rule 1022(b), 
which requires such broker-dealers to employ a Series 27 principal. 
The Exchange's proposal recognizes this class of broker-dealers by 
providing that broker-dealers participating in JBO arrangements must 
either employ ``or have access to'' a qualified Series 27 principal. 
According to the Exchange, the phrase ``or have access to'' means 
that a JBO participant may employ a Series 27 principal on a part-
time basis or as a consultant. Telephone conversation between Scott 
Van Hatten, Legal Counsel, Exchange, and Michael Loftus, Special 
Counsel, Division of Market Regulation, Commission (November 10, 
1999).
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    b. Requirements for JBO Clearing Members. The proposed rule change 
would require each member clearing JBO accounts to notify its 
Designated Examining Authority in writing of its intention to clear JBO 
accounts and to comply with additional net capital requirements 
prescribed by the Exchange. Specifically, a JBO clearing member must 
maintain either: (1) tentative net capital of $25 million; \12\ or (2) 
net capital of $7 million, if the clearing member's primary business is 
clearing option market maker accounts.\13\ A JBO clearing member that 
primarily conducts an options market maker clearing business would be 
required to include the gross deductions calculated for all JBO 
participant accounts in its ratio of gross options market maker 
deductions to adjusted net capital.
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    \12\ The term ``tentative net capital'' generally refers to a 
clearing member's net capital before the application of haircuts and 
undue concentration deductions.
    \13\ A clearing member would be deemed to be primarily 
conducting an options market maker clearing business if at least 60% 
of the gross haircuts calculated for all options market maker and 
JBO participant accounts, in aggregate, could be attributed to 
options market maker transactions.
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    Under the proposal, a JBO clearing member would be required to 
adjust its net worth each day by deducting any deficiency between a JBO 
participant's account equity and the proprietary haircut calculated 
pursuant to Rule 15c3-1 for the positions maintained in the JBO 
account. Additionally, clearing members that maintained JBO accounts 
would be required to ensure that each JBO participant maintained equity 
of $1 million over all related funds. The JBO clearing member would be 
required to issue a margin call if the JBO participant's account equity 
fell below the $1 million threshold. Each JBO clearing member also 
would be required to establish and maintain written ownership standards 
for its JBO accounts.\14\ Finally, JBO clearing members would be 
required to develop acceptable risk analysis standards and comply with 
the requirements of Amex Rule 462.
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    \14\ The Exchange would not require JBO clearing members to 
establish ownership standards that meet any minimum guidelines in 
addition to the rules of the Exchange. As a result, clearing members 
would possess the discretion to develop the ownership criteria 
governing their JBO accounts. However, should the Exchange learn of 
any inappropriate ownership standards through its audit and 
surveillance activities, the Exchange would move to correct the 
impropriety.
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    c. Margin Requirements for Broker-Dealer Accounts. Currently, any 
deficiency between the equity maintained in a proprietary account 
carried for a broker-dealer and the maintenance margin required by 
Exchange Rule 462(b)(1)(i.e., 25% of the current market value of 
securities held ``long'' in the account) is deducted in computing the 
net capital of the clearing member organization. To treat introducing 
broker-dealers and JBO participants similarly, the proposed rule change 
predicates the deduction to a clearing member organization's net 
capital upon the haircut requirements of Rule 15c3-1 (i.e., 15% of the 
current market value for long positions) \15\ rather than the 25% 
maintenance margin requirement under Exchange Rule 462(b)(1).
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    \15\ 17 CFR 240.15c3-1.
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    d. Margin Requirements for Specialist and Market Maker Accounts. 
The proposal would likewise change the manner in which deductions to a 
clearing member organization's net capital are computed for specialist 
and market maker accounts. Presently, the amount of any deficiency 
between the equity in the account carried for a specialist or market 
maker and the 25% maintenance margin required by Exchange Rule 
462(b)(1) is deducted in computing the net capital of the clearing 
member organization. Under the proposed rule change, the deduction 
would be based upon the haircut requirements of Rule 15c3-1 (i.e., 15%) 
rather than the margin requirements under Exchange Rule 462(b)(1)(i.e., 
25%).
    The same modification would be made to the margin provision 
governing joint accounts carried by member organizations in which the 
member organizations also participate. If the equity maintained in the 
joint account by other participants is deficient, the proposal would 
require the clearing member organization to compute the deduction to 
its net capital based upon the haircut requirements of Rule 15c3-1 
rather than the margin requirements of Exchange Rule 462(b)(1).
2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with the requirements of Section 6(b) of the Act,\16\ in general, and 
further the objectives of Section 6(b)(5) of the Act,\17\ in 
particular, in that it is designed to prevent fraudulent and 
manipulative acts and practices, promote just and equitable principles 
of trade, foster cooperation and coordination with persons engaged in 
facilitating transactions in securities, and remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system.
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    \16\ 15 U.S.C. 78f(b).
    \17\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange believes that the proposed rule change will not impose 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    The Exchange has neither solicited nor received written comments on 
the proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding, or (ii) as to 
which the Exchange consents, the Commission will:
    A. By order approve the proposed rule change, or
    B. Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule

[[Page 63836]]

change is consistent with the 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 submissions, 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 persons, 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 at the 
Commission's Public Reference Room, 450 Fifth Street, NW, Washington, 
DC 20549-0609. Copies of such filing will also be available for 
inspection and copying at the principal office of the Exchange. All 
submissions should refer to File No. SR-Amex-99-26 and should be 
submitted by December 13, 1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-30319 Filed 11-19-99; 8:45 am]
BILLING CODE 8010-01-M