Self-Regulatory Organizations; New York Stock Exchange LLC; Notice of Filing of Proposed Rule Change to Rule 431 (“Margin Requirements”) and Rule 726 (“Delivery of Options Disclosure Document and Prospectus”) To Expand the Products Eligible for Customer Portfolio Margining and Cross-Margining and Eliminate Separate Cross-Margin Accounts, 17539-17549 [E6-5019]

Download as PDF Federal Register / Vol. 71, No. 66 / Thursday, April 6, 2006 / Notices SECURITIES AND EXCHANGE COMMISSION [Release No. 34–53577; File No. SR–NYSE– 2006–13] Self-Regulatory Organizations; New York Stock Exchange LLC; Notice of Filing of Proposed Rule Change to Rule 431 (‘‘Margin Requirements’’) and Rule 726 (‘‘Delivery of Options Disclosure Document and Prospectus’’) To Expand the Products Eligible for Customer Portfolio Margining and Cross-Margining and Eliminate Separate Cross-Margin Accounts March 30, 2006. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Exchange Act’’), 1 and Rule 19b–4 thereunder,2 notice is hereby given that on March 2, 2006, the New York Stock Exchange LLC (‘‘NYSE’’ or ‘‘Exchange’’) filed with the Securities and Exchange Commission (‘‘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. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The NYSE is filing with the Commission proposed amendments to NYSE Rule 431 (‘‘Margin Requirements’’) that would further expand the scope of products that are eligible for treatment as part of the Commission approved Portfolio Margin Pilot Program 3 (‘‘Pilot’’) and eliminate the requirement for a separate crossmargin account for margining eligible 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 See Exchange Act Release No. 52031 (July 14, 2005), 70 FR 42130 (July 21, 2005) (SR–NYSE– 2002–19). On July 14, 2005, the Commission approved on a pilot basis expiring July 31, 2007, amendments to Exchange Rule 431 to permit the use of a prescribed risk-based margin requirement (‘‘portfolio margin’’), for certain specified products (e.g., listed, broad-based U.S. index options and warrants, along with any underlying instruments), as an alternative to the strategy based margin requirements currently required by Rule 431. Amendments to Rule 726 were also approved to require disclosure to, and written acknowledgment from, customers in connection with the use of portfolio margin. See NYSE Information Memo 05– 56 for additional information; see also SR–NYSE– 2005–93 in which the Exchange filed with the Commission amendments to Rule 431 which would expand the approved products for certain customers that are eligible for treatment under portfolio margin requirements to include U.S. security futures and single stock options. See Exchange Act Release No. 53126 (Jan.13, 2006), 71 FR 3586 (Jan. 23, 2006) (SR–NYSE–2005–93). sroberts on PROD1PC70 with NOTICES 2 17 VerDate Aug<31>2005 19:52 Apr 05, 2006 Jkt 208001 security products with eligible commodity products. Amendments to Rule 726 (‘‘Delivery of Options Disclosure Document and Prospectus’’) also are proposed to include the Commission approved products on the disclosure document required to be furnished to customers pursuant to this rule. The text of the proposed rule change is below. Additions are in italics. Deletions are in brackets. * * * * * Margin Requirements Rule 431. (a) through (f) unchanged. Portfolio Margin [and Cross-Margin] (g) As an alternative to the ‘‘strategy’’ based margin requirements set forth in sections (a) through (f) of this Rule, member organizations may elect to apply the portfolio margin requirements set forth in this section (g) to [1) listed, broad-based U.S. index options, index warrants and underlying instruments and 2) listed security futures contracts and listed single stock options] all margin eligible securities 4, listed options, OTC derivatives, and U.S. security futures 5, provided certain requirements are met. (See section (g)(6)(C)(1)) In addition, member organizations, provided they are a Futures Commission Merchant (‘‘FCM’’) and are either a clearing member of a futures clearing organization or have an affiliate that is a clearing member of a futures clearing organization, are permitted under this section (g) to combine an eligible participant’s related instruments as defined in section (g)(2)(D) [(C)], with listed, [broad-based] U.S. index options, options on exchange traded funds (‘‘ETF’’), index warrants and underlying instruments and compute a margin requirement for such combined products on a portfolio margin basis. [(’’cross-margin’’). Member organizations must confine cross-margin positions to a portfolio margin account dedicated exclusively to crossmargining.] The portfolio margin [and crossmargining] provisions of this Rule shall not apply to Individual Retirement Accounts (‘‘IRAs’’). (1) Member organizations must monitor the risk of portfolio margin accounts and maintain a comprehensive 4 For purposes of this section (g) of the Rule, the term ‘‘margin eligible security’’ utilizes the definition at section 220.2 of Regulation T of the Board of Governors of the Federal Reserve System, excluding a nonequity security. 5 For purposes of this section (g) of the Rule, the term ‘‘security future’’ utilizes the definition at section 3(a)(55) of the Exchange Act. [, excluding narrow-based indices.] PO 00000 Frm 00106 Fmt 4703 Sfmt 4703 17539 written risk analysis methodology for assessing the potential risk to the member organization’s capital over a specified range of possible market movements of positions maintained in such accounts. The risk analysis methodology shall specify the computations to be made, the frequency of computations, the records to be reviewed and maintained, and the person(s) within the organization responsible for the risk function. This risk analysis methodology [shall be made available to] must be approved by the New York Stock Exchange (‘‘Exchange’’) [upon request.] and submitted to the Securities and Exchange Commission (‘‘SEC’’) prior to the implementation of portfolio margining. In performing the risk analysis of portfolio margin accounts required by this Rule, each member organization shall include [the following] in the written risk analysis methodology procedures and guidelines for: (A) obtaining and reviewing the appropriate account documentation and financial information necessary for assessing the amount of credit to be extended to eligible participants. (B) [(A) Procedures and guidelines for] the determination, review and approval of credit limits to each eligible participant, and across all eligible participants, utilizing a portfolio margin account[.], (C) [(B) Procedures and guidelines for] monitoring credit risk exposure to the member organization from portfolio margin accounts, on both an [including] intra-day and end of day basis [credit risk], including the type, scope and frequency of reporting to senior management [related to portfolio margin accounts.], (D) [(C) Procedures and guidelines for] the use of stress testing of portfolio margin accounts in order to monitor market risk exposure from individual accounts and in the aggregate[.], (E) [(D) Procedures providing for] the regular review and testing of these risk analysis procedures by an independent unit such as internal audit or other comparable group[.], (F) Managing the impact of credit extension related to portfolio margin accounts on the member organization’s overall risk exposure, (G) The appropriate response by management when limits on credit extensions related to portfolio margin accounts have been exceeded, and (H) Determining the need to collect additional margin from a particular eligible participant, including whether that determination was based upon the E:\FR\FM\06APN1.SGM 06APN1 17540 Federal Register / Vol. 71, No. 66 / Thursday, April 6, 2006 / Notices creditworthiness of the participant and/ or the risk of the eligible product. Moreover, management must periodically review, in accordance with written procedures, the member organization’s credit extension activities for consistency with these guidelines. Management must periodically determine if the data necessary to apply this section (g) is accessible on a timely basis and information systems are available to adequately capture, monitor, analyze and report relevant data. (2) Definitions.—For purposes of this section (g), the following terms shall have the meanings specified below: (A) The term ‘‘listed option’’ means any option traded on a registered national securities exchange or automated facility of a registered national securities association. (B) The term ‘‘OTC derivative’’ means any equity-based or equity index-based unlisted option, forward contract, or security-based swap that can be valued by a theoretical pricing model approved by the Exchange and submitted to the SEC. (C) [(B)] The term ‘‘underlying instrument’’ means a security or security index upon which any listed option, OTC derivative, U.S. security future, or broad-based U.S index future is based. [long and short positions in an exchange traded fund or other fund product registered under the Investment Company Act of 1940, that holds the same securities, and in the same proportion, as contained in a broadbased index on which options are listed. In the case of a listed security futures contract, ‘‘underlying instrument’’ means listed single stock option on the same security and in the same proportion. The term ‘‘underlying instrument’’ shall not be deemed to include options on futures contracts, or unlisted instruments.] (D) [(C)] The term ‘‘related instrument’’ within a security [an option] class or product group means broad-based U.S. index futures [contracts] and options on broad-based U.S index futures [contracts] covering the same underlying instrument. The term ‘‘related instrument’’ does not include security futures or options on security futures. (E) [(D)] The term ‘‘security [options] class’’ refers to all securities [options] covering the same underlying instrument. (F) [(E)] The term ‘‘portfolio’’ means any eligible product, as defined in section (g)(6)(C)(1), grouped with their underlying instruments and related instruments. [(F) The term ‘‘option series’’ relates to listed options and means all option contracts of the same type (either a call or a put) and exercise style, covering the same underlying instrument with the same exercise price, expiration date, and number of underlying units.] (G) The term ‘‘product group’’ means two or more portfolios of the same type (see table in section (g)(2)(I) below) for which it has been determined by Rule 15c3–1a under the Securities Exchange Act of 1934 (‘‘Exchange Act’’) that a percentage of offsetting profits may be applied to losses at the same valuation point. (H) For purposes of portfolio margin [and cross-margin] requirements the term ‘‘equity’’, as defined in section (a)(4) of this Rule, includes the market value of any long or short [option] positions held in an eligible participant’s [a customer’s] account. (I) The term ‘‘theoretical gains and losses’’ means the gain and loss in the value of individual eligible products and related instruments at ten [10] equidistant intervals (valuation points) ranging from an assumed movement (both up and down) in the current market value of the underlying instrument. The magnitude of the valuation point range shall be as follows: Up/down market move (high & low valuation points) Portfolio type High Capitalization Broad-based U.S. Market Index [Option] 6 .......................................................................................................... Non-High Capitalization, Broad-based U.S. Market Index [Option] 7 ................................................................................................. Margin Eligible Security,Listed Equity Option, Listed Narrow-based Index Option, [Listed] U.S. Security Future, and OTC Derivative [Instrument] (Including forward contracts and swaps) [Listed Security Futures Contract and Listed Single Stock Option]. sroberts on PROD1PC70 with NOTICES (3) Approved Theoretical Pricing Models.—Theoretical pricing models must be approved by the Exchange [a Designated Examining Authority] and submitted to [reviewed by] the SEC [Securities and Exchange Commission (‘‘The Commission’’)] in order to qualify.8 [Currently, the theoretical model utilized by the Options Clearing Corporation (‘‘The OCC’’) is the only model qualified pursuant to the Commission’s Net Capital Rule. All member organizations shall obtain their theoretical values from the OCC.] 6 In accordance with section (b)(1)(i)(B) of Rule 15c3–1a (Appendix A to Rule 15c3–1) under the Securities Exchange Act of 1934, 17 CFR 240.15c3– 1a(b)(1)(i)(B). 7 See footnote above. 8 Currently, the theoretical model utilized by the Options Clearing Corporation (‘‘OCC’’) is the only model qualified. VerDate Aug<31>2005 19:52 Apr 05, 2006 Jkt 208001 (4) Eligible Participants.—The application of the portfolio margin provisions of this section (g)[, including cross-margining, is limited to] include the following: (A) Any broker or dealer registered pursuant to Section 15 of the [Securities] Exchange Act; [of 1934;] (B) Any member of a national futures exchange to the extent that listed index options hedge the member’s index futures; and (C) Any person or entity not included in sections (g)(4)(A) and (g)(4)(B) above approved for options or U.S. security futures transactions. However, an eligible participant under this section (g)(4)(C) may not establish or maintain positions in OTC derivatives unless minimum equity of at least five million dollars is established and maintained with the member organization. [any PO 00000 Frm 00107 Fmt 4703 Sfmt 4703 +6%¥8% +/¥10% +/¥15% other person or entity not included in sections (g)(4)(A) and (g)(4)(B) above that has or establishes, and maintains, equity of at least five million dollars.] For purposes of this minimum equity requirement, all securities and futures accounts carried by the member organization for the same eligible participant may be combined provided ownership across the accounts is identical. A guarantee pursuant to section (f)(4) of this Rule is not permitted for purposes of the minimum equity requirement. [For those accounts that are solely limited to listed security futures contracts and listed single stock options, the five million dollar equity requirement shall be waived.] (5) Opening of Accounts. (A) Member organizations must notify and receive approval from the Exchange prior to establishing a portfolio margin E:\FR\FM\06APN1.SGM 06APN1 sroberts on PROD1PC70 with NOTICES Federal Register / Vol. 71, No. 66 / Thursday, April 6, 2006 / Notices [or cross-margin] methodology for eligible participants. (B) Only eligible participants that have been [approved for options transactions and] approved to engage in uncovered short option contracts pursuant to Exchange Rule 721, are permitted to utilize a portfolio margin account. (C) On or before the date of the initial transaction in a portfolio margin account, a member organization shall: (1) Furnish the eligible participant with a special written disclosure statement describing the nature and risks of portfolio margining [and crossmargining] which includes an acknowledgement for all portfolio margin account owners to sign, [and an additional acknowledgement for owners that also engage in cross-margining to sign,] attesting that they have read and understood the disclosure statement, and agree to the terms under which a portfolio margin account [and the crossmargin account respectively, are] is provided (see Exchange Rule 726 (d)), and (2) Obtain the signed acknowledgement[(s)] noted above from the eligible participant [(both of which are required for cross-margining eligible participants)] and record the date of receipt. (6) Establishing Account and Eligible Positions (A) [Portfolio Margin Account.] For purposes of applying the portfolio margin requirements prescribed in this section (g), and combining related instruments with listed, U.S. index options, options on exchange traded funds (‘‘ETF’’), index warrants, and underlying instruments, member organizations are to establish and utilize a specific securities margin account, or sub-account of a margin account, clearly identified as a portfolio margin account that is separate from any other securities account carried for an eligible participant. [(B) Cross-Margin Account. For purposes of combining related instruments with listed, broad-based U.S. index options, index warrants, and underlying instruments, and applying the portfolio margin requirements, member organizations are to establish a cross-margin account that is separate from any other securities account or portfolio margin account carried for an eligible participant.] A margin deficit in [either] the portfolio margin account [or the crossmargin account] of an eligible participant may not be considered as satisfied by excess equity in [the other] another account. Funds and/or securities must be transferred to the VerDate Aug<31>2005 19:52 Apr 05, 2006 Jkt 208001 deficient account and a written record created and maintained. (B) [(C)] [Portfolio Margin Account—] Eligible Products (1) For eligible participants as described in sections (g)(4)(A) through (g)(4)(C), a transaction in, or transfer of, an eligible product may be effected in the portfolio margin account. Eligible products under this section (g) consist of: [(i) A listed, broad-based U.S. index option or index warrant and underlying instrument. (ii) A listed security futures contract or listed single stock option.] (i) A margin eligible security, a listed option, a security future, an option on a security future, or OTC derivative. (ii) A foreign equity security and option on a foreign equity security, provided the foreign equity security is deemed to have a ‘‘ready market’’ under SEC Rule 15c3–1 or a ‘‘no-action’’ position issued thereunder. (iii) A margin eligible control or restricted security, provided the security has met the requirements in a manner consistent with SEC Rule 144 or an SEC ‘‘no-action’’ position issued thereunder, sufficient enough to permit the sale of the security, upon exercise of any listed option or OTC derivative written against it, without restriction. (iv) related instruments as defined in section (2)(D) [(2) A transaction in, or transfer of, an underlying instrument may be effected in the portfolio margin account provided a position in an offsetting eligible product is in the account or is established in the account on the same day. (3) A transaction in, or transfer of, a listed security futures contract or listed single stock option may also be effected in the portfolio margin account.] (2) [(4)] For eligible participants as described in section (g)(4)(C) that do not maintain five million dollars in equity, any [Any] long position or any short position in any OTC derivative [eligible product] that is no longer part of a hedge strategy must be transferred from the portfolio margin account to the appropriate securities account within ten business days, subject to any applicable margin requirement, unless the position becomes part of a hedge strategy again. Member organizations will be expected to monitor portfolio margin accounts for possible abuse of this provision. [(D) Cross-Margin Account—Eligible Products (1) For eligible participants as described in sections (g)(4)(A) through PO 00000 Frm 00108 Fmt 4703 Sfmt 4703 17541 (g)(4)(C), a transaction in, or transfer of, an eligible product may be effected in the cross-margin account. (2) A transaction in, or transfer of, a related instrument may be effected in the cross-margin account provided a position in an offsetting eligible product is in the account or is established in the account on the same day. (3) Any long position or any short position in any eligible product that is no longer part of a hedge strategy must be transferred from the cross-margin account to the appropriate securities account or futures account within ten business days, subject to any applicable margin requirement, unless the position becomes part of a hedge strategy again. Member organizations will be expected to monitor cross-margin accounts for possible abuse of this provision.] (7) [Initial and Maintenance] Margin Required.—The amount of margin required under this section (g) for each portfolio shall be the greater of: (A) the amount for any of the ten 10 equidistant valuation points representing the largest theoretical loss as calculated pursuant to section (g)(8) below, or (B) for eligible participants as described in section (g)(4)(A) through (g)(4)(C), $.375 for each listed option, OTC derivative, U.S. security future, [contract] and related instrument, multiplied by the contract’s or instrument’s multiplier, not to exceed the market value in the case of long contracts [positions] in eligible products. (C) Account guarantees pursuant to section (f)(4) of this Rule are not permitted for purposes of meeting [initial and maintenance] margin requirements. (8) Method of Calculation (A) Long and short contracts, including underlying instruments and related instruments, are to be grouped by security class; each security class group being [as] a ‘‘portfolio’’. Each portfolio is categorized as one of the portfolio types specified in section (g)(2)(I) above. (B) For each portfolio, theoretical gains and losses are calculated for each position as specified in section (g)(2)(I) above. For purposes of determining the theoretical gains and losses at each valuation point, member organizations shall obtain and utilize the theoretical values of eligible products as described in this section (g) rendered by an approved theoretical pricing model. (C) Offsets. Within each portfolio, theoretical gains and losses may be netted fully at each valuation point. Offsets between portfolios within the E:\FR\FM\06APN1.SGM 06APN1 17542 Federal Register / Vol. 71, No. 66 / Thursday, April 6, 2006 / Notices eligible product groups, as described in section (g)(2)(I), may then be applied as permitted by Rule 15c3–1a under the [Securities] Exchange Act [of 1934]. (D) After applying the offsets above, the sum of the greatest loss from each portfolio is computed to arrive at the total margin required for the account (subject to the per contract minimum). sroberts on PROD1PC70 with NOTICES (9) Portfolio Margin Minimum Equity Deficiency [Call] (A) If, as of the close of business, [at any time,] the equity in the portfolio margin [or cross-margin] account of an eligible participant as described in section (g)(4)(C), declines below the five million dollar minimum equity required, and is not restored to at least five million dollars within three business days [(T+3)] by a deposit of funds and/or securities, member organizations are prohibited from accepting [opening] new orders beginning on the fourth business day, [starting on T+4,] except that [opening] new orders entered for the purpose of hedging existing positions may be accepted if the result would be to lower margin requirements. This prohibition shall remain in effect until, (1) Equity of five million dollars is established[.] or, (2) any OTC derivative is liquidated or transferred from the portfolio margin account to the appropriate securities account. [For those accounts that are solely limited to security futures contracts and single stock options, the five million dollar equity requirement shall be waived.] (B) Member organizations will not be permitted to deduct any portfolio margin minimum equity deficiency [call] amount from Net Capital in lieu of collecting the minimum equity required. (10) Portfolio Margin [Maintenance] Deficiency [Call] (A) If, as of the close of business, [at any time,] the equity in the portfolio margin [or cross-margin] account of an eligible participant, as described in section (g)(4)(A) through (g)(4)(C), is less than the margin required, the eligible participant may deposit additional margin or establish a hedge to meet the margin requirement within three business days [(T+3)]. After [During] the three business day period, member organizations are prohibited from accepting [opening] new orders, except that [opening] new orders entered for the purpose of hedging existing positions may be accepted if the result would be to lower margin requirements. In the event an eligible participant fails to hedge existing positions or deposit additional margin in an amount VerDate Aug<31>2005 19:52 Apr 05, 2006 Jkt 208001 sufficient to eliminate any margin deficiency after [within] three business days, the member organization must liquidate positions in an amount sufficient to, at a minimum, lower the total margin required to an amount less than or equal to the account equity. (B) If the portfolio margin [maintenance] deficiency [call] is not met by the close of business on the next business day after the business day on which such deficiency arises, [T+1,] member organizations will be required to deduct the amount of the deficiency from Net Capital [the amount of the call] until such time the deficiency [call] is satisfied. (C) Member organizations will not be permitted to deduct any portfolio margin [maintenance] deficiency [call] amount from Net Capital in lieu of collecting the margin required. (D) The Exchange may grant additional time for an eligible participant to meet a portfolio margin deficiency upon written request, which is expected to be granted in unique circumstances only. (E) Member organizations should not permit an eligible participant to make a practice of meeting a portfolio margin deficiency by liquidation. (11) Determination of Value for Margin Purposes.—For the purposes of this section (g), all eligible products and related instrument positions shall be valued at current market prices. Account equity for the purposes of [this] sections (g)(9)(A) and (g)(10)(A) shall be calculated separately for each portfolio margin [or cross-margin] account. (12) Net Capital Treatment of Portfolio Margin [and Cross-Margin] Accounts. (A) No member organization that requires margin in any portfolio margin [eligible participant] account pursuant to section (g) of this Rule shall permit the aggregate [eligible participant] portfolio margin [and cross-margin initial and maintenance] requirements to exceed ten times its Net Capital [net capital] for any period exceeding three business days. The member organization shall, beginning on the fourth business day, cease opening new portfolio margin [and cross-margin] accounts until compliance is achieved. (B) If, at any time, a member organization’s aggregate [eligible participant] portfolio margin [and crossmargin] requirements exceed ten times its net capital, the member organization shall immediately transmit telegraphic or facsimile notice of such deficiency to the principal office of the Securities and Exchange Commission in Washington, DC, the district or regional office of the Securities and Exchange Commission for the district or region in which the PO 00000 Frm 00109 Fmt 4703 Sfmt 4703 member organization maintains its principal place of business; and to the [New York Stock] Exchange. (13) Day Trading Requirements.— [The requirements of sub-paragraph (f)(8)(B) of this Rule—Day-Trading shall not apply to portfolio margin accounts including cross-margin accounts.] Day trading is not permitted in portfolio margin accounts. Member organizations are expected to monitor portfolio margin accounts to detect and prevent circumvention of the day trading requirements. (14) [Cross-Margin Accounts—] Requirements to Liquidate (A) A member organization is required immediately either to liquidate, or transfer to another brokerdealer eligible to carry portfolio [cross-] margin accounts, all [eligible participant] portfolio [cross-] margin accounts that contain positions eligible for portfolio [cross-] margining if the member organization is: (1) Insolvent as defined in section 101 of title 11 of the United States Code, or is unable to meet its obligations as they mature; (2) The subject of a proceeding pending in any court or before any agency of the United States or any State in which a receiver, trustee, or liquidator for such debtor has been appointed; (3) Not in compliance with applicable requirements under the [Securities] Exchange Act [of 1934] or rules of the Securities and Exchange Commission or any self-regulatory organization with respect to financial responsibility or hypothecation of eligible participant’s securities; or (4) Unable to make such computations as may be necessary to establish compliance with such financial responsibility or hypothecation rules. (B) Nothing in this section (14) shall be construed as limiting or restricting in any way the exercise of any right of a registered clearing agency to liquidate or cause the liquidation of positions in accordance with its by-laws and rules. (15) Member organizations must ensure that portfolio margin accounts are in compliance with all other applicable Exchange rules promulgated in Rules 700 through 795. * * * * * Delivery of Options Disclosure Document and Prospectus Rule 726 (a) through (c) unchanged. Portfolio Margining [and CrossMargining] Disclosure Statement and Acknowledgement (d) The special written disclosure statement describing the nature and E:\FR\FM\06APN1.SGM 06APN1 Federal Register / Vol. 71, No. 66 / Thursday, April 6, 2006 / Notices risks of portfolio margining [and crossmargining], and acknowledgement for an eligible participant signature, required by Rule 431(g)(5)(B) shall be in a format prescribed by the Exchange or in a format developed by the member organization, provided it contains substantially similar information as in the prescribed Exchange format and has received the prior written approval of the Exchange. Sample Portfolio Margining [and CrossMargining] Risk Disclosure Statement To Satisfy Requirements of Exchange Rule 431(g) Overview of Portfolio Margining 1. Portfolio margining is a margin methodology that sets margin requirements for an account based on the greatest projected net loss of all positions in a ‘‘security [product] class’’ or ‘‘product group’’ as determined by [an options] a theoretical pricing model using multiple pricing scenarios. These pricing scenarios are designed to measure the theoretical loss of the positions given changes in both the underlying price and implied volatility inputs to the model. [Portfolio margining is currently limited to product classes and groups of index products relating to listed, broad-based market indexes, listed security futures contracts and listed single stock options.] 2. The goal of portfolio margining is to set levels of margin that more precisely reflect[s] actual net risk. The eligible participant benefits from portfolio margining in that margin requirements calculated on net risk are generally lower than alternative ‘‘position’’ or ‘‘strategy’’ based methodologies for determining margin requirements. Lower margin requirements allow the customer more leverage in an account. sroberts on PROD1PC70 with NOTICES Customers Eligible for Portfolio Margining 3. To be eligible for portfolio margining, eligible participants (other than broker-dealers) must meet the basic standards for having an options account that is approved for uncovered writing. In addition, eligible participants holding positions in over-the-counter (‘‘OTC’’) derivatives [and] must have and maintain at all times account net equity of not less than five million dollars, aggregated across all accounts under identical ownership at the clearing broker. The identical ownership requirement excludes accounts held by the same customer in different capacities (e.g., as a trustee and as an individual) and accounts where VerDate Aug<31>2005 19:52 Apr 05, 2006 Jkt 208001 ownership is overlapping but not identical (e.g., individual accounts and joint accounts). [For those accounts that are solely limited to security futures contracts and single stock options, the five million dollar equity requirement shall be waived.] 4. Members of futures exchanges on which portfolio margining eligible index contracts are traded are also permitted to carry positions in portfolio margin accounts without regard to the minimum aggregate account equity. Positions Eligible for a Portfolio Margin Account 5. [4.] All positions in [listed] margin eligible securities, listed options, OTC derivatives, and U.S. security futures [contracts, listed single stock options, listed, broad-based U.S. index options or index warrants, exchange traded funds and other products registered under the Investment Company Act of 1940 that are managed to track the same index that underlies permitted index options], are eligible for a portfolio margin account. In addition, listed, U.S index options, options on exchange traded funds (‘‘ETF’’), index warrants and underlying instruments can be combined with offsetting positions in related instruments, for the purpose of computing a margin requirement based on the net risk. This generally produces lower margin requirements than if the related instruments9 and securities products are viewed separately, thus providing more leverage in the account. 6. All broad-based U.S. listed market index futures and options on index futures traded on a designated contract market subject to the jurisdiction of the Commodity Futures Trading Commission (‘‘CFTC’’) are eligible for portfolio margining. Special Rules for Portfolio Margin Accounts 7. [5.] A portfolio margin account may be either a separate account or a subaccount of a customer’s standard margin account. In the case of a sub-account, equity in the standard account will be available to satisfy any margin requirement in the portfolio margin subaccount without transfer to the subaccount. 8. [6.] A portfolio margin account or sub-account will be subject to a minimum margin requirement of $.375, multiplied by the contract’s multiplier, for [every] each listed option, OTC 9 For purposes of this Rule, the term ‘‘related instruments,’’ within a security class or product group means broad-based U.S. index futures and options on broad-based U.S. index futures covering the same underlying instrument. PO 00000 Frm 00110 Fmt 4703 Sfmt 4703 17543 derivative, U.S. security future, and related instrument [contract] carried long or short in the account. [No minimum margin is required in the case of eligible exchange traded funds or other eligible fund products.] 9. [7.] A margin [Margin] deficiency [calls] in the portfolio margin account or sub-account, regardless of whether due to new commitments or the effect of adverse market movements on existing positions, must be met within three business days. Any shortfall in aggregate net equity across accounts must be met within three business days. Failure to meet a portfolio margin [maintenance] deficiency [call] when due will result in immediate liquidation of positions to the extent necessary to reduce the margin requirement. Failure to meet a minimum equity deficiency [call] prior to the end of the third business day will result in a prohibition on entering any [opening] new orders, with the exception of [opening] new orders that hedge existing positions, beginning on the fourth business day and continuing until such time as the minimum equity requirement is satisfied[.] or until any OTC derivative is liquidated or transferred from the portfolio margin account to the appropriate securities account. [8. A position in an exchange traded index fund or other eligible fund product may not be established in a portfolio margin account unless there exists, or there is established on the same day, an offsetting position in a related or underlying security, or other eligible securities. The position(s) will be transferred out of the portfolio margin account and into a standard securities account subject to any applicable margin requirement if the offsetting securities options, other eligible securities and/or related instruments no longer remain in the account for ten business days.] 10. [9.] When a broker-dealer carries a standard cash account or margin account for a customer, the brokerdealer is limited by rules of the Securities and Exchange Commission and of the [The] Options Clearing Corporation (‘‘OCC’’) to the extent to which the broker-dealer may permit the OCC to have a lien against long option positions in those accounts. In contrast, the OCC will have a lien against all long option positions that are carried by a broker-dealer in a portfolio margin account, and this could, under certain circumstances, result in greater losses to a customer having long option positions in such an account in the event of the insolvency of the customer’s broker. Accordingly, to the extent that a customer does not borrow against long E:\FR\FM\06APN1.SGM 06APN1 17544 Federal Register / Vol. 71, No. 66 / Thursday, April 6, 2006 / Notices sroberts on PROD1PC70 with NOTICES option positions in a portfolio margin account or have margin requirements in the account against which the long option can be credited, there is no advantage to carrying the long options in a portfolio margin account and the customer should consider carrying them in an account other than a portfolio margin account. 11. Customers participating in portfolio margining will be required to sign an agreement acknowledging that their positions and property in the portfolio margin account will be subject to the customer protection provisions of Rule 15c3–3 under the Securities Exchange Act of 1934 and the Securities Investor Protection Act. Special Risks of Portfolio Margin Accounts 12. [10.] Portfolio margining generally permits greater leverage in an account, and greater leverage creates greater losses in the event of adverse market movements. 13. [11.] Because the time limit for meeting a margin deficiency [calls]is shorter than in a standard margin account, and may be shorter than the time ordinarily required by a Futures Commission Merchant for meeting a margin deficiency in a futures account, there is increased risk that a customer’s portfolio margin account will be liquidated involuntarily, possibly causing losses to the customer. 14. [12.] Because portfolio margin requirements are determined using sophisticated mathematical calculations and theoretical values that must be calculated from market data, it may be more difficult for customers to predict the size of any future margin deficiency [calls] in a portfolio margin account. This is particularly true in the case of customers who do not have access to specialized software necessary to make such calculations or who do not receive theoretical values calculated and distributed periodically by [The] the Options Clearing Corporation. 15. [13.] For the reasons noted above, a customer that carries long options positions in a portfolio margin account could, under certain circumstances, be less likely to recover the full value of those positions in the event of the insolvency of the carrying broker. 16. [14.] Trading of [securities index] eligible products in a portfolio margin account is generally subject to all the risks of trading those same products in a standard securities margin account. Customers should be thoroughly familiar with the risk disclosure materials applicable to those products, including the booklet entitled ‘‘Characteristics and Risks of VerDate Aug<31>2005 19:52 Apr 05, 2006 Jkt 208001 Standardized Options’’[.] and the risk disclosure document required by the CFTC to be delivered to futures customers. Customers should review these materials carefully before trading in a portfolio margin account. 17. [15.] Customers should consult with their tax advisers to be certain that they are familiar with the tax treatment of transactions in these products, [securities options and futures products] including tax consequences of trading strategies involving these eligible products. 18. [16.] The descriptions in this disclosure statement relating to eligibility requirements for portfolio margin accounts, and minimum equity and margin requirements for those accounts, are minimums imposed under Exchange rules. Time frames within which a margin or [and] equity deficiency [calls] must be met are maximums imposed under Exchange rules. Broker-dealers may impose [their own] more stringent requirements. 19. According to the rules of the exchanges, a broker dealer is required to immediately liquidate, or, if feasible, transfer to another broker-dealer eligible to carry portfolio margin accounts, all customer portfolio margin accounts that contain positions in futures in the event that the carrying broker-dealer becomes insolvent. 20. In signing the agreement referred to above, a customer also acknowledges that a portfolio margin account that contains positions in futures will be immediately liquidated, or, if feasible, transferred to another broker-dealer eligible to carry portfolio margin accounts, in the event that the carrying broker-dealer becomes insolvent. 21. As noted above, portfolio margin accounts are securities accounts and are subject to the customer protections setforth in Rule 15c3–3 under the Securities Exchange Act of 1934 and the Securities Investor Protection Act. 22. Customers should bear in mind that the discrepancies in the cash flow characteristics of futures and certain options are still present even when those products are carried together in a portfolio margin account. Both futures and options contracts are generally marked to the market at least once each business day, but the marks may take place with different frequency and at different times within the day. When a futures contract is marked to the market, the gain or loss is immediately credited to or debited from the customer’s account in cash. While an increase in the value of a long option contract may increase the equity in the account, the gain is not realized until the option is sold or exercised. PO 00000 Frm 00111 Fmt 4703 Sfmt 4703 Accordingly, a customer may be required to deposit cash in the account in order to meet a variation payment on a futures contract even though the customer is in a hedged position and has experienced a corresponding (but yet unrealized) gain on a long option. Alternatively, a customer who is in a hedged position and would otherwise be entitled to receive a variation payment on a futures contract may find that the cash is required to be held in the account as margin collateral on an offsetting option position. [Overview of Cross-Margining 17. In a cross-margin account, index futures, security futures and options on index and security futures are combined with offsetting positions in listed securities and underlying instruments, for the purpose of computing a margin requirement based on the net risk. This generally produces lower margin requirements than if the related instruments 10 and securities products are viewed separately, thus providing more leverage in the account. 18. Cross-margining must be effected in a portfolio margin account type. A separate portfolio margin account must be established exclusively for crossmargining. 19. Cross-margining is achieved when index futures are combined with offsetting positions in index options and underlying instruments in a dedicated account, and a portfolio margining methodology is applied to them. Customers Eligible for Cross-Margining 20. The eligibility requirements for cross-margining are generally the same as for portfolio margining. Accordingly, any customer eligible for portfolio margining is eligible for crossmargining. 21. Members of futures exchanges on which cross-margining eligible index contracts are traded are also permitted to carry positions in cross-margin accounts without regard to the minimum aggregate account equity. Positions Eligible for Cross-Margining 22. All securities products eligible for portfolio margining are also eligible for cross-margining. 23. All broad-based U.S. listed market index futures and options on index futures traded on a designated contract market subject to the jurisdiction of the Commodity Futures Trading 10 [For purposes of this Rule, the term ‘‘related instruments,’’ within an option class or product group means futures contracts and options on futures contracts covering the same underlying instrument.] E:\FR\FM\06APN1.SGM 06APN1 Federal Register / Vol. 71, No. 66 / Thursday, April 6, 2006 / Notices sroberts on PROD1PC70 with NOTICES Commission (‘‘CFTC’’) are eligible for cross-margining. Special Rules for Cross-Margining 24. Cross-margining must be conducted in a portfolio margin account type. A separate portfolio margin account must be established exclusively for cross-margining. A cross margin account is a securities account, and must be maintained separately from all other securities account. 25. Cross-margining is automatically accomplished with the portfolio margining methodology. Cross-margin positions are subject to the same minimum margin requirement for every contract, including futures contracts. 26. Margin calls arising in a crossmargin account, and any shortfall in aggregate net equity across accounts, must be satisfied within the same timeframe, and subject to the same consequences, as in a portfolio margin account. 27. A position in a futures product may not be established in a cross-margin account unless there exists, or there is established on the same day, an offsetting position in securities options and/or other eligible securities. Related instruments will be transferred out of the cross-margin account and into a futures account if, for more than ten business days and for any reason, the offsetting securities options and/or other eligible securities no longer remain in the account. If the transfer of related instruments to a futures account causes the futures account to be undermargined, a margin call will be issued or positions will be liquidated to the extent necessary to eliminate the deficit. 28. Customers participating in crossmargining will be required to sign an agreement acknowledging that their positions and property in the crossmargin account will be subject to the customer protection provisions of Rule 15c3–3 under the Securities Exchange Act of 1934 and the Securities Investor Protection Act, and will not be subject to the provisions of the Commodity Exchange Act, including segregation of funds. 29. According to the rules of the exchanges, a broker dealer is required to immediately liquidate, or, if feasible, transfer to another broker-dealer eligible to carry cross-margin accounts, all customer cross-margin accounts that contain positions in futures in the event that the carrying broker-dealer becomes insolvent. 30. In signing the agreement referred to in paragraph 28 above, a customer also acknowledges that a cross-margin account that contains positions in VerDate Aug<31>2005 19:52 Apr 05, 2006 Jkt 208001 futures will be immediately liquidated, or, if feasible, transferred to another broker-dealer eligible to carry crossmargin accounts, in the event that the carrying broker-dealer becomes insolvent. Special Risks of Cross-Margining 31. Cross-margining must be conducted in a portfolio margin account type. Generally, cross-margining and the portfolio margining methodology both contribute to provide greater leverage than a standard margin account, and greater leverage creates greater losses in the event of adverse market movements. 32. Since cross-margining must be conducted in a portfolio margin account type, the time required for meeting a margin deficiency [calls] is shorter than in a standard securities margin account and may be shorter than the time ordinarily required by a futures commission merchant for meeting a margin deficiency [calls] in a futures account. Consequently, there is increased risk that a customer’s crossmargin positions will be liquidated involuntarily, causing possible loss to the customer. 33. As noted above, cross-margin accounts are securities accounts and are subject to the customer protections setforth in Rule 15c3–3 under the Securities Exchange Act of 1934 and the Securities Investor Protection Act. Cross-margin positions are not subject to the customer protection rules under the segregation provisions of the Commodity Exchange Act and the rules of the CFTC adopted pursuant to the Commodity Exchange Act. 34. Trading of index options and futures contracts in a cross-margin account is generally subject to all the risks of trading those same products in a futures account or a standard securities margin account. Customers should be thoroughly familiar with the risk disclosure materials applicable to those products, including the booklet entitled Characteristics and Risks of Standardized Options and the risk disclosure document required by the CFTC to be delivered to futures customers. Because this disclosure statement does not disclose the risks and other significant aspects of trading in futures and options, customers should review those materials carefully before trading in a cross-margin account. 35. Customers should bear in mind that the discrepancies in the cash flow characteristics of futures and certain options are still present even when those products are carried together in a cross margin account. Both futures and options contracts are generally marked PO 00000 Frm 00112 Fmt 4703 Sfmt 4703 17545 to the market at least once each business day, but the marks may take place with different frequency and at different times within the day. When a futures contract is marked to the market, the gain or loss is immediately credited to or debited from the customer’s account in cash. While an increase in the value of a long option contract may increase the equity in the account, the gain is not realized until the option is sold or exercised. Accordingly, a customer may be required to deposit cash in the account in order to meet a variation payment on a futures contract even though the customer is in a hedged position and has experienced a corresponding (but yet unrealized) gain on a long option. Alternatively, a customer who is in a hedged position and would otherwise be entitled to receive a variation payment on a futures contract may find that the cash is required to be held in the account as margin collateral on an offsetting option position. 36. Customers should consult with their tax advisers to be certain that they are familiar with the tax treatment of transactions in these products, including tax consequences of trading strategies involving both futures and option contracts] 37. The descriptions in this disclosure statement relating to eligibility requirements for cross-margining, and minimum equity and margin requirements for cross margin accounts, are minimums imposed under Exchange rules. Time frames within which margin and equity calls must be met are maximums imposed under Exchange rules. The broker-dealer carrying a customer’s portfolio margin account, including any cross-margin account, may impose more stringent requirements.] * * * * * Sample Portfolio Margining [and CrossMargining] Acknowledgement[s] Acknowledgement for Customers Utilizing a Portfolio Margin Account [—Cross-Margining and Non-CrossMargining—] Rule 15c3–3 under the Securities Exchange Act of 1934 requires that a broker or dealer promptly obtain and maintain physical possession or control of all fully-paid securities and excess margin securities of a customer. Fullypaid securities are securities carried in a cash account and margin equity securities carried in a margin or special account (other than a cash account) that have been fully paid for. Excess margin securities are a customer’s margin securities having a market value in E:\FR\FM\06APN1.SGM 06APN1 17546 Federal Register / Vol. 71, No. 66 / Thursday, April 6, 2006 / Notices sroberts on PROD1PC70 with NOTICES excess of 140% of the total of the debit balances in the customer’s non-cash accounts. For the purposes of Rule 15c3–3, securities held subject to a lien to secure obligations of the brokerdealer are not within the broker-dealer’s physical possession or control. The Commission staff has taken the position that all long option positions in a customer’s portfolio margining account [(including any cross-margin account)] may be subject to such a lien by the OCC and will not be deemed fully-paid or excess margin securities under Rule 15c3–3. The hypothecation rules under the Securities Exchange Act of 1934 (Rules 8c–1 and 15c2–1), prohibit brokerdealers from permitting the hypothecation of customer securities in a manner that allows those securities to be subject to any lien or liens in an amount that exceeds the customer’s aggregate indebtedness. However, all long option positions in a portfolio margining account [(including any cross-margining account)] will be subject to the OCC’s lien, including any positions that exceed the customer’s aggregate indebtedness. The Commission staff has taken a position that would allow customers to carry positions in portfolio margining accounts, [(including any crossmargining account)] even when those positions exceed the customer’s aggregate indebtedness. Accordingly, within a portfolio margin account [or cross-margin account], to the extent that you have long option positions that do not operate to offset your aggregate indebtedness and thereby reduce your margin requirement you receive no benefit from carrying those positions in your portfolio margin account [or crossmargin account] and incur the additional risk of the OCC’s lien on your long option position(s). [By signing below the customer affirms that the customer has read and understood the foregoing disclosure statement and acknowledges and agrees that long option positions in portfolio margining accounts, and cross-margining accounts, will be exempted from certain customer protection rules of the Securities and Exchange Commission as described above and will be subject to a lien by the Options Clearing Corporation without regard to such rules. Customer name: ____ By: ____ (Signature/title) Date ____ VerDate Aug<31>2005 19:52 Apr 05, 2006 Jkt 208001 Acknowledgement for Customers Engaged in Cross-Margining As disclosed above, futures contracts and other property carried in customer accounts with Futures Commission Merchants (‘‘FCM’’) are normally subject to special protection afforded under the customer segregation provisions of the Commodity Exchange Act (‘‘CEA’’) and the rules of the Commodity Futures Trading Commission (‘‘CFTC’’) adopted pursuant to the CEA. These rules require that customer funds be segregated from the accounts of financial intermediaries and be accounted for separately. However, they do not provide for, and standard futures accounts do not enjoy the benefit of, insurance protecting customer accounts against loss in the event of the insolvency of the intermediary carrying the accounts.] As discussed above, portfolio [cross-] margining must be conducted in [a portfolio margin] an account[,] dedicated exclusively to portfolio [cross-] margining and portfolio [cross-] margin accounts are not treated as a futures account with an FCM. Instead, portfolio [cross-] margin accounts are treated as securities accounts carried with broker-dealers. As such, portfolio [cross-] margin accounts are covered by Rule 15c3–3 under the Securities Exchange Act of 1934, which protects customer accounts. Rule 15c3–3, among other things, requires a broker-dealer to maintain physical possession or control of all fully-paid and excess margin securities and maintain a special reserve account for the benefit of their customers. However, with regard to portfolio [cross] margin accounts, there is an exception to the possession or control requirement of Rule 15c3–3 that permits [The] the Options Clearing Corporation to have a lien on long positions. This exception is outlined in a separate acknowledgement form that must be signed prior to or concurrent with this form. Additionally, the Securities Investor Protection Corporation (‘‘SIPC’’) insures customer accounts against the financial insolvency of a broker-dealer in the amount of up to $500,000 to protect against the loss of registered securities and cash maintained in the account for purchasing securities or as proceeds from selling securities (although the limit on cash claims is $100,000). According to the rules of the exchanges, a broker-dealer is required to immediately liquidate, or, if feasible, transfer to another broker-dealer eligible to carry portfolio [cross-] margin accounts, all customer portfolio [cross] PO 00000 Frm 00113 Fmt 4703 Sfmt 4703 margin accounts that contain positions in futures and/or options on futures in the event that the carrying broker-dealer becomes insolvent. By signing below the customer affirms that the customer has read and understood the foregoing disclosure statement and acknowledges and agrees that: (1) long option positions in portfolio margining accounts will be exempted from certain customer protection rules of the Securities and Exchange Commission as described above and will be subject to a lien by the Options Clearing Corporation without regard to such rules, and [positions and property in cross-margining accounts, will not be subject to the customer protection rules under the customer segregation provisions of the Commodity Exchange Act and the rules of the Commodity Futures Trading Commission adopted pursuant to the CEA and] (2) portfolio [cross-] margining accounts that contain positions in futures and/or options on futures will be immediately liquidated, or if feasible, transferred to another broker-dealer eligible to carry portfolio [cross-] margin accounts in the event that the carrying broker-dealer becomes insolvent. Customer name: ____ By:____ (Signature/title) Date: ____ 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 Exchange included statements concerning the purpose of, and basis for, the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in Sections A, B, and C below, of the most significant aspects of such statements.11 A. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose Proposed amendments to NYSE Rule 431 would further expand the recently Commission approved and NYSE proposed products that are eligible for 11 The Commission has modified the text of the summaries prepared by the NYSE. Telephone conversation between William Jannace, Director— Rule & Interpretive Standards, Member Firm Regulation, NYSE and Randall Roy, Branch Chief, and Sheila Swartz, Special Counsel, Division of Market Regulations, Commission, on March 29, 2006. E:\FR\FM\06APN1.SGM 06APN1 Federal Register / Vol. 71, No. 66 / Thursday, April 6, 2006 / Notices treatment under portfolio margin requirements to include: All margin eligible securities,12 listed options, OTC derivatives, and U.S. security futures provided certain requirements are met. Amendments to Rule 726 are also proposed to include the Commission approved products on the disclosure document required to be furnished to options customers pursuant to this rule. a. Background Section 7(a) 13 of the Exchange Act 14 empowers the Board of Governors of the Federal Reserve System to prescribe the rules and regulations regarding credit that may be extended by broker-dealers on securities (Regulation T) to their customers. NYSE Rule 431 prescribes specific margin requirements that must be maintained in all customers accounts, based on the type of securities products held in such accounts. In April 1996, the Exchange established a Rule 431 Committee (the ‘‘Committee’’) to assess the adequacy of Rule 431 on an ongoing basis, review margin requirements, and make recommendations for change. The Committee has endorsed the proposed amendments discussed below.15 sroberts on PROD1PC70 with NOTICES b. The Pilot The Board of Governors of the Federal Reserve System in its amendments to Regulation T in 1998 permitted SROs to implement portfolio margin rules, subject to Commission approval.16 As noted above, on July 14, 2005 the Commission approved amendments to Exchange Rules 431 and 726 to permit, on a two-year pilot basis, the use of a prescribed risk-based methodology (‘‘portfolio margin’’) 17 for certain 12 The term all ‘‘margin eligible security’’ utilizes the definition at Section 220.2 of Regulation T of the Board of Governors of the Federal Reserve System. 13 15 U.S.C. 78g. 14 15 U.S.C. 78a et seq. 15 The Committee is currently composed of several member organizations, including Goldman, Sachs & Co., Morgan Stanley & Co., Inc., Merrill Lynch, Pierce, Fenner and Smith, Inc., Bear Stearns Corp, Credit Suisse First Boston Corp, and several self-regulatory organizations (‘‘SROs’’) including: the NYSE, the Chicago Board Options Exchange (‘‘CBOE’’), NASD as well as representatives from the Securities Industry Association’s Ad Hoc Committee on Portfolio Margining. 16 See Federal Reserve System, ‘‘Securities Credit Transactions; Borrowing by Broker and Dealers’’; Regulations G, T, U and X; Docket Nos. R–0905, R– 0923 and R–0944, 63 FR 2806 (January 16, 1998). 17 As a pre-condition to permitting portfolio margining, member organization are required to establish procedures and guidelines to monitor credit risk to the member organization’s capital, including intra-day credit risk and stress testing of portfolio margin accounts. Further, member organizations must establish procedures for regular review and testing of these required risk analysis procedures (see Rule 431(g)(1)). VerDate Aug<31>2005 20:35 Apr 05, 2006 Jkt 208001 products, as an alternative to the strategy or position based margin requirements 18 currently required in Rule 431(a) through (f). Exchange member organizations may utilize portfolio margin for listed, broad-based U.S. index options and index warrants, along with any underlying instruments.19 These positions are to be margined (either for initial or maintenance) in a separate portfolio margin account dedicated exclusively for such margin computation. In addition, as noted above, the Exchange on December 29, 2005, filed with the Commission amendments to Rule 431 which would expand the approved products for certain customers that are eligible for treatment under portfolio margin requirements to include security futures and single stock options.20 The filing was noticed for comment in the Federal Register on January 23, 2006 21 and resulted in the Commission receiving three comment letters.22 c. Portfolio Margin Requirements Portfolio margining is a margin methodology that sets margin requirements for an account based on the greatest projected net loss of all 18 Prior to the Pilot, member organizations were solely subject, pursuant to NYSE Rule 431, to strategy or positioned-based margin requirements. This methodology applied specific margin percentage requirements as prescribed in Rule 431 to each security position and/or strategy, either long or short, held in customer’s account, irrespective of the fact that all security (e.g., options) prices do not change equally (in percentage terms) with a change in the price of the underlying security. When utilizing a portfolio margin methodology, offsets are fully realized, whereas under strategy or positionbased methodology, positions and or groups of positions comprising a single strategy are margined independently of each other and offsets between them do not efficiently impact the total margin requirement. 19 For purposes of the Pilot and SR–NYSE–2005– 93, the term ‘‘underlying instrument,’’ means long and short positions in an exchange traded fund or other fund product registered under the Investment Company Act of 1940, that holds the same securities, and in the same proportion, as contained in a broad-based index on which options are listed. The term ‘‘underlying instrument’’ shall not be deemed to include futures contracts, options on futures contracts, underlying stock baskets, or unlisted instruments. 20 Commission Chairman Christopher Cox, in a letter dated September 27, 2005 to William J. Brodsky and John A. Thain, the Chief Executive Officers of CBOE and NYSE, respectively, encouraged each SRO to file a rule proposal to expand portfolio margining to a broader universe of products. 21 See supra note 3. 22 Comment letters were received from: (1) The Futures Industry Associations; (2) the Securities Industry Association; and (3) Citigroup Global Markets Inc. The Exchange will be filing a separate response to comments with the Commission. Some of the major comments, however, have been addressed by the amendments the Exchange is proposing herein. PO 00000 Frm 00114 Fmt 4703 Sfmt 4703 17547 positions in a product class or group. The Pilot utilizes a Commission approved theoretical options pricing model using multiple pricing scenarios to set or determine the risk level.23 These scenarios are designed to measure the theoretical loss of the positions given changes in both the underlying price and implied volatility inputs to the model. Accordingly, the margin required is based on the greatest loss that would be incurred in a portfolio if the value of its components move up or down by a predetermined amount. In permitting a margin computation based on actual net risk, member organizations are no longer required to compute a margin requirement for each individual position or strategy in a customer’s account.24 As discussed in more detail below, utilizing portfolio margin for the above noted products and any underlying instruments enables the portfolio to be subjected to certain preset market volatility parameters that reflect historical moves in the underlying security thereby assessing potential loss in the portfolio in the aggregate. Accordingly, such a methodology provides an accurate and realistic assessment of reasonable margin requirements. d. Proposed Amendments Eligible Products The proposed amendments to Rule 431 seek to expand the scope of eligible products 25 previously approved, provided all such products can be priced within a prescribed risk-based theoretical pricing methodology that has been approved by the Exchange and submitted to the Commission. Specifically, the proposed amendments noted above will expand the eligible products to further include all margin eligible securities, listed options, OTC 23 The theoretical options pricing model is used to derive position values at each valuation point for the purpose of determining the gain or loss. For purposes of the Pilot and SR–NYSE–2005–93 the amount of initial and maintenance margin required with respect to a portfolio was the larger of: (1) The greatest loss amount among the valuation calculations; or (2) the sum of $.375 for each option and security future in the portfolio multiplied by the contract’s (e.g., 100 shares per contract) or instrument’s multiplier. 24 See NYSE Rule 431. 25 Under the current Pilot, eligible products consist of listed broad-based U.S. index options, index warrants along with any underlying instruments. On December 29, 2005, the Exchange filed with the Commission amendments to Rule 431, which would expand the approved products that are eligible for treatment under portfolio margin requirements to include security futures and single stock options. See SR–NYSE–2005–93. E:\FR\FM\06APN1.SGM 06APN1 17548 Federal Register / Vol. 71, No. 66 / Thursday, April 6, 2006 / Notices derivatives and U.S. security futures, provided certain requirements are met. Risk Analysis Methodology Rule 431(g)(1) requires member organizations to monitor the risk of portfolio margin accounts and maintain a written risk analysis methodology for assessing potential risk to the firm’s capital. Such methodology must specify the computations to be made, the frequency of the computations, the records to be reviewed and maintained and the person responsible for such risk function. Under the approved pilot, this risk analysis methodology shall be made available to the Exchange upon request. As proposed, the risk analysis methodology must now be comprehensive, approved by the Exchange and submitted to the Commission prior to implementation. Minimum Equity Requirements The proposed amendments also will permit eligible participants (as defined in proposed Rule 431(g)(4)) effecting transactions in eligible products to do so without maintaining $5.0 million in equity, which is currently required for eligible products under the Pilot.26 As proposed, however, eligible participants may not establish or maintain positions in OTC derivatives unless equity of at least $5.0 million is established and maintained in a portfolio margin account. sroberts on PROD1PC70 with NOTICES Portfolio Margin Minimum Equity Deficiency Proposed Rule 431(g)(9)(A) provides that in the event the equity of an eligible participant, subject to the $5.0 million equity requirement, declines below such minimum requirement, it must be restored within three business days and prohibits member organizations from accepting new orders beginning on the fourth business day, except for new orders effected solely for the purpose of hedging existing positions and lowering margin requirements. 26 Under the approved pilot, eligible participants are any broker-dealer registered pursuant to Section 15 of the Exchange Act, any member of a national futures exchange to the extent that listed index options hedge the member’s index futures, and any other person or entity not included above that has or establishes, and maintains, equity of at least $5.0 million dollars. In SY–NYSE–2005–93, the Exchange proposed amendments that would permit customers effecting transactions in listed security futures and listed single stock options to do so without maintaining the $5.0 million equity requirement, which is currently required under the Pilot for all other eligible products. However, as proposed herein, only customer transactions in OTC derivatives (including forwards and swaps) with require an minimum equity $5 million dollars. For transactions in all other eligible products (including all listed products), this minimum requirements would not apply. VerDate Aug<31>2005 19:52 Apr 05, 2006 Jkt 208001 Valuation Points The Pilot established ten equidistant valuation points for the following eligible products: Non-High Capitalization/Broad-based U.S. Market Index Options (+/¥10%) and High Capitalization/Broad-based U.S. Market Index Option (+6%/¥8%). In SR– NYSE–2005–93, the Exchange proposed amendments that would establish theoretical valuation points within a range consisting of an increase or a decrease of +/¥15% (i.e., +/¥3%, 6%, 9%, 12%, and 15%) for security futures and single stock options. Similarly, the proposed amendments also would establish theoretical valuation points of +/¥15% for margin eligible securities, listed equity options, listed narrowbased index options, and OTC derivatives (including forward contracts and swaps). Cross-Margin Account The proposed amendments will remove the provisions approved in the Pilot pertaining to the use of a crossmargin account for margining eligible securities products with eligible commodity products. Under the proposed rule change, a single portfolio margin account would be used for margining all eligible products. Maintaining and monitoring two separate accounts for a customer’s trading activities would be operationally difficult for both broker-dealers and customers. In this regard, the SIA and FIA comment letters received to the Exchange’s recent portfolio margin filing,27 stated that the industry has legal, regulatory and operational concerns regarding the maintenance of a separate cross margin account for customers who maintain both securities and commodity positions.28 Both the SIA and the FIA urged the Commission to work with the CFTC, the exchanges and the clearing corporations to resolve the legal and regulatory issues that may create a barrier to comprehensive crossmargining at both the broker-dealer and clearing organization level.29 27 See supra note 3. letter from Gerard J. Quinn, Vice President and Associate General Counsel, Securities Industry Association, to Nancy M. Morris, Secretary, Commission, dated February 13, 2006 (‘‘SIA Letter’’); letter from Barbara Wierzynski, Executive Vice President and General Counsel, Futures Industry Association, to Nancy M. Morris, Secretary, Commission, dated February 13, 2006 (‘‘FIA Letter’’); and letter from Severino Renna, Director, Citigroup Global Markets, Inc., to Nancy M. Morris, Secretary, dated February 13, 2006 (‘‘Citigroup Letter’’). 29 Id. 28 See PO 00000 Frm 00115 Fmt 4703 Sfmt 4703 Definitions The proposed amendments change the definition of ‘‘underlying instrument’’ to mean a security or security index upon which any listed option, OTC derivative, U.S. security future, or broad-based U.S. Index future is based. In addition the term ‘‘related instrument’’ (as approved in the Pilot) is being changed to mean broad-based U.S. index futures, and options on broadbased index futures covering the same underlying instrument. In addition, a new definition of ‘‘OTC derivative’’ was added to the proposed rule change to include any equity-based or equity index-based unlisted option, forward contract or swap that can be valued by a theoretical pricing model approved by the Exchange and submitted to the Commission. Disclosure Document and Customer Attestation Exchange Rule 726 prescribes requirements for the delivery of options disclosure documents concerning the opening of customer accounts. As part of the Pilot, members and member organizations are required to provide every portfolio margin customer with a written risk disclosure statement 30 at or prior to the initial opening of a portfolio margin account. In addition, at or prior to the time a portfolio margin account is initially opened, members and member organizations are required to obtain a signed acknowledgement regarding certain implications of portfolio margining (e.g. treatment under Exchange Act Rules 15c2–1 and 15c3– 3) from the customer. As proposed, the disclosure document required by Rule 726 is being amended to incorporate the expanded list of eligible products. Finally, the filing includes several minor technical amendments to the rules for purposes of clarity and consistency. 2. Statutory Basis The statutory basis for this proposed rule change is Section 6(b)(5) 31 of the Exchange Act which requires, among other things, that the rules of the Exchange are designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation 30 The disclosure statement discloses the special risk and operation of portfolio margin accounts, and the differences between portfolio margin and strategy-based margin requirements. The disclosure statement also addresses who is eligible to open a portfolio margin account, the instruments that are allowed, and when deposits to meet margin and minimum equity are required. 31 15 U.S.C. 78f(b)(5). E:\FR\FM\06APN1.SGM 06APN1 Federal Register / Vol. 71, No. 66 / Thursday, April 6, 2006 / Notices and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, to remove impediments to perfect the mechanism of a free and open market and national market system, and in general to protect investors and the public interest. The proposed amendments are consistent with this section in that they will better align margin requirements with the actual risk of hedged products, will also potentially alleviate excess margin calls and potentially reduce the risk of forced liquidations of positions in customer accounts. B. Self-Regulatory Organization’s Statement on Burden on Competition The Exchange does not believe that the proposed rule change will impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Exchange 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 such proposed rule change; or (B) Institute proceedings to determine whether the proposed rule change should be disapproved. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–NYSE–2006–13. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (https://www.sec.gov/ rules/sro/shtml). 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 also will be available for inspection and copying at the principal office of the NYSE. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submission should refer to File Number SR–NYSE–2006–13 and should be submitted on or before April 27, 2006. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.32 Nancy M. Morris, Secretary. [FR Doc. E6–5019 Filed 4–5–06; 8:45 am] BILLING CODE 8010–01–P IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Exchange Act. Comments may be submitted by any of the following methods: sroberts on PROD1PC70 with NOTICES Electronic Comments • Use the Commission’s Internet comment form (https://www.sec.gov/ rules/sro.shtml); or • Send e-mail to rulecomments@sec.gov. Please include File Number SR–NYSE–2006–13 on the subject line. VerDate Aug<31>2005 19:52 Apr 05, 2006 Jkt 208001 SMALL BUSINESS ADMINISTRATION Interest Rates The Small Business Administration publishes an interest rate called the optional ‘‘peg’’ rate (13 CFR 120.214) on a quarterly basis. This rate is a weighted average cost of money to the government for maturities similar to the average SBA direct loan. This rate may be used as a base rate for guaranteed fluctuating interest rate SBA loans. This 32 17 PO 00000 CFR 200.30–3(a)(12). Frm 00116 Fmt 4703 Sfmt 4703 17549 rate will be 4.500 (41⁄2) percent for the April–June quarter of FY 2006. James E. Rivera, Associate Administrator for Financial Assistance. [FR Doc. E6–5022 Filed 4–5–06; 8:45 am] BILLING CODE 8025–01–P SOCIAL SECURITY ADMINISTRATION Agency Information Collection Activities: Proposed Request and Comment Request The Social Security Administration (SSA) publishes a list of information collection packages that will require clearance by the Office of Management and Budget (OMB) in compliance with Public Law 104–13, the Paperwork Reduction Act of 1995, effective October 1, 1995. The information collection packages that may be included in this notice are for new information collections, approval of existing information collections, revisions to OMB-approved information collections, and extensions (no change) of OMBapproved information collections. SSA is soliciting comments on the accuracy of the agency’s burden estimate; the need for the information; its practical utility; ways to enhance its quality, utility, and clarity; and on ways to minimize burden on respondents, including the use of automated collection techniques or other forms of information technology. Written comments and recommendations regarding the information collection(s) should be submitted to the OMB Desk Officer and the SSA Reports Clearance Officer. The information can be mailed and/or faxed to the individuals at the addresses and fax numbers listed below: (OMB), Office of Management and Budget, Attn: Desk Officer for SSA, Fax: 202–395–6974.(SSA), Social Security Administration, DCFAM, Attn: Reports Clearance Officer, 1333 Annex Building, 6401 Security Blvd., Baltimore, MD 21235, Fax: 410–965–6400. I. The information collections listed below are pending at SSA and will be submitted to OMB within 60 days from the date of this notice. Therefore, your comments should be submitted to SSA within 60 days from the date of this publication. You can obtain copies of the collection instruments by calling the SSA Reports Clearance Officer at 410– 965–0454 or by writing to the address listed above. 1. Application for Special Age 72-orOver Monthly Payments—20 CFR 404.380–404.384—0960–0096. Form SSA–19–F6 collects the information E:\FR\FM\06APN1.SGM 06APN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 71, Number 66 (Thursday, April 6, 2006)]
[Notices]
[Pages 17539-17549]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E6-5019]



[[Page 17539]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53577; File No. SR-NYSE-2006-13]


Self-Regulatory Organizations; New York Stock Exchange LLC; 
Notice of Filing of Proposed Rule Change to Rule 431 (``Margin 
Requirements'') and Rule 726 (``Delivery of Options Disclosure Document 
and Prospectus'') To Expand the Products Eligible for Customer 
Portfolio Margining and Cross-Margining and Eliminate Separate Cross-
Margin Accounts

March 30, 2006.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act''), \1\ and Rule 19b-4 thereunder,\2\ notice is hereby 
given that on March 2, 2006, the New York Stock Exchange LLC (``NYSE'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``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.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The NYSE is filing with the Commission proposed amendments to NYSE 
Rule 431 (``Margin Requirements'') that would further expand the scope 
of products that are eligible for treatment as part of the Commission 
approved Portfolio Margin Pilot Program \3\ (``Pilot'') and eliminate 
the requirement for a separate cross-margin account for margining 
eligible security products with eligible commodity products. Amendments 
to Rule 726 (``Delivery of Options Disclosure Document and 
Prospectus'') also are proposed to include the Commission approved 
products on the disclosure document required to be furnished to 
customers pursuant to this rule. The text of the proposed rule change 
is below. Additions are in italics. Deletions are in brackets.
---------------------------------------------------------------------------

    \3\ See Exchange Act Release No. 52031 (July 14, 2005), 70 FR 
42130 (July 21, 2005) (SR-NYSE-2002-19). On July 14, 2005, the 
Commission approved on a pilot basis expiring July 31, 2007, 
amendments to Exchange Rule 431 to permit the use of a prescribed 
risk-based margin requirement (``portfolio margin''), for certain 
specified products (e.g., listed, broad-based U.S. index options and 
warrants, along with any underlying instruments), as an alternative 
to the strategy based margin requirements currently required by Rule 
431. Amendments to Rule 726 were also approved to require disclosure 
to, and written acknowledgment from, customers in connection with 
the use of portfolio margin. See NYSE Information Memo 05-56 for 
additional information; see also SR-NYSE-2005-93 in which the 
Exchange filed with the Commission amendments to Rule 431 which 
would expand the approved products for certain customers that are 
eligible for treatment under portfolio margin requirements to 
include U.S. security futures and single stock options. See Exchange 
Act Release No. 53126 (Jan.13, 2006), 71 FR 3586 (Jan. 23, 2006) 
(SR-NYSE-2005-93).
---------------------------------------------------------------------------

* * * * *
Margin Requirements
    Rule 431. (a) through (f) unchanged.

Portfolio Margin [and Cross-Margin]

    (g) As an alternative to the ``strategy'' based margin requirements 
set forth in sections (a) through (f) of this Rule, member 
organizations may elect to apply the portfolio margin requirements set 
forth in this section (g) to [1) listed, broad-based U.S. index 
options, index warrants and underlying instruments and 2) listed 
security futures contracts and listed single stock options] all margin 
eligible securities \4\, listed options, OTC derivatives, and U.S. 
security futures \5\, provided certain requirements are met. (See 
section (g)(6)(C)(1))
---------------------------------------------------------------------------

    \4\ For purposes of this section (g) of the Rule, the term 
``margin eligible security'' utilizes the definition at section 
220.2 of Regulation T of the Board of Governors of the Federal 
Reserve System, excluding a nonequity security.
    \5\ For purposes of this section (g) of the Rule, the term 
``security future'' utilizes the definition at section 3(a)(55) of 
the Exchange Act. [, excluding narrow-based indices.]
---------------------------------------------------------------------------

    In addition, member organizations, provided they are a Futures 
Commission Merchant (``FCM'') and are either a clearing member of a 
futures clearing organization or have an affiliate that is a clearing 
member of a futures clearing organization, are permitted under this 
section (g) to combine an eligible participant's related instruments as 
defined in section (g)(2)(D) [(C)], with listed, [broad-based] U.S. 
index options, options on exchange traded funds (``ETF''), index 
warrants and underlying instruments and compute a margin requirement 
for such combined products on a portfolio margin basis. [(''cross-
margin''). Member organizations must confine cross-margin positions to 
a portfolio margin account dedicated exclusively to cross-margining.]
    The portfolio margin [and cross-margining] provisions of this Rule 
shall not apply to Individual Retirement Accounts (``IRAs'').
    (1) Member organizations must monitor the risk of portfolio margin 
accounts and maintain a comprehensive written risk analysis methodology 
for assessing the potential risk to the member organization's capital 
over a specified range of possible market movements of positions 
maintained in such accounts. The risk analysis methodology shall 
specify the computations to be made, the frequency of computations, the 
records to be reviewed and maintained, and the person(s) within the 
organization responsible for the risk function. This risk analysis 
methodology [shall be made available to] must be approved by the New 
York Stock Exchange (``Exchange'') [upon request.] and submitted to the 
Securities and Exchange Commission (``SEC'') prior to the 
implementation of portfolio margining. In performing the risk analysis 
of portfolio margin accounts required by this Rule, each member 
organization shall include [the following] in the written risk analysis 
methodology procedures and guidelines for:
    (A) obtaining and reviewing the appropriate account documentation 
and financial information necessary for assessing the amount of credit 
to be extended to eligible participants.
    (B) [(A) Procedures and guidelines for] the determination, review 
and approval of credit limits to each eligible participant, and across 
all eligible participants, utilizing a portfolio margin account[.],
    (C) [(B) Procedures and guidelines for] monitoring credit risk 
exposure to the member organization from portfolio margin accounts, on 
both an [including] intra-day and end of day basis [credit risk], 
including the type, scope and frequency of reporting to senior 
management [related to portfolio margin accounts.],
    (D) [(C) Procedures and guidelines for] the use of stress testing 
of portfolio margin accounts in order to monitor market risk exposure 
from individual accounts and in the aggregate[.],
    (E) [(D) Procedures providing for] the regular review and testing 
of these risk analysis procedures by an independent unit such as 
internal audit or other comparable group[.],
    (F) Managing the impact of credit extension related to portfolio 
margin accounts on the member organization's overall risk exposure,
    (G) The appropriate response by management when limits on credit 
extensions related to portfolio margin accounts have been exceeded, and
    (H) Determining the need to collect additional margin from a 
particular eligible participant, including whether that determination 
was based upon the

[[Page 17540]]

creditworthiness of the participant and/or the risk of the eligible 
product.
    Moreover, management must periodically review, in accordance with 
written procedures, the member organization's credit extension 
activities for consistency with these guidelines. Management must 
periodically determine if the data necessary to apply this section (g) 
is accessible on a timely basis and information systems are available 
to adequately capture, monitor, analyze and report relevant data.
    (2) Definitions.--For purposes of this section (g), the following 
terms shall have the meanings specified below:
    (A) The term ``listed option'' means any option traded on a 
registered national securities exchange or automated facility of a 
registered national securities association.
    (B) The term ``OTC derivative'' means any equity-based or equity 
index-based unlisted option, forward contract, or security-based swap 
that can be valued by a theoretical pricing model approved by the 
Exchange and submitted to the SEC.
    (C) [(B)] The term ``underlying instrument'' means a security or 
security index upon which any listed option, OTC derivative, U.S. 
security future, or broad-based U.S index future is based. [long and 
short positions in an exchange traded fund or other fund product 
registered under the Investment Company Act of 1940, that holds the 
same securities, and in the same proportion, as contained in a broad-
based index on which options are listed. In the case of a listed 
security futures contract, ``underlying instrument'' means listed 
single stock option on the same security and in the same proportion. 
The term ``underlying instrument'' shall not be deemed to include 
options on futures contracts, or unlisted instruments.]
    (D) [(C)] The term ``related instrument'' within a security [an 
option] class or product group means broad-based U.S. index futures 
[contracts] and options on broad-based U.S index futures [contracts] 
covering the same underlying instrument. The term ``related 
instrument'' does not include security futures or options on security 
futures.
    (E) [(D)] The term ``security [options] class'' refers to all 
securities [options] covering the same underlying instrument.
    (F) [(E)] The term ``portfolio'' means any eligible product, as 
defined in section (g)(6)(C)(1), grouped with their underlying 
instruments and related instruments.
    [(F) The term ``option series'' relates to listed options and means 
all option contracts of the same type (either a call or a put) and 
exercise style, covering the same underlying instrument with the same 
exercise price, expiration date, and number of underlying units.]
    (G) The term ``product group'' means two or more portfolios of the 
same type (see table in section (g)(2)(I) below) for which it has been 
determined by Rule 15c3-1a under the Securities Exchange Act of 1934 
(``Exchange Act'') that a percentage of offsetting profits may be 
applied to losses at the same valuation point.
    (H) For purposes of portfolio margin [and cross-margin] 
requirements the term ``equity'', as defined in section (a)(4) of this 
Rule, includes the market value of any long or short [option] positions 
held in an eligible participant's [a customer's] account.
    (I) The term ``theoretical gains and losses'' means the gain and 
loss in the value of individual eligible products and related 
instruments at ten [10] equidistant intervals (valuation points) 
ranging from an assumed movement (both up and down) in the current 
market value of the underlying instrument. The magnitude of the 
valuation point range shall be as follows:

------------------------------------------------------------------------
                                              Up/down market move  (high
               Portfolio type                  & low valuation points)
------------------------------------------------------------------------
High Capitalization Broad-based U.S. Market  +6%-8%
 Index [Option] \6\.
Non-High Capitalization, Broad-based U.S.    +/-10%
 Market Index [Option] \7\.
Margin Eligible Security,Listed Equity       +/-15%
 Option, Listed Narrow-based Index Option,
 [Listed] U.S. Security Future, and OTC
 Derivative [Instrument] (Including forward
 contracts and swaps) [Listed Security
 Futures Contract and Listed Single Stock
 Option].
------------------------------------------------------------------------

    (3) Approved Theoretical Pricing Models.--Theoretical pricing 
models must be approved by the Exchange [a Designated Examining 
Authority] and submitted to [reviewed by] the SEC [Securities and 
Exchange Commission (``The Commission'')] in order to qualify.\8\ 
[Currently, the theoretical model utilized by the Options Clearing 
Corporation (``The OCC'') is the only model qualified pursuant to the 
Commission's Net Capital Rule. All member organizations shall obtain 
their theoretical values from the OCC.]
---------------------------------------------------------------------------

    \6\ In accordance with section (b)(1)(i)(B) of Rule 15c3-1a 
(Appendix A to Rule 15c3-1) under the Securities Exchange Act of 
1934, 17 CFR 240.15c3-1a(b)(1)(i)(B).
    \7\ See footnote above.
    \8\ Currently, the theoretical model utilized by the Options 
Clearing Corporation (``OCC'') is the only model qualified.
---------------------------------------------------------------------------

    (4) Eligible Participants.--The application of the portfolio margin 
provisions of this section (g)[, including cross-margining, is limited 
to] include the following:
    (A) Any broker or dealer registered pursuant to Section 15 of the 
[Securities] Exchange Act; [of 1934;]
    (B) Any member of a national futures exchange to the extent that 
listed index options hedge the member's index futures; and
    (C) Any person or entity not included in sections (g)(4)(A) and 
(g)(4)(B) above approved for options or U.S. security futures 
transactions. However, an eligible participant under this section 
(g)(4)(C) may not establish or maintain positions in OTC derivatives 
unless minimum equity of at least five million dollars is established 
and maintained with the member organization. [any other person or 
entity not included in sections (g)(4)(A) and (g)(4)(B) above that has 
or establishes, and maintains, equity of at least five million 
dollars.] For purposes of this minimum equity requirement, all 
securities and futures accounts carried by the member organization for 
the same eligible participant may be combined provided ownership across 
the accounts is identical. A guarantee pursuant to section (f)(4) of 
this Rule is not permitted for purposes of the minimum equity 
requirement. [For those accounts that are solely limited to listed 
security futures contracts and listed single stock options, the five 
million dollar equity requirement shall be waived.]
    (5) Opening of Accounts.
    (A) Member organizations must notify and receive approval from the 
Exchange prior to establishing a portfolio margin

[[Page 17541]]

[or cross-margin] methodology for eligible participants.
    (B) Only eligible participants that have been [approved for options 
transactions and] approved to engage in uncovered short option 
contracts pursuant to Exchange Rule 721, are permitted to utilize a 
portfolio margin account.
    (C) On or before the date of the initial transaction in a portfolio 
margin account, a member organization shall:
    (1) Furnish the eligible participant with a special written 
disclosure statement describing the nature and risks of portfolio 
margining [and cross-margining] which includes an acknowledgement for 
all portfolio margin account owners to sign, [and an additional 
acknowledgement for owners that also engage in cross-margining to 
sign,] attesting that they have read and understood the disclosure 
statement, and agree to the terms under which a portfolio margin 
account [and the cross-margin account respectively, are] is provided 
(see Exchange Rule 726 (d)), and
    (2) Obtain the signed acknowledgement[(s)] noted above from the 
eligible participant [(both of which are required for cross-margining 
eligible participants)] and record the date of receipt.
    (6) Establishing Account and Eligible Positions
    (A) [Portfolio Margin Account.] For purposes of applying the 
portfolio margin requirements prescribed in this section (g), and 
combining related instruments with listed, U.S. index options, options 
on exchange traded funds (``ETF''), index warrants, and underlying 
instruments, member organizations are to establish and utilize a 
specific securities margin account, or sub-account of a margin account, 
clearly identified as a portfolio margin account that is separate from 
any other securities account carried for an eligible participant.
    [(B) Cross-Margin Account. For purposes of combining related 
instruments with listed, broad-based U.S. index options, index 
warrants, and underlying instruments, and applying the portfolio margin 
requirements, member organizations are to establish a cross-margin 
account that is separate from any other securities account or portfolio 
margin account carried for an eligible participant.]
    A margin deficit in [either] the portfolio margin account [or the 
cross-margin account] of an eligible participant may not be considered 
as satisfied by excess equity in [the other] another account. Funds 
and/or securities must be transferred to the deficient account and a 
written record created and maintained.
(B) [(C)] [Portfolio Margin Account--] Eligible Products
    (1) For eligible participants as described in sections (g)(4)(A) 
through (g)(4)(C), a transaction in, or transfer of, an eligible 
product may be effected in the portfolio margin account. Eligible 
products under this section (g) consist of:
    [(i) A listed, broad-based U.S. index option or index warrant and 
underlying instrument.
    (ii) A listed security futures contract or listed single stock 
option.]
    (i) A margin eligible security, a listed option, a security future, 
an option on a security future, or OTC derivative.
    (ii) A foreign equity security and option on a foreign equity 
security, provided the foreign equity security is deemed to have a 
``ready market'' under SEC Rule 15c3-1 or a ``no-action'' position 
issued thereunder.
    (iii) A margin eligible control or restricted security, provided 
the security has met the requirements in a manner consistent with SEC 
Rule 144 or an SEC ``no-action'' position issued thereunder, sufficient 
enough to permit the sale of the security, upon exercise of any listed 
option or OTC derivative written against it, without restriction.
    (iv) related instruments as defined in section (2)(D)
    [(2) A transaction in, or transfer of, an underlying instrument may 
be effected in the portfolio margin account provided a position in an 
offsetting eligible product is in the account or is established in the 
account on the same day.
    (3) A transaction in, or transfer of, a listed security futures 
contract or listed single stock option may also be effected in the 
portfolio margin account.]
    (2) [(4)] For eligible participants as described in section 
(g)(4)(C) that do not maintain five million dollars in equity, any 
[Any] long position or any short position in any OTC derivative 
[eligible product] that is no longer part of a hedge strategy must be 
transferred from the portfolio margin account to the appropriate 
securities account within ten business days, subject to any applicable 
margin requirement, unless the position becomes part of a hedge 
strategy again. Member organizations will be expected to monitor 
portfolio margin accounts for possible abuse of this provision.
[(D) Cross-Margin Account--Eligible Products
    (1) For eligible participants as described in sections (g)(4)(A) 
through (g)(4)(C), a transaction in, or transfer of, an eligible 
product may be effected in the cross-margin account.
    (2) A transaction in, or transfer of, a related instrument may be 
effected in the cross-margin account provided a position in an 
offsetting eligible product is in the account or is established in the 
account on the same day.
    (3) Any long position or any short position in any eligible product 
that is no longer part of a hedge strategy must be transferred from the 
cross-margin account to the appropriate securities account or futures 
account within ten business days, subject to any applicable margin 
requirement, unless the position becomes part of a hedge strategy 
again. Member organizations will be expected to monitor cross-margin 
accounts for possible abuse of this provision.]
    (7) [Initial and Maintenance] Margin Required.--The amount of 
margin required under this section (g) for each portfolio shall be the 
greater of:
    (A) the amount for any of the ten \10\ equidistant valuation points 
representing the largest theoretical loss as calculated pursuant to 
section (g)(8) below, or
    (B) for eligible participants as described in section (g)(4)(A) 
through (g)(4)(C), $.375 for each listed option, OTC derivative, U.S. 
security future, [contract] and related instrument, multiplied by the 
contract's or instrument's multiplier, not to exceed the market value 
in the case of long contracts [positions] in eligible products.
    (C) Account guarantees pursuant to section (f)(4) of this Rule are 
not permitted for purposes of meeting [initial and maintenance] margin 
requirements.
(8) Method of Calculation
    (A) Long and short contracts, including underlying instruments and 
related instruments, are to be grouped by security class; each security 
class group being [as] a ``portfolio''. Each portfolio is categorized 
as one of the portfolio types specified in section (g)(2)(I) above.
    (B) For each portfolio, theoretical gains and losses are calculated 
for each position as specified in section (g)(2)(I) above. For purposes 
of determining the theoretical gains and losses at each valuation 
point, member organizations shall obtain and utilize the theoretical 
values of eligible products as described in this section (g) rendered 
by an approved theoretical pricing model.
    (C) Offsets. Within each portfolio, theoretical gains and losses 
may be netted fully at each valuation point. Offsets between portfolios 
within the

[[Page 17542]]

eligible product groups, as described in section (g)(2)(I), may then be 
applied as permitted by Rule 15c3-1a under the [Securities] Exchange 
Act [of 1934].
    (D) After applying the offsets above, the sum of the greatest loss 
from each portfolio is computed to arrive at the total margin required 
for the account (subject to the per contract minimum).
(9) Portfolio Margin Minimum Equity Deficiency [Call]
    (A) If, as of the close of business, [at any time,] the equity in 
the portfolio margin [or cross-margin] account of an eligible 
participant as described in section (g)(4)(C), declines below the five 
million dollar minimum equity required, and is not restored to at least 
five million dollars within three business days [(T+3)] by a deposit of 
funds and/or securities, member organizations are prohibited from 
accepting [opening] new orders beginning on the fourth business day, 
[starting on T+4,] except that [opening] new orders entered for the 
purpose of hedging existing positions may be accepted if the result 
would be to lower margin requirements. This prohibition shall remain in 
effect until,
    (1) Equity of five million dollars is established[.] or,
    (2) any OTC derivative is liquidated or transferred from the 
portfolio margin account to the appropriate securities account. [For 
those accounts that are solely limited to security futures contracts 
and single stock options, the five million dollar equity requirement 
shall be waived.]
    (B) Member organizations will not be permitted to deduct any 
portfolio margin minimum equity deficiency [call] amount from Net 
Capital in lieu of collecting the minimum equity required.
(10) Portfolio Margin [Maintenance] Deficiency [Call]
    (A) If, as of the close of business, [at any time,] the equity in 
the portfolio margin [or cross-margin] account of an eligible 
participant, as described in section (g)(4)(A) through (g)(4)(C), is 
less than the margin required, the eligible participant may deposit 
additional margin or establish a hedge to meet the margin requirement 
within three business days [(T+3)]. After [During] the three business 
day period, member organizations are prohibited from accepting 
[opening] new orders, except that [opening] new orders entered for the 
purpose of hedging existing positions may be accepted if the result 
would be to lower margin requirements. In the event an eligible 
participant fails to hedge existing positions or deposit additional 
margin in an amount sufficient to eliminate any margin deficiency after 
[within] three business days, the member organization must liquidate 
positions in an amount sufficient to, at a minimum, lower the total 
margin required to an amount less than or equal to the account equity.
    (B) If the portfolio margin [maintenance] deficiency [call] is not 
met by the close of business on the next business day after the 
business day on which such deficiency arises, [T+1,] member 
organizations will be required to deduct the amount of the deficiency 
from Net Capital [the amount of the call] until such time the 
deficiency [call] is satisfied.
    (C) Member organizations will not be permitted to deduct any 
portfolio margin [maintenance] deficiency [call] amount from Net 
Capital in lieu of collecting the margin required.
    (D) The Exchange may grant additional time for an eligible 
participant to meet a portfolio margin deficiency upon written request, 
which is expected to be granted in unique circumstances only.
    (E) Member organizations should not permit an eligible participant 
to make a practice of meeting a portfolio margin deficiency by 
liquidation.
    (11) Determination of Value for Margin Purposes.--For the purposes 
of this section (g), all eligible products and related instrument 
positions shall be valued at current market prices. Account equity for 
the purposes of [this] sections (g)(9)(A) and (g)(10)(A) shall be 
calculated separately for each portfolio margin [or cross-margin] 
account.
    (12) Net Capital Treatment of Portfolio Margin [and Cross-Margin] 
Accounts.
    (A) No member organization that requires margin in any portfolio 
margin [eligible participant] account pursuant to section (g) of this 
Rule shall permit the aggregate [eligible participant] portfolio margin 
[and cross-margin initial and maintenance] requirements to exceed ten 
times its Net Capital [net capital] for any period exceeding three 
business days. The member organization shall, beginning on the fourth 
business day, cease opening new portfolio margin [and cross-margin] 
accounts until compliance is achieved.
    (B) If, at any time, a member organization's aggregate [eligible 
participant] portfolio margin [and cross-margin] requirements exceed 
ten times its net capital, the member organization shall immediately 
transmit telegraphic or facsimile notice of such deficiency to the 
principal office of the Securities and Exchange Commission in 
Washington, DC, the district or regional office of the Securities and 
Exchange Commission for the district or region in which the member 
organization maintains its principal place of business; and to the [New 
York Stock] Exchange.
    (13) Day Trading Requirements.--[The requirements of sub-paragraph 
(f)(8)(B) of this Rule--Day-Trading shall not apply to portfolio margin 
accounts including cross-margin accounts.] Day trading is not permitted 
in portfolio margin accounts. Member organizations are expected to 
monitor portfolio margin accounts to detect and prevent circumvention 
of the day trading requirements.
(14) [Cross-Margin Accounts--] Requirements to Liquidate
    (A) A member organization is required immediately either to 
liquidate, or transfer to another broker-dealer eligible to carry 
portfolio [cross-] margin accounts, all [eligible participant] 
portfolio [cross-] margin accounts that contain positions eligible for 
portfolio [cross-] margining if the member organization is:
    (1) Insolvent as defined in section 101 of title 11 of the United 
States Code, or is unable to meet its obligations as they mature;
    (2) The subject of a proceeding pending in any court or before any 
agency of the United States or any State in which a receiver, trustee, 
or liquidator for such debtor has been appointed;
    (3) Not in compliance with applicable requirements under the 
[Securities] Exchange Act [of 1934] or rules of the Securities and 
Exchange Commission or any self-regulatory organization with respect to 
financial responsibility or hypothecation of eligible participant's 
securities; or
    (4) Unable to make such computations as may be necessary to 
establish compliance with such financial responsibility or 
hypothecation rules.
    (B) Nothing in this section (14) shall be construed as limiting or 
restricting in any way the exercise of any right of a registered 
clearing agency to liquidate or cause the liquidation of positions in 
accordance with its by-laws and rules.
    (15) Member organizations must ensure that portfolio margin 
accounts are in compliance with all other applicable Exchange rules 
promulgated in Rules 700 through 795.
* * * * *
Delivery of Options Disclosure Document and Prospectus
    Rule 726 (a) through (c) unchanged.
    Portfolio Margining [and Cross-Margining] Disclosure Statement and 
Acknowledgement
    (d) The special written disclosure statement describing the nature 
and

[[Page 17543]]

risks of portfolio margining [and cross-margining], and acknowledgement 
for an eligible participant signature, required by Rule 431(g)(5)(B) 
shall be in a format prescribed by the Exchange or in a format 
developed by the member organization, provided it contains 
substantially similar information as in the prescribed Exchange format 
and has received the prior written approval of the Exchange.
Sample Portfolio Margining [and Cross-Margining] Risk Disclosure 
Statement To Satisfy Requirements of Exchange Rule 431(g)
Overview of Portfolio Margining
    1. Portfolio margining is a margin methodology that sets margin 
requirements for an account based on the greatest projected net loss of 
all positions in a ``security [product] class'' or ``product group'' as 
determined by [an options] a theoretical pricing model using multiple 
pricing scenarios. These pricing scenarios are designed to measure the 
theoretical loss of the positions given changes in both the underlying 
price and implied volatility inputs to the model. [Portfolio margining 
is currently limited to product classes and groups of index products 
relating to listed, broad-based market indexes, listed security futures 
contracts and listed single stock options.]
    2. The goal of portfolio margining is to set levels of margin that 
more precisely reflect[s] actual net risk. The eligible participant 
benefits from portfolio margining in that margin requirements 
calculated on net risk are generally lower than alternative 
``position'' or ``strategy'' based methodologies for determining margin 
requirements. Lower margin requirements allow the customer more 
leverage in an account.
Customers Eligible for Portfolio Margining
    3. To be eligible for portfolio margining, eligible participants 
(other than broker-dealers) must meet the basic standards for having an 
options account that is approved for uncovered writing. In addition, 
eligible participants holding positions in over-the-counter (``OTC'') 
derivatives [and] must have and maintain at all times account net 
equity of not less than five million dollars, aggregated across all 
accounts under identical ownership at the clearing broker. The 
identical ownership requirement excludes accounts held by the same 
customer in different capacities (e.g., as a trustee and as an 
individual) and accounts where ownership is overlapping but not 
identical (e.g., individual accounts and joint accounts). [For those 
accounts that are solely limited to security futures contracts and 
single stock options, the five million dollar equity requirement shall 
be waived.]
    4. Members of futures exchanges on which portfolio margining 
eligible index contracts are traded are also permitted to carry 
positions in portfolio margin accounts without regard to the minimum 
aggregate account equity.
Positions Eligible for a Portfolio Margin Account
    5. [4.] All positions in [listed] margin eligible securities, 
listed options, OTC derivatives, and U.S. security futures [contracts, 
listed single stock options, listed, broad-based U.S. index options or 
index warrants, exchange traded funds and other products registered 
under the Investment Company Act of 1940 that are managed to track the 
same index that underlies permitted index options], are eligible for a 
portfolio margin account. In addition, listed, U.S index options, 
options on exchange traded funds (``ETF''), index warrants and 
underlying instruments can be combined with offsetting positions in 
related instruments, for the purpose of computing a margin requirement 
based on the net risk. This generally produces lower margin 
requirements than if the related instruments\9\ and securities products 
are viewed separately, thus providing more leverage in the account.
---------------------------------------------------------------------------

    \9\ For purposes of this Rule, the term ``related instruments,'' 
within a security class or product group means broad-based U.S. 
index futures and options on broad-based U.S. index futures covering 
the same underlying instrument.
---------------------------------------------------------------------------

    6. All broad-based U.S. listed market index futures and options on 
index futures traded on a designated contract market subject to the 
jurisdiction of the Commodity Futures Trading Commission (``CFTC'') are 
eligible for portfolio margining.
Special Rules for Portfolio Margin Accounts
    7. [5.] A portfolio margin account may be either a separate account 
or a sub-account of a customer's standard margin account. In the case 
of a sub-account, equity in the standard account will be available to 
satisfy any margin requirement in the portfolio margin sub-account 
without transfer to the sub-account.
    8. [6.] A portfolio margin account or sub-account will be subject 
to a minimum margin requirement of $.375, multiplied by the contract's 
multiplier, for [every] each listed option, OTC derivative, U.S. 
security future, and related instrument [contract] carried long or 
short in the account. [No minimum margin is required in the case of 
eligible exchange traded funds or other eligible fund products.]
    9. [7.] A margin [Margin] deficiency [calls] in the portfolio 
margin account or sub-account, regardless of whether due to new 
commitments or the effect of adverse market movements on existing 
positions, must be met within three business days. Any shortfall in 
aggregate net equity across accounts must be met within three business 
days. Failure to meet a portfolio margin [maintenance] deficiency 
[call] when due will result in immediate liquidation of positions to 
the extent necessary to reduce the margin requirement. Failure to meet 
a minimum equity deficiency [call] prior to the end of the third 
business day will result in a prohibition on entering any [opening] new 
orders, with the exception of [opening] new orders that hedge existing 
positions, beginning on the fourth business day and continuing until 
such time as the minimum equity requirement is satisfied[.] or until 
any OTC derivative is liquidated or transferred from the portfolio 
margin account to the appropriate securities account.
    [8. A position in an exchange traded index fund or other eligible 
fund product may not be established in a portfolio margin account 
unless there exists, or there is established on the same day, an 
offsetting position in a related or underlying security, or other 
eligible securities. The position(s) will be transferred out of the 
portfolio margin account and into a standard securities account subject 
to any applicable margin requirement if the offsetting securities 
options, other eligible securities and/or related instruments no longer 
remain in the account for ten business days.]
    10. [9.] When a broker-dealer carries a standard cash account or 
margin account for a customer, the broker-dealer is limited by rules of 
the Securities and Exchange Commission and of the [The] Options 
Clearing Corporation (``OCC'') to the extent to which the broker-dealer 
may permit the OCC to have a lien against long option positions in 
those accounts. In contrast, the OCC will have a lien against all long 
option positions that are carried by a broker-dealer in a portfolio 
margin account, and this could, under certain circumstances, result in 
greater losses to a customer having long option positions in such an 
account in the event of the insolvency of the customer's broker. 
Accordingly, to the extent that a customer does not borrow against long

[[Page 17544]]

option positions in a portfolio margin account or have margin 
requirements in the account against which the long option can be 
credited, there is no advantage to carrying the long options in a 
portfolio margin account and the customer should consider carrying them 
in an account other than a portfolio margin account.
    11. Customers participating in portfolio margining will be required 
to sign an agreement acknowledging that their positions and property in 
the portfolio margin account will be subject to the customer protection 
provisions of Rule 15c3-3 under the Securities Exchange Act of 1934 and 
the Securities Investor Protection Act.
Special Risks of Portfolio Margin Accounts
    12. [10.] Portfolio margining generally permits greater leverage in 
an account, and greater leverage creates greater losses in the event of 
adverse market movements.
    13. [11.] Because the time limit for meeting a margin deficiency 
[calls]is shorter than in a standard margin account, and may be shorter 
than the time ordinarily required by a Futures Commission Merchant for 
meeting a margin deficiency in a futures account, there is increased 
risk that a customer's portfolio margin account will be liquidated 
involuntarily, possibly causing losses to the customer.
    14. [12.] Because portfolio margin requirements are determined 
using sophisticated mathematical calculations and theoretical values 
that must be calculated from market data, it may be more difficult for 
customers to predict the size of any future margin deficiency [calls] 
in a portfolio margin account. This is particularly true in the case of 
customers who do not have access to specialized software necessary to 
make such calculations or who do not receive theoretical values 
calculated and distributed periodically by [The] the Options Clearing 
Corporation.
    15. [13.] For the reasons noted above, a customer that carries long 
options positions in a portfolio margin account could, under certain 
circumstances, be less likely to recover the full value of those 
positions in the event of the insolvency of the carrying broker.
    16. [14.] Trading of [securities index] eligible products in a 
portfolio margin account is generally subject to all the risks of 
trading those same products in a standard securities margin account. 
Customers should be thoroughly familiar with the risk disclosure 
materials applicable to those products, including the booklet entitled 
``Characteristics and Risks of Standardized Options''[.] and the risk 
disclosure document required by the CFTC to be delivered to futures 
customers. Customers should review these materials carefully before 
trading in a portfolio margin account.
    17. [15.] Customers should consult with their tax advisers to be 
certain that they are familiar with the tax treatment of transactions 
in these products, [securities options and futures products] including 
tax consequences of trading strategies involving these eligible 
products.
    18. [16.] The descriptions in this disclosure statement relating to 
eligibility requirements for portfolio margin accounts, and minimum 
equity and margin requirements for those accounts, are minimums imposed 
under Exchange rules. Time frames within which a margin or [and] equity 
deficiency [calls] must be met are maximums imposed under Exchange 
rules. Broker-dealers may impose [their own] more stringent 
requirements.
    19. According to the rules of the exchanges, a broker dealer is 
required to immediately liquidate, or, if feasible, transfer to another 
broker-dealer eligible to carry portfolio margin accounts, all customer 
portfolio margin accounts that contain positions in futures in the 
event that the carrying broker-dealer becomes insolvent.
    20. In signing the agreement referred to above, a customer also 
acknowledges that a portfolio margin account that contains positions in 
futures will be immediately liquidated, or, if feasible, transferred to 
another broker-dealer eligible to carry portfolio margin accounts, in 
the event that the carrying broker-dealer becomes insolvent.
    21. As noted above, portfolio margin accounts are securities 
accounts and are subject to the customer protections set-forth in Rule 
15c3-3 under the Securities Exchange Act of 1934 and the Securities 
Investor Protection Act.
    22. Customers should bear in mind that the discrepancies in the 
cash flow characteristics of futures and certain options are still 
present even when those products are carried together in a portfolio 
margin account. Both futures and options contracts are generally marked 
to the market at least once each business day, but the marks may take 
place with different frequency and at different times within the day. 
When a futures contract is marked to the market, the gain or loss is 
immediately credited to or debited from the customer's account in cash. 
While an increase in the value of a long option contract may increase 
the equity in the account, the gain is not realized until the option is 
sold or exercised. Accordingly, a customer may be required to deposit 
cash in the account in order to meet a variation payment on a futures 
contract even though the customer is in a hedged position and has 
experienced a corresponding (but yet unrealized) gain on a long option. 
Alternatively, a customer who is in a hedged position and would 
otherwise be entitled to receive a variation payment on a futures 
contract may find that the cash is required to be held in the account 
as margin collateral on an offsetting option position.
[Overview of Cross-Margining
    17. In a cross-margin account, index futures, security futures and 
options on index and security futures are combined with offsetting 
positions in listed securities and underlying instruments, for the 
purpose of computing a margin requirement based on the net risk. This 
generally produces lower margin requirements than if the related 
instruments \10\ and securities products are viewed separately, thus 
providing more leverage in the account.
---------------------------------------------------------------------------

    \10\ [For purposes of this Rule, the term ``related 
instruments,'' within an option class or product group means futures 
contracts and options on futures contracts covering the same 
underlying instrument.]
---------------------------------------------------------------------------

    18. Cross-margining must be effected in a portfolio margin account 
type. A separate portfolio margin account must be established 
exclusively for cross-margining.
    19. Cross-margining is achieved when index futures are combined 
with offsetting positions in index options and underlying instruments 
in a dedicated account, and a portfolio margining methodology is 
applied to them.
Customers Eligible for Cross-Margining
    20. The eligibility requirements for cross-margining are generally 
the same as for portfolio margining. Accordingly, any customer eligible 
for portfolio margining is eligible for cross-margining.
    21. Members of futures exchanges on which cross-margining eligible 
index contracts are traded are also permitted to carry positions in 
cross-margin accounts without regard to the minimum aggregate account 
equity.
Positions Eligible for Cross-Margining
    22. All securities products eligible for portfolio margining are 
also eligible for cross-margining.
    23. All broad-based U.S. listed market index futures and options on 
index futures traded on a designated contract market subject to the 
jurisdiction of the Commodity Futures Trading

[[Page 17545]]

Commission (``CFTC'') are eligible for cross-margining.
Special Rules for Cross-Margining
    24. Cross-margining must be conducted in a portfolio margin account 
type. A separate portfolio margin account must be established 
exclusively for cross-margining. A cross margin account is a securities 
account, and must be maintained separately from all other securities 
account.
    25. Cross-margining is automatically accomplished with the 
portfolio margining methodology. Cross-margin positions are subject to 
the same minimum margin requirement for every contract, including 
futures contracts.
    26. Margin calls arising in a cross-margin account, and any 
shortfall in aggregate net equity across accounts, must be satisfied 
within the same timeframe, and subject to the same consequences, as in 
a portfolio margin account.
    27. A position in a futures product may not be established in a 
cross-margin account unless there exists, or there is established on 
the same day, an offsetting position in securities options and/or other 
eligible securities. Related instruments will be transferred out of the 
cross-margin account and into a futures account if, for more than ten 
business days and for any reason, the offsetting securities options 
and/or other eligible securities no longer remain in the account. If 
the transfer of related instruments to a futures account causes the 
futures account to be undermargined, a margin call will be issued or 
positions will be liquidated to the extent necessary to eliminate the 
deficit.
    28. Customers participating in cross-margining will be required to 
sign an agreement acknowledging that their positions and property in 
the cross-margin account will be subject to the customer protection 
provisions of Rule 15c3-3 under the Securities Exchange Act of 1934 and 
the Securities Investor Protection Act, and will not be subject to the 
provisions of the Commodity Exchange Act, including segregation of 
funds.
    29. According to the rules of the exchanges, a broker dealer is 
required to immediately liquidate, or, if feasible, transfer to another 
broker-dealer eligible to carry cross-margin accounts, all customer 
cross-margin accounts that contain positions in futures in the event 
that the carrying broker-dealer becomes insolvent.
    30. In signing the agreement referred to in paragraph 28 above, a 
customer also acknowledges that a cross-margin account that contains 
positions in futures will be immediately liquidated, or, if feasible, 
transferred to another broker-dealer eligible to carry cross-margin 
accounts, in the event that the carrying broker-dealer becomes 
insolvent.
Special Risks of Cross-Margining
    31. Cross-margining must be conducted in a portfolio margin account 
type. Generally, cross-margining and the portfolio margining 
methodology both contribute to provide greater leverage than a standard 
margin account, and greater leverage creates greater losses in the 
event of adverse market movements.
    32. Since cross-margining must be conducted in a portfolio margin 
account type, the time required for meeting a margin deficiency [calls] 
is shorter than in a standard securities margin account and may be 
shorter than the time ordinarily required by a futures commission 
merchant for meeting a margin deficiency [calls] in a futures account. 
Consequently, there is increased risk that a customer's cross-margin 
positions will be liquidated involuntarily, causing possible loss to 
the customer.
    33. As noted above, cross-margin accounts are securities accounts 
and are subject to the customer protections set-forth in Rule 15c3-3 
under the Securities Exchange Act of 1934 and the Securities Investor 
Protection Act. Cross-margin positions are not subject to the customer 
protection rules under the segregation provisions of the Commodity 
Exchange Act and the rules of the CFTC adopted pursuant to the 
Commodity Exchange Act.
    34. Trading of index options and futures contracts in a cross-
margin account is generally subject to all the risks of trading those 
same products in a futures account or a standard securities margin 
account. Customers should be thoroughly familiar with the risk 
disclosure materials applicable to those products, including the 
booklet entitled Characteristics and Risks of Standardized Options and 
the risk disclosure document required by the CFTC to be delivered to 
futures customers. Because this disclosure statement does not disclose 
the risks and other significant aspects of trading in futures and 
options, customers should review those materials carefully before 
trading in a cross-margin account.
    35. Customers should bear in mind that the discrepancies in the 
cash flow characteristics of futures and certain options are still 
present even when those products are carried together in a cross margin 
account. Both futures and options contracts are generally marked to the 
market at least once each business day, but the marks may take place 
with different frequency and at different times within the day. When a 
futures contract is marked to the market, the gain or loss is 
immediately credited to or debited from the customer's account in cash. 
While an increase in the value of a long option contract may increase 
the equity in the account, the gain is not realized until the option is 
sold or exercised. Accordingly, a customer may be required to deposit 
cash in the account in order to meet a variation payment on a futures 
contract even though the customer is in a hedged position and has 
experienced a corresponding (but yet unrealized) gain on a long option. 
Alternatively, a customer who is in a hedged position and would 
otherwise be entitled to receive a variation payment on a futures 
contract may find that the cash is required to be held in the account 
as margin collateral on an offsetting option position.
    36. Customers should consult with their tax advisers to be certain 
that they are familiar with the tax treatment of transactions in these 
products, including tax consequences of trading strategies involving 
both futures and option contracts]
    37. The descriptions in this disclosure statement relating to 
eligibility requirements for cross-margining, and minimum equity and 
margin requirements for cross margin accounts, are minimums imposed 
under Exchange rules. Time frames within which margin and equity calls 
must be met are maximums imposed under Exchange rules. The broker-
dealer carrying a customer's portfolio margin account, including any 
cross-margin account, may impose more stringent requirements.]
* * * * *
Sample Portfolio Margining [and Cross-Margining] Acknowledgement[s]
Acknowledgement for Customers Utilizing a Portfolio Margin Account
[--Cross-Margining and Non-Cross-Margining--]
    Rule 15c3-3 under the Securities Exchange Act of 1934 requires that 
a broker or dealer promptly obtain and maintain physical possession or 
control of all fully-paid securities and excess margin securities of a 
customer. Fully-paid securities are securities carried in a cash 
account and margin equity securities carried in a margin or special 
account (other than a cash account) that have been fully paid for. 
Excess margin securities are a customer's margin securities having a 
market value in

[[Page 17546]]

excess of 140% of the total of the debit balances in the customer's 
non-cash accounts. For the purposes of Rule 15c3-3, securities held 
subject to a lien to secure obligations of the broker-dealer are not 
within the broker-dealer's physical possession or control. The 
Commission staff has taken the position that all long option positions 
in a customer's portfolio margining account [(including any cross-
margin account)] may be subject to such a lien by the OCC and will not 
be deemed fully-paid or excess margin securities under Rule 15c3-3.
    The hypothecation rules under the Securities Exchange Act of 1934 
(Rules 8c-1 and 15c2-1), prohibit broker-dealers from permitting the 
hypothecation of customer securities in a manner that allows those 
securities to be subject to any lien or liens in an amount that exceeds 
the customer's aggregate indebtedness. However, all long option 
positions in a portfolio margining account [(including any cross-
margining account)] will be subject to the OCC's lien, including any 
positions that exceed the customer's aggregate indebtedness. The 
Commission staff has taken a position that would allow customers to 
carry positions in portfolio margining accounts, [(including any cross-
margining account)] even when those positions exceed the customer's 
aggregate indebtedness. Accordingly, within a portfolio margin account 
[or cross-margin account], to the extent that you have long option 
positions that do not operate to offset your aggregate indebtedness and 
thereby reduce your margin requirement you receive no benefit from 
carrying those positions in your portfolio margin account [or cross-
margin account] and incur the additional risk of the OCC's lien on your 
long option position(s). [By signing below the customer affirms that 
the customer has read and understood the foregoing disclosure statement 
and acknowledges and agrees that long option positions in portfolio 
margining accounts, and cross-margining accounts, will be exempted from 
certain customer protection rules of the Securities and Exchange 
Commission as described above and will be subject to a lien by the 
Options Clearing Corporation without regard to such rules.

Customer name: --------

By: --------

    (Signature/title)

Date --------
Acknowledgement for Customers
Engaged in Cross-Margining
    As disclosed above, futures contracts and other property carried in 
customer accounts with Futures Commission Merchants (``FCM'') are 
normally subject to special protection afforded under the customer 
segregation provisions of the Commodity Exchange Act (``CEA'') and the 
rules of the Commodity Futures Trading Commission (``CFTC'') adopted 
pursuant to the CEA. These rules require that customer funds be 
segregated from the accounts of financial intermediaries and be 
accounted for separately. However, they do not provide for, and 
standard futures accounts do not enjoy the benefit of, insurance 
protecting customer accounts against loss in the event of the 
insolvency of the intermediary carrying the accounts.]
    As discussed above, portfolio [cross-] margining must be conducted 
in [a portfolio margin] an account[,] dedicated exclusively to 
portfolio [cross-] margining and portfolio [cross-] margin accounts are 
not treated as a futures account with an FCM. Instead, portfolio 
[cross-] margin accounts are treated as securities accounts carried 
with broker-dealers. As such, portfolio [cross-] margin accounts are 
covered by Rule 15c3-3 under the Securities Exchange Act of 1934, which 
protects customer accounts. Rule 15c3-3, among other things, requires a 
broker-dealer to maintain physical possession or control of all fully-
paid and excess margin securities and maintain a special reserve 
account for the benefit of their customers. However, with regard to 
portfolio [cross] margin accounts, there is an exception to the 
possession or control requirement of Rule 15c3-3 that permits [The] the 
Options Clearing Corporation to have a lien on long positions. This 
exception is outlined in a separate acknowledgement form that must be 
signed prior to or concurrent with this form. Additionally, the 
Securities Investor Protection Corporation (``SIPC'') insures customer 
accounts against the financial insolvency of a broker-dealer in the 
amount of up to $500,000 to protect against the loss of registered 
securities and cash maintained in the account for purchasing securities 
or as proceeds from selling securities (although the limit on cash 
claims is $100,000). According to the rules of the exchanges, a broker-
dealer is required to immediately liquidate, or, if feasible, transfer 
to another broker-dealer eligible to carry portfolio [cross-] margin 
accounts, all customer portfolio [cross] margin accounts that contain 
positions in futures and/or options on futures in the event that the 
carrying broker-dealer becomes insolvent.
    By signing below the customer affirms that the customer has read 
and understood the foregoing disclosure statement and acknowledges and 
agrees that: (1) long option positions in portfolio margining accounts 
will be exempted from certain customer protection rules of the 
Securities and Exchange Commission as described above and will be 
subject to a lien by the Options Clearing Corporation without regard to 
such rules, and [positions and property in cross-margining accounts, 
will not be subject to the customer protection rules under the customer 
segregation provisions of the Commodity Exchange Act and the rules of 
the Commodity Futures Trading Commission adopted pursuant to the CEA 
and] (2) portfolio [cross-] margining accounts that contain positions 
in futures and/or options on futures will be immediately liquidated, or 
if feasible, transferred to another broker-dealer eligible to carry 
portfolio [cross-] margin accounts in the event that the carrying 
broker-dealer becomes insolvent.

Customer name: --------

By:--------

    (Signature/title)

Date: --------

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 Exchange included statements 
concerning the purpose of, and basis for, the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
Sections A, B, and C below, of the most significant aspects of such 
statements.\11\
---------------------------------------------------------------------------

    \11\ The Commission has modified the text of the summaries 
prepared by the NYSE. Telephone conversation between William 
Jannace, Director--Rule & Interpretive Standards, Member Firm 
Regulation, NYSE and Randall Roy, Branch Chief, and Sheila Swartz, 
Special Counsel, Division of Market Regulations, Commission, on 
March 29, 2006.
---------------------------------------------------------------------------

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

1. Purpose
    Proposed amendments to NYSE Rule 431 would further expand the 
recently Commission approved and NYSE proposed products that are 
eligible for

[[Page 17547]]

treatment under portfolio margin requirements to include: All margin 
eligible securities,\12\ listed options, OTC derivatives, and U.S. 
security futures provided certain requirements are met. Amendments to 
Rule 726 are also proposed to include the Commission approved products 
on the disclosure document required to be furnished to options 
customers pursuant to this rule.
---------------------------------------------------------------------------

    \12\ The term all ``margin eligible security'' utilizes the 
definition at Section 220.2 of Regulation T of the Board of 
Governors of the Federal Reserve System.
---------------------------------------------------------------------------

a. Background
    Section 7(a) \13\ of the Exchange Act \14\ empowers the Board of 
Governors of the Federal Reserve System to prescribe the rules and 
regulations regarding credit that may be extended by broker-dealers on 
securities (Regulation T) to their customers. NYSE Rule 431 prescribes 
specific margin requirements that must be maintained in all customers 
accounts, based on the type of securities products held in such 
accounts. In April 1996, the Exchange established a Rule 431 Committee 
(the ``Committee'') to assess the adequacy of Rule 431 on an ongoing 
basis, review margin requirements, and make recommendations for change. 
The Committee has endorsed the proposed amendments discussed below.\15\
---------------------------------------------------------------------------

    \13\ 15 U.S.C. 78g.
    \14\ 15 U.S.C. 78a et seq.
    \15\ The Committee is currently composed of several member 
organizations, including Goldman, Sachs & Co., Morgan Stanley & Co., 
Inc., Merrill Lynch, Pierce, Fenner and Smith, Inc., Bear Stearns 
Corp, Credit Suisse First Boston Corp, and several self-regulatory 
organizations (``SROs'') including: the NYSE, the Chicago Board 
Options Exchange (``CBOE''), NASD as well as representatives from 
the Securities Industry Association's Ad Hoc Committee on Portfolio 
Margining.
---------------------------------------------------------------------------

b. The Pilot
    The Board of Governors of the Federal Reserve System in its 
amendments to Regulation T in 1998 permitted SROs to implement 
portfolio margin rules, subject to Commission approval.\16\
---------------------------------------------------------------------------

    \16\ See Federal Reserve System, ``Securities Credit 
Transactions; Borrowing by Broker and Dealers''; Regulations G, T, U 
and X; Docket Nos. R-0905, R-0923 and R-0944, 63 FR 2806 (January 
16, 1998).
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    As noted above, on July 14, 2005 the Commission approved amendments 
to Exchange Rules 431 and 726 to permit, on a two-year pilot basis, the 
use of a prescribed risk-based methodology (``portfolio margin'') \17\ 
for certain products, as an alternative to the strategy or position 
based margin requirements \18\ currently required in Rule 431(a) 
through (f). Exchange member organizations may utilize portfolio margin 
for listed, broad-based U.S. index options and index warrants, along 
with any underlying instruments.\19\ These positions are to be margined 
(either for initial or maintenance) in a separate portfolio margin 
account dedicated exclusively for such margin computation.
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    \17\ As a pre-condition to permitting portfolio margining, 
member organization are required to establish procedures and 
guidelines to monitor credit risk to the member organization's 
capital, including intra-day credit risk and stress testing of 
portfolio margin accounts. Further, member organizations must 
establish procedures for regular review and testing of these 
required risk analysis procedures (see Rule 431(g)(1)).
    \18\ Prior to the Pilot, member organizations were solely 
subject, pursuant to NYSE Rule 431, to strategy or positioned-based 
margin requirements. This methodology applied specific margin 
percentage requirements as prescribed in Rule 431 to each security 
position and/or strategy, either long or short, held in customer's 
account, irrespective of the fact that all security (e.g., options) 
prices do not change equally (in percentage terms) with a change in 
the price of the underlying security. When utilizing a portfolio 
margin methodology, offsets are fully realized, whereas under 
strategy or position-based methodology, positions and or groups of 
positions comprising a single strategy are margined independently of 
each other and offsets between them do not efficiently impact the 
total margin requirement.
    \19\ For purposes of the Pilot and SR-NYSE-2005-93, the term 
``underlying instrument,'' means long and short positions in an 
exchange traded fund or other fund product registered under the 
Investment Company Act of 1940, that holds the same securities, and 
in the same proportion, as contained in a broad-based index on which 
options are listed. The term ``underlying instrument'' shall not be 
deemed to include futures contracts, options on futures contracts, 
underlying stock baskets,

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