Self-Regulatory Organizations; Chicago Board Options Exchange, Incorporated; Notice of Filing of Amendment Nos. 1 and 2 to the Proposed Rule Change Relating to Customer Portfolio Margining; Order Granting Accelerated Approval to the Proposed Rule Change, as Amended, 75781-75788 [E6-21480]

Download as PDF Federal Register / Vol. 71, No. 242 / Monday, December 18, 2006 / Notices Electronic Comments • Use the Commission’s Internet comment form (http://www.sec.gov/ rules/sro.shtml); or • Send an e-mail to rulecomments@sec.gov. Please include File Number SR–BSE–2006–54 on the subject line. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, Station Place, 100 F Street, NE., Washington, DC 20549–1090. SECURITIES AND EXCHANGE COMMISSION [Release No. 34–54919; File No. SR–CBOE– 2006–14] Self-Regulatory Organizations; Chicago Board Options Exchange, Incorporated; Notice of Filing of Amendment Nos. 1 and 2 to the Proposed Rule Change Relating to Customer Portfolio Margining; Order Granting Accelerated Approval to the Proposed Rule Change, as Amended December 12, 2006. I. Introduction On February 2, 2006, the Chicago All submissions should refer to File Board Options Exchange, Incorporated Number SR–BSE–2006–54. This file (‘‘CBOE’’ or ‘‘Exchange’’) filed with the number should be included on the Securities and Exchange Commission subject line if e-mail is used. To help the (‘‘Commission’’), pursuant to Section Commission process and review your 19(b)(1) of the Securities Exchange Act comments more efficiently, please use of 1934 (‘‘Act’’ or ‘‘Exchange Act’’) 1 and only one method. The Commission will Rule 19b–4 2 thereunder, a proposed post all comments on the Commission’s rule change seeking to amend CBOE Rule 12.4 to expand the scope of Internet Web site (http://www.sec.gov/ products that are eligible for treatment rules/sro.shtml). Copies of the as part of CBOE’s approved portfolio submission, all subsequent margin pilot program and to eliminate amendments, all written statements the requirement for a separate crosswith respect to the proposed rule margin account.3 The proposed rule change that are filed with the change would expand the scope of Commission, and all written eligible products in the pilot to include communications relating to the margin equity securities,4 unlisted proposed rule change between the derivatives, listed options and securities Commission and any person, other than futures.5 The proposed rule change was those that may be withheld from the published in the Federal Register on public in accordance with the April 6, 2006.6 The Commission provisions of 5 U.S.C. 552, will be 1 15 U.S.C. 78s(b)(1). available for inspection and copying in 2 17 CFR 240.19b–4. the Commission’s Public Reference 3 See Exchange Act Release No. 52032 (July 14, Room. Copies of such filing also will be 2005), 70 FR 42118 (July 21, 2005) (SR–CBOE– available for inspection and copying at 2002–03). On July 14, 2005, the Commission the principal office of the Exchange. All approved on a pilot basis expiring July 31, 2007, amendments to CBOE’s margin rules that permit comments received will be posted broker-dealers to determine customer margin without change; the Commission does requirements for portfolios of listed broad-based not edit personal identifying securities index options, warrants, futures, futures options and related exchange-traded funds using a information from submissions. You specified portfolio margin methodology. The should submit only information that Commission also approved rule amendments to you wish to make available publicly. All require disclosure to, and written acknowledgment from, customers using a portfolio margin account. submissions should refer to File 4 For purposes of the pilot, a margin equity Number SR–BSE–2006–54 and should security is a security that meets the definition of a be submitted on or before January 8, ‘‘margin equity security’’ under Regulation T of the Federal Reserve Board (‘‘FRB’’). See 12 CFR 220.2. 2007. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.15 Florence E. Harmon, Deputy Secretary. [FR Doc. E6–21477 Filed 12–15–06; 8:45 am] jlentini on PROD1PC65 with NOTICES BILLING CODE 8011–01–P 15 17 CFR 200.30–3(a)(12). VerDate Aug<31>2005 16:16 Dec 15, 2006 Jkt 211001 An unlisted derivative means ‘‘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 Securities and Exchange Commission.’’ See proposed Rule 12.4(a)(4). 5 In addition to CBOE Rule 12.4, the proposed rule change also approves changes to CBOE Rules 9.15, 13.5 and 15.8A. 6 See Exchange Act Release No. 53576 (March 30, 2006), 71 FR 17519 (April 6, 2006) (SR–CBOE– 2006–14). The New York Stock Exchange LLC (‘‘NYSE’’) also filed a similar proposed rule filing seeking to expand the scope of eligible products under its portfolio margin pilot program. See Exchange Act Release No. 53577 (March 30, 2006), 71 FR 17539 (April 6, 2006) (SR–NYSE–2006–13). PO 00000 Frm 00074 Fmt 4703 Sfmt 4703 75781 subsequently extended the comment period for the original proposed rule filing until May 11, 2006.7 The Commission received 7 comment letters in response to the Federal Register notice.8 On July 26, 2006, CBOE filed a response to these comments.9 The comment letters and CBOE’s response to the comments are summarized below. On August 9, 2006, CBOE filed Amendment No. 1 to the proposed rule change.10 On September 27, 2006, CBOE filed Amendment No. 2 to the proposed rule change.11 This order provides notice of filing of Amendment Nos. 1 and 2 and solicits comments from interested persons on Amendment Nos. 1 and 2. This order also grants accelerated approval of the proposed rule change, as amended by Amendment Nos. 1 and 2.12 II. Description a. Portfolio Margining The proposed rule change consists of amendments to Rule 12.4 to include 7 See Exchange Act Release No. 53728 (April 26, 2006), 71 FR 25878 (May 2, 2006). 8 See letter from Timothy H. Thompson, Senior Vice President, Chief Regulatory Officer, Regulatory Services Division, CBOE, to Nancy Morris, Secretary, Commission, dated June 5, 2006 (‘‘CBOE Letter’’); letter from William H. Navin, Executive Vice President, General Counsel and Secretary, The Options Clearing Corporation (‘‘OCC’’), to Nancy M. Morris, Secretary, Commission, dated May 19, 2006 (‘‘OCC Letter’’); letter from James Barry, on behalf of the Ad Hoc Portfolio Margin Committee, John Vitha, Chair, Derivatives Product Committee and Christopher Nagy, Chair, Options Committee, Securities Industry Association, to Nancy M. Morris, Secretary, dated May 16, 2006 (‘‘SIA Letter’’); letter from Gary Alan DeWaal, Group General Counsel and Director of Legal and Compliance, Fimat USA, LLC, to Nancy M. Morris, Secretary, Commission, dated May 11, 2006 (‘‘Fimat Letter’’); letter from Stuart J. Kaswell, Partner, Dechert LLP, Counsel for Federated Investors, Inc., to Nancy M. Morris, Secretary, Commission, dated May 10, 2006 (‘‘Federated Letter’’); letter from Craig S. Donohue, Chief Executive Officer, Chicago Mercantile Exchange Inc., to Jonathan G. Katz, Secretary, Commission, dated May 9, 2006 (‘‘CME Letter’’); and letter from Gerard J. Quinn, Vice President and Associate General Counsel, SIA, to Nancy M. Morris, Secretary, Commission, dated April 21, 2006 (‘‘SIA Extension Letter’’). 9 See letter from Timothy H. Thompson, Senior Vice President, Chief Regulatory Officer, Regulatory Services Division, CBOE, to Nancy M. Morris, Secretary, Commission, dated July 26, 2006 (‘‘CBOE Response’’). 10 CBOE filed Amendment No. 1 in response to comments received and to make other clarifying changes to the proposed rule filing. Amendment No. 1 replaced and superceded the original filing in its entirety. 11 CBOE filed partial Amendment No. 2 to conform its day trading language to the NYSE rule language and to request accelerated approval. A clean copy of the proposed rule, as amended by Amendment Nos. 1 and 2, is attached to this order as Exhibit A. 12 By separate order, the Commission also is approving a parallel rule filing by the NYSE (SR– NYSE–2006–13). Exchange Act Release No. 54918; see also supra note 6. E:\FR\FM\18DEN1.SGM 18DEN1 75782 Federal Register / Vol. 71, No. 242 / Monday, December 18, 2006 / Notices jlentini on PROD1PC65 with NOTICES margin equity securities (as defined in Regulation T), unlisted derivatives, listed options and securities futures as eligible products for the portfolio margining pilot.13 The proposed rule change also includes amendments to eliminate the requirement of a separate cross-margin account. CBOE Rule 12.3 prescribes specific margin requirements for customers based on the type of securities held in their accounts.14 Outside the existing pilot program, CBOE’s margin rules require that margin be calculated using fixed percentages, on a position-by-position basis. In contrast, the current portfolio margin pilot program permits a broker-dealer to calculate customer margin requirements by grouping all products in an account that are based on the same index or issuer into a single portfolio. For example, futures, options and exchange traded funds based on the S&P 500 would each be grouped in a portfolio and products based on IBM would be grouped into a separate portfolio. The broker-dealer then calculates a customer’s margin requirement by ‘‘shocking’’ each portfolio at different equidistant points along a range representing a potential percentage increase and decrease in the value of the instrument or underlying instrument in the case of a derivative product. Currently, under the pilot, products of portfolios based on high capitalization, broad-based securities indexes are shocked along a range spanning an increase of 6% and a decrease of 8%. Portfolios of products based on nonhigh capitalization, broad-based securities indexes are shocked along a range spanning an increase of 10% and a decrease of 10%. The proposed rule change would continue to apply these shock ranges. Under the proposed amendments, portfolios of products based on an equity security or a narrowbased index would be shocked along a range spanning an increase of 15% and a decrease of 15%.15 In addition, as with the current pilot, a theoretical options pricing model would continue to be used to derive position values at each valuation point for the purpose of determining the gain or loss.16 The portfolio shocks described above result in a gain or loss for each instrument in a portfolio at each calculation point along the range. These gains and losses are netted to derive a potential portfolio-wide gain or loss for the point. The margin requirement for a portfolio is the amount of the greatest portfolio-wide loss among the calculation points. The margin requirements for each portfolio are added together to calculate the total margin requirement for the portfolio margin account. This approach, in most cases, will generally lower customer margin requirements.17 The amount of margin (initial and maintenance) required with respect to a given portfolio would be the larger of: (1) The greatest portfolio-wide loss amount among the valuation point calculations; or (2) the sum of $.375 for each option and future in the portfolio multiplied by the contract’s or instrument’s multiplier.18 The second computation establishes a minimum margin requirement to ensure that a certain level of margin is required from the customer in the event the greatest portfolio-wide loss among the valuation points is de minimis. 13 The list of eligible products under the pilot currently includes listed broad-based securities index options, warrants, futures, futures options and related exchange-traded funds. 14 The margin rules specify the amount of equity a customer must maintain in his or her margin account with respect to securities positions financed by the broker-dealer. The equity protects the broker-dealer in the event the customer defaults on the obligation to re-pay the financing and the broker-dealer is forced to liquidate the position at a loss. 15 For example, under the pilot, a portfolio of single stock futures and listed equity options would be shocked at 10 equidistant points along a range bounded on one end by a 15% increase in the market value of the instrument and at the other end by a 15% decrease (i.e., at ±3%, ±6%, ±9%, ±12% and ±15%). 16 Currently, the only model that qualifies is the OCC’s Theoretical Intermarket Margining System (TIMS). 17 For example, the current required initial and maintenance margin requirements for an equity security are 50% and 25%, respectively. The market movement range to calculate the potential gains and losses under the proposed portfolio margin rule for equity securities is ±15%. 18 The multiplier for a standard listed option is fixed by the options market on which the options series is traded. For example, a cash settled equity option generally has a multiplier of 100. Therefore, the minimum margin for one options contract would be $37.50. The multipliers for different securities and futures products may vary. 19 Margin equity securities include certain foreign equity securities and options on foreign equity securities. See 12 CFR 220.2 VerDate Aug<31>2005 16:16 Dec 15, 2006 Jkt 211001 b. Expansion of Eligible Products Under CBOE’s proposed rule, products eligible for portfolio margining would be expanded to include margin equity securities (as defined under Regulation T),19 unlisted derivatives, listed options and securities futures. The unlisted derivatives would be included in a portfolio based on the underlying reference index or security. Individual equities and narrow-based index futures would be included in a portfolio shocked at a range spanning an increase of 15% and a decrease of 15%. PO 00000 Frm 00075 Fmt 4703 Sfmt 4703 c. Margin Deficiency The proposed rule change would require a customer to satisfy a margin deficiency in a portfolio margin account within three business days by depositing additional margin or effecting an offsetting hedge. The current pilot requires that a customer deposit addition margin by T+1. The proposed rule also would require a broker-dealer to deduct from its net capital the amount of any portfolio margin call not met by the close of business on T+1 and until the call is satisfied. Additionally, the proposal would further require a broker-dealer to have in place procedures to identify accounts that periodically liquidate positions to eliminate margin deficiencies, and to take appropriate action when warranted.20 d. $5 Million Equity Requirement The current pilot requires customers that are not broker-dealers or futures firms to maintain minimum account equity of $5 million dollars. The proposed rule change would eliminate the $5 million account equity requirement for all portfolio margin accounts, except those holding unlisted derivatives.21 e. Risk Management Methodology The pilot requires member brokerdealers to monitor the risk of portfolio margin accounts and maintain a written risk analysis methodology for assessing potential risk to the firm’s capital. This risk analysis methodology must be filed and maintained with CBOE. The proposed rule change strengthens these requirements by providing that, member organizations must file the risk analysis methodology with its firm’s DEA and submit it to the Commission prior to implementation.22 The proposed rule change also requires the inclusion of additional procedures and guidelines as part of the methodology.23 f. Cross-Margin Account The proposed rule change would eliminate the requirement that portfolios with futures positions be held in a separate cross-margin account. Under the proposal, a customer would be permitted to use a single securities margin account for all eligible products. The Exchange and commenters have 20 See proposed rule 12.4(i)(1). proposed rule 12.4(b)(3). 22 See proposed Rule 12.4(b), under which the broker-dealer must receive prior approval from its DEA prior to offering portfolio margining to its customers. As part of the approval process, CBOE will require a firm to demonstrate compliance with the risk management analysis rules. 23 See proposed Rule 15.8A. 21 See E:\FR\FM\18DEN1.SGM 18DEN1 Federal Register / Vol. 71, No. 242 / Monday, December 18, 2006 / Notices CBOE noted that it would be operationally difficult to move positions in and out of the portfolio margin account based on whether they are currently being offset. indicated that maintaining and monitoring two separate margin accounts would be operationally difficult and that it would be more efficient to hold all positions in one securities account. g. Excess Equity and Collateral CBOE also proposes to amend Rule 12.4 to add language allowing a customer to use excess equity in a regular margin account to meet a margin deficiency in a portfolio margin account without having to transfer any funds or securities where the portfolio margin account is a sub-account of the regular margin account. In addition, the proposed rule change adds language allowing positions (including nonequity securities and money market mutual funds) not eligible for portfolio margin treatment to be carried in the portfolio margin account for their collateral value, subject to the margin requirements of a regular margin account. h. Day Trading The proposed rule change amends the day trading provisions of Rule 12.4 to provide that CBOE’s day trading rules do not apply to portfolio margin accounts that have at least $5 million equity, provided the member firm has the ability to monitor the intra-day risk associated with day trading. In addition, the proposed rule change would provide that day trading will not be deemed to have occurred whenever the position or positions day traded were part of a hedge strategy 24 that reduced the risk of the portfolio. i. Risk Disclosure Statement The proposed rule change eliminates the sample risk disclosure statement and acknowledgement in the rule text.25 jlentini on PROD1PC65 with NOTICES j. Hedged Positions Under the pilot, an underlying security in a portfolio margin account must be removed from the account if it is no longer offset by an option position. The amendments propose to eliminate the requirement to remove instruments that are no longer offset by options positions. CBOE made this change in response to comments that all positions eligible for a portfolio margin account, including underlying securities, should receive equal treatment. Moreover, 24 A ‘‘hedge strategy’’ for purposes of the day trading restrictions on portfolio margining means a transaction or series of transactions that reduces or offsets a material portion of the risk in a portfolio. 25 Instead the Exchange will send out a regulatory circular with the sample disclosure language. The Exchange made this change to avoid having to file a proposed rule change each time in the risk disclosure document is changed. VerDate Aug<31>2005 16:16 Dec 15, 2006 Jkt 211001 III. Summary of Comments Received and CBOE Response The Commission received a total of 7 comment letters to the proposed rule change.26 The comments, in general, were supportive. One commenter stated that it strongly supports ‘‘the significant step forward represented by the currently proposed changes.’’ 27 Another commenter stated that the portfolio margining of securities products will ‘‘help U.S. brokers and exchanges compete more effectively with their overseas counterparts * * * and thereby increase the strength and liquidity of U.S. markets.’’ 28 Each commenter, however, recommended changes to specific provisions of the proposed rule change. Several commenters 29 submitted comments regarding the ability to use portfolio margin methodologies other than the method prescribed in the rule to calculate customer margin requirements. One commenter stated that the Commission has experience in approving proprietary market risk models for consolidated supervised entities (CSEs) and OTC derivatives dealers.30 The Exchange stated, however, that initially, the most prudent course is for all broker-dealers to utilize the rule’s specified methodology and that in the longer term, proprietary risk models could be considered as alternatives.31 One commenter suggested that CBOE eliminate the requirement for a separate cross margin account and provide for one portfolio margin account for both futures and options; eliminate the requirement that stock must be hedged in order to be carried in a portfolio margin account; and eliminate the twotiered per contract minimum margin requirement in favor of one overall minimum.32 The CBOE stated that it agrees with the proposed changes and believes they are operationally feasible. In response, CBOE made these changes 26 See supra note 8. One of the comment letters related to the extension of the comment period for the proposed rule change. See SIA Extension Letter. 27 See SIA Letter. 28 See Fimat Letter. 29 See SIA Letter and OCC Letter; see also CME Letter (discussing SPAN). 30 See SIA Letter. 31 See CBOE Response, supra note 9. 32 See SIA Letter. PO 00000 Frm 00076 Fmt 4703 Sfmt 4703 75783 in Amendment No. 1 to the proposed rule filing.33 One commenter stated that portfolio margining should be expanded to include nonequity securities, interest rate derivatives, collateralized debt obligations and other similar non-equity related products, and foreign currency derivatives.34 This commenter also requested that nonequity securities be permitted to be held in the portfolio margin account for collateral purposes only, subject to the other applicable margin requirements.35 The Exchange noted that it agrees with the commenter to the extent that nonequity securities may serve as collateral in the portfolio margin account.36 One commenter requested that CBOE and NYSE eliminate differences between the CBOE and NYSE risk disclosure documents. In response, CBOE (and the NYSE) amended the rule text to eliminate the risk disclosure language.37 IV. Discussion and Commission Findings The Commission finds that the proposed rule change, as amended, is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange.38 In particular, the Commission believes that the proposed rule change, as amended, is consistent with section 6(b)(5) of the Act 39 in that it is designed to perfect the mechanism of a free and open market and to protect investors and the public interest. The Commission notes that the proposed portfolio margin rule change is intended to promote greater reasonableness, accuracy and efficiency with respect to Exchange margin requirements and will better align margin requirements with actual risk. Under a portfolio margin system, offsets are fully realized, whereas under the Exchange’s current margin rules, positions are margined independent of each other and offsets between them do not figure into the total margin requirement. A portfolio margin system recognizes the offsetting gains from positions that react favorably in market declines, while market rises are 33 CBOE also made these changes to maintain consistency with the NYSE filing. 34 See SIA Letter. 35 See SIA Letter. 36 See Amendment No. 1; see also CBOE Response, supra note 9. 37 Id.; see supra note 25. 38 In approving this proposed rule change, the Commission notes that it has considered the proposed rule’s impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f). 39 15 U.S.C. 78f(b)(5). E:\FR\FM\18DEN1.SGM 18DEN1 75784 Federal Register / Vol. 71, No. 242 / Monday, December 18, 2006 / Notices jlentini on PROD1PC65 with NOTICES tempered by offsetting losses from positions that react negatively. Consequently, a portfolio margin approach can have a neutralizing effect on the volatility of margin requirements. Thus, a portfolio margin system may better align a customer’s total margin requirement with the actual risk associated with the customer’s positions taken as a whole. The Commission further notes portfolio margining may alleviate excessive margin calls, improve cash flows and liquidity, and reduce volatility. Moreover, the Commission notes that approving the proposed rule change would enhance portfolio margining by permitting more products to be margined under this methodology. This is consistent with the amendments to Regulation T made by the FRB in 1998, which sought to advance the use of portfolio margining.40 The Commission also believes that this expanded program for portfolio margining will serve to advance the development of even more risk-sensitive approaches to margining customer positions, including the use of internal models as advocated by commenters. The Commission intends to work with CBOE and the NYSE towards this objective after it gains experience with the portfolio margining system of this proposal. The Commission believes that while the portfolio margining system in the proposed rule will have the effect of reducing customer margin (in most cases), the methodology is relatively conservative in that it requires positions to be shocked at specified market move ranges (e.g., ±15% for individual equities) that represent potential future stress events. Essentially the same portfolio methodology has been used by broker-dealers to calculate haircuts on options positions for net capital purposes.41 Furthermore, the proposed requirement that a firm receive preapproval from the Exchange prior to offering portfolio margining to its customers, coupled with the requirement for enhanced risk management procedures, is designed to ensure that only those firms with 40 Federal Reserve System, ‘‘Securities Credit Transactions; Borrowing by Brokers and Dealers,’’ 63 FR 2806 (January 16, 1998); see also 12 CFR 220.1(b)(3)(i); see also letter from the FRB to James E. Newsome, Acting Chairman, Commodity Futures Trading Commission, and Laura S. Unger, Acting Chairman, Commission, dated March 6, 2001. The FRB concluded the letter by writing ‘‘the Board anticipates that the creation of securities futures products will provide another opportunity to develop more risk-sensitive, portfolio-based approaches for all securities, including securities options and securities futures products.’’ Id. 41 See Exchange Act Release No. 38248 (February 6, 1997), 62 FR 6474 (February 12, 1997). VerDate Aug<31>2005 16:16 Dec 15, 2006 Jkt 211001 adequate controls would be eligible to implement a customer portfolio margining program.42 CBOE also has requested that the Commission approve Amendment Nos. 1 and 2 to the proposed rule change prior to the thirtieth day after publication of notice of the filing in the Federal Register. The Commission believes that the changes in Amendment Nos. 1 and 2 to the proposed rule change do not raise significant new or unique issues from those previously raised in the earlier portfolio margin rule filings.43 The changes proposed by the Exchange in Amendment Nos. 1 and 2 are designed to ensure consistency with the companion NYSE proposed rule filing and to respond to comments received as a result of the Federal Register notice.44 The Commission believes that these proposed changes strengthen the proposed rule change. Accordingly, the Commission finds good cause for approving Amendment Nos. 1 and 2 to the proposed rule change prior to the thirtieth day after the date of publication of notice thereof in the Federal Register. Specifically, the Commission believes that it is consistent with section 19(b)(2) of the Act 45 to approve Amendment Nos. 1 and 2 to CBOE’s proposed rule change prior to the thirtieth day after publication of the notice of filing thereof in the Federal Register. Uniform Effective Date The Commission believes that approving the amendments on an accelerated basis will permit CBOE to begin the process of approving brokerdealers to implement portfolio margining and would allow firms to begin to make the necessary changes and upgrades to their systems, as well as their policies and procedures, in order to accommodate customer portfolio. The Commission, however, believes that if some firms receive CBOE approval to begin offering customer portfolio margining to customers before other firms, these other firms would be at a competitive disadvantage. Therefore, the Commission has determined to set a uniform effective date of April 2, 2007 for the proposed rule change, as amended. As stated above, the Commission believes that 42 The proposed rules also would continue to require a minimum per contract charge of $.375. The Commission also notes that the proposed rules contain a leverage test under which a broker-dealer cannot permit the amount of portfolio margin required of its customers to exceed 10 times the firm’s net capital. 43 See supra note 3. 44 See supra notes 6 and 7. 45 15 U.S.C. 78s(b)(2). PO 00000 Frm 00077 Fmt 4703 Sfmt 4703 setting a uniform effective date will avoid placing some firms at a competitive disadvantage and reduce confusion in the marketplace. V. Solicitation of Comments of Amendment Nos. 1 and 2 Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change, as amended, is consistent with the Exchange Act. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission’s Internet comment form (http://www.sec.gov/ rules/sro.shtml); or • Send e-mail to rulecomments@sec.gov. Please include File Number SR–CBOE–2006–14 on the subject line. 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–CBOE–2006–14. 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 (http://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 Exchange. 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–CBOE–2006–14 and should be submitted on or before January 8, 2007. E:\FR\FM\18DEN1.SGM 18DEN1 75785 Federal Register / Vol. 71, No. 242 / Monday, December 18, 2006 / Notices VI. Conclusion It is therefore ordered, pursuant to section 19(b)(2) of the Act,46 that the proposed rule change (File No. SR– CBOE–2006–14), as amended, be and it hereby is, approved on an accelerated basis, on a pilot basis to expire on July 31, 2007. The effective date will be April 2, 2007. By the Commission. Florence E. Harmon, Deputy Secretary. Exhibit A—Chicago Board Options Exchange, Inc. Chapter XII jlentini on PROD1PC65 with NOTICES Margins Rule 12.4. Portfolio Margin As an alternative to the transaction/ position specific margin requirements set forth in Rule 12.3 of this Chapter 12, a member organization may require margin for all margin equity securities (as defined in Section 220.2 of Regulation T), listed options, unlisted derivatives, security futures products, and index warrants in accordance with the portfolio margin requirements contained in this Rule 12.4. In addition, a member organization, provided it is a Futures Commission Merchant (‘‘FCM’’) and is either a clearing member of a futures clearing organization or has an affiliate that is a clearing member of a futures clearing organization, is permitted under this Rule 12.4 to combine a customer’s related instruments (as defined below), listed index options, unlisted derivatives, options on exchange traded funds, index warrants, and underlying instruments and compute a margin requirement for such combined products on a portfolio margin basis. Application of the portfolio margin provisions of this Rule 12.4 to IRA accounts is prohibited. (a) Definitions. (1) The term ‘‘listed option’’ shall mean any equity (or equity index-based) option traded on a registered national securities exchange or automated facility of a registered national securities association. (2) The term ‘‘security future’’ means a contract of sale for future delivery of a single security or of a narrow-based security index, including any interest therein or based on the value thereof, to the extent that that term is defined in Section 3(a)(55) of the Securities Exchange Act of 1934. (3) The term ‘‘security futures product’’ means a security future, or an option on any security future. 46 15 U.S.C. 78s(b)(2). VerDate Aug<31>2005 16:16 Dec 15, 2006 Jkt 211001 (4) The term ‘‘unlisted derivative’’ means 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 Securities and Exchange Commission. (5) The term ‘‘option series’’ 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. (6) The term ‘‘class’’ refers to all listed options, unlisted derivatives, security futures products, and related instruments that are based on the same underlying instrument, and the underlying instrument itself. (7) The term ‘‘portfolio’’ means products of the same class grouped together. (8) The term ‘‘related instrument’’ within a class or product group means index futures contracts and options on index futures contracts covering the same underlying instrument, but does not include security futures products. (9) The term ‘‘underlying instrument’’ means a security or security index upon which any listed option, unlisted derivative, security futures product or related instrument is based. The term underlying instrument shall not be deemed to include futures contracts, options on futures contracts or underlying stock baskets. (10) The term ‘‘product group’’ means two or more portfolios of the same type for which it has been determined by Rule 15c3–1a(b)(ii) under the Securities Exchange Act of 1934 that a percentage of offsetting profits may be applied to losses at the same valuation point. (11) The terms ‘‘theoretical gains and losses’’ means the gain and loss in the value of each eligible position at 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) (percent) Portfolio type High Capitalization, Broadbased Market Index 1. Non-High Capitalization, Broad-based Market Index 1. Narrow-based Index 1 .......... PO 00000 Frm 00078 Fmt 4703 +6/¥8 +/¥10 +/¥15 Sfmt 4703 Portfolio type Individual Equity 1 ................ Up/down market move (high & low valuation points) (percent) +/¥15 1 In accordance with sub-paragraph (b)(1)(i)(B) of Rule 15c3–1a under the Securities Exchange Act of 1934. (b) Eligible Participants. Any member organization intending to apply the portfolio margin provisions of this Rule 12.4 to its accounts must receive prior approval from its DEA. The member organization will be required to, among other things, demonstrate compliance with Rule 15.8A—Risk Analysis of Portfolio Margin Accounts, and with the net capital requirements of Rule 13.5— Customer Portfolio Margin Accounts. The application of the portfolio margin provisions of this Rule 12.4 is limited to the following customers: (1) Any broker or dealer registered pursuant to Section 15 of the Securities Exchange Act of 1934; (2) any member of a national futures exchange to the extent that listed index options, unlisted derivatives, options on exchange traded funds, index warrants or underlying instruments hedge the member’s related instruments, and (3) any person or entity not included in (b)(1) or (b)(2) above that is approved for writing uncovered options. However, such persons or entities may not establish or maintain positions in unlisted derivatives unless minimum equity of at least five million dollars is established and maintained with the member organization. For purposes of the five million dollar minimum equity requirement, all securities and futures accounts carried by the member organization for the same customer may be combined provided ownership across the accounts is identical. A guarantee by any other account for purposes of the minimum equity requirement is not permitted. (c) Opening of Accounts. (1) Only customers that, pursuant to Rule 9.7, have been approved for writing uncovered options are permitted to utilize a portfolio margin account. (2) On or before the date of the initial transaction in a portfolio margin account, a member shall: (A) Furnish the customer with a special written disclosure statement describing the nature and risks of portfolio margining and which includes an acknowledgement for all portfolio margin account owners to sign, attesting that they have read and understood the disclosure statement, and agree to the E:\FR\FM\18DEN1.SGM 18DEN1 jlentini on PROD1PC65 with NOTICES 75786 Federal Register / Vol. 71, No. 242 / Monday, December 18, 2006 / Notices terms under which a portfolio margin account is provided, and (B) obtain a signed acknowledgement from the customer and record the date of receipt. (d) Establishing Account and Eligible Positions. (1) For purposes of applying the portfolio margin requirements provided in this Rule 12.4, member organizations are to establish and utilize a dedicated securities margin account, or subaccount of a margin account, clearly identified as a portfolio margin account that is separate from any other securities account carried for a customer. A margin deficit in the portfolio margin account of a customer may not be considered as satisfied by excess equity in another account. Funds and/ or securities must be transferred to the deficient account and a written record created and maintained. In the case of a portfolio margin account carried as a sub-account of a margin account, excess equity in the margin account may be used to satisfy a margin deficiency in the portfolio margin sub-account without transferring funds and/or securities to the portfolio margin subaccount. (3) Eligible Positions (A) (i) a margin equity security (including 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; and a 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 to permit the sale of the security, upon exercise of any listed option or unlisted derivative written against it, without restriction). (ii) a listed option on an equity security or index of equity securities, (iii) a security futures product, (iv) an unlisted derivative on an equity security or index of equity securities, (v) a warrant on an equity security or index of equity securities, and (vi) a related instrument. (4) Positions other than those listed in (3)(A) above are not eligible for portfolio margin treatment. However, positions not eligible for portfolio margin treatment (except for ineligible related instruments) may be carried in a portfolio margin account subject to the margin required pursuant Rule 12.3 of this Chapter 12. Shares of a money market mutual fund may be carried in a portfolio margin account subject to the margin required pursuant to Exchange VerDate Aug<31>2005 16:16 Dec 15, 2006 Jkt 211001 Rule 12.3 of this Chapter 12 provided that: (i) The customer waives any right to redeem the shares without the member organization’s consent, (ii) the member organization (or, if the shares are deposited with a clearing organization, the clearing organization) obtains the right to redeem the shares in cash upon request, (iii) the fund agrees to satisfy any conditions necessary or appropriate to ensure that the shares may be redeemed in cash, promptly upon request, and (iv) the member organization complies with the requirements of Section 11(d)(1) of the Securities Exchange Act of 1934 and Rule 11d1– 2 thereunder. (e) Initial and Maintenance Margin Required. The amount of margin required under this Rule 12.4 for each portfolio shall be the greater of: (1) The amount for any of the ten equidistant valuation points representing the largest theoretical loss as calculated pursuant to paragraph (f) below or (2) $.375 for each listed option, unlisted derivative, security futures product, and related instrument multiplied by the contract or instrument’s multiplier, not to exceed the market value in the case of long positions. (f) Method of Calculation. (1) Long and short positions in eligible positions are to be grouped by class; each class group being a ‘‘portfolio’’. Each portfolio is categorized as one of the portfolio types specified in paragraph (a)(11) above. (2) For each portfolio, theoretical gains and losses are calculated for each position as specified in paragraph (a)(11) above. For purposes of determining the theoretical gains and losses at each valuation point, member organizations shall obtain and utilize the theoretical value of a listed option, unlisted derivative, security futures product, underlying instrument, and related instrument rendered by a theoretical pricing model that has been approved by the Securities and Exchange Commission.1 (3) Offsets. Within each portfolio, theoretical gains and losses may be netted fully at each valuation point. Offsets between portfolios within the High Capitalization, Broad-Based Index Option, Non-High Capitalization, BroadBased Index Option and Narrow-Based Index Option product groups may then be applied as permitted by Rule 15c3– 1 Currently, the theoretical model utilized by the Options Clearing Corporation is the only model qualified. PO 00000 Frm 00079 Fmt 4703 Sfmt 4703 1a under the Securities Exchange Act of 1934. (4) After applying paragraph (3) 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). (5) In addition, if a security that is convertible, exchangeable, or exercisable into a security that is an underlying instrument requires the payment of money or would result in a loss if converted, exchanged, or exercised at the time when the security is deemed an underlying instrument, the full amount of the conversion loss is required. (g) Minimum Equity Deficiency. If, as of the close of business, the equity in the portfolio margin account declines below the five million dollar minimum equity required under Paragraph (b) of this Rule 12.4 and is not restored to the required level within three (3) business days by a deposit of funds or securities, or through favorable market action; member organizations are prohibited from accepting new orders beginning on the fourth business day, except that new orders entered for the purpose of reducing market risk may be accepted if the result would be to lower margin requirements. This prohibition shall remain in effect until such time as: (1) The required minimum account equity is re-established or (2) all unlisted derivatives are liquidated or transferred from the portfolio margin account to the appropriate account. In computing net capital, a deduction in the amount of a customer’s equity deficiency may not serve in lieu of complying with the above requirements. (h) Determination of Value for Margin Purposes. For the purposes of this Rule 12.4, all eligible positions shall be valued at current market prices. Account equity for the purposes of this Rule 12.4 shall be calculated separately for each portfolio margin account by adding the current market value of all long positions, subtracting the current market value of all short positions, and adding the credit (or subtracting the debit) balance in the account. (i) Additional Margin. (1) If, as of the close of business, the equity in any portfolio margin account is less than the margin required, the customer may deposit additional margin or establish a hedge to meet the margin requirement within three business days. After the three business day period, member organizations are prohibited from accepting new orders, except that new orders entered for the purpose of reducing market risk may be accepted if the result would be to lower margin E:\FR\FM\18DEN1.SGM 18DEN1 jlentini on PROD1PC65 with NOTICES Federal Register / Vol. 71, No. 242 / Monday, December 18, 2006 / Notices requirements. In the event a customer fails to deposit additional margin in an amount sufficient to eliminate any margin deficiency or hedge existing positions after 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 account equity. Member organizations should not permit a customer to make a practice of meeting a portfolio margin deficiency by liquidation. Member organizations must have procedures in place to identify accounts that periodically liquidate positions to eliminate margin deficiencies, and a member organization is expected to take appropriate action when warranted. Liquidations to eliminate margin deficiencies that are caused solely by adverse price movements may be disregarded. Guarantees by any other account for purposes of margin requirements is not permitted. (2) Pursuant to Rule 13.5—Customer Portfolio Margin Accounts, if additional margin required is not obtained by the close of business on T+1, member organizations must deduct in computing net capital any amount of the additional margin that is still outstanding until such time as the additional margin is obtained or positions are liquidated pursuant to (i)(1) above. (3) A deduction in computing net capital in the amount of a customer’s margin deficiency may not serve in lieu of complying with the requirements of (i)(1) above. (4) A member organization may request from its DEA an extension of time for a customer to deposit additional margin. Such request must be in writing and will be granted only in extraordinary circumstances. (5) The day trading restrictions promulgated under Rule 12.3(j) shall not apply to portfolio margin accounts that establish and maintain at least five million dollars in equity, provided a member organization has the ability to monitor the intra-day risk associated with day trading. Portfolio margin accounts that do not establish and maintain at least five million dollars in equity will be subject to the day trading restrictions under Rule 12.3(j), provided the member organization has the ability to apply the applicable day trading restrictions under that Rule. However, if the position or positions day traded were part of a hedge strategy, the day trading restrictions will not apply. A ‘‘hedge strategy’’ for the purpose of this rule means a transaction or a series of transactions that reduces or offsets a material portion of the risk in a VerDate Aug<31>2005 16:16 Dec 15, 2006 Jkt 211001 portfolio. Member organizations are also expected to monitor these portfolio margin accounts to detect and prevent circumvention of the day trading requirements. (j) Portfolio Margin Accounts— Requirement to Liquidate. (1) A member organization is required immediately either to liquidate, or transfer to another broker-dealer eligible to carry related instruments within portfolio margin accounts, all customer portfolio margin accounts with positions in related instruments if the member is: (i) Insolvent as defined in section 101 of title 11 of the United States Code, or is unable to meet its obligations as they mature; (ii) 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; (iii) 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 customers’ securities; or (iv) Unable to make such computations as may be necessary to establish compliance with such financial responsibility or hypothecation rules. (2) Nothing in this paragraph (j) 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. * * * * * (Note: The sample risk description document is deleted in its entirety) 75787 Chapter XIII Net Capital Rule 13.5. Customer Portfolio Margin Accounts (a) No member organization that requires margin in any customer accounts pursuant to Rule 12.4— Portfolio Margin shall permit gross customer portfolio margin requirements to exceed 1,000 percent of its net capital for any period exceeding three business days. The member organization shall, beginning on the fourth business day of any non-compliance, cease opening new portfolio margin accounts until compliance is achieved. (b) If, at any time, a member organization’s gross customer portfolio margin requirements exceed 1,000 percent of its net capital, the member organization shall immediately transmit telegraphic or facsimile notice of such deficiency to the Office of Market Supervision, Division of Market Regulation, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549; to 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 its Designated Examining Authority. (c) If any customer portfolio margin account becomes subject to a call for additional margin, and all of the additional margin is not obtained by the close of business on T+1, member organizations must deduct in computing net capital any amount of the additional margin that is still outstanding until such time as it is obtained or positions are liquidated pursuant to Rule 12.4(i)(1). * * * * * Chapter XV Chapter 9 Records, Reports and Audits Doing Business with the Public Rule 9.15. Delivery of Current Options Disclosure Documents and Prospectus (a) no change (b) no change (c) The special written disclosure statement describing the nature and risks of portfolio margining and acknowledgement for customer signature, required by Rule 12.4(c)(2) 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 the prescribed Exchange format and has received prior written approval of the Exchange. * * * * * PO 00000 Frm 00080 Fmt 4703 Sfmt 4703 Rule 15.8A. Risk Analysis of Portfolio Margin Accounts (a) Each member organization that maintains any portfolio margin accounts for customers shall establish and maintain a comprehensive written risk analysis methodology for assessing and monitoring 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 E:\FR\FM\18DEN1.SGM 18DEN1 jlentini on PROD1PC65 with NOTICES 75788 Federal Register / Vol. 71, No. 242 / Monday, December 18, 2006 / Notices risk analysis methodology must be filed with the member organization’s Designated Examining Authority and submitted to the SEC prior to the implementation of portfolio margining. (b) Upon direction by the Department of Member Firm Regulation, each affected member organization shall provide to the Department such information as the Department may reasonably require with respect to the member organization’s risk analysis for any or all of the portfolio margin accounts it maintains for customers. (c) In conducting the risk analysis of portfolio margin accounts required by this Rule 15.8A, each member organization shall include in the written risk analysis methodology required pursuant to paragraph (a) above procedures and guidelines for: (1) Obtaining and reviewing the appropriate customer account documentation and financial information necessary for assessing the amount of credit extended to customers, (2) the determination, review and approval of credit limits to each customer, and across all customers, utilizing a portfolio margin account, (3) monitoring credit risk exposure to the member organization from portfolio margin accounts, on both an intra-day and end of day basis, including the type, scope and frequency of reporting to senior management, (4) the use of stress testing of portfolio margin accounts in order to monitor market risk exposure from individual accounts and in the aggregate, (5) the regular review and testing of these risk analysis procedures by an independent unit such as internal audit or other comparable group, (6) managing the impact of credit extension on the member organization’s overall risk exposure, (7) the appropriate response by management when limits on credit extensions have been exceeded, and (8) determining the need to collect additional margin from a particular eligible participant, including whether that determination was based upon the creditworthiness of the participant and/ or the risk of the eligible position(s). 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 Rule 15.8A is accessible on a timely basis and information systems are available to capture, monitor, analyze and report relevant data. [FR Doc. E6–21480 Filed 12–15–06; 8:45 am] BILLING CODE 8011–01–P VerDate Aug<31>2005 16:16 Dec 15, 2006 Jkt 211001 SECURITIES AND EXCHANGE COMMISSION [Release No. 34–54909; File No. SR–NASD– 2006–129] Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Notice of Filing and Immediate Effectiveness of a Proposed Rule Change Relating to the Use of a Special Indicator for Transactions Reported in Accordance With Section 3 of Schedule A to the NASD By-Laws December 11, 2006. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’),1 and Rule 19b–4 thereunder,2 notice is hereby given that on November 29, 2006, the National Association of Securities Dealers, Inc. (‘‘NASD’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change as described in Items I and II below, which Items have been prepared by the NASD. The NASD has submitted the proposed rule change under Section 19(b)(3)(A) of the Act 3 and Rule 19b–4(f)(6) thereunder,4 which renders the proposal effective upon filing with the Commission.5 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 NASD proposes to adopt new paragraph (f) of NASD Rule 6130C, ‘‘Trade Report Input,’’ which will require members that report to the NASD/NSX Trade Reporting Facility (‘‘NASD/NSX TRF’’) 6 odd-lot transactions, sales where the buyer and seller have agreed to a price substantially unrelated to the current market for the security (also referred to as ‘‘away from the market sales’’), and purchases or sales of securities effected upon the exercise of an over-the-counter (‘‘OTC’’) option to use a special indicator denoting that such transactions are reported in accordance with Section 3 of Schedule A to the NASD By-Laws. Because the systems changes required to enable the NASD/ NSX TRF to support the proposed new trade report modifiers have not been 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 15 U.S.C. 78s(b)(3)(A). 4 17 CFR 240.19b–4(f)(6). 5 The NASD has asked the Commission to waive the 30-day operative delay provided in Rule 19b– 4(f)(6)(iii). 17 CFR 240.19b–4(f)(6)(iii). 6 The NASD/NSX TRF is the trade reporting facility established by the NASD and the National Stock Exchange. 2 17 PO 00000 Frm 00081 Fmt 4703 Sfmt 4703 completed, proposed NASD Rule 6130C(f) specifies that prior to December 15, 2006, members cannot use the NASD/NSX TRF to report these transactions to the NASD and must use another electronic mechanism to satisfy their reporting obligations. The text of proposed NASD Rule 6130C(f) is substantially similar to NASD Rule 6130(g), which the Commission approved on June 12, 2006,7 and which became effective on December 1, 2006. In this proposal, the NASD also is proposing technical conforming changes to NASD Rule 6130(g). The text of the proposed rule change is available at www.nasd.com, at the principal offices of the NASD, and at the Commission’s Public Reference Room. 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 NASD included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The NASD has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose Background In the June 2006 Order, the Commission approved an NASD proposal that, among other things, amended the NASD’s By-Laws to require members to report to the NASD in an automated manner all transactions that must be reported to the NASD and that are subject to a regulatory transaction fee pursuant to Section 3 of Schedule A to the NASD By-Laws (‘‘Section 3’’).8 In that proposal, the NASD also adopted NASD Rule 6130(g), which requires members to report to the System, defined to include the NASD/ 7 See Securities Exchange Act Release No. 53977 (June 12, 2006), 71 FR 34976 (June 16, 2006) (order approving SR-NASD–2006–055) (‘‘June 2006 Order’’). 8 See June 2006 Order, supra note 7. Pursuant to Section 31 of the Act, the NASD and the national securities exchanges are required to pay transaction fees and assessments to the Commission that are designed to recover the costs related to the government’s supervision and regulation of the securities markets and securities professionals. The NASD obtains its Section 31 fees and assessments from its membership, in accordance with Section 3. E:\FR\FM\18DEN1.SGM 18DEN1

Agencies

[Federal Register Volume 71, Number 242 (Monday, December 18, 2006)]
[Notices]
[Pages 75781-75788]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E6-21480]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54919; File No. SR-CBOE-2006-14]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Notice of Filing of Amendment Nos. 1 and 2 to the 
Proposed Rule Change Relating to Customer Portfolio Margining; Order 
Granting Accelerated Approval to the Proposed Rule Change, as Amended

December 12, 2006.

I. Introduction

    On February 2, 2006, the Chicago Board Options Exchange, 
Incorporated (``CBOE'' or ``Exchange'') filed with the Securities and 
Exchange Commission (``Commission''), pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'' or ``Exchange Act'') \1\ 
and Rule 19b-4 \2\ thereunder, a proposed rule change seeking to amend 
CBOE Rule 12.4 to expand the scope of products that are eligible for 
treatment as part of CBOE's approved portfolio margin pilot program and 
to eliminate the requirement for a separate cross-margin account.\3\ 
The proposed rule change would expand the scope of eligible products in 
the pilot to include margin equity securities,\4\ unlisted derivatives, 
listed options and securities futures.\5\ The proposed rule change was 
published in the Federal Register on April 6, 2006.\6\ The Commission 
subsequently extended the comment period for the original proposed rule 
filing until May 11, 2006.\7\ The Commission received 7 comment letters 
in response to the Federal Register notice.\8\ On July 26, 2006, CBOE 
filed a response to these comments.\9\ The comment letters and CBOE's 
response to the comments are summarized below. On August 9, 2006, CBOE 
filed Amendment No. 1 to the proposed rule change.\10\ On September 27, 
2006, CBOE filed Amendment No. 2 to the proposed rule change.\11\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Exchange Act Release No. 52032 (July 14, 2005), 70 FR 
42118 (July 21, 2005) (SR-CBOE-2002-03). On July 14, 2005, the 
Commission approved on a pilot basis expiring July 31, 2007, 
amendments to CBOE's margin rules that permit broker-dealers to 
determine customer margin requirements for portfolios of listed 
broad-based securities index options, warrants, futures, futures 
options and related exchange-traded funds using a specified 
portfolio margin methodology. The Commission also approved rule 
amendments to require disclosure to, and written acknowledgment 
from, customers using a portfolio margin account.
    \4\ For purposes of the pilot, a margin equity security is a 
security that meets the definition of a ``margin equity security'' 
under Regulation T of the Federal Reserve Board (``FRB''). See 12 
CFR 220.2. An unlisted derivative means ``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 
Securities and Exchange Commission.'' See proposed Rule 12.4(a)(4).
    \5\ In addition to CBOE Rule 12.4, the proposed rule change also 
approves changes to CBOE Rules 9.15, 13.5 and 15.8A.
    \6\ See Exchange Act Release No. 53576 (March 30, 2006), 71 FR 
17519 (April 6, 2006) (SR-CBOE-2006-14). The New York Stock Exchange 
LLC (``NYSE'') also filed a similar proposed rule filing seeking to 
expand the scope of eligible products under its portfolio margin 
pilot program. See Exchange Act Release No. 53577 (March 30, 2006), 
71 FR 17539 (April 6, 2006) (SR-NYSE-2006-13).
    \7\ See Exchange Act Release No. 53728 (April 26, 2006), 71 FR 
25878 (May 2, 2006).
    \8\ See letter from Timothy H. Thompson, Senior Vice President, 
Chief Regulatory Officer, Regulatory Services Division, CBOE, to 
Nancy Morris, Secretary, Commission, dated June 5, 2006 (``CBOE 
Letter''); letter from William H. Navin, Executive Vice President, 
General Counsel and Secretary, The Options Clearing Corporation 
(``OCC''), to Nancy M. Morris, Secretary, Commission, dated May 19, 
2006 (``OCC Letter''); letter from James Barry, on behalf of the Ad 
Hoc Portfolio Margin Committee, John Vitha, Chair, Derivatives 
Product Committee and Christopher Nagy, Chair, Options Committee, 
Securities Industry Association, to Nancy M. Morris, Secretary, 
dated May 16, 2006 (``SIA Letter''); letter from Gary Alan DeWaal, 
Group General Counsel and Director of Legal and Compliance, Fimat 
USA, LLC, to Nancy M. Morris, Secretary, Commission, dated May 11, 
2006 (``Fimat Letter''); letter from Stuart J. Kaswell, Partner, 
Dechert LLP, Counsel for Federated Investors, Inc., to Nancy M. 
Morris, Secretary, Commission, dated May 10, 2006 (``Federated 
Letter''); letter from Craig S. Donohue, Chief Executive Officer, 
Chicago Mercantile Exchange Inc., to Jonathan G. Katz, Secretary, 
Commission, dated May 9, 2006 (``CME Letter''); and letter from 
Gerard J. Quinn, Vice President and Associate General Counsel, SIA, 
to Nancy M. Morris, Secretary, Commission, dated April 21, 2006 
(``SIA Extension Letter'').
    \9\ See letter from Timothy H. Thompson, Senior Vice President, 
Chief Regulatory Officer, Regulatory Services Division, CBOE, to 
Nancy M. Morris, Secretary, Commission, dated July 26, 2006 (``CBOE 
Response'').
    \10\ CBOE filed Amendment No. 1 in response to comments received 
and to make other clarifying changes to the proposed rule filing. 
Amendment No. 1 replaced and superceded the original filing in its 
entirety.
    \11\ CBOE filed partial Amendment No. 2 to conform its day 
trading language to the NYSE rule language and to request 
accelerated approval. A clean copy of the proposed rule, as amended 
by Amendment Nos. 1 and 2, is attached to this order as Exhibit A.
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    This order provides notice of filing of Amendment Nos. 1 and 2 and 
solicits comments from interested persons on Amendment Nos. 1 and 2. 
This order also grants accelerated approval of the proposed rule 
change, as amended by Amendment Nos. 1 and 2.\12\
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    \12\ By separate order, the Commission also is approving a 
parallel rule filing by the NYSE (SR-NYSE-2006-13). Exchange Act 
Release No. 54918; see also supra note 6.
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II. Description

a. Portfolio Margining

    The proposed rule change consists of amendments to Rule 12.4 to 
include

[[Page 75782]]

margin equity securities (as defined in Regulation T), unlisted 
derivatives, listed options and securities futures as eligible products 
for the portfolio margining pilot.\13\ The proposed rule change also 
includes amendments to eliminate the requirement of a separate cross-
margin account. CBOE Rule 12.3 prescribes specific margin requirements 
for customers based on the type of securities held in their 
accounts.\14\ Outside the existing pilot program, CBOE's margin rules 
require that margin be calculated using fixed percentages, on a 
position-by-position basis. In contrast, the current portfolio margin 
pilot program permits a broker-dealer to calculate customer margin 
requirements by grouping all products in an account that are based on 
the same index or issuer into a single portfolio. For example, futures, 
options and exchange traded funds based on the S&P 500 would each be 
grouped in a portfolio and products based on IBM would be grouped into 
a separate portfolio.
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    \13\ The list of eligible products under the pilot currently 
includes listed broad-based securities index options, warrants, 
futures, futures options and related exchange-traded funds.
    \14\ The margin rules specify the amount of equity a customer 
must maintain in his or her margin account with respect to 
securities positions financed by the broker-dealer. The equity 
protects the broker-dealer in the event the customer defaults on the 
obligation to re-pay the financing and the broker-dealer is forced 
to liquidate the position at a loss.
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    The broker-dealer then calculates a customer's margin requirement 
by ``shocking'' each portfolio at different equidistant points along a 
range representing a potential percentage increase and decrease in the 
value of the instrument or underlying instrument in the case of a 
derivative product. Currently, under the pilot, products of portfolios 
based on high capitalization, broad-based securities indexes are 
shocked along a range spanning an increase of 6% and a decrease of 8%. 
Portfolios of products based on non-high capitalization, broad-based 
securities indexes are shocked along a range spanning an increase of 
10% and a decrease of 10%. The proposed rule change would continue to 
apply these shock ranges. Under the proposed amendments, portfolios of 
products based on an equity security or a narrow-based index would be 
shocked along a range spanning an increase of 15% and a decrease of 
15%.\15\ In addition, as with the current pilot, a theoretical options 
pricing model would continue to be used to derive position values at 
each valuation point for the purpose of determining the gain or 
loss.\16\
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    \15\ For example, under the pilot, a portfolio of single stock 
futures and listed equity options would be shocked at 10 equidistant 
points along a range bounded on one end by a 15% increase in the 
market value of the instrument and at the other end by a 15% 
decrease (i.e., at 3%, 6%, 9%, 
12% and 15%).
    \16\ Currently, the only model that qualifies is the OCC's 
Theoretical Intermarket Margining System (TIMS).
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    The portfolio shocks described above result in a gain or loss for 
each instrument in a portfolio at each calculation point along the 
range. These gains and losses are netted to derive a potential 
portfolio-wide gain or loss for the point. The margin requirement for a 
portfolio is the amount of the greatest portfolio-wide loss among the 
calculation points. The margin requirements for each portfolio are 
added together to calculate the total margin requirement for the 
portfolio margin account. This approach, in most cases, will generally 
lower customer margin requirements.\17\
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    \17\ For example, the current required initial and maintenance 
margin requirements for an equity security are 50% and 25%, 
respectively. The market movement range to calculate the potential 
gains and losses under the proposed portfolio margin rule for equity 
securities is 15%.
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    The amount of margin (initial and maintenance) required with 
respect to a given portfolio would be the larger of: (1) The greatest 
portfolio-wide loss amount among the valuation point calculations; or 
(2) the sum of $.375 for each option and future in the portfolio 
multiplied by the contract's or instrument's multiplier.\18\ The second 
computation establishes a minimum margin requirement to ensure that a 
certain level of margin is required from the customer in the event the 
greatest portfolio-wide loss among the valuation points is de minimis.
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    \18\ The multiplier for a standard listed option is fixed by the 
options market on which the options series is traded. For example, a 
cash settled equity option generally has a multiplier of 100. 
Therefore, the minimum margin for one options contract would be 
$37.50. The multipliers for different securities and futures 
products may vary.
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b. Expansion of Eligible Products

    Under CBOE's proposed rule, products eligible for portfolio 
margining would be expanded to include margin equity securities (as 
defined under Regulation T),\19\ unlisted derivatives, listed options 
and securities futures. The unlisted derivatives would be included in a 
portfolio based on the underlying reference index or security. 
Individual equities and narrow-based index futures would be included in 
a portfolio shocked at a range spanning an increase of 15% and a 
decrease of 15%.
---------------------------------------------------------------------------

    \19\ Margin equity securities include certain foreign equity 
securities and options on foreign equity securities. See 12 CFR 
220.2
---------------------------------------------------------------------------

c. Margin Deficiency

    The proposed rule change would require a customer to satisfy a 
margin deficiency in a portfolio margin account within three business 
days by depositing additional margin or effecting an offsetting hedge. 
The current pilot requires that a customer deposit addition margin by 
T+1. The proposed rule also would require a broker-dealer to deduct 
from its net capital the amount of any portfolio margin call not met by 
the close of business on T+1 and until the call is satisfied. 
Additionally, the proposal would further require a broker-dealer to 
have in place procedures to identify accounts that periodically 
liquidate positions to eliminate margin deficiencies, and to take 
appropriate action when warranted.\20\
---------------------------------------------------------------------------

    \20\ See proposed rule 12.4(i)(1).
---------------------------------------------------------------------------

d. $5 Million Equity Requirement

    The current pilot requires customers that are not broker-dealers or 
futures firms to maintain minimum account equity of $5 million dollars. 
The proposed rule change would eliminate the $5 million account equity 
requirement for all portfolio margin accounts, except those holding 
unlisted derivatives.\21\
---------------------------------------------------------------------------

    \21\ See proposed rule 12.4(b)(3).
---------------------------------------------------------------------------

e. Risk Management Methodology

    The pilot requires member broker-dealers to monitor the risk of 
portfolio margin accounts and maintain a written risk analysis 
methodology for assessing potential risk to the firm's capital. This 
risk analysis methodology must be filed and maintained with CBOE. The 
proposed rule change strengthens these requirements by providing that, 
member organizations must file the risk analysis methodology with its 
firm's DEA and submit it to the Commission prior to implementation.\22\ 
The proposed rule change also requires the inclusion of additional 
procedures and guidelines as part of the methodology.\23\
---------------------------------------------------------------------------

    \22\ See proposed Rule 12.4(b), under which the broker-dealer 
must receive prior approval from its DEA prior to offering portfolio 
margining to its customers. As part of the approval process, CBOE 
will require a firm to demonstrate compliance with the risk 
management analysis rules.
    \23\ See proposed Rule 15.8A.
---------------------------------------------------------------------------

f. Cross-Margin Account

    The proposed rule change would eliminate the requirement that 
portfolios with futures positions be held in a separate cross-margin 
account. Under the proposal, a customer would be permitted to use a 
single securities margin account for all eligible products. The 
Exchange and commenters have

[[Page 75783]]

indicated that maintaining and monitoring two separate margin accounts 
would be operationally difficult and that it would be more efficient to 
hold all positions in one securities account.

g. Excess Equity and Collateral

    CBOE also proposes to amend Rule 12.4 to add language allowing a 
customer to use excess equity in a regular margin account to meet a 
margin deficiency in a portfolio margin account without having to 
transfer any funds or securities where the portfolio margin account is 
a sub-account of the regular margin account. In addition, the proposed 
rule change adds language allowing positions (including nonequity 
securities and money market mutual funds) not eligible for portfolio 
margin treatment to be carried in the portfolio margin account for 
their collateral value, subject to the margin requirements of a regular 
margin account.

h. Day Trading

    The proposed rule change amends the day trading provisions of Rule 
12.4 to provide that CBOE's day trading rules do not apply to portfolio 
margin accounts that have at least $5 million equity, provided the 
member firm has the ability to monitor the intra-day risk associated 
with day trading. In addition, the proposed rule change would provide 
that day trading will not be deemed to have occurred whenever the 
position or positions day traded were part of a hedge strategy \24\ 
that reduced the risk of the portfolio.
---------------------------------------------------------------------------

    \24\ A ``hedge strategy'' for purposes of the day trading 
restrictions on portfolio margining means a transaction or series of 
transactions that reduces or offsets a material portion of the risk 
in a portfolio.
---------------------------------------------------------------------------

i. Risk Disclosure Statement

    The proposed rule change eliminates the sample risk disclosure 
statement and acknowledgement in the rule text.\25\
---------------------------------------------------------------------------

    \25\ Instead the Exchange will send out a regulatory circular 
with the sample disclosure language. The Exchange made this change 
to avoid having to file a proposed rule change each time in the risk 
disclosure document is changed.
---------------------------------------------------------------------------

j. Hedged Positions

    Under the pilot, an underlying security in a portfolio margin 
account must be removed from the account if it is no longer offset by 
an option position. The amendments propose to eliminate the requirement 
to remove instruments that are no longer offset by options positions. 
CBOE made this change in response to comments that all positions 
eligible for a portfolio margin account, including underlying 
securities, should receive equal treatment. Moreover, CBOE noted that 
it would be operationally difficult to move positions in and out of the 
portfolio margin account based on whether they are currently being 
offset.

III. Summary of Comments Received and CBOE Response

    The Commission received a total of 7 comment letters to the 
proposed rule change.\26\ The comments, in general, were supportive. 
One commenter stated that it strongly supports ``the significant step 
forward represented by the currently proposed changes.'' \27\ Another 
commenter stated that the portfolio margining of securities products 
will ``help U.S. brokers and exchanges compete more effectively with 
their overseas counterparts * * * and thereby increase the strength and 
liquidity of U.S. markets.'' \28\ Each commenter, however, recommended 
changes to specific provisions of the proposed rule change.
---------------------------------------------------------------------------

    \26\ See supra note 8. One of the comment letters related to the 
extension of the comment period for the proposed rule change. See 
SIA Extension Letter.
    \27\ See SIA Letter.
    \28\ See Fimat Letter.
---------------------------------------------------------------------------

    Several commenters \29\ submitted comments regarding the ability to 
use portfolio margin methodologies other than the method prescribed in 
the rule to calculate customer margin requirements. One commenter 
stated that the Commission has experience in approving proprietary 
market risk models for consolidated supervised entities (CSEs) and OTC 
derivatives dealers.\30\ The Exchange stated, however, that initially, 
the most prudent course is for all broker-dealers to utilize the rule's 
specified methodology and that in the longer term, proprietary risk 
models could be considered as alternatives.\31\
---------------------------------------------------------------------------

    \29\ See SIA Letter and OCC Letter; see also CME Letter 
(discussing SPAN).
    \30\ See SIA Letter.
    \31\ See CBOE Response, supra note 9.
---------------------------------------------------------------------------

    One commenter suggested that CBOE eliminate the requirement for a 
separate cross margin account and provide for one portfolio margin 
account for both futures and options; eliminate the requirement that 
stock must be hedged in order to be carried in a portfolio margin 
account; and eliminate the two-tiered per contract minimum margin 
requirement in favor of one overall minimum.\32\ The CBOE stated that 
it agrees with the proposed changes and believes they are operationally 
feasible. In response, CBOE made these changes in Amendment No. 1 to 
the proposed rule filing.\33\
---------------------------------------------------------------------------

    \32\ See SIA Letter.
    \33\ CBOE also made these changes to maintain consistency with 
the NYSE filing.
---------------------------------------------------------------------------

    One commenter stated that portfolio margining should be expanded to 
include nonequity securities, interest rate derivatives, collateralized 
debt obligations and other similar non-equity related products, and 
foreign currency derivatives.\34\ This commenter also requested that 
nonequity securities be permitted to be held in the portfolio margin 
account for collateral purposes only, subject to the other applicable 
margin requirements.\35\ The Exchange noted that it agrees with the 
commenter to the extent that nonequity securities may serve as 
collateral in the portfolio margin account.\36\
---------------------------------------------------------------------------

    \34\ See SIA Letter.
    \35\ See SIA Letter.
    \36\ See Amendment No. 1; see also CBOE Response, supra note 9.
---------------------------------------------------------------------------

    One commenter requested that CBOE and NYSE eliminate differences 
between the CBOE and NYSE risk disclosure documents. In response, CBOE 
(and the NYSE) amended the rule text to eliminate the risk disclosure 
language.\37\
---------------------------------------------------------------------------

    \37\ Id.; see supra note 25.
---------------------------------------------------------------------------

IV. Discussion and Commission Findings

    The Commission finds that the proposed rule change, as amended, is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\38\ In particular, the Commission believes that the proposed 
rule change, as amended, is consistent with section 6(b)(5) of the Act 
\39\ in that it is designed to perfect the mechanism of a free and open 
market and to protect investors and the public interest. The Commission 
notes that the proposed portfolio margin rule change is intended to 
promote greater reasonableness, accuracy and efficiency with respect to 
Exchange margin requirements and will better align margin requirements 
with actual risk.
---------------------------------------------------------------------------

    \38\ In approving this proposed rule change, the Commission 
notes that it has considered the proposed rule's impact on 
efficiency, competition, and capital formation. 15 U.S.C. 78c(f).
    \39\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    Under a portfolio margin system, offsets are fully realized, 
whereas under the Exchange's current margin rules, positions are 
margined independent of each other and offsets between them do not 
figure into the total margin requirement. A portfolio margin system 
recognizes the offsetting gains from positions that react favorably in 
market declines, while market rises are

[[Page 75784]]

tempered by offsetting losses from positions that react negatively. 
Consequently, a portfolio margin approach can have a neutralizing 
effect on the volatility of margin requirements. Thus, a portfolio 
margin system may better align a customer's total margin requirement 
with the actual risk associated with the customer's positions taken as 
a whole. The Commission further notes portfolio margining may alleviate 
excessive margin calls, improve cash flows and liquidity, and reduce 
volatility.
    Moreover, the Commission notes that approving the proposed rule 
change would enhance portfolio margining by permitting more products to 
be margined under this methodology. This is consistent with the 
amendments to Regulation T made by the FRB in 1998, which sought to 
advance the use of portfolio margining.\40\ The Commission also 
believes that this expanded program for portfolio margining will serve 
to advance the development of even more risk-sensitive approaches to 
margining customer positions, including the use of internal models as 
advocated by commenters. The Commission intends to work with CBOE and 
the NYSE towards this objective after it gains experience with the 
portfolio margining system of this proposal.
---------------------------------------------------------------------------

    \40\ Federal Reserve System, ``Securities Credit Transactions; 
Borrowing by Brokers and Dealers,'' 63 FR 2806 (January 16, 1998); 
see also 12 CFR 220.1(b)(3)(i); see also letter from the FRB to 
James E. Newsome, Acting Chairman, Commodity Futures Trading 
Commission, and Laura S. Unger, Acting Chairman, Commission, dated 
March 6, 2001. The FRB concluded the letter by writing ``the Board 
anticipates that the creation of securities futures products will 
provide another opportunity to develop more risk-sensitive, 
portfolio-based approaches for all securities, including securities 
options and securities futures products.'' Id.
---------------------------------------------------------------------------

    The Commission believes that while the portfolio margining system 
in the proposed rule will have the effect of reducing customer margin 
(in most cases), the methodology is relatively conservative in that it 
requires positions to be shocked at specified market move ranges (e.g., 
15% for individual equities) that represent potential 
future stress events. Essentially the same portfolio methodology has 
been used by broker-dealers to calculate haircuts on options positions 
for net capital purposes.\41\ Furthermore, the proposed requirement 
that a firm receive pre-approval from the Exchange prior to offering 
portfolio margining to its customers, coupled with the requirement for 
enhanced risk management procedures, is designed to ensure that only 
those firms with adequate controls would be eligible to implement a 
customer portfolio margining program.\42\
---------------------------------------------------------------------------

    \41\ See Exchange Act Release No. 38248 (February 6, 1997), 62 
FR 6474 (February 12, 1997).
    \42\ The proposed rules also would continue to require a minimum 
per contract charge of $.375. The Commission also notes that the 
proposed rules contain a leverage test under which a broker-dealer 
cannot permit the amount of portfolio margin required of its 
customers to exceed 10 times the firm's net capital.
---------------------------------------------------------------------------

    CBOE also has requested that the Commission approve Amendment Nos. 
1 and 2 to the proposed rule change prior to the thirtieth day after 
publication of notice of the filing in the Federal Register. The 
Commission believes that the changes in Amendment Nos. 1 and 2 to the 
proposed rule change do not raise significant new or unique issues from 
those previously raised in the earlier portfolio margin rule 
filings.\43\ The changes proposed by the Exchange in Amendment Nos. 1 
and 2 are designed to ensure consistency with the companion NYSE 
proposed rule filing and to respond to comments received as a result of 
the Federal Register notice.\44\ The Commission believes that these 
proposed changes strengthen the proposed rule change.
---------------------------------------------------------------------------

    \43\ See supra note 3.
    \44\ See supra notes 6 and 7.
---------------------------------------------------------------------------

    Accordingly, the Commission finds good cause for approving 
Amendment Nos. 1 and 2 to the proposed rule change prior to the 
thirtieth day after the date of publication of notice thereof in the 
Federal Register. Specifically, the Commission believes that it is 
consistent with section 19(b)(2) of the Act \45\ to approve Amendment 
Nos. 1 and 2 to CBOE's proposed rule change prior to the thirtieth day 
after publication of the notice of filing thereof in the Federal 
Register.
---------------------------------------------------------------------------

    \45\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

Uniform Effective Date

    The Commission believes that approving the amendments on an 
accelerated basis will permit CBOE to begin the process of approving 
broker-dealers to implement portfolio margining and would allow firms 
to begin to make the necessary changes and upgrades to their systems, 
as well as their policies and procedures, in order to accommodate 
customer portfolio. The Commission, however, believes that if some 
firms receive CBOE approval to begin offering customer portfolio 
margining to customers before other firms, these other firms would be 
at a competitive disadvantage. Therefore, the Commission has determined 
to set a uniform effective date of April 2, 2007 for the proposed rule 
change, as amended. As stated above, the Commission believes that 
setting a uniform effective date will avoid placing some firms at a 
competitive disadvantage and reduce confusion in the marketplace.

V. Solicitation of Comments of Amendment Nos. 1 and 2

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Exchange Act. Comments may 
be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send e-mail to rule-comments@sec.gov. Please include File 
Number SR-CBOE-2006-14 on the subject line.

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-CBOE-2006-14. 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 (http://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 Exchange. 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-CBOE-2006-14 and should be submitted on or before 
January 8, 2007.

[[Page 75785]]

VI. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\46\ that the proposed rule change (File No. SR-CBOE-2006-14), as 
amended, be and it hereby is, approved on an accelerated basis, on a 
pilot basis to expire on July 31, 2007. The effective date will be 
April 2, 2007.
---------------------------------------------------------------------------

    \46\ 15 U.S.C. 78s(b)(2).

    By the Commission.
Florence E. Harmon,
Deputy Secretary.

Exhibit A--Chicago Board Options Exchange, Inc.

Chapter XII

Margins

Rule 12.4. Portfolio Margin
    As an alternative to the transaction/position specific margin 
requirements set forth in Rule 12.3 of this Chapter 12, a member 
organization may require margin for all margin equity securities (as 
defined in Section 220.2 of Regulation T), listed options, unlisted 
derivatives, security futures products, and index warrants in 
accordance with the portfolio margin requirements contained in this 
Rule 12.4.
    In addition, a member organization, provided it is a Futures 
Commission Merchant (``FCM'') and is either a clearing member of a 
futures clearing organization or has an affiliate that is a clearing 
member of a futures clearing organization, is permitted under this Rule 
12.4 to combine a customer's related instruments (as defined below), 
listed index options, unlisted derivatives, options on exchange traded 
funds, index warrants, and underlying instruments and compute a margin 
requirement for such combined products on a portfolio margin basis. 
Application of the portfolio margin provisions of this Rule 12.4 to IRA 
accounts is prohibited.
    (a) Definitions.
    (1) The term ``listed option'' shall mean any equity (or equity 
index-based) option traded on a registered national securities exchange 
or automated facility of a registered national securities association.
    (2) The term ``security future'' means a contract of sale for 
future delivery of a single security or of a narrow-based security 
index, including any interest therein or based on the value thereof, to 
the extent that that term is defined in Section 3(a)(55) of the 
Securities Exchange Act of 1934.
    (3) The term ``security futures product'' means a security future, 
or an option on any security future.
    (4) The term ``unlisted derivative'' means 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 Securities and 
Exchange Commission.
    (5) The term ``option series'' 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.
    (6) The term ``class'' refers to all listed options, unlisted 
derivatives, security futures products, and related instruments that 
are based on the same underlying instrument, and the underlying 
instrument itself.
    (7) The term ``portfolio'' means products of the same class grouped 
together.
    (8) The term ``related instrument'' within a class or product group 
means index futures contracts and options on index futures contracts 
covering the same underlying instrument, but does not include security 
futures products.
    (9) The term ``underlying instrument'' means a security or security 
index upon which any listed option, unlisted derivative, security 
futures product or related instrument is based. The term underlying 
instrument shall not be deemed to include futures contracts, options on 
futures contracts or underlying stock baskets.
    (10) The term ``product group'' means two or more portfolios of the 
same type for which it has been determined by Rule 15c3-1a(b)(ii) under 
the Securities Exchange Act of 1934 that a percentage of offsetting 
profits may be applied to losses at the same valuation point.
    (11) The terms ``theoretical gains and losses'' means the gain and 
loss in the value of each eligible position at 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)
                                                     (percent)
------------------------------------------------------------------------
High Capitalization, Broad-based Market   +6/-8
 Index \1\.
Non-High Capitalization, Broad-based      +/-10
 Market Index \1\.
Narrow-based Index \1\..................  +/-15
Individual Equity \1\...................  +/-15
------------------------------------------------------------------------
\1\ In accordance with sub-paragraph (b)(1)(i)(B) of Rule 15c3-1a under
  the Securities Exchange Act of 1934.

    (b) Eligible Participants.
    Any member organization intending to apply the portfolio margin 
provisions of this Rule 12.4 to its accounts must receive prior 
approval from its DEA. The member organization will be required to, 
among other things, demonstrate compliance with Rule 15.8A--Risk 
Analysis of Portfolio Margin Accounts, and with the net capital 
requirements of Rule 13.5--Customer Portfolio Margin Accounts.
    The application of the portfolio margin provisions of this Rule 
12.4 is limited to the following customers:
    (1) Any broker or dealer registered pursuant to Section 15 of the 
Securities Exchange Act of 1934;
    (2) any member of a national futures exchange to the extent that 
listed index options, unlisted derivatives, options on exchange traded 
funds, index warrants or underlying instruments hedge the member's 
related instruments, and
    (3) any person or entity not included in (b)(1) or (b)(2) above 
that is approved for writing uncovered options. However, such persons 
or entities may not establish or maintain positions in unlisted 
derivatives unless minimum equity of at least five million dollars is 
established and maintained with the member organization. For purposes 
of the five million dollar minimum equity requirement, all securities 
and futures accounts carried by the member organization for the same 
customer may be combined provided ownership across the accounts is 
identical. A guarantee by any other account for purposes of the minimum 
equity requirement is not permitted.
    (c) Opening of Accounts.
    (1) Only customers that, pursuant to Rule 9.7, have been approved 
for writing uncovered options are permitted to utilize a portfolio 
margin account.
    (2) On or before the date of the initial transaction in a portfolio 
margin account, a member shall:
    (A) Furnish the customer with a special written disclosure 
statement describing the nature and risks of portfolio margining and 
which includes an acknowledgement for all portfolio margin account 
owners to sign, attesting that they have read and understood the 
disclosure statement, and agree to the

[[Page 75786]]

terms under which a portfolio margin account is provided, and
    (B) obtain a signed acknowledgement from the customer and record 
the date of receipt.
    (d) Establishing Account and Eligible Positions.
    (1) For purposes of applying the portfolio margin requirements 
provided in this Rule 12.4, member organizations are to establish and 
utilize a dedicated 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 a customer.
    A margin deficit in the portfolio margin account of a customer may 
not be considered as satisfied by excess equity in another account. 
Funds and/or securities must be transferred to the deficient account 
and a written record created and maintained. In the case of a portfolio 
margin account carried as a sub-account of a margin account, excess 
equity in the margin account may be used to satisfy a margin deficiency 
in the portfolio margin sub-account without transferring funds and/or 
securities to the portfolio margin sub-account.
    (3) Eligible Positions
    (A)
    (i) a margin equity security (including 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; and a 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 to permit the sale of the security, upon 
exercise of any listed option or unlisted derivative written against 
it, without restriction).
    (ii) a listed option on an equity security or index of equity 
securities,
    (iii) a security futures product,
    (iv) an unlisted derivative on an equity security or index of 
equity securities,
    (v) a warrant on an equity security or index of equity securities, 
and
    (vi) a related instrument.
    (4) Positions other than those listed in (3)(A) above are not 
eligible for portfolio margin treatment. However, positions not 
eligible for portfolio margin treatment (except for ineligible related 
instruments) may be carried in a portfolio margin account subject to 
the margin required pursuant Rule 12.3 of this Chapter 12. Shares of a 
money market mutual fund may be carried in a portfolio margin account 
subject to the margin required pursuant to Exchange Rule 12.3 of this 
Chapter 12 provided that:
    (i) The customer waives any right to redeem the shares without the 
member organization's consent,
    (ii) the member organization (or, if the shares are deposited with 
a clearing organization, the clearing organization) obtains the right 
to redeem the shares in cash upon request,
    (iii) the fund agrees to satisfy any conditions necessary or 
appropriate to ensure that the shares may be redeemed in cash, promptly 
upon request, and
    (iv) the member organization complies with the requirements of 
Section 11(d)(1) of the Securities Exchange Act of 1934 and Rule 11d1-2 
thereunder.
    (e) Initial and Maintenance Margin Required. The amount of margin 
required under this Rule 12.4 for each portfolio shall be the greater 
of:
    (1) The amount for any of the ten equidistant valuation points 
representing the largest theoretical loss as calculated pursuant to 
paragraph (f) below or
    (2) $.375 for each listed option, unlisted derivative, security 
futures product, and related instrument multiplied by the contract or 
instrument's multiplier, not to exceed the market value in the case of 
long positions.
    (f) Method of Calculation.
    (1) Long and short positions in eligible positions are to be 
grouped by class; each class group being a ``portfolio''. Each 
portfolio is categorized as one of the portfolio types specified in 
paragraph (a)(11) above.
    (2) For each portfolio, theoretical gains and losses are calculated 
for each position as specified in paragraph (a)(11) above. For purposes 
of determining the theoretical gains and losses at each valuation 
point, member organizations shall obtain and utilize the theoretical 
value of a listed option, unlisted derivative, security futures 
product, underlying instrument, and related instrument rendered by a 
theoretical pricing model that has been approved by the Securities and 
Exchange Commission.\1\
---------------------------------------------------------------------------

    \1\ Currently, the theoretical model utilized by the Options 
Clearing Corporation is the only model qualified.
---------------------------------------------------------------------------

    (3) Offsets. Within each portfolio, theoretical gains and losses 
may be netted fully at each valuation point.
    Offsets between portfolios within the High Capitalization, Broad-
Based Index Option, Non-High Capitalization, Broad-Based Index Option 
and Narrow-Based Index Option product groups may then be applied as 
permitted by Rule 15c3-1a under the Securities Exchange Act of 1934.
    (4) After applying paragraph (3) 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).
    (5) In addition, if a security that is convertible, exchangeable, 
or exercisable into a security that is an underlying instrument 
requires the payment of money or would result in a loss if converted, 
exchanged, or exercised at the time when the security is deemed an 
underlying instrument, the full amount of the conversion loss is 
required.
    (g) Minimum Equity Deficiency. If, as of the close of business, the 
equity in the portfolio margin account declines below the five million 
dollar minimum equity required under Paragraph (b) of this Rule 12.4 
and is not restored to the required level within three (3) business 
days by a deposit of funds or securities, or through favorable market 
action; member organizations are prohibited from accepting new orders 
beginning on the fourth business day, except that new orders entered 
for the purpose of reducing market risk may be accepted if the result 
would be to lower margin requirements. This prohibition shall remain in 
effect until such time as:
    (1) The required minimum account equity is re-established or
    (2) all unlisted derivatives are liquidated or transferred from the 
portfolio margin account to the appropriate account.
    In computing net capital, a deduction in the amount of a customer's 
equity deficiency may not serve in lieu of complying with the above 
requirements.
    (h) Determination of Value for Margin Purposes. For the purposes of 
this Rule 12.4, all eligible positions shall be valued at current 
market prices. Account equity for the purposes of this Rule 12.4 shall 
be calculated separately for each portfolio margin account by adding 
the current market value of all long positions, subtracting the current 
market value of all short positions, and adding the credit (or 
subtracting the debit) balance in the account.
    (i) Additional Margin.
    (1) If, as of the close of business, the equity in any portfolio 
margin account is less than the margin required, the customer may 
deposit additional margin or establish a hedge to meet the margin 
requirement within three business days. After the three business day 
period, member organizations are prohibited from accepting new orders, 
except that new orders entered for the purpose of reducing market risk 
may be accepted if the result would be to lower margin

[[Page 75787]]

requirements. In the event a customer fails to deposit additional 
margin in an amount sufficient to eliminate any margin deficiency or 
hedge existing positions after 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 account equity. Member organizations should not permit a 
customer to make a practice of meeting a portfolio margin deficiency by 
liquidation. Member organizations must have procedures in place to 
identify accounts that periodically liquidate positions to eliminate 
margin deficiencies, and a member organization is expected to take 
appropriate action when warranted. Liquidations to eliminate margin 
deficiencies that are caused solely by adverse price movements may be 
disregarded. Guarantees by any other account for purposes of margin 
requirements is not permitted.
    (2) Pursuant to Rule 13.5--Customer Portfolio Margin Accounts, if 
additional margin required is not obtained by the close of business on 
T+1, member organizations must deduct in computing net capital any 
amount of the additional margin that is still outstanding until such 
time as the additional margin is obtained or positions are liquidated 
pursuant to (i)(1) above.
    (3) A deduction in computing net capital in the amount of a 
customer's margin deficiency may not serve in lieu of complying with 
the requirements of (i)(1) above.
    (4) A member organization may request from its DEA an extension of 
time for a customer to deposit additional margin. Such request must be 
in writing and will be granted only in extraordinary circumstances.
    (5) The day trading restrictions promulgated under Rule 12.3(j) 
shall not apply to portfolio margin accounts that establish and 
maintain at least five million dollars in equity, provided a member 
organization has the ability to monitor the intra-day risk associated 
with day trading. Portfolio margin accounts that do not establish and 
maintain at least five million dollars in equity will be subject to the 
day trading restrictions under Rule 12.3(j), provided the member 
organization has the ability to apply the applicable day trading 
restrictions under that Rule. However, if the position or positions day 
traded were part of a hedge strategy, the day trading restrictions will 
not apply. A ``hedge strategy'' for the purpose of this rule means a 
transaction or a series of transactions that reduces or offsets a 
material portion of the risk in a portfolio. Member organizations are 
also expected to monitor these portfolio margin accounts to detect and 
prevent circumvention of the day trading requirements.
    (j) Portfolio Margin Accounts--Requirement to Liquidate.
    (1) A member organization is required immediately either to 
liquidate, or transfer to another broker-dealer eligible to carry 
related instruments within portfolio margin accounts, all customer 
portfolio margin accounts with positions in related instruments if the 
member is:
    (i) Insolvent as defined in section 101 of title 11 of the United 
States Code, or is unable to meet its obligations as they mature;
    (ii) 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;
    (iii) 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 customers' securities; or
    (iv) Unable to make such computations as may be necessary to 
establish compliance with such financial responsibility or 
hypothecation rules.
    (2) Nothing in this paragraph (j) 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.
* * * * *

    (Note: The sample risk description document is deleted in its 
entirety)

Chapter 9

Doing Business with the Public

Rule 9.15. Delivery of Current Options Disclosure Documents and 
Prospectus
    (a) no change
    (b) no change
    (c) The special written disclosure statement describing the nature 
and risks of portfolio margining and acknowledgement for customer 
signature, required by Rule 12.4(c)(2) 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 the 
prescribed Exchange format and has received prior written approval of 
the Exchange.
* * * * *

Chapter XIII

Net Capital

Rule 13.5. Customer Portfolio Margin Accounts
    (a) No member organization that requires margin in any customer 
accounts pursuant to Rule 12.4--Portfolio Margin shall permit gross 
customer portfolio margin requirements to exceed 1,000 percent of its 
net capital for any period exceeding three business days. The member 
organization shall, beginning on the fourth business day of any non-
compliance, cease opening new portfolio margin accounts until 
compliance is achieved.
    (b) If, at any time, a member organization's gross customer 
portfolio margin requirements exceed 1,000 percent of its net capital, 
the member organization shall immediately transmit telegraphic or 
facsimile notice of such deficiency to the Office of Market 
Supervision, Division of Market Regulation, Securities and Exchange 
Commission, 100 F Street, NE, Washington, DC 20549; to 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 its Designated Examining Authority.
    (c) If any customer portfolio margin account becomes subject to a 
call for additional margin, and all of the additional margin is not 
obtained by the close of business on T+1, member organizations must 
deduct in computing net capital any amount of the additional margin 
that is still outstanding until such time as it is obtained or 
positions are liquidated pursuant to Rule 12.4(i)(1).
* * * * *

Chapter XV

Records, Reports and Audits

Rule 15.8A. Risk Analysis of Portfolio Margin Accounts
    (a) Each member organization that maintains any portfolio margin 
accounts for customers shall establish and maintain a comprehensive 
written risk analysis methodology for assessing and monitoring 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

[[Page 75788]]

risk analysis methodology must be filed with the member organization's 
Designated Examining Authority and submitted to the SEC prior to the 
implementation of portfolio margining.
    (b) Upon direction by the Department of Member Firm Regulation, 
each affected member organization shall provide to the Department such 
information as the Department may reasonably require with respect to 
the member organization's risk analysis for any or all of the portfolio 
margin accounts it maintains for customers.
    (c) In conducting the risk analysis of portfolio margin accounts 
required by this Rule 15.8A, each member organization shall include in 
the written risk analysis methodology required pursuant to paragraph 
(a) above procedures and guidelines for:
    (1) Obtaining and reviewing the appropriate customer account 
documentation and financial information necessary for assessing the 
amount of credit extended to customers,
    (2) the determination, review and approval of credit limits to each 
customer, and across all customers, utilizing a portfolio margin 
account,
    (3) monitoring credit risk exposure to the member organization from 
portfolio margin accounts, on both an intra-day and end of day basis, 
including the type, scope and frequency of reporting to senior 
management,
    (4) the use of stress testing of portfolio margin accounts in order 
to monitor market risk exposure from individual accounts and in the 
aggregate,
    (5) the regular review and testing of these risk analysis 
procedures by an independent unit such as internal audit or other 
comparable group,
    (6) managing the impact of credit extension on the member 
organization's overall risk exposure,
    (7) the appropriate response by management when limits on credit 
extensions have been exceeded, and
    (8) determining the need to collect additional margin from a 
particular eligible participant, including whether that determination 
was based upon the creditworthiness of the participant and/or the risk 
of the eligible position(s).
    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 Rule 15.8A 
is accessible on a timely basis and information systems are available 
to capture, monitor, analyze and report relevant data.

 [FR Doc. E6-21480 Filed 12-15-06; 8:45 am]
BILLING CODE 8011-01-P