[Federal Register Volume 59, Number 8 (Wednesday, January 12, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-739]
[[Page Unknown]]
[Federal Register: January 12, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33413; File No. SR-DGOC-91-01]
Self-Regulatory Organizations; Delta Government Options Corp.;
Order Approving a Proposed Rule Change Relating to Permissible Forms of
Margin Deposits
January 4, 1994.
On February 12, 1991, Delta Government Options Corp. (``Delta'')
filed with the Securities and Exchange Commission (``Commission'') a
proposed rule change pursuant to section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'')\1\ relating to the acceptance of U.S.
Treasury bills, notes, and bonds as margin. On March 23, 1991, the
Commission published notice of the proposed rule change in the Federal
Register to solicit comments from interested persons.\2\ One comment
letter was received in response to which Delta amended its proposal on
April 25, 1991.\3\ On September 8, 1993, Delta submitted a second
amendment concerning the participation of registered investment
companies.\4\ As discussed below, the Commission is approving Delta's
proposal as amended.
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\Securities Exchange Act Release No. 28983 (March 18, 1991),
56 FR 12572.
\3\The one comment letter, submitted by The First Boston
Corporation (``First Boston''), generally supported Delta's proposal
because it believed the acceptance of Treasury bills as margin would
increase the competitiveness and usefulness of Delta and would not
infuse any additional credit risk into the settlement system. First
Boston noted, however, that pursuant to Delta's original proposal
(1) deposits of Treasury bills as margin would have to be made in
principal amounts of $500,000 and integral multiples thereof and (2)
where the margin was deposited in the form of Treasury bills, excess
margin of less than $500,000 would not be automatically returned to
participants. First Boston stated that these $500,000 minimums were
unreasonably high and would reduce needlessly the utility of using
Treasury bills as margin. Letter from Scott H. Rockoff, Vice
President, Regulatory Reporting and Analysis, First Boston, to
Jonathan G. Katz, Secretary, Commission (April 15, 1991). In
response, Delta amended its proposal so that the deposit and
automatic return minimums are $50,000. Delta also added a provision
to the proposal whereby participants can waive their rights to
receive on a daily basis excess margin. Participants have an
unqualified right to withdraw such a waiver at any time during
business hours. Letter from Robert C. Mendelson, Morgan, Lewis and
Bockius (Counsel for Delta), to Ross Pazzol, Esq., Division of
Market Regulation (``Division''), Commission (April 24, 1991) and
letter from David J. Maloy, President, Delta, to Sonia Burnett,
Esq., Division, Commission (December 3, 1993).
\4\When Delta filed the original proposal, its rules permitted
investment companies registered under the Investment Company Act of
1940 (``1940 Act''), 15 U.S.C. 80a (1990), to be participants.
Accordingly, the original proposal would have allowed investment
companies to deposit with their custodian banks that hold margin for
the benefit of Delta Treasury bills, notes, and bonds as margin.
Staff of the Commission's Division of Investment Management (``IM'')
raised concerns relating to Delta's custody and control of
investment companies' securities deposited as margin. In response,
Delta amended the proposal to prohibit participation in Delta by
registered investment companies. Delta intends to remove the
participation prohibition at such time as Delta and Commission staff
determine the conditions under which investment companies may become
participants. Letter from David J. Maloy, President, Delta, to Julia
Ulstrup, Senior Counsel, IM, Commission (September 8, 1993).
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I. Description
Delta's proposal expands the permissible forms of margin by
permitting participants to deposit not only Fed Funds\5\ but also U.S.
Treasury bills with a remaining term to maturity of 365 days or less
and Treasury securities which would be deliverable by a participant if
an option contract written by the participant was exercised and
assigned to the participant (i.e., ``cover).\6\ Treasury bills
deposited as margin will be valued for purposes of determining the
amount of margin on deposit with Delta as 100% of the lesser of their
par value or their market value. Deposits of Treasury bills as margin
must be made in principal amounts of $50,000 and integral multiples
thereof.
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\5\Under Delta's previous rules, Delta accepted as margin only
``Fed Funds.'' Fed Funds is now defined in Delta's rules as cash
balances available for immediate withdrawal in accounts maintained
at banks that are members of the Federal Reserve System.
\6\Delta issues and clears put and call options on Treasury
bills, notes, and bonds written or purchased by participants;
therefore, cover can consist of Treasury bills, notes, or bonds.
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In the event that Treasury bills deposited as margin mature while
on deposit with Delta, Delta will hold the cash proceeds as margin and
will invest them in accordance with its rules governing the investment
of cash margin deposits.\7\ If a participant that is an employee
benefit plan (i.e., pension plan) subject to the Employee Retirement
Income Security Act of 1974 (``ERISA'')\8\ deposits Treasury bills as
margin, Delta will monitor the maturity date of such Treasury bills and
will require the pension plan to substitute collateral prior to the
maturity of the Treasury bills.\9\
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\7\Letter from Robert C. Mendelson, Morgan, Lewis & Bockius
(Counsel for Delta), to Ross Pazzol, Esq., Division, Commission
(April 24, 1991).
Pursant to Delta's procedures, margin deposited in the form of
Fed Funds (i.e., cash) can be invested in overnight repurchase
agreements that require as collateral the delivery of Treasury bills
with maturities not to exceed 180 days from the date of the
repurchase agreement. Delta Procedures, Article VI, Section 601.
\8\Public Law 93-406. 88 Stat. 829 (1974) (codified at 29 U.S.C.
1001-1461).
\9\Letter from Robert C. Mendelson, Esq., Morgan, Lewis &
Bockius (Counsel for Delta), to Ross Pazzol, Esq., Division,
Commission (April 24, 1991). Under section 1002(21) of ERISA, a
person that exercises discretionary authority or control over the
assets of an employee benefit plan is deemed to be a plan fiduciary
and is required to act solely in the interest of the plan's
participants and beneficiaries and exclusively to provide benefits
to these participants and beneficiaries. Because such fiduciary
responsibilities may interfere and potentially conflict with Delta's
obligations to its participants as a registered clearing agency,
Delta is implementing a special procedure for handling margin
deposited by pension plans to avoid this potential ERISA problem.
Furthermore, as explained in greater detail in Section II of this
order, the Pension and Welfare Benefits Administration of the
Department of Labor has granted an exemption for certain
transactions involving Delta that facilitates the participation of
employee benefit plans in Delta.
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II. Discussion
The Commission believes Delta's proposal is consistent with the Act
and particularly with sections 17A(b)(3) (A) and (F) of the Act.10
Those sections require that a clearing agency be organized and its
rules be designed to promote the prompt and accurate clearance and
settlement of securities transactions and to assure the safeguarding of
securities and funds which are in its custody or control or for which
it is responsible.
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\1\015 U.S.C. 78q-1(b)(3) (A) and (F) (1988).
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Delta's proposal will provide flexibility to its participants by
expanding the types of assets eligible to be deposited as margin
without exposing Delta to undue credit risk, market risk, or
liquidation risk.11 Because Treasury securities are backed by the
full faith and credit of the United States, Delta is not subject to the
credit risk of the obligor.12 To reduce its exposure to market
risk and liquidation risk, Delta will mark Treasury bills to market on
a daily basis and will value them at the lower of par or fair market
value. Furthermore, because the market for Treasury bills is extremely
large and relatively liquid, Delta's liquidation risk is minimal.
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\1\1Credit risk is the risk that the counterparty to a
transaction will not fulfill its obligation. Market risk is the risk
associated with adverse changes in the market price of a security.
Liquidation risk is the risk that the full value of collateral will
not be realized upon liquidation of such collateral.
\1\2Of course, Delta remains subject to the credit risk of its
participants.
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The Commission also believes that Delta's proposal to accept cover
as margin for short call option positions is appropriate. As an initial
matter, the Commission notes that The Options Clearing Corporation
(``OCC''), another registered clearing agency, accepts deposits of the
security underlying a call option written by a participant in lieu of
margin.13 The deposit of cover protects Delta to the maximum
extent possible by fully collateralizing a participant's obligations to
Delta and by eliminating Delta's credit risk with respect to the
depositing participant's short position. Accordingly, the Commission
believes that Delta's proposal to accept Treasury bills and cover as
margin is consistent with its obligation to safeguard the securities
and funds for which it is responsible.
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\1\3OCC Rule 610.
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The Commission also believes that the special procedures for
handling margin deposited by ERISA pension plan participants is both
necessary and appropriate. Until now, Delta's procedures for investing
margin deposits and certain aspects of ERISA have made participation in
Delta impracticable for such plans. Under Delta's rules, Delta may
invest the cash margin received from participants in overnight
repurchase agreements and pass the profits earned on such investments
back to participants.14 Under section 1002(21) of ERISA, a person
could be deemed to be a plan fiduciary to the extent that such person
exercises discretionary authority over the assets of a plan.15
Accordingly, if Delta were to follow its usual investment procedures
with respect to pension plan assets, Delta might be deemed to be a plan
fiduciary under ERISA. In light of these provisions, Delta has not
permitted pension plans to participate in its system.16
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\1\4Delta Procedures, Article VI, Rule 601.
\1\5See supra note 10.
\1\6Section 17A of the Act enumerates the types of entities that
may participate in registered clearing agencies. That section
neither expressly permits nor precludes participation in a
registered clearing agency by pension plans. Section 17A provides
that the rules of a clearing agency must permit any (1) registered
broker-dealer, (2) bank, (3) insurance company, (4) registered
clearing agency, or (5) registered investment company to become a
participant in a registered clearing agency. 15 U.S.C. 78q-
1(b)(3)(B).
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On March 15, 1991, the Pension and Welfare Benefits Administration
of the Department of Labor (``DOL'') granted an exemption that permits
ERISA pension plans to participate in Delta without Delta becoming a
plan fiduciary provided neither Delta nor any of its affiliates
exercise discretionary authority or control with respect to the
investment of plan assets.17 To comply with the DOL exemption,
Delta is implementing a procedure whereby pension plans will deposit
substitute collateral upon the maturity of Treasury bills deposited as
margin in order that Delta is not viewed as exercising discretionary
authority or control with respect to the investment of any funds that
are deemed to be plan assets.18 Delta's proposal appears to
provide a reasonable method of permitting employee benefit plans that
are subject to ERISA to participate in Delta's system and thereby
promotes the prompt and accurate clearance and settlement of securities
transactions without exposing Delta to potential ERISA liability.
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\1\7DOL, Prohibited Transaction Exemption 91-19, Exemption
Application No. D-8492, 56 FR 12396 (March 25, 1991) (``DOL
Exemption'').
\1\8Because the plan will have no right to the Treasury bills it
deposits with Delta as margin (unless the market has moved in its
favor or it has closed out its positions), such Treasury bills will
not be ``plan assets'' under ERISA.
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The Commission notes that under the DOL exemption, Delta is
permitted to liquidate certain assets of a defaulting plan without
being deemed to be exercising discretionary authority.19 Delta's
risk exposure is reduced to the extent that it has the authority to
liquidate such assets free of ERISA constraints.
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\1\9Specifically, Delta may draw on a letter of credit or a
surety bond that has been issued to Delta on behalf of such
participant. DOL Exemption, supra note 17 at 12397.
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III. Conclusion
For the reasons stated above, the Commission finds that the
proposed rule change (File No. SR-DGOC-91-01) is consistent with
section 17A of the Act.
It is therefore ordered, Pursuant to section 19(b)(2) of the Act,
that the proposed rule change (SR-DGOC-91-01) be, and hereby is,
approved.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.20
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\2\017 CFR 200.30-3(a)(12) (1990).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-739 Filed 1-11-94; 8:45 am]
BILLING CODE 8010-01-M