[Federal Register Volume 66, Number 150 (Friday, August 3, 2001)]
[Pages 40764-40766]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-19384]



[Release No. 34-44608; File No. SR-OCC-2001-02]

Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Proposed Rule Change Relating to Deposits of Nasdaq 
SmallCap Securities as Margin Collateral Pursuant to Rule 604(d)

July 27, 2001.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ notice is hereby given that on April 11, 2001, The 
Options Clearing Corporation (``OCC'') filed with the Securities and 
Exchange Commission (``Commission'') the proposed rule change as 
described in Items I, II, and III below, which items have been prepared 
primarily by OCC. The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested parties.

    \1\ 15 U.S.C. 78s(b)(1).

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

    The proposed rule change would amend OCC Rule 604(d) to allow 
Nasdaq SmallCap Market Securities to be deposited as margin collateral. 
The rule change also makes certain other technical changes to the 

    \2\ A copy of OCC's proposed rule change is available at the 
Commission's Public Reference Section or through OCC.

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

    In its filing with the Commission, OCC 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. OCC has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of these 

    \3\ The Commission has modified the text of the summaries 
prepared by OCC.

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

    The primary purpose of this rule change is to allow securities 
traded in the Nasdaq SmallCap market to the deposited as collateral 
pursuant to Rule 604(d). The rule change also makes certain other 
technical changes to the rule.
Nasdaq SmallCap Securities
    In 1984, OCC received Commission approval to amend Rule 604(d) to 
allow the deposit of securities traded in the Nasdaq National Market 
System (``NMS'') as a form of margin collateral.\4\ Nasdaq formed the 
NMS market in 1982 to distinguish NMS securities as those securities 
that met its highest listing standards and that were subject to real-
time sale price and volume reporting. Securities that did not meet NMS 
standards were termed ``regular Nasdaq securities.'' While the 
eligibility criteria found in Rule 604(d) have remained relatively 
unchanged since 1984, the structure of the Nasdaq market has evolved 
substantially since then.

    \4\ Securities Exchange Act Release No. 20558 (January 18, 
1984), 49 FR 2183 [File No. SR-OCC-83-17] (order approving an OCC 
rule change allowing clearing members to deposit certain common 
stocks not underlying options to satisfy their margin obligations).

    The Nasdaq market structure has had many notable changes. For 
example, in 1992, all Nasdaq securities became subject to real-time 
last sale price and volume reporting requirements, increasing the 
transparency for all Nasdaq issues (i.e., NMS and regular Nasdaq 
securities).\5\ Then, in 1994, the Nasdaq Stock Market was created with 
two distinct tiers: The Nasdaq National Market (``NNM,'' 
formerly the NMS market) and the SmallCap market (formally the regular 
Nasdaq securities).\6\ Later, in 1997, the qualification standards of 
both the NNM and the SmallCap market tiers were substantially 

    \5\ Securities Exchange Act Release No. 30569 (April 16, 1992), 
57 FR 13396 [File No. SR-NASD-91-50] (order approving a rule change 
requiring real-time trade reporting of transactions in Nasdaq 
securities, except convertible debt, and allowing the NASD to 
publicly disseminate the information).
    \6\ Securities Exchange Act Release No. 34928 (November 9, 
1994), 59 FR 55906 [File No. SR-NASD-94-48] (order clarifying the 
two tiers of the Nasdaq Stock Market as the Nasdaq SmallCap Market 
and the Nasdaq National Market).
    \7\ Securities Exchange Act Release No. 38961 (August 29, 1997), 
62 FR 45895 [File No. SR-NASD-97-16] (order revising the listing and 
maintenance standards to increase the quality of companies listed on 
Nasdaq and raising the level of investor protection).

    The upgraded qualification standards applicable to Nasdaq SmallCap 
issuers set forth minimum and ongoing financial criteria (e.g., assets, 
capitalization, and income), share float and price criteria, corporate 
governance (e.g., independent directors, audit committee formation and 
activities, auditor peer review, and voting rights), and public 
disclosure (e.g., timely filing and distribution of annual and interim 
financial reports and annual meeting of shareholders).\8\ These 
qualification criteria exceed the standards that governed the Nasdaq 
NMS securities at the time those securities were approved for margin 
purposes in 1984. The Nasdaq SmallCap qualification standards 
approximate American Stock Exchange (``Amex'') listing criteria 
applicable to equity securities.\9\ Such Amex listed equity securities 
are accepted by OCC for margin purposes. OCC therefore believes that 
the qualification standards that are applicable to SmallCap issues 
provide sufficient safeguards to address concerns about the quality of 
securities trade in that market tier.

    \8\ NASD Rules 4310 and 4350.
    \9\ American Stock Exchange Company Guide, Sections 101, 102, 
and 120-132.

    The ten dollar minimum price per share requirement and 
concentration limit (i.e., the securities of any one issuer cannot 
exceed 10% of the margin requirement for any one clearing member 
account) of Rule 604(d) also provide additional safeguards to

[[Page 40765]]

minimize issuer quality concerns. OCC has analyzed the market and 
liquidity risks associated with accepting SmallCap securities for 
margin purposes by utilizing daily returns and volume statistics for 
the last four years. Average daily returns and standard deviation of 
average daily returns for the entire population of SmallCap securities 
as well as a subset of the population having a price of greater than 
ten dollars per share were computed. For comparison, a similar 
computation was performed for NNM securities. A summary of this 
analysis is outlined below:

                                                   Average range   Average range  Average move *     standard
                      Class                        minimum  (in    maximum  (in     (in percent)  deviation  (in
                                                     percent)        percent)                        percent)
NNM (All).......................................           -24.5           +86.2             3.6             7.5
NNM (>$10)......................................           -21,3           +29.9             3.2             4.8
SmallCap (>All).................................           -33.9          +128.2             5.0            10.7
SmallCap (>$10).................................           -21.1           +51.4             2.6            5.3
*Computed on the basis of the absolute value daily returns.

Based on this analysis, OCC has concluded that the average SmallCap 
security presents market risks similar to that of NNM securities, 
especially for those securities that trade at a price greater than ten 
dollars per share.\10\ This analysis also confirms that the current 70% 
valuation rate provides a sufficient cushion to protect against adverse 
market moves in SmallCap securities.

    \10\ Approximately 12% of SmallCap securities trade at over ten 
dollars per share.

    Finally, OCC performed a volume analysis to assess the liquidity of 
SmallCap securities over the same four-year period which confirmed that 
SmallCap securities are not as liquid as NNM securities.\11\ However, 
the analysis also showed that a material portion of this average share 
volume is concentrated in a relatively small number of NNM issuers. For 
example, 20% of the NNM average share volume is attributable to the 
shares of five issuers. However, there are over 2,150 additional NNM 
securities that may be deposited for margin purposes. In light of the 
concentration within the NNM, OCC believes that there is sufficient 
liquidity in SmallCap issues over ten dollars to support their 
acceptance for margin purposes.

    \11\ Average daily share volume of NNM securities trading over 
ten dollars per share was 594,632 while the average daily share 
volume of SmallCap securities trading above ten dollars was 15,005 

Conforming Changes
    Certain changes are also being proposed for Rule 604(d) to conform 
its terms to similar changes elsewhere in OCC's By-Laws and Rules that 
were previously approved by the Commission. Rule 604(d) currently 
provides that no security that has been suspended from trading or is 
subject to special margin requirements by its ``primary market'' may be 
deposited as margin. The rule also defines the current market value of 
a stock or bond to be its closing price on the ``primary market'' for 
such stock or bond.
    OCC is proposing to delete the term ``primary market'' from certain 
OCC rules.\12\ Removing the term ``primary market'' was prompted by 
recognition that the equity markets were becoming increasingly 
fragmented. OCC desired the discretion to designate the market whose 
closing price would serve as the benchmark in order to avoid disputes 
over which market is a stock's primary market. OCC believes that it is 
appropriate to make this same change for Rule 604(d) purposes. For 
purposes of determining whether a security has been suspended from 
trading or subject to special margin requirements, OCC would use its 
discretion as to which of the markets that listed or otherwise 
qualified the security for trading would be followed.

    \12\ Securities Exchange Act Release Nos. 43782 (January 9, 
2001), 66 FR 1712 [File No. SR-OCC-00-04] (notice of proposed rule 
change revising OCC's price determination rules); and 41089 (March 
1, 1999), 64 FR 10051 [File No. SR-OCC-98-14] (order approving the 
revision of OCC Rule 805 with respect to closing prices in 
expiration processing).

    Another conforming change concerns the time when a ``closing 
price'' is determined. To address any questions that may arise with the 
growth of after-hours trading, OCC is proposing to amend Rule 604(d) to 
provide that the closing price will be determined at the close of 
``regular trading hours (as defined by the Corporation) * * *. '' This 
change allows OCC to avoid potential disputes by (i) eliminating any 
basis for arguing that the closing price should be determined based on 
after-hours trading and (ii) giving OCC the discretion to determine 
when ``regular trading hours'' end.
    Finally, OCC is proposing to eliminate those provisions of Rule 
604(d) that require stocks that are deposited as margin to be subject 
to last sales reporting. It is OCC's understanding that all exchange 
traded Nasdaq Stock Market securities are now subject to last sales 
reporting, making the requirement unnecessary.
    The proposed rule change is consistent with Section 17A of the Act 
because it enables clearing members to use additional securities as 
margin collateral without adversely affecting the safekeeping of 
securities that are in OCC's possession, custody, or control.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    OCC does not believe that the proposed rule change would impose any 
burden on competition.

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

    Written comments were not and are not intended to be solicited with 
respect to the proposed rule change, and none have been received.

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

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

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act.

[[Page 40766]]

Persons making written submissions should file six copies thereof with 
the Secretary, Securities and Exchange Commission, 450 Fifth Street, 
N.W., Washington, D.C. 20549-0609. 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 Section, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of such filing also will be available for inspection and copying 
at the principal office of OCC. All submissions should refer to File 
No. SR-OCC-2001-02 and should be submitted by August 24, 2001.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-19384 Filed 8-2-01; 8:45 am]