The Options Clearing Corporation
One North Wacker Drive, Suite 600, Chicago, Illinois 60606

William H. Navin
Executive Vice President and General Counsel
Tel: 312.322.1817       Fax: 312.322.1836
email: wnavin@theocc.com

January 21, 2003

Mr. Jonathan G. Katz
Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609

Re: S7-34-02, Rule 15c3-3a Reserve Requirements for Margin Related to Security Futures Products

Dear Mr. Katz:

The Options Clearing Corporation ("OCC") submits this letter to supplement its earlier comment letter, dated October 23, 2002, on the above-captioned proposed rulemaking by the Commission. Since writing the earlier letter, OCC has been informed by the Commission staff that the staff would consider taking this opportunity to make a further change in the reserve formula to address an additional current development in the securities markets-namely, the proposal for a pilot program that would allow certain highly qualified customers to maintain special securities accounts in which they could obtain cross-margining treatment for offsetting transactions in eligible broad-based index products. OCC supports the adoption of such an additional amendment to Rule 15c3-3a and strongly urges the Commission to take any other necessary action to allow the pilot to go forward at the earliest possible date.

Background

As the Commission staff is aware, OCC has been working for several years with the Chicago Board Options Exchange ("CBOE"), the New York Stock Exchange, the Chicago Mercantile Exchange and other securities and futures markets and their member firms to launch a pilot program under which qualified customers would be permitted to establish cross-margining accounts. In these "customer cross-margining accounts," customers could carry positions in CFTC-regulated futures products as well as OCC-issued options and related products that would be margined on a risk-based or portfolio margin basis. The accounts would be limited initially to specified broad-based index products, although the longer-range goal would be to expand the accounts to include individual equity securities, single stock derivatives and other products.

It was originally proposed that these accounts be treated for regulatory purposes as futures accounts subject to the segregation provisions of Section 4d(2) of the Commodity Exchange Act (the "CEA") just as existing cross-margining accounts for securities options market-makers are treated. However, the Commission staff has determined that customer cross-margining accounts should be carried as securities accounts subject to the provisions of Rule 15c3-3 rather than as futures accounts. We believe treating the accounts as securities accounts is a reasonable alternative, and may facilitate the expansion of the program to include stocks and other securities products. In order to implement this approach, CBOE has submitted a request to the Commodity Futures Trading Commission (the "CFTC") asking the CFTC to exempt customer cross-margining accounts from the segregation provisions of Section 4d(2), which would otherwise require the segregation of futures contracts and related futures customer property. This relief is necessary in order to permit cross-margining accounts to be carried as securities accounts.

If customer cross-margining accounts are to be treated as securities accounts, however, there are certain regulatory issues under the securities laws that also need to be addressed. One such issue involves the application of the reserve formula of Rule 15c3-3a, and another has to do with the treatment of such accounts under the Securities Investor Protection Act of 1970 ("SIPA"). We request that the Commission use its rule-making authority to address both of these issues.

The Reserve Formula

We request that the reserve formula of Rule 15c3-3a be amended to permit a broker-dealer to treat margin related to transactions in customer cross-margining accounts that is required and on deposit with a clearing organization as a "debit item" in calculating its reserve requirement under the formula in Rule 15c3-3a. The effect of permitting such a debit is to reduce the amount that the broker-dealer is required to set aside in the "special bank account for the exclusive benefit of customers" under Rule 15c3-3(e). The debit is appropriate because the funds held by the clearing organization represent funds already set aside by the broker to satisfy customer claims. A similar debit is currently provided for options margin on deposit at OCC in respect of a clearing member's customers' account,¹ and the Commission has proposed in the current proceeding to provide a similar debit item for margin deposited in respect of transactions of securities customers in security futures products ("SFPs").

In the case of cross-margining arrangements between OCC and CME or other CFTC-regulated derivatives clearing organizations ("DCOs"), contracts cleared at different clearing organizations are margined on a combined basis at the clearing level as well as at the firm level, and the clearing organizations hold margin jointly to cover the net risk of the cross-margined portfolio. Where customer cross-margining accounts are carried as securities accounts for securities customers, it is essential that the carrying broker-dealer receive the same treatment under the reserve formula for clearing margin deposited under the joint control of OCC and one or more other DCOs as it receives for options margin or margin on SFPs that is deposited with a securities clearing agency or a qualified DCO.² Accordingly, OCC strongly supports a further amendment to Rule 15c3-3a to bring about this result.

Securities Investor Protection Act

By amending the reserve formula to include property on deposit with clearing organizations to secure obligations arising from customer cross-margining accounts, the Commission would effectively recognize that such assets would be included, in the event of a broker-dealer insolvency, in the pool of customer property available to satisfy the net equity claims of securities customers. In order to further solidify this interpretation, we ask that the Commission exercise its authority under Section 16 of SIPA to ensure consistency with its Section 15c3-3a interpretation.

Section 16(4)(B) of SIPA defines "customer property" to include:

[R]esources provided through the use or realization of customers' debit cash balances and other customer-related debit items as defined by the Commission by rule [emphasis added].

By defining "customer-related debit items" to include clearing level margin deposits in respect of customer cross-margining accounts, the Commission would effectively acknowledge that a cross-margining customer is a securities "customer" within the meaning of SIPA.

Under Section 16(4), "customer property" would include not only the clearing level margin deposits but also the futures and options positions in customer cross-margining accounts at the clearing organizations because Section 16(4)(D) includes within the definition of "customer property:"

[A]ny other property of the debtor which, upon compliance with applicable laws, rules, and regulations, would have been set aside or held for the benefit of customers, unless the trustee determines that including such property within the meaning of such term would not significantly increase customer property.

As we have discussed with the Commission's staff and with the staff of the Securities Investor Protection Corporation ("SIPC"), it is essential to the proposed cross-margining program not only that the assets in a cross-margining account be treated as "customer property," but also that the cross-margining customer have a claim under SIPA as a securities "customer" for all of the property in the account, including futures and futures options, in the event of the insolvency of the carrying broker. We urge the Commission to take any action it deems necessary to ensure this result.

Conclusion

We strongly urge the Commission to amend Rule 15c3-3a to permit clearing margin deposited in respect of customer cross-margining accounts to be included as a debit in the reserve formula. We further urge the Commission to exercise its authority under SIPA to provide that those same margin deposits be included within the definition of "customer property" within the meaning of that statute. Finally, we request that the Commission take any other action in consideration of the issues discussed above that the Commission and its staff believe necessary or appropriate to ensure that the claim of a cross-margining customer will be treated as the net equity claim of a securities customer with respect to all assets in the account in the event of the insolvency of the carrying broker-dealer.

We would be pleased to discuss any of these issues with you further. Please feel free to contact me at (312)322-1817, Andy Naughton at (312)322-2007 or OCC's outside counsel, James R. McDaniel, at (312)853-2665.

Sincerely,

/s/ William H. Navin

William H. Navin

cc: Michael Macchiaroli, SEC
Jerry Carpenter, SEC
Michael Don, SIPC

bcc: James R. McDaniel, Sidley Austin
Andrew Naughton, OCC
Rich Lewandowski, CBOE

CH1 2542840v6

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1	See Item 13 of Rule 15c3-3a.
2	OCC is registered both as a clearing agency and as a DCO.