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federal reserve Ba n k DALLAS, TEXA S of Dallas 75222 Circular No. 80-133 July 10, 1980 AMENDMENT TO REGULATION T TO ALL MEMBER BANKS AND OTHERS CONCERNED IN THE ELEVENTH FEDERAL RESERVE DISTRICT: The Board of Governors of the Federal Reserve System has amended, effectiv e August 11, 1980, its Regulation T, "Credit for Brokers and Dealers". Printed on the following pages is the press release and the text of the Board's order as submitted for publication in the Federal Register. Enclosed is the final copy of the amendment in slip sheet form. It should be inserted into your Regulations Binders. Any questions concerning Regulation T should be directed to the Consumer Affairs Section of our Bank Supervision and Regulations De partment, Ext. 6171. Sincerely yours, Robert H. Boykin First Vice President Enclosure Banks and others are encouraged to use the following incoming W A T S numbers in contacting this Bank: 1-800-442-7140 (intrastate) and 1-800-527-9200 (interstate). For calls placed locally, please use 651 plus the extension referred to above. This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) FEDERA^RESERV^pi^s^^lease For Immediate release June 12, 1980 The Federal Reserve Board today announced adoption of an amendment to Its Regulation T -- margin requirements for brokers and dealers — affecting specialists and options market-makers. The amendment, which reflects comment received on a proposal for public comment, Is effective August 11. The principal features of the amendment, as adopted, are: 1. In general, the amendment permits good faith financing of positions in securities in which a specialist makes a market, but requires a 25 percent margin for positions in the related security acquired for hedging or covering purposes and the generally applicable margin (50 percent) for other securities. 2. Creditors extending credit to a specialist's joint account will no longer be required to participate in the account. 3. Specialists and options market-makers will be able to use securities issued by the United States Government or its agencies as collateral in their specialist accounts. 4. Several other changes, including: a rule restricting "free-riding" on underlying stock positions carried in an options marketmaker's account which will apply only to market-makers whose own exchange has not adopted a rule on "free riding" approved by the Securities and Exchange Commission; a rule affecting the withdrawal of cash or securities from their accounts by specialists and market-makers; and a rule defining positions that may be carried on preferential credit terms in the accounts of specialists and market-makers. The Board today rescinded, effective August 11, suspension of the effective date of a rule, as it applies to options specialists, establishing uniform margin requirements for the writing of options. The suspension was adopted in January 1977 ant11 the Board coaid consider a separate, self-contained rule for options specialists. This has now been done, timfc-fng the suspension oo longer necessary. The Board's orders in these matters are attached. Final Rulemaking Title 12 - Banks and Banking Chapter II - FEDERAL RESERVE SYSTEM SUBCHAPTER A - BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM [Regulation T; Docket No. R-0054] PART 220 - CREDIT BY BROKERS AND DEALERS Credit extended to Exchange Specialists AGENCY: Board of Governors of the Federal Reserve System ACTION: Final rule SUMMARY: This amendment revises a proposed amendment published by the Board in the federal Register on August 15, 1979 (44 F.R. 47775) to reflect coranents received. It will permit stock specialists and option marketmakers to finance with a broker/dealer certain offsetting positions in related securities on more advantageous terms than are available to the ordinary customer. This concession is given to those exchange-registered dealers who are obliged to promote fair and orderly markets in their specialty securities. The present rule limits margin concessions to the financing of specialty securities only. This action derives from the advent of exchange-traded options in 1973. EFFECTIVE DATE: August 11, 1980 FOR FURTHER INFORMATION CONTACT: Laura Homer, Chief Attorney or Patsy Abelle, Senior Attorney, Securities Regulation Section, Division of Banking Supervision and Regulation, Board of Governors of the Federal Reserve System, (202) 452-2781. SUPPLEMENTARY INFORMATION: The final rule includes a number of revisions to the August 15, 1979 proposal, based upon comments received. These include: (1) In response to comments received from the Securities and Exchange Commission ("SEC") and the National Association of Securities Dealers, Inc. ("NASD") references to a "registered securities association" are being deleted from the rule. These agencies noted that it may be inappropriate to include broker-dealers making markets in the over-the-counter market within the definition of "specialist" since under the Securities Exchange Act of 1934 that term is used only in connection with securities exchange markets. As an alternative they suggested that the financing of the market-making activities of these firms be treated in a separate section of Regulation T. (2) The rule has also been revised to permit a specialist to purchase or sell short in the account securities other than the specialist securities or the permitted offset positions if the regular margin require ments are met. This revision was made at the request of the Chicago Board Options Exchange, Inc. ("CBOE") which noted that the August 15 proposal required creditors "to perform the time consuming and burdensome -2 - task of manually transferring certain stock positions from a specialist's account to a general account." The Board believes this revision will substantially reduce this operational problem. (3) Hie definition of an "in or at the money" option has been broadened to permit specialists to offset their options positions with the underlying security provided the price of the security is within one standard exercise interval of the option being offset. The August 15 proposal required the underlying security to be within $2.50 or 5 percent of the option being offset. This change is intended to provide greater flexibility to specialists in employing hedging and spreading strategies to reduce the risk associated with making a market in options. It will also reduce an operational problem. The CBOE in commenting on this aspect of the August 15 proposal noted that it did not provide sufficient opportunities for hedging with the underlying security. (4> The requirement has been deleted that the creditor call for additional margin whenever securities no longer serving as permitted offset positions continue to be retained in the account. Several commenters, including the New York Stock Exchange, Inc. ("NYSE"), the American Stock Exchange, Inc. ("ASE") and the CBOE, noted that this provision constitutes a maintenance margin requirement and that historically the Board has left the promulgation of rules governing maintenance margins to the exchanges. The Board in reviewing this matter was satisfied that the 25 percent initial margin requirement on the purchase of permitted offset positions, when viewed together with the limitations on the withdrawal of equity contained in the rule, provided a reasonable cushion against adverse variations in market prices. (5) The "free-riding" penalty has been relaxed to exenpt the acquisition or liquidation of permitted offset positions and to reduce the number of days the "free-riding" penalty must be in effect from 30 to 15 calendar days. Those commenting on the August 15 proposal stated that the "free-riding" penalty was unduly harsh and recommended it be deleted and that the exchanges be allowed to adopt "anti-free-riding" rules of their own. The Board notes that the SEC in its "Report of the Special Study of the Cptions Markets" (the "Option Study") cited "free-riding" as one of the practices prevalent in the options markets and recommended that the Board consider adopting rules curtailing it. The Board recognizes that the exchanges through their surveillance and enforcement program are in a better position to police this activity, and this revised amendment provides a means through which these agencies may adopt their own rules to limit this activity. If the level of enforcement of the exchange rule is not sufficient to curtail the practice, the Board will consider eliminating the exemption. The Board continues to believe that a 25 percent margin is appropriate for permitted offset positions. Three option exchanges asked that it be changed to a "good faith" margin. Under the rule being adopted, the 25 percent initial margin requirement on permitted offset positions -3 - in concert with the limitations on the withdrawal of equity serve as the basis for accommodating market needs without permitting the excessive use of credit for purchasing or carrying securities. Accordingly, pursuant to sections 7 and 23 of the Securities Exchange Act of 1934, as amended (15 U.S.C. 78g and w), the Board revises section 220.4(g) of Regulation T (12 CFR 220.4(g)) to read as follows: 220.4 - SPECIAL ACCOUNTS * * * * * * * T i t l e 12— Banks and Banking CHAPTER II— FEDERAL RESERVE SYSTEM SUBCHAPTER A— BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM PART 220— CREDIT BY BROKERS AND DEALERS [Docket No. R-0004] Notice of Termination of Suspension of Uniform Margin Requirements for Options Specialists AGENCY: Board of Governors of the Federal Reserve System. ACTION: Rescission of order of suspension. SUMMARY: In January, 1977, the Board of Governors suspended, for options specialists, the effective date of a new rule establishing uniform margin requirements for the writing of options (42 Fed. Reg. 752). The suspension was put into effect until the Board could consider a separate, self-contained rule for options specialists. Since the Board has adopted such a separate rule today by a final amendment of section 220.4(g) of Regulation T, the suspension order is no longer necessary. Lifting the suspension is a housekeeping matter that will have no practical effect. EFFECTIVE DATE: August 11, 1980 FOR FURTHER INFORMATION CONTACT: Robert Lord, Securities Regulation Section, Division of Banking Supervision and Regulation, Board of Governors of the Federal Reserve System, Washington, D. C. 20551, (202-452-2781). SUPPLEMENTARY INFORMATION: Ch September 27, 1976, the Board adopted an amendment to Regulation T, effective January 1, 1977, which established a uniform margin requirement for the writing of options. (41 Fed. Reg. 43895) Although this rule was intended generally to apply to customer accounts, it also affected Specialists' accounts under the then-existing terms of Section 220.4(g) of Regulation T, which required, with two exceptions, that credit terms to Specialists conform to those available to public customers in a general account. On December 15, 1976, the Board proposed an amendment to § 220.4(g) which would have allowed options specialists to calculate required margin differently from that provided in the new uniform margin rule applicable to public customers. (41 Fed. Reg. 55552) The Board was, however, unable to act on the proposed alternate method of calculation by January 1, 1977, the effective date of the new uniform rule. It therefore suspended, for options specialists, the effective date of the uniform rule. (42 Fed. Reg. 752, January 4, 1977) In effect, the suspension permitted options specialists to use the pre-existing provisions of § 220.3(d)(5) instead of the new general account provisions. Today, the Board adopted a final amendment to the specialist's credit rule (section 220.4(g)), effective August 11, 1980. The new rule is self-contained and does not incorporate by reference the conditions of the regulation applicable to general customers, as did the prior rule. Since the prior order temporarily suspending the applicability of sections 220.3(d)(5) and 220.3(i) to options specialists will no longer be necessary, the Board hereby rescinds that prior order effective August 11, 1980 (the date the amendment to section 220.4(g) becomes effective). By order of the Board of Governors of the Federal Reserve System, June 11, 1980. (signed) Griffith L. Garwood Griffith L. Garwood Assistant Secretary of the Board [SEAL] BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM CREDIT BY BROKERS AND DEALERS A M E N D M E N T S TO R E G U L A T IO N T f 1. E ffective July 12, 1978, section 2 2 0 .4 is a m e n d e d to r e a d as follows: te re d security, O T C m a rg in stock o r O T C m a rg in b ond. * * * * * S E C T I O N 2 2 0 .4 — S P E C I A L A C C O U N T S * * * * * (f) Special m iscellaneous account. In a special m iscellan eo u s ac c o u n t, a c re d ito r m ay: (2) * * * * * * * * (ii)— E x te n d a n d m a in ta in a su b o rd in a te d lo a n to a n o th e r c re d ito r f o r cap ital purposes: Provided, T h a t ( a ) E ith er th e le n d e r o r th e b o rr o w e r is a firm o r c o rp o r a tio n w hich is a m e m b e r o f a n a tio n a l securities ex ch an g e o r natio n al securities asso cia tion, the o th e r p arty to the c re d it is a n affiliated c o rp o r a tio n o f such firm o r c o rp o r a tio n , the credit is n o t in c o n tra v e n tio n o f any rule o f the e x c h a n g e o r association an d the cred it h as th e a p p ro v a l o f a p p r o p r ia t e c o m m itte e s o f th e e x c h a n g e o r association, o r ( b ) T h e le n d e r as well as th e b o r r o w e r is a cre d ito r , as defined in section 220.2(b), th e su b o rd in a te d loan a g re e m e n t h as th e a p p ro v a l o f the a p p ro p r ia te E x a m in in g A u th o rity as defined in S ecurities a n d E x c h a n g e C o m m iss io n R u le 15c3-l (c)( 12) (12 C F R 2 4 0 .1 5 c 3 -l(c )(1 2 )) a n d su ch E x am in in g A u th o rity is satisfied, in the case o f a b o rr o w e r w ho w o u ld b e co n sid e re d a c u s to m e r of th e le n d e r a p a r t fr o m the s u b o r d in a te d loan, tha t the lo a n will n ot be used to in crease the a m o u n t o f dealing in securities fo r th e a c c o u n t o f th e b o rro w er, his firm o r c o rp o r a tio n o r an affiliated c o rp o r a tio n o f su ch firm o r c o rp o ra tio n . 2. E ffe c tiv e O c to b e r 3 0 , 1978, sectio n s 2 2 0 .2 and 2 2 0.4 are am en ded to read as follows: S E C T I O N 2 2 0 .2 — D E F I N I T I O N S * * * * * (f) (i) T h e te rm “ O T C m a rg in b o n d ” m e a n s a d e b t security n o t tra d e d o n a n a tio n a l securities ex c h a n g e w h ich m eets all o f th e follow ing re q u ire m ents: (1) A t th e tim e o f th e ex ten sio n o f credit, a p rin cip al a m o u n t of no t less th a n $ 2 5 ,0 0 0 ,0 0 0 of th e issue is o u tstan d in g . (2) T h e issue was registered u n d e r sectio n 5 o f the Securities A ct o f 1933 a n d th e issuer e ith e r files p eriodic re p o rts p u rs u a n t to section 13(a) or 15(d) o f th e S ecurities E x c h a n g e A c t o f 1934 o r is an in s u ra n c e c o m p a n y w h ic h m eets all o f th e c o n d itio n s specified in sectio n 12 (g)(2)(G) o f th e A ct. (3) A t th e tim e o f the ex ten sio n o f credit, th e c re d ito r h as a re a s o n a b le basis fo r believing th a t the issuer is n o t in d e fa u lt o n interest o r p rincipal p aym ents. S E C T I O N 220.4— S P E C I A L A C C O U N T S * * * * * (i) Special bond account. In a special b o n d a c c o u n t a c re d ito r m a y ex te n d a n d m a in ta in c re d it on an y ex e m p te d security, registered n o n -e q u ity secu rity o r O T C m a rg in bon d. T h e m a x im u m lo an value o f securities h eld in th is a c c o u n t shall be as p re s c rib e d fr o m tim e to tim e in § 220.8 (the S u p p le m e n t to R e g u la tio n T). C all o p tio n s m a y be issued, e n d o rs e d o r g u a r an te e d in this a c c o u n t o n any u n d e rly in g e q u ity s ecu rity w h ich is h eld in this a c c o u n t b ecau se it is a n e x e m p te d security. T h e te rm m a rg in security m e a n s a n y regis * * * * * f The complete Regulation comprises: 1) Regulation T, as amended effective June 1, 1977, printed in the pamphlet “ Securities Credit Transactions.” 2) The Supplement to Regulation T (section 220.8) dated October 1978, effective October 30, 1978. 3) This slip sheet. (Destroy slip sheet dated October 1978.) JUNE 1980 3. Effective August 11, 1980. section 220.4(g) is am ended to read as follows: S E C T IO N 2 20 .4— S P E C IA L A C C O U N T S * * * * * (g) S p e c ia lis t’s A ccount. ( I ) A p p lic a b ility. In a sp ecialist's account, a creditor may clear and finance for a specialist w ho is a m em b er o f a national securi ties exchange the m e m b er’s specialist transactions or transactions of any joint account in w hich all partici pants, or all participants other than the creditor, are registered and act as specialists. T he provisions o f this subsection are available to a specialist w ho is a m em ber of a national securities exchange which sub mits to the B oard o f G o verno rs o f the Federal R e serve System reports suitable for supplying current inform ation regarding the use o f specialist credit. (2) D e fin itio n s . F or the purpose o f this su b se c tion: (i) “ Joint a c c o u n t” m ean s an account in w hich the c re d ito r m ay p articipate and w hich by w ritten agreem ent perm its the com m in glin g o f the security positions o f the participants and provides for a shar ing o f profits and losses from the account on some predeterm ined ratio; (ii) “ U n d e rly in g s e c u r it y ” m e a n s th e secu rity w hich will be delivered upon exercise of the option and does not include a security convertible into the underlying security; (iii) "O v e rly in g o p tio n ” means (A) a put option purchased o r a call option written against an existing long position in a specialist’s o r m a rket-m aker’s ac count, or (B) a call option purchased or a'p u t option w ritten ag ain st a short p osition in a s p e c ia list’s or m arket-m ak er’s account. (iv) “ In or at the m o n e y ," with respect to a call option, indicates that the c u n e n t market price o f the un d erly in g security is no t m ore than one standard exercise interval below the exercise price o f the o p tion, and, w ith respect to a put option, that the cur rent m a rket price o f the un d erly in g security is not more than one standard exercise interval above the exercise price o f the option. (v) “ In the m o n e y ,” w ith respect to a call o p tion, in dicates that the curren t m a rket price o f the underlying security is not below the exercise price of the option and, with respect to a put option, that the current m arket price of the underlying security is not above the exercise price of the option. (3) P erm itted offset positions. A specialist in op tions is p erm itted to establish in this acco u n t on a share-for-share basis a long or short position in the securities un d erly in g the o p tions in w hich the sp e cialist m akes a market, and a specialist in securities other than options is perm itted to purchase or write options overlying the securities in which the special ist m akes a m arket, only under one or more o f the follow ing conditions (such positions are referred to in this paragraph as “ perm itted offset positions' ): (i) T h e a c c o u n t h o ld s a s h o r t o p tio n p o s itio n which is " i n or at the m o n e y " and is not offset by a long or short option position for an equal o r greater n u m b e r o f sh ares o f the sam e un d erly in g security which is " i n the m o n e y " : (ii) T h e a c c o u n t h o ld s a lo n g o p tio n p o s itio n w hich is “ in or at the m o n e y " and is not offset by a long or short option position for an equal or greater n u m b e r o f shares o f the sam e u n d erly in g security which is " i n the m o n e y " : (iii) T h e a c c o u n t h eld a s h o rt o p tio n p o sitio n against w hich an exercise notice was tendered: (iv ) T h e a c c o u n t h e ld a lo n g o p ti o n p o s itio n which was exercised: (v) The account holds a net long position in a se curity (other than an option) in w hich the specialist makes a market: or, (vi) T he a cco u n t holds a net short position in a security (other than an option) in which the special ist makes a market. (4) M a x i m u m lo a n v a lu e . T h e m a x im u m loan value o f securities w hich may be used as collateral in the account shall be: (i) No more than 100 per cent o f the current m ar ket value o f any long position in a security in which the sp e c ia list m a k es a m a rk e t or a w h o lly -o w n e d margin security; (ii) 75 per cent of the current market value o f any u n d erly in g security or o v e rly in g option pu rch ased and held in the account as a perm itted offset po si tion; (iii) T h e m a xim um loan value prescribed by the Board in section 220.8 (the Sup plem ent to R egula tion T) w hen a security p u rchased and held in the account does not qualify as a specialist or perm itted offset position. (5) A d ju ste d debit b alance. T h e am ount to be in cluded in the adjusted debit balance o f the account shall be: (i) Not less than 100 per cent o f the current m ar ket value o f either a security sold short or an option written w here such position qualifies as a specialist transaction; (ii) 125 per cent of the cu rren t m a rket value o f any security sold short o r option written and held in the account as a perm itted offset Position; (iii) T he am ount prescribed by the Board in sec tion 2 20.8 (the Supplem ent to Regulation T) when a security sold short in the account does not qualify as a sp ecialist o r p erm itted offset position plus, for a short position in a security other than an option, the current m arket value o f the security sold short. (6) Additional margin; “free-rid in g ." Except as required by paragraph (g)(8), on any day w hen addi tional margin is required as a result o f transactions in the acco unt, the c red ito r shall issue a call for a deposit o f cash o r securities having loan value and m ay a llo w the s p e c ia lis t a m a x im u m o f five full business days to m ake a dep osit sufficient to meet the call. T o prevent “ free-ridin g” in the account, a cre d ito r w h o has not o b ta in e d this d e p o sit (and is therefore required to liquidate sufficient securities to meet the call) is prohibited for a 15 day period from extending any further credit in the account to finance transactio ns in securities in w h ich the specialist is not registered to m ake a m arket. T h e acquisition or liquidation o f a perm itted offset position shall not be subject to this “ free-riding ” penalty. T he restriction on “ free-riding” shall not apply to any national se curities exchange adopting a “ free-riding” rule ap plicable to specialists w hich has been approved by the Securities and E xchange C om m ission. (7) Withdrawals. O n any d ay w hen a specialist requests a withdrawal o f cash or securities from the account, the creditor shall com pute the status o f the account for non-specialist securities positions in ac co rdance w ith the provisio ns o f section 2 20.8 (the Supplem ent to R egulation T ), perm itted offset posi tio n s in a c c o r d a n c e w ith th e p r o v is io n s o f p a r a graphs (g)(4)(ii) and (g)(5)(ii), and specialist po si tions on a “ good faith” basis. W ithdraw als shall be perm itted to the e x ten t that the adju sted debit bal ance in the accoun t does not exceed the m ax im um loan value o f all o f the collateral held in the account after the withdrawal has been made. (8) D eficit accounts. O n any day w h en the a c count w ould liquidate to a deficit, the creditor shall n ot e x te n d any fu r th e r c re d it in the a c c o u n t, and shall issue a call for ad d itio n a l cash or co llateral, w hich shall be met by noon o f the follow ing busi ness day. In the event sufficient cash or collateral is not deposited the creditor shall liquidate existing po sitions in the account.