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FEDERAL RESERVE BANK O F N EW YORK f Circular No. 7 9 4 2 1 L August 24, 1976 J INTERPRETATION OF REGULATION T Use of Escrow Receipts for Option Transactions T o A l l B r o k e r s a n d D e a lers, a n d M e m b e r s o f N a tio n a l S e c u r itie s E x c h a n g e s , in the S e c o n d F e d e ra l R e s e r v e D is tr ic t: The Board of Governors of the Federal Reserve System has issued an interpre tation of its Regulation T, “Credit by Brokers and D ealers,” regarding the use of escrow receipts for option transactions effected in special cash accounts. Enclosed is a copy of the interpretation. Any inquiries thereon may be directed to the Securities Regulations Division of our Bank Regulations D epartm ent. A ddi tional copies of the enclosure will be furnished upon request. P aul A. V olcker, President. Board of Governors of the Federal Reserve System CREDIT BY BROKERS AND DEALERS IN T E R P R E T A T IO N O F R E G U L A T IO N T Use of Escrow Receipts for Option Transactions Effected in Special Cash Account §220.130 E scrow receip ts for o p tio n tran s actions. The Board of Governors has interpreted § 220.4(c) of Regulation T as allowing the use of escrow receipts for option transactions effec ted in a special cash account if the customer represents that the covering securities or funds are held by a bank and the broker independently verifies that the appropriate escrow receipt will be delivered no later than three business days after the option is written. (a) The Board has been asked whether or not it is permissible under the provisions of § 220.4(c) of Regulation T (12 C FR 220.4(C)) relating to the special cash account, to allow customers to write put and call securities options which are “covered” by the escrow receipt of a bank when the escrow receipt, because of the mechanics of the trade, cannot be delivered to the broker on the day the option is written. When exchange-traded securities options were first introduced in 1973, the Board expressed the view that certain option transactions were permitted in the cash account (1973 B u lletin 525; 12 CFR 220.126) under circumstances which indicated their nature as bona fide cash transactions. Basically, that interpretation indi cates that the special cash account can be used if the underlying securities, or the funds necessary to pay for the securities, are held in the account o n the day the option is written. (This is com monly referred to as a “covered” transaction.) The use of “escrow receipts” for option trans actions to be effected in a special cash account was not considered by the Board at the time of the 1973 interpretation. (b) An escrow receipt is an agreement under which a bank represents and warrants that it holds for the account of a customer the securities which are the subject of a call, or the cash to purchase the securities which are the subject of a put, and will continue to hold the same until the option is either exercised or expires. If the option is exercised, the bank will deliver or accept delivery of the appropriate securities against payment, as the circumstances require. (c) It has been represented to the Board that customers who wish to write covered options in a cash account using escrow receipts are ham pered because of procedural delays in trans mitting the escrow receipt from the bank to the broker. Up to three business days may elapse before the receipt can be in the physical posses sion of the broker because, for example, some banks will not issue the receipt until the premium for writing the option is delivered. (d) The Board is of the view that a broker may effect an option transaction in a special cash account where the customer represents that the required securities or cash are then held for that customer at a bank and the broker independently verifies that the appropriate escrow receipt will be delivered to the broker by the bank as soon as possible but, in no event, later than three busi ness days after the option is written. (The term “bank’’ as defined in section 3(a)(6) of the Securities Exchange Act of 1934 includes banks, trust companies and those branches of foreign banks which are located in the United States and are supervised and examined by State banking authorities.) Any delay in delivery of the escrow receipt resulting from factors within the cus tomer’s control would, of course, cast doubt on the eligibility of the transaction as a bona fide cash transaction. By order of the Board of Governors, August 13, 1976, PRINTED IN NEW YORK [Enc. Cir. No. 79421