[Federal Register Volume 80, Number 16 (Monday, January 26, 2015)]
[Notices]
[Pages 4001-4005]
[FR Doc No: 2015-01245]

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-74091; File No. SR-OCC-2014-811]

Self-Regulatory Organizations; The Options Clearing Corporation;
Notice of Filing of an Advance Notice, and Amendment No. 1 Thereto, To
Establish Procedures Regarding the Monthly Resizing of its Clearing
Fund and the Addition of Financial Resources

January 20, 2015.
    Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall
Street Reform and Consumer Protection Act entitled the Payment,
Clearing, and Settlement Supervision Act of 2010 (``Payment, Clearing
and Settlement Supervision Act'') \1\ and Rule 19b-4(n)(1)(i) under the
Securities Exchange Act of 1934 (``Exchange Act'') \2\ notice is hereby
given that on December 1, 2014, The Options Clearing Corporation
(``OCC'') filed with the Securities and Exchange Commission
(``Commission'') the advance notice as described in Items I, II and III
below, which Items have been prepared by OCC. On December 16, 2014, OCC
filed amendment no. 1 to the advance notice (``Amendment No. 1'').\3\
This Amendment No. 1 amends and replaces, in its entirety, the advance
notice as originally filed on December 1, 2014. The Commission is
publishing this notice to solicit comments on the advance notice, as
amended, from interested persons.
---------------------------------------------------------------------------

    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ In Amendment No. 1, OCC amended the advance notice to
include the Monthly Clearing Fund Sizing Procedure and the Financial
Resource Monitoring and Call Procedure as exhibits to the filing,
both defined hereinafter, as Exhibit 5A and Exhibit 5B,
respectively. OCC has requested confidential treatment for Exhibit
5A and Exhibit 5B pursuant to the Rule 24b-2 under the Exchange Act.
---------------------------------------------------------------------------

I. Clearing Agency's Statement of the Terms of Substance of the Advance
Notice

    This advance notice is filed by OCC in connection with OCC's
proposal to establish procedures regarding the monthly resizing of its
Clearing Fund and the addition of financial resources through intra-day
margin calls and/or an intra-month increase of the Clearing Fund to
ensure that it maintains adequate financial resources in the event of a
default of a Clearing Member or group of affiliated Clearing Members
presenting the largest exposure to OCC.

II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Advance Notice

    In its filing with the Commission, OCC included statements
concerning the purpose of and basis for the advance notice and
discussed any comments it received on the advance notice. 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) and (B)
below, of the most significant aspects of these statements.

(A) Clearing Agency's Statement on Comments on the Advance Notice
Received From Members, Participants or Others

    Written comments on the advance notice were not and are not
intended to be solicited with respect to the advance notice and none
have been received.

(B) Advance Notices Filed Pursuant to Section 806(e) of the Payment,
Clearing and Settlement Supervision Act

    This Amendment No. 1 to SR-OCC-2014-811 (``Filing'') amends and
replaces in its entirety the Filing as originally submitted on December
1, 2014. The purpose of this Amendment

No. 1 to the Filing is to include the procedures that support the
processes described in Item 3 of the Filing as Exhibit 5A, Monthly
Clearing Fund Sizing Procedure, and Exhibit 5B, Financial Resources
Monitoring and Call Procedure.
    The proposed change would establish new procedures regarding the
monthly resizing of the Clearing Fund and the addition of financial
resources through intra-day margin calls and/or an intra-month increase
of the Clearing Fund to ensure that OCC maintains adequate Financial
Resources in the event of a default of a Clearing Member or group of
affiliated Clearing Members presenting the largest exposure to OCC.
Purpose of the Proposed Change
    The proposed change is intended to describe the situations in which
OCC would exercise authority under its Rules to ensure that it
maintains adequate Financial Resources \4\ in the event that stress
tests reveal a default of the Clearing Member or Clearing Member Group
\5\ presenting the largest exposure would threaten the then-current
Financial Resources. This proposed change would establish procedures
governing: (i) OCC's resizing of the Clearing Fund on a monthly basis
pursuant to Rule 1001(a) (the ``Monthly Clearing Fund Sizing
Procedure''); and (ii) the addition of Financial Resources through an
intra-day margin call on one or more Clearing Members under Rule 609
and, if necessary, an intra-month increase of the Clearing Fund
pursuant to Rule 1001(a) (the ``Financial Resource Monitoring and Call
Procedure'').\6\ The Monthly Clearing Fund Sizing Procedure would
permit OCC to determine the size of the Clearing Fund by relying on a
broader range of sound risk management practices than those
historically used under Rule 1001(a).\7\ The Financial Resource
Monitoring and Call Procedure would require OCC to collect additional
Financial Resources in certain circumstances, establish how OCC
calculates and collects such resources and provide the timing by which
such resources would be required to be deposited by Clearing Members.
---------------------------------------------------------------------------

    \4\ ``Financial Resources'' means, with respect to a projected
loss attributable to a particular Clearing Member, the sum of the
margin deposits and deposits in lieu of margin in respect of such
Clearing Member' accounts, and the value of OCC's Clearing Fund,
including both the Base Amount, as defined below, and the prudential
margin of safety, as discussed below.
    \5\ ``Clearing Member Group'' means a Clearing Member and any
affiliated entities that control, are controlled by or are under
common control with such Clearing Member. See OCC By-Laws, Article
I, Sections 1.C.(15) and 1.M(11).
    \6\ This advance notice filing has also been filed as a proposed
rule change (SR-OCC-2014-22).
    \7\ The procedures described herein would be in effect until the
development of a new standard Clearing Fund sizing methodology.
Following such development, which will include a quantitative
approach to calculating the ``prudential margin of safety,'' as
discussed below, OCC will file a separate rule change and advance
notice with the Commission that will include a description of the
new methodology as well as a revised Monthly Clearing Fund Sizing
Procedure.
---------------------------------------------------------------------------

Background
    OCC monitors the sufficiency of the Clearing Fund on a daily basis
but, prior to emergency action taken on October 15, 2014,\8\ OCC had no
express authority to increase the size of the Clearing Fund on an
intra-month basis.\9\ During ordinary course daily monitoring on
October 15, 2014, and as a result of increased volatility in the
financial markets in October 2014, OCC determined that the Financial
Resources needed to cover the potential loss associated with a default
of the Clearing Member or Clearing Member Group presenting the largest
exposure could have exceeded the Financial Resources then available to
apply to such a default.
---------------------------------------------------------------------------

    \8\ On October 16, 2014, OCC filed an emergency notice with the
Commission to suspend the effectiveness of the second sentence of
Rule 1001(a). See Securities Exchange Act Release No. 73579
(November 12, 2014), 79 FR 68747 (November 18, 2014) (SR-OCC-2014-
807). On November 13, 2014, OCC filed SR-OCC-2014-21 with the
Commission to delete the second sentence of Rule 1001(a), preserving
the suspended effectiveness of that sentence until such time as the
Commission approves or disapproves SR-OCC-2014-21. See Securities
Exchange Act Release No. 73685 (November 25, 2014) (SR-OCC-2014-21).
At the time of this filing, the referenced Securities Exchange Act
Release had not yet been published in the Federal Register.
    \9\ See OCC Rule 1001(a).
---------------------------------------------------------------------------

    To permit OCC to increase the size of its Clearing Fund prior to
the next monthly resizing that was scheduled to take place on the first
business day of November 2014, OCC's Executive Chairman, on October 15,
2014, exercised certain emergency powers as set forth in Article IX,
Section 14 of OCC's By-Laws \10\ to waive the effectiveness of the
second sentence of Rule 1001(a), which states that OCC will adjust the
size of the Clearing Fund monthly and that any resizing will be based
on data from the preceding month. OCC then filed an emergency notice
with the Commission pursuant to Section 806(e)(2) of the Payment,
Clearing and Settlement Supervision Act of 2010 \11\ and increased the
Clearing Fund size for the remainder of October 2014 as otherwise
provided for in the first sentence of Rule 1001(a).\12\
---------------------------------------------------------------------------

    \10\ OCC also has submitted an advance notice that would provide
greater detail concerning conditions under which OCC would increase
the size of the Clearing Fund intra-month. The change would permit
an intra-month increase in the event that the five-day rolling
average of projected draws are 150% or more of the Clearing Fund's
then current size. See Securities Exchange Act Release No. 72804
(August 11, 2014), 79 FR 48276 (August 15, 2014) (SR-OCC-2014-804).
    \11\ 12 U.S.C. 5465(e)(2).
    \12\ See supra, note 9.
---------------------------------------------------------------------------

    Clearing Members were informed of the action taken by the Executive
Chairman \13\ and the amount of their additional Clearing Fund
requirements, which were met without incident. As a result of these
actions, OCC's Clearing Fund for October 2014 was increased by $1.8
billion. In continued reliance on the emergency rule waiver and in
accordance with the first sentence of Rule 1001(a), OCC set the
November 2014 Clearing Fund size at $7.8 billion, which included an
amount determined by OCC to be sufficient to protect OCC against loss
under simulated default scenarios (i.e., $6 billion), plus a prudential
margin of safety (the additional $1.8 billion collected in
October).\14\ All required contributions to the November 2014 Clearing
Fund were met by affected Clearing Members.
---------------------------------------------------------------------------

    \13\ See Information Memorandum #35397, dated October 16, 2014,
available on OCC's Web site, http://www.theocc.com/clearing/clearing-infomemos/infomemos1.jsp. Clearing members also were
informed that a prudential margin of safety of $1.8 billion would be
retained until a new Clearing Fund sizing formula has been approved
and implemented.
    \14\ See Information Memorandum #35507, dated October 31, 2014,
available on OCC's Web site, http://www.theocc.com/clearing/clearing-infomemos/infomemos1.jsp.
---------------------------------------------------------------------------

    Under Article IX, Section 14(c), absent the submission of a
proposed rule change to the Commission seeking approval of OCC's waiver
of the provisions of the second sentence of Rule 1001(a), such waiver
would not be permitted to continue for more than thirty calendar days
from the date thereof.\15\ Accordingly, on November 13, 2014, OCC
submitted SR-OCC-2014-21 to delete the second sentence of Rule 1001(a)
and, by the terms of Article IX, Section 14(c), preserve the suspended
effectiveness of the second sentence of Rule 1001(a) beyond thirty
calendar days.\16\
---------------------------------------------------------------------------

    \15\ See OCC By-Laws, Article IX, Section 14(c).
    \16\ See supra, note 9. OCC also submitted this proposed rule
change to the Commodity Futures Trading Commission.
---------------------------------------------------------------------------

    SR-OCC-2014-21 was submitted in part to permit OCC to determine the
size of its Clearing Fund by relying on a broader range of sound risk
management practices than considered in basing such size on the average
daily calculations under Rule 1001(a) that are performed during the
preceding calendar month. The Monthly Clearing Fund Sizing Procedure,
as described below, is based on such broader risk management practices
and establishes the procedures

OCC would use to determine the size of the Clearing Fund on a monthly
basis. Similarly, SR-OCC-2014-21 was submitted in part to permit OCC to
resize the Clearing Fund more frequently than monthly when the
circumstances warrant an increase of the Clearing Fund. The Financial
Resource Monitoring and Call Procedure, as described below, establishes
the procedures that OCC would use to add Financial Resources through an
intra-day margin call on one or more Clearing Members under Rule 609
and, if necessary, an intra-month increase of the Clearing Fund
pursuant to Rule 1001(a).\17\
---------------------------------------------------------------------------

    \17\ As noted in SR-OCC-2014-21, OCC would use its intra-month
resizing authority only to increase the size of the Clearing Fund
where appropriate, not to decrease the size of the Clearing Fund.
---------------------------------------------------------------------------

Monthly Clearing Fund Sizing Procedure
    Under the Monthly Clearing Fund Sizing Procedure, OCC would
continue to calculate the size of the Clearing Fund based on its daily
stress test exposures under simulated default scenarios as described in
the first sentence of Rule 1001(a) and resize the Clearing Fund on the
first business day of each month. However, instead of resizing the
Clearing Fund based on the average of the daily calculations during the
preceding calendar month, as stated in the suspended second sentence of
Rule 1001, OCC would resize the Clearing Fund so that it is the sum of:
(i) An amount equal to the peak five-day rolling average of Clearing
Fund draws observed over the preceding three calendar months of daily
idiosyncratic default and minor systemic default scenario calculations
based on OCC's daily Monte Carlo simulations (``Base Amount'') and (ii)
a prudential margin of safety determined by OCC and currently set at
$1.8 billion.\18\
---------------------------------------------------------------------------

    \18\ On a daily basis, OCC computes its exposure under the
idiosyncratic and minor systemic events. The greater of these two
exposures is that day's ``peak exposure.'' To calculate the
``rolling five day average'' OCC computes the average of the peak
exposure for each consecutive five-day period observed over the
prior three-month period. To determine the Base Amount, OCC would
use the largest five-day rolling average observed over the past
three-months. This methodology was used to determine the Base Amount
of the Clearing Fund for November 2014 and December 2014.
---------------------------------------------------------------------------

    OCC believes that the proposed Monthly Clearing Fund Sizing
Procedure provides a sound and prudent approach to ensure that the
Financial Resources are adequate to protect against the largest risk of
loss presented by the default of a Clearing Member or Clearing Member
Group. By virtue of using only the peak five-day rolling average and by
extending the look-back period, the proposed Monthly Clearing Fund
Sizing Procedure is both more responsive to sudden increases in
exposure and less susceptible to recently observed decreases in
exposure that would reduce the overall sizing of the Clearing Fund,
thus mitigating procyclicality.\19\ Furthermore, the prudential margin
of safety provides an additional buffer to absorb potential future
exposures not previously observed during the look-back period. The
proposed Monthly Clearing Fund Sizing Procedure would be supplemented
by the Financial Resource Monitoring and Call Procedure, described
below, to provide further assurance that the Financial Resources are
adequate to protect against such risk of loss.
---------------------------------------------------------------------------

    \19\ Considering only the peak exposures is a more conservative
methodology that gives greater weighting to sudden increases in
exposure experienced by Clearing Members, thus enhancing the
responsiveness of the procedure to such sudden increases. By using a
longer look-back period, the methodology would respond more slowly
to recently observed decreases in peak exposures.
---------------------------------------------------------------------------

Financial Resource Monitoring and Call Procedure
    Under the Financial Resource Monitoring and Call Procedure, OCC
would use the same daily idiosyncratic default calculation as under the
Monthly Clearing Fund Sizing Procedure to monitor daily the adequacy of
the Financial Resources to withstand a default by the Clearing Member
or Clearing Member Group presenting the largest exposure under extreme
but plausible market conditions.\20\ If such a daily idiosyncratic
default calculation projected a draw on the Clearing Fund (a
``Projected Draw'') that is at least 75% of the Clearing Fund
maintained by OCC, OCC would be required to issue an intra-day margin
call pursuant to Rule 609 against the Clearing Member or Clearing
Member Group that caused such a draw (``Margin Call Event'').\21\
Subject to a limitation described below, the amount of the margin call
would be the difference between the Projected Draw and the Base
Clearing Fund (``Exceedance Above Base Amount''). In the case of a
Clearing Member Group that causes the Exceedance Above Base Amount, the
Exceedance Above Base Amount would be pro-rated among the individual
Clearing Members that compose the Clearing Member Group based on each
individual Clearing Member's proportionate share of the ``total risk''
for such Clearing Member Group as defined in Rule 1001(b), i.e., the
margin requirement with respect to all accounts of the Clearing Member
Group exclusive of the net asset value of the positions in such
accounts aggregated across all such accounts. However, in the case of
an individual Clearing Member or a Clearing Member Group, the margin
call would be subject to a limitation under which it could not exceed
the lower \22\ of: (a) $500 million, or (b) 100% of a Clearing Member's
net capital, measured cumulatively with any other funds deposited with
OCC by the same Clearing Member pursuant to a Margin Call Event within
the same month (the ``500/100 Limitation'').\23\
---------------------------------------------------------------------------

    \20\ Since the minor systemic default scenario contemplates two
Clearing Members' simultaneously defaulting and OCC maintains
Financial Resources sufficient to cover a default by a Clearing
Member or Clearing Member Group representing the greatest exposure
to OCC, OCC does not use the minor systemic default scenario to
determine the adequacy of the Financial Resources under the
Financial Resource Monitoring and Call Procedure.
    \21\ Rule 609 authorizes OCC to require the deposit of
additional margin in any account at any time during any business day
by any Clearing Member for, inter alia, the protection of OCC, other
Clearing Members or the general public. Clearing Members must meet a
required deposit of intra-day margin in immediately available funds
at a time prescribed by OCC or within one hour of OCC's issuance of
debit settlement instructions against the bank account(s) of the
applicable Clearing Member(s), thereby ensuring the prompt deposit
of additional Financial Resources.
    \22\ ``Capping'' the intra-day margin call avoids placing a
``liquidity squeeze'' on the subject Clearing Member(s) based on
exposures presented by a hypothetical stress test, which would have
the potential for causing a default on the intra-day margin call.
Back testing results determined that such calls would have been made
against Clearing Members that are large, well-capitalized firms,
with more than sufficient resources to satisfy the call for
additional margin with the proposed limitations.
    \23\ The Risk Committee would be notified, and could take action
to address potential Financial Resource deficiencies, in the event
that a Projected Draw resulted in a Margin Call Event and as a
result of the 500/100 Limitation the margin call was less than the
Exceedance Above Base Amount, but the Projected Draw was not so
large as to result in an increase in the Clearing Fund as discussed
below.
---------------------------------------------------------------------------

    Upon satisfaction of the margin call, OCC would use its authority
under Rule 608 to preclude the withdrawal of such additional margin
amount until the next monthly resizing of the Clearing Fund. Based on
three years of back testing data, OCC determined that it would have had
Margin Call Events in 10 of the months during this time period. For
each of these months, the maximum call amount would have been equal to
$500 million, with one exception in which the maximum call amount for
the month was $7.7 million.\24\ After giving effect to the intra-day
margin calls, i.e., by increasing the Financial Resources by $500
million, there was only one Margin Call Event where there was an
observed

stress test exceedance of the Financial Resources.
---------------------------------------------------------------------------

    \24\ The back testing analysis performed assumed a single
Clearing Member caused the exceedance.
---------------------------------------------------------------------------

    To address this one observed instance, the Financial Resource
Monitoring and Call Procedure also would require OCC to increase the
size of the Clearing Fund (``Clearing Fund Intra-month Increase
Event'') if a Projected Draw exceeds 90% of the Clearing Fund, after
applying any funds then on deposit with OCC from the applicable
Clearing Member or Clearing Member Group pursuant to a Margin Call
Event. The amount of such increase (``Clearing Fund Increase'') would
be the greater of: (a) $1 billion; or (b) 125% of the difference
between (i) the Projected Draw, as reduced by the deposits resulting
from the Margin Call Event and (ii) the Clearing Fund. Each Clearing
Member's proportionate share of the Clearing Fund Increase would equal
its proportionate share of the variable portion of the Clearing Fund
for the month in question as calculated pursuant to Rule 1001(b). OCC
would notify the Risk Committee of the Board of Directors (the ``Risk
Committee''), Clearing Members and appropriate regulatory authorities
of the Clearing Fund Increase on the business day on which the Clearing
Fund Intra-month Increase Event occurred. This ensures that OCC
management maintains authority to address any potential Financial
Resource deficiencies when compared to its Projected Draw estimates.
The Risk Committee would then determine whether the Clearing Fund
Increase was sufficient, and would retain authority to increase the
Clearing Fund Increase or the margin call made pursuant to a Margin
Call Event in its discretion. Clearing Members would be required to
meet the call for additional Clearing Fund assets by 9:00 a.m. CT on
the second business day following the Clearing Fund Intra-month
Increase Event. OCC believes that this collection process ensures
additional Clearing Fund assets are promptly deposited by Clearing
Members following notice of a Clearing Fund Increase, while also
providing Clearing Members with a reasonable period of time to source
such assets. Based on OCC's back testing results, after giving effect
to the intra-day margin call in response to a Margin Call Event plus
the prudential margin of safety, the Financial Resources would have
been sufficient upon implementing the one instance of a Clearing Fund
Intra-month Increase Event.
    OCC believes the Financial Resource Monitoring and Call Procedure
strikes a prudent balance between mutualizing the burden of requiring
additional Financial Resources and requiring the Clearing Member or
Clearing Member Group causing the increased exposure to bear such
burden. As noted above, in the event of a Margin Call Event, OCC limits
the margin call to a monthly aggregate of $500 million, or 100% of a
Clearing Member's net capital in order to avoid putting an undue
liquidity strain on any one Clearing Member. However, where a Projected
Draw exceeds 90% of OCC's Clearing Fund, OCC must act to ensure that it
has sufficient Financial Resources, and determined that it should
mutualize the burden of the additional Financial Resources at this
threshold through a Clearing Fund Increase. OCC believes that this
balance would provide OCC with sufficient Financial Resources without
increasing the likelihood that its procedures would, based solely on
stress testing results, cause a liquidity strain on any on Clearing
Member that could result in such member's default.
    The following examples illustrate the manner in which the Financial
Resource Monitoring and Call Procedure would be applied. All assume
that the Clearing Fund size is $7.8 billion, $6 billion of which is the
Base Amount and $1.8 billion of which is the prudential margin of
safety. The 75% threshold in these examples is $5.85 billion.
    Example 1:  Single CM.
    Under OCC's stress testing the Projected Draw attributable to
Clearing Member ABC, a Clearing Member with no affiliated Clearing
Members and net capital of $500 million, is $6.4 billion, or 82% of
the Clearing Fund. OCC would make a margin call for $400 million,
which represents the Exceedance Above Base Amount. In this case the
500/100 Limitation would not be applicable because the Exceedance
Above Base Amount is less than $500 million and 100% of the Clearing
Member's net capital. The Clearing Member would be required to meet
the $400 million call within one hour unless OCC prescribed a
different time, and OCC would retain the $400 million until the next
monthly Clearing Fund sizing calculation.
    If, on a different day within the same month, CM ABC's Projected
Draw minus the $400 million already deposited with OCC results in an
Exceedance Above Base Amount, another Margin Call Event would be
triggered, with the amount currently deposited with OCC applying
toward the 500/100 Limitation.
    Example 2: Clearing Member Group.
    Under OCC's stress testing the Projected Draw attributable to
Clearing Member Group DEF, comprised of two Clearing Members each
with net capital of $800 million, is $6.2 billion, or 79% of OCC's
Clearing Fund. OCC would initiate a margin call on Clearing Member
Group DEF for $200 million. The call would be allocated to the two
Clearing Members that compose the Clearing Member Group based on
each Clearing Member's risk margin allocation. In this case the 500/
100 Limitation would not be applicable because the Exceedance Above
Base Amount is less than $500 million and 100% of net capital. The
margin call would be required to be met within one hour of the call
unless OCC prescribed a different time. For example, in the case
where one Clearing Member accounts for 75% of the risk margin for
the Clearing Member Group, that Clearing Member would be allocated
$150 million of the call and the other Clearing Member, accounting
for 25% of the risk margin for the Clearing Member Group, would be
allocated $50 million of the call. The funds would remain deposited
with OCC until the next monthly Clearing Fund sizing calculation.
    Example 3: Clearing Member Group With $500 Million Cap.
    Under OCC's stress testing the Projected Draw attributable to
Clearing Member Group GHI, comprised of two Clearing Members each
with net capital of $800 million, is $6.8 billion, or 87% of the
Clearing Fund. The Exceedance Above Base Amount would be $800
million, allocated to the two Clearing Members that compose the
Clearing Member Group based on each Clearing Member's risk margin
allocation. Using the 75/25 risk margin allocation from Example 2,
one Clearing Member would be allocated $600 million and the other
Clearing Member would be allocated $200 million. The first Clearing
Member would be required to deposit $500 million with OCC, which is
the lowest of $500 million, that member's net capital, or that
member's share of the Exceedance Above Base Amount, and the other
Clearing Member would be required to deposit $200 million with OCC.
After collecting the additional margin, OCC would determine whether
the Projected Draw would exceed 90% of the Clearing Fund after
reducing the Projected Draw by the additional margin. This
calculation would divide a Projected Draw of $6.1 billion, which is
the original Projected Draw of $6.8 billion reduced by the
additional margin, by the Clearing Fund of $7.8 billion. The
resulting percentage of 78% would be below the 90% threshold, and
accordingly there would not be a Clearing Fund Intra-month Increase
Event.
    Example 4: Margin Call and Increase in Size of Clearing Fund
    Under OCC's stress testing the Projected Draw attributable to
Clearing Member JKL, a Clearing Member with no affiliated Clearing
Members and net capital of $600 million, is $10.0 billion, or 128%
of the Clearing Fund. OCC would make a margin call for $500 million,
which represents the lowest of the Exceedance Above Base Amount,
$500 million and 100% of net capital. The Clearing Member would be
required to meet the $500 million call within one hour unless OCC
prescribed a different time, and OCC would retain the $500 million
until the next monthly Clearing Fund sizing calculation.
    After collecting the additional margin, OCC would determine
whether the Projected Draw would exceed 90% of the Clearing Fund
after reducing the Projected Draw by the additional margin. This
calculation would divide a Projected Draw of $9.5 billion, which is
the original Projected Draw of $10 billion reduced by the additional
margin, by the Clearing Fund of $7.8 billion. The resulting
percentage of 122%, while lower, would still exceed the 90%
threshold, and

accordingly OCC would declare a Clearing Fund Intra-month Increase
Event. To calculate the Clearing Fund Increase, OCC would first
determine the difference between the modified Projected Draw ($9.5
billion) and the Clearing Fund ($7.8 billion), which in this case
would be $1.7 billion, OCC would then multiply this by 1.25,
resulting in $2.125 billion. Because this amount is greater than $1
billion, the Clearing Fund Increase would be $2.125 billion and a
modified Clearing Fund of OCC totaling $9.925 billion ($425 million
in excess of the modified Projected Draw of $9.5 billion).
Consistency With the Payment, Clearing and Settlement Supervision Act
    OCC believes that the proposed change regarding the establishment
of the Monthly Clearing Fund Sizing Procedure and Financial Resource
Monitoring and Call Procedure described above is consistent with
Section 805(b)(1) of the Payment, Clearing and Settlement Supervision
Act \25\ because the proposed procedures will promote robust risk
management by setting forth a process in order to ensure that OCC
maintains adequate Financial Resources in the event of a default of a
Clearing Member or Clearing Member Group presenting the largest
exposure to OCC. The proposed change regarding the establishment of
these procedures is also consistent with Section 806(e)(2) of the
Payment, Clearing and Settlement Supervision Act, upon which OCC relied
in originally suspending the effectiveness of the second sentence of
Rule 1001(a) and increasing the size of the Clearing Fund on October
15, 2014, because it allows OCC to continue to provide its services in
a safe and sound manner.\26\
---------------------------------------------------------------------------

    \25\ 12 U.S.C. 5464(b)(1).
    \26\ 12 U.S.C. 5464(e)(2); see SR-OCC-2014-807, supra, note 9.
---------------------------------------------------------------------------

Anticipated Effect on and Management of Risk
    OCC believes that the proposed change will reduce OCC's overall
level of risk because the proposed change makes it less likely that
OCC's Clearing Fund would be insufficient should OCC need to use its
Clearing Fund to manage a Clearing Member or Clearing Member Group
default. The Monthly Clearing Fund Sizing Procedure would permit OCC to
determine the size of its Clearing Fund by relying on a broader range
of sound risk management practices than those considered in the
suspended second sentence of Rule 1001(a). OCC believes that using the
peak five-day rolling average of Clearing Fund draws observed over a
three-month period will result in a monthly resizing of the Clearing
Fund that will better reflect the risks posed by sudden increases in
exposure experienced by Clearing Members. OCC also believes that the
proposed prudential margin of safety will provide an additional buffer
to protect against exposures not reflected in the three-month look-back
period. The Financial Resource Monitoring and Call Procedure would
enable OCC to minimize losses in the event of a default of a Clearing
Member or Clearing Member Group presenting the largest exposure to OCC,
by allowing it the flexibility to obtain additional Financial Resources
either through an intra-day margin call or an intra-month increase in
the size of the Clearing Fund, which would ensure that the clearance
and settlement of transactions in options and other contracts occurs
without interruption. Accordingly, OCC believes that the proposed
changes would reduce risks to OCC and its participants. Moreover, and
for the same reasons, the proposed change will facilitate OCC's ability
to manage risk.

III. Date of Effectiveness of the Advance Notice and Timing for
Commission Action

    The advance notice may be implemented if the Commission does not
object to the advance notice within 60 days of the later of (i) the
date that the advance notice was filed with the Commission or (ii) the
date that any additional information requested by the Commission is
received. OCC shall not implement the advance notice if the Commission
has any objection to the advance notice.
    The Commission may extend the period for review by an additional 60
days if the advance notice raises novel or complex issues, subject to
the Commission providing OCC with prompt written notice of the
extension. An advance notice may be implemented in less than 60 days
from the date the advance notice is filed, or the date further
information requested by the Commission is received, if the Commission
notifies OCC in writing that it does not object to the advance notice
and authorizes OCC to implement the advance notice on an earlier date,
subject to any conditions imposed by the Commission.
    The clearing agency shall post notice on its Web site of proposed
changes that are implemented.
    The proposal shall not take effect until all regulatory actions
required with respect to the proposal are completed.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and
arguments concerning the foregoing. Comments may be submitted by any of
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to<EMAIL_ADDRESS>Please include
File Number SR-OCC-2014-811 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-OCC-2014-811. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the advance notice that are filed
with the Commission, and all written communications relating to the
advance notice 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 Web site viewing and printing in
the Commission's Public Reference Room, 100 F Street NE., Washington,
DC 20549 on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of the filing also will be available for inspection
and copying at the principal office of OCC and on OCC's Web site at
http://www.theocc.com/about/publications/bylaws.jsp.
All comments received will be posted without change; the Commission
does not edit personal identifying information from submissions. You
should submit only information that you wish to make available
publicly. All submissions should refer to File Number SR-OCC-2014-811
and should be submitted on or before February 17, 2015.

By the Commission.
Brent J. Fields,
Secretary.
[FR Doc. 2015-01245 Filed 1-23-15; 8:45 am]
BILLING CODE 8011-01-P


[Federal Register Volume 76, Number 66 (Wednesday, April 6, 2011)]
[Notices]
[Pages 19155-19160]
[FR Doc No: 2011-8200]

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-64166; File No. SR-FINRA-2010-035]

Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of Amendment No. 1 and Order Granting
Accelerated Approval of a Proposed Rule Change, as Modified by
Amendment No. 1, Relating to Amendments to the Discovery Guide and
Rules 12506 and 12508 of the Code of Arbitration Procedure for Customer
Disputes

April 1, 2011.

I. Introduction

    On July 12, 2010, the Financial Industry Regulatory Authority, Inc.
(``FINRA'') filed with the Securities and Exchange Commission (``SEC''
or ``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Exchange Act'' or ``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to amend the Discovery Guide,
which includes Document Production Lists, and to make conforming
changes to Rules 12506 and 12508 of the Code of Arbitration Procedure
for Customer Disputes (``Customer Code''). The proposed rule change was
published for comment in the Federal Register on August 3, 2010.\3\ The
Commission received 55 comment letters on the

proposed rule change.\4\ On February 8, 2011, the Commission received
from FINRA a Response to Comments and Partial Amendment No. 1 to the
proposed rule change.\5\ The Commission is publishing this notice and
order to solicit comment on Amendment No. 1 and to approve the proposed
rule change, as modified by Amendment No. 1, on an accelerated basis.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Exchange Act Release No. 62584 (July 28, 2010), 75 FR
45685 (August 3, 2010).
    \4\ See comment letters submitted by Richard A. Stephens, Esq.,
dated August 6, 2010 (``Stephens comment''); Seth E. Lipner, Esq.,
Baruch College, Member, Deutsch & Lipner, dated August 15, 2010
(``Lipner comment''); Leonard Steiner, Esq., dated August 16, 2010
(``Steiner comment''); Robert C. Port, Esq., Cohen Goldstein Port
Gottlieb, LLP, dated August 19, 2010 (``Port comment''); Steven M.
McCauley, Esq., dated August 19, 2010 (``McCauley comment''); Steven
B. Caruso, Esq., Maddox Hargett & Caruso, P.C., dated August 20,
2010 (``Caruso comment''); Diane Nygaard, Esq., dated August 20,
2010 (``Nygaard comment''); Ryan K. Bakhtiari, Esq., Aidikoff, Uhl
and Bakhtiari, dated August 20, 2010 (``Bakhtiari comment''); Thomas
R. Cox, Esq., Miller, Canfield, Paddock and Stone, P.L.C., dated
August 20, 2010 (``Cox comment''); Steven J. Gard, Esq., dated
August 22, 2010 (``Gard comment''); John W. Shaw, Esq., Berkowitz,
Oliver, Williams, Shaw and Eisenbrandt, dated August 23, 2010
(``Shaw comment''); Stephen Krosschell, Esq., Goodman & Nekvasil,
P.A., dated August 23, 2010 (``Krosschell comment''); David P.
Neuman, Esq., Stoltmann Law Offices, P.C., dated August 23, 2010
(``Neuman comment''); Theodore A. Krebsbach, Esq., Krebsbach and
Snyder, P.C., dated August 23, 2010 (``Krebsbach comment''); Eric G.
Wallis, Esq., Reed Smith LLP, dated August 23, 2010 (``Wallis
comment''); Herb Pounds, Jr., Esq., dated August 23, 2010 (``Pounds
comment''); Alan S. Brodherson, Esq., dated August 24, 2010
(``Brodherson comment''); Joseph Terry, dated August 24, 2010
(``Terry comment''); Mark James, dated August 24, 2010 (``James
comment''); Jonathan W. Evans, Esq., and Michael S. Edmiston, Esq.,
Law Offices of Jonathan W. Evans & Associates, dated August 24, 2010
(``Evans and Edmiston comment''); G. Kirk Ellis, Esq., dated August
24, 2010 (``Ellis comment''); Jason R. Doss, Esq., The Doss Firm,
LLC, dated August 24, 2010 (``Doss comment''); Jenice L. Malecki,
Esq., Malecki Law, dated August 24, 2010 (``Malecki comment'');
Frances Ruby, dated August 24, 2010 (``Ruby comment''); Carrie L.
Chelko, Esq., Deputy General Counsel, Janney Montgomery Scott LLC,
dated August 24, 2010 (``Janney comment''); Raymond W. Henney, Esq.,
Honigman Miller Schwartz and Cohn LLP, dated August 24, 2010
(``Henney comment''); Jonathan Kord Lagemann, Esq., dated August 24,
2010 (``Lagemann comment''); Brian N. Smiley, Esq., Smiley Bishop &
Porter, LLP, dated August 24, 2010 (``Smiley comment''); Stanley
Yorsz, Esq., Buchanan Ingersoll & Rooney PC, dated August 24, 2010
(``Yorsz comment''); Dominick F. Evangelista, Esq., Bressler, Amery
& Ross, P.C., dated August 24, 2010 (``Evangelista comment'');
Michael N. Ungar, Esq., Kenneth A. Bravo, Esq., Joseph S. Simms,
Esq., and Jill Y. Coen, Esq., Ulmer & Berne LLP, dated August 24,
2010 (``Ulmer & Berne comment''); Barry D. Estell, Esq., dated
August 24, 2010 (``Estell comment''); Richard A. Lewins, Esq., dated
August 24, 2010 (``Lewins comment''); Robert M. Rudnicki, Esq., Vice
President and Director of Litigation, Raymond James & Associates,
Inc., on behalf of Raymond James Financial, Inc. and Raymond James &
Associates, Inc., dated August 24, 2010 (``Raymond James comment'');
Lee H. Schillinger, dated August 24, 2010 (``Schillinger comment'');
Paula D. Shaffner, Esq., Stradley Ronon Stevens & Young, LLP, dated
August 24, 2010 (``Shaffner comment''); Kelly J. Moynihan, Esq.,
Keesal, Young & Logan, dated August 24, 2010 (``Moynihan comment'');
Richard L. Martens, Esq., Jason S. Haselkorn, Esq., Patricia M.
Christiansen, Esq., Charles L. Pickett, Esq., Casey Ciklin Lubitz
Martens & O'Connell, dated August 24, 2010 (``Casey Ciklin
comment''); Peter J. Mougey, Esq., Levin Papantonio Thomas Mitchell
Rafferty & Proctor, P.A., dated August 24, 2010 (``Mougey
comment''); Rob Bleecher, Esq., dated August 24, 2010 (``Bleecher
comment''); Scott R. Shewan, Esq., President, Public Investors
Arbitration Bar Association, dated August 24, 2010 (``PIABA
comment''); Bradford D. Kaufman, Esq., Greenberg Traurig, P.A.,
dated August 24, 2010 (``Kaufman comment''); William A. Jacobson,
Esq., Associate Clinical Professor, Cornell Law School, and
Director, Cornell Securities Law Clinic, dated August 24, 2010
(``Cornell Securities Law Clinic comment''); S. Lawrence Polk, Esq.,
Sutherland Asbill & Brennan LLP, dated August 24, 2010 (``Polk
comment''); John R. Cronin, Vermont Securities Director and Chair,
NASAA Arbitration Project Group, dated August 25, 2010 (``NASAA
comment''); Theodore M. Davis, Esq., dated August 25, 2010 (``Davis
comment''); Eliot Goldstein, Esq., Law Offices of Eliot Goldstein,
LLP, dated August 25, 2010 (``Goldstein comment''); Richard M.
Layne, Esq., dated August 26, 2010 (``Layne comment''); Royal B.
Lea, Esq., dated August 27, 2010 (``Lea comment''); Keith L.
Griffin, Esq., Griffin Law Firm, LLC, dated August 27, 2010
(``Griffin comment''); Patricia Cowart, Esq., Chair, SIFMA
Arbitration Committee, dated September 10, 2010 (``SIFMA comment'');
Gail E. Boliver, Esq., Boliver & Bidwell, dated September 16, 2010
(``Boliver comment''); Scott C. Ilgenfritz, Esq., Johnson, Pope,
Bokor, Ruppel & Burns, LLP, dated September 24, 2010 (``Ilgenfritz
comment''); Matthew Farley, Esq., Drinker Biddle & Reath LLP, dated
September 24, 2010 (``Drinker Biddle comment''); and Kathy A.
Besmer, dated November 6, 2010 (``Besmer comment'').
    \5\ See letter from Margo A. Hassan, Assistant Chief Counsel,
FINRA Dispute Resolution, to Elizabeth Murphy, Secretary,
Commission, dated February 8, 2011 (``Response Letter''). The text
of the proposed rule change and FINRA's Response Letter are
available on FINRA's Web site at http://www.finra.org, at the
principal office of FINRA, on the Commission's Web site at http://www.sec.gov, and at the Commission's Public Reference Room.
---------------------------------------------------------------------------

II. Description of Proposed Rule Change and Summary of Comments

    As described in Exchange Act Release No. 62584,\6\ FINRA is
proposing to amend the Discovery Guide, which includes Document
Production Lists, and to make conforming changes to Rules 12506 and
12508 of the Customer Code. Of the 55 comments received on the initial
proposal, 15 supported it with modifications,\7\ 36 opposed it,\8\ and
4 addressed particular aspects of the proposal without expressing a
position on whether the Commission should approve the proposed rule
change.\9\
---------------------------------------------------------------------------

    \6\ See note 3 supra.
    \7\ See Caruso, Bakhtiari, Cox, Pounds, Doss, Malecki, Smiley,
Lewins, Raymond James, Mougey, PIABA, Cornell Securities Law Clinic,
SIFMA, Boliver, and Ilgenfritz comments.
    \8\ See Lipner, Steiner, Port, McCauley, Nygaard, Gard, Shaw,
Neuman, Krebsbach, Krosschell, Brodherson, Terry, James, Evans and
Edmiston, Ellis, Ruby, Janney, Lagemann, Yorsz, Evangelista, Ulmer &
Berne, Estell, Schillinger, Shaffner, Moynihan, Casey Ciklin,
Bleecher, Kaufman, NASAA, Davis, Goldstein, Layne, Lea, Griffin,
Drinker Biddle, and Besmer comments.
    \9\ See Stephens, Wallis, Henney, and Polk comments.
---------------------------------------------------------------------------

    In its Response Letter, FINRA stated that the initial proposed rule
change reflected several years of close consultation with FINRA's
constituents, including investor and industry representatives,
arbitrators, and attorneys that handle investor claims at securities
arbitration clinics. FINRA also stated that, because the Discovery
Guide, as amended by the initial proposed rule change, was comprised of
language that was discussed at length with these constituents and
crafted to balance the parties' discovery needs with the goal of
keeping FINRA arbitration efficient and cost effective, FINRA was, for
the most part, making only limited further revisions to the proposed
rule change to provide additional clarification and guidance.\10\
---------------------------------------------------------------------------

    \10\ Response Letter.
---------------------------------------------------------------------------

    In addition, FINRA stated that, if the Commission approves the
proposed rule change as amended, it would establish a Discovery Task
Force under the auspices of FINRA's National Arbitration and Mediation
Committee to review substantive issues relating to the Discovery Guide
on an ongoing basis, for the purpose of keeping the Discovery Guide
current as products change and new discovery issues arise.\11\ FINRA
stated that it would convene the Discovery Task Force approximately six
months after implementing the revised Discovery Guide to allow
practitioners time to gauge the efficacy of the new Discovery
Guide.\12\
---------------------------------------------------------------------------

    \11\ Id.
    \12\ Id.
---------------------------------------------------------------------------

    FINRA's responses to comments and changes to the proposed rule
change made by Amendment No. 1 are described below.

A. Guide Introduction

1. Arbitrator Discretion
    Commenters expressed concerns that arbitrators may adhere strictly
to the Discovery Guide's two lists of documents (the first itemizing
categories of documents to be produced by firms and their associated
persons, and the second itemizing categories of documents to be
produced by customers--together, ``Lists'') when making discovery
decisions and may not use the flexibility the Discovery Guide provides
to them.\13\ FINRA responded that it wants arbitrators to be aware of
the flexibility they have when

asked to decide discovery disputes, and therefore the initial proposal
included revisions to the introduction of the Discovery Guide stating
that arbitrators may order production of documents not appearing on the
Lists, and that arbitrators can order that parties do not have to
produce all items on the Lists in a particular case.\14\ Further, these
revisions added guidance on how arbitrators should handle objections
based on cost or burden of production.\15\
---------------------------------------------------------------------------

    \13\ See Lipner, Krebsbach, Evans and Edmiston, Shaffner,
Bleecher, Griffin, Henney, NASAA, Yorsz, Goldstein, SIFMA, and
Drinker Biddle comments.
    \14\ Response Letter.
    \15\ Id.
---------------------------------------------------------------------------

    In addition to these changes, and in response to commenters'
concerns, FINRA has proposed changes to the introduction to explain
that arbitrators must use their judgment in considering requests for
documents beyond those contained in the Lists and may not deny document
requests on the grounds that the documents are not expressly listed in
the Discovery Guide.\16\ FINRA stated that, in addition to expanding
the language in the Discovery Guide, if the SEC approves the proposed
rule change, FINRA would revise the Arbitrator's Reference Guide, which
is posted on the FINRA Web site, to include a discussion on how
arbitrators should use the new Discovery Guide.\17\ FINRA also stated
that it would update its arbitrator training materials to ensure that
FINRA makes arbitrators aware of the revisions.\18\ In addition, FINRA
stated that it would offer training on the revised Discovery Guide in a
workshop that FINRA would post as an audio file on its Web site if the
proposed rule change, as amended, is approved.\19\
---------------------------------------------------------------------------

    \16\ Id.
    \17\ Id.
    \18\ Id.
    \19\ Id.
---------------------------------------------------------------------------

2. Business Models and Types of Customer Claims
    FINRA initially proposed adding language to the introduction of the
Discovery Guide stating that parties and arbitrators should recognize
that not all firms have the same business models and that certain items
on the Lists may not be relevant in a particular case when the firm's
business model (e.g., full service firm, discount broker, or online
broker) is taken into consideration.\20\ Commenters requested that
FINRA add ``clearing firm'' to the parenthetical listing examples of
business models.\21\ FINRA agrees that adding ``clearing firm'' to the
parenthetical would be helpful to parties and arbitrators and has
amended the proposed language of the parenthetical accordingly.\22\
FINRA is also proposing in that same paragraph to replace the phrase
``be relevant in'' with the phrase ``apply to'' because ``apply to''
would more precisely convey the intended meaning of the sentence.\23\
In addition, commenters asked for new language indicating that items on
the Customer List may not apply in a particular case depending on the
claims asserted.\24\ FINRA agrees that adding such guidance regarding
customer claims would be helpful, and has amended the proposed rule
change accordingly.\25\
---------------------------------------------------------------------------

    \20\ See note 3 supra.
    \21\ See SIFMA and Drinker Biddle comments. The Drinker Biddle
comment also asked FINRA to add ``prime-brokerage firm'' to the
parenthetical. FINRA believes that adding ``clearing firm'' to the
parenthetical will add sufficient clarity for the Guide's users and
is not proposing to add ``prime-brokerage firm'' at this time.
    \22\ Response Letter.
    \23\ Id.
    \24\ See PIABA and Caruso comments.
    \25\ Response Letter.
---------------------------------------------------------------------------

    In the initial proposed rule change, FINRA included language
stating that electronic files are ``documents'' within the meaning of
the Discovery Guide.\26\ Commenters suggested that FINRA should include
additional guidance concerning electronic files.\27\ FINRA responded
that it understands that issues relating to electronic discovery are
becoming more prevalent and intends to recommend that the Discovery
Task Force include the topic on its agenda.\28\ However, FINRA is not
proposing any additional revisions concerning electronic discovery at
this time.
---------------------------------------------------------------------------

    \26\ See note 3 supra.
    \27\ See Yorsz and Martens comments.
    \28\ Response Letter.
---------------------------------------------------------------------------

3. Privilege
    Several commenters raised concerns that List items might require
production of privileged documents.\29\ One commenter suggested that
parties raise objections based on unspecified or unrecognized
privileges.\30\ Based on these comments, FINRA believes that additional
guidance on acceptable grounds for assertions of privilege would be
helpful to parties and arbitrators, and is proposing to add language to
the introduction stating that parties are not required to produce
documents that are otherwise subject to an established privilege,
including the attorney-client privilege and attorney work product
doctrine.\31\
---------------------------------------------------------------------------

    \29\ See Krosschell, Pounds, Evans and Edmiston, Schillinger,
PIABA, Polk, Layne, SIFMA, Drinker Biddle, and Janney comments.
    \30\ See Estell comments.
    \31\ Id.
---------------------------------------------------------------------------

4. Enforcing Document Production
    Commenters raised concerns about arbitrators not adequately
enforcing the discovery rules, including through reluctance to impose
sanctions for party failure to comply with discovery rules.\32\ FINRA
believes that the appropriate places to address the arbitrators' duty
to enforce discovery requirements are the Code of Arbitration Procedure
and FINRA's training materials.\33\ FINRA stated that it trains
arbitrators concerning the discovery rules and available sanctions.\34\
FINRA also stated that, to reinforce the training, it had included a
discussion in the revised Arbitrator's Reference Guide (which FINRA
indicated would be posted to FINRA's Web site in the near future) that
addresses discovery obligations and discusses sanctions.\35\
---------------------------------------------------------------------------

    \32\ See Krebsbach, Lewins, PIABA, and Boliver comments.
    \33\ Response Letter.
    \34\ Id.
    \35\ Id.
---------------------------------------------------------------------------

B. Document Production Lists

1. Eliminating the Discovery Guide
    Several commenters asserted that FINRA should eliminate the
Discovery Guide.\36\ FINRA disagreed with the commenters and stated
that experience with the current Discovery Guide since its inauguration
in 1999 indicates that the Discovery Guide and its Lists help parties
obtain the documents they need to develop a case.\37\ FINRA believes
that the proposed rule change, which incorporated user feedback after
years of experience with the Discovery Guide, will improve the
discovery process for customers, and for firms and their associated
persons.\38\
---------------------------------------------------------------------------

    \36\ See Lipner, McCauley, Gard, Terry, Evans and Edmiston, and
Bleecher comments.
    \37\ Response Letter.
    \38\ Id.
---------------------------------------------------------------------------

2. Production Burden
    Several commenters expressed the view that document production
under the Guide is burdensome to investors.\39\ Others raised concerns
about the burdens imposed on firms and their associated persons.\40\
FINRA stated that it created the Discovery Guide to facilitate the
exchange of the kinds of documents that parties routinely sought during
discovery and that arbitrators regularly ordered produced. FINRA also
stated that the proposed revisions reflect experience gained over the
years since FINRA implemented the Discovery Guide.\41\ In addition,
FINRA stated that

balancing the desire to provide parties with the documents they need to
prepare their cases with a desire to minimize production burdens is
challenging, but, based on years of experience with the Discovery Guide
and constituent feedback, FINRA believed that the proposed rule change,
as amended, would strike an appropriate balance.\42\
---------------------------------------------------------------------------

    \39\ See Lipner, McCauley, Neuman, Krebsbach, James, Evans and
Edmiston, Doss, Ruby, Smiley, Estell, Mougey, Bleecher, NASAA,
Davis, Layne, and Ilgenfritz comments.
    \40\ See Cox, Krebsbach, Janney, Evangelista, Ulmer & Berne,
SIFMA, and Drinker Biddle comments.
    \41\ Response Letter.
    \42\ Id.
---------------------------------------------------------------------------

3. Two List Format
    Several commenters objected to FINRA's proposal to consolidate the
Lists from 14 claim-specific lists to two general Lists (one for firms
and their associated persons, and one for customers) citing, among
other objections, additional production burdens and the potential for
producing documents that are not needed in every case.\43\ FINRA stated
that it proposed the consolidation in response to suggestions from
advocates for customers that FINRA eliminate the Lists for specific
types of claims because customers are not required to plead causes of
action under the Customer Code.\44\ FINRA also stated that, along with
consolidating the Lists, FINRA proposed expanding the guidance it gives
to arbitrators in the Discovery Guide's introduction on how to handle
discovery issues so that arbitrators understand that they may tailor
the Discovery Guide to unique circumstances that arise in arbitration
cases.\45\ FINRA stated that the consolidation would better serve forum
users and ultimately reduce the number and limit the scope of disputes
involving document production.\46\
---------------------------------------------------------------------------

    \43\ See Port, Cox, Shaw, Krebsbach, Brodherson, Janney, Yorsz,
Shaffner, Martens, Ulmer & Berne, and SIFMA comments.
    \44\ FINRA stated that it proposed to update the Discovery Guide
in 2008, and, although the 2008 proposal was withdrawn, FINRA
incorporated many suggestions made in comments on that proposal,
including the suggestion that FINRA consolidate the lists, in the
current proposal. See Response Letter.
    \45\ Response Letter.
    \46\ Id.
---------------------------------------------------------------------------

4. Time Periods and Scope of Production
    Several commenters objected to the time periods specified in the
proposed consolidated List items.\47\ FINRA responded by stating that
investor and industry representatives that collaborated with FINRA on
the proposed rule change considered each List item on its own merits
and discussed, over several meetings, the time periods for each
item.\48\ FINRA explained that, given the effort that went into
determining appropriate time periods for production, FINRA was not
proposing to change any of the time periods in the proposed rule
change.\49\ FINRA also stated that the Discovery Task Force may choose
to revisit the time periods for production of certain documents after
forum users have gained experience with the revised Discovery
Guide.\50\
---------------------------------------------------------------------------

    \47\ See Stephens, Caruso, Krosschell, Pounds, Evans and
Edmiston, Smiley, Ulmer & Berne, Estell, Raymond James, Shillinger,
Shafner, Mougey, PIABA, Cornell Securities Law Clinic, Davis,
Goldstein, Layne, SIFMA, Boliver, and Drinker Biddle comments.
Commenters asserted, among other objections, that time periods were
too short, or too long, or were not consistent between customers and
firms/associated persons.
    \48\ Response Letter.
    \49\ Id.
    \50\ Id.
---------------------------------------------------------------------------

5. Product Cases
    Several commenters raised concerns that the Guide does not
sufficiently address claims alleging the defective structuring or
widespread mismarketing of a specific security, or ``product cases.''
\51\ One commenter expressed the belief that the Guide should not
address specific products.\52\ FINRA responded by stating that it
believes product cases are an appropriate subject for the Discovery
Task Force, and that it intends to suggest that the Task Force consider
the topic further.\53\
---------------------------------------------------------------------------

    \51\ See Lipner, Bakhtiari, Malecki, Mougey, and Goldstein
comments.
    \52\ See Krebsbach comments.
    \53\ Response Letter.
---------------------------------------------------------------------------

6. Distinguishing Customer Parties From Other Customers
    Commenters asked FINRA to revise the proposed List items to
distinguish between customers that are parties to a case and other,
non-party customers.\54\ FINRA agreed that making such a distinction in
the proposed List items would add clarity to the Discovery Guide.\55\
FINRA has accordingly amended the proposed preamble to the Lists to
state that, throughout the Lists, FINRA will refer to customers that
are parties to an arbitration case as ``customer parties'' and other,
non-party customers as ``customers.'' \56\
---------------------------------------------------------------------------

    \54\ See SIFMA and Raymond James comments.
    \55\ Response Letter.
    \56\ Id.
---------------------------------------------------------------------------

7. Accounts or Transactions at Issue
    Several proposed List items called for a firm or associated person
to produce documents relating to the accounts or transactions at
issue.\57\ Upon further consideration, FINRA has amended the proposed
rule change by specifying that, in addition to documents relating to
the accounts or transactions at issue, these items cover documents
relating to the claims, and products or types of products, at
issue.\58\
---------------------------------------------------------------------------

    \57\ See List 1, items 2, 7, 9, 11, 12, 13, and 17.
    \58\ Response Letter.
---------------------------------------------------------------------------

C. Individual List Items

    In addition to the amendments described above, FINRA has made a
number of revisions to the proposed rule change that are specific to
individual items on the Lists.
1. List 1, Item 2
    As initially proposed, this item would have called for production
of all correspondence sent to customers or received by firms and their
associated persons specifically relating to the accounts or
transactions at issue including, but not limited to, documents relating
to asset allocation, diversification, trading strategies, and market
conditions; and all advertising materials sent to customers of the firm
that refer to the securities or account types at issue.\59\ Unless
separately requested, the documents would not have included
confirmation slips and monthly statements.
---------------------------------------------------------------------------

    \59\ See note 3 supra.
---------------------------------------------------------------------------

    FINRA has made several changes to this proposed item that FINRA
believes would clarify the item's application and provide additional
guidance to parties and arbitrators.\60\ As amended, the item would
require production of all correspondence sent to the customer parties
or received by the firm or its associated persons that relate to the
claims, accounts, transactions, or products or types of products at
issue including, but not limited to, documents relating to asset
allocation, diversification, trading strategies, and market conditions;
and all advertising materials sent to customers of the firm that refer
to the products or account types that are at issue or that were used by
the firm or its associated persons to solicit or provide services to
the customer parties. In addition, if requested, the documents would
include confirmation slips and monthly statements. Even if not
requested, the documents would include confirmation slips and monthly
statements that have handwritten notations or that are not identical to
those the firm sent to the customer parties.
---------------------------------------------------------------------------

    \60\ Response Letter.
---------------------------------------------------------------------------

2. List 1, Item 4
    Currently, for claims alleging unauthorized trading, the Discovery
Guide presumes that firms will produce order tickets for the customers'
transactions at issue. FINRA initially proposed to delete this
requirement on

the grounds that production of order tickets is burdensome, and
evidence relating to whether the claimants authorized a particular
transaction would be produced under proposed List 1, Items 4, 6, and 8.
Several commenters objected to the proposed deletion and stated, among
other things, that order tickets provide evidence of whether a trade
was solicited or unsolicited, evidence of whether a trade was reviewed
and approved by supervisory personnel, and evidence of the time that an
order was entered.\61\ FINRA found the comments persuasive, and has
amended the proposed item to restore the presumption that firms will
produce order tickets for the customer parties' transactions at issue
in cases alleging unauthorized trading.\62\ FINRA believes that the
arbitrators can effectively address issues of production burden on a
case-by-case basis.\63\
---------------------------------------------------------------------------

    \61\ See Stephens, Caruso, Nygaard, Krosschell, Evans and
Edmiston, Schillinger, Layne, and Pounds comments.
    \62\ Response Letter.
    \63\ Id.
---------------------------------------------------------------------------

3. List 1, Item 5(a)
    As initially proposed, this item would have provided for production
of all materials that the firm or its associated persons prepared, used
or provided to customers relating to the transactions or products at
issue, including research reports, sales materials, performance or risk
data, prospectuses, and other offering documents, including documents
intended or identified as being ``for internal use only.'' \64\ In
response to comments, FINRA is proposing to amend the proposed item to
clarify its intended scope by specifying that the documents include
copies of news articles or outside research.\65\
---------------------------------------------------------------------------

    \64\ See note 3 supra.
    \65\ See Response Letter. Cf. Estell comments (relating to news
articles or outside research).
---------------------------------------------------------------------------

4. List 1, Item 6
    As initially proposed, this item would have required production of
all notes the firm or its associated persons made, including, but not
limited to, entries in any diary or calendar, relating to the customers
or the customers' accounts or transactions at issue.\66\ For clarity,
FINRA has amended this proposed item to require production of all notes
the firm or its associated persons made relating to the customer
parties or the customer parties' claims, accounts, transactions, or
products or types of products at issue, including, but not limited to,
entries in any diary or calendar, relating to the claims or products at
issue.\67\
---------------------------------------------------------------------------

    \66\ See note 3 supra.
    \67\ Response Letter.
---------------------------------------------------------------------------

5. List 1, Item 7(a)
    As initially proposed, this item would have required production of
all notes or memoranda evidencing supervisory, compliance, or
managerial review of the customers' accounts or trades therein for the
period at issue.\68\ FINRA has amended this proposed item to expand the
guidance provided to parties and arbitrators by requiring production of
all notes or memoranda evidencing supervisory, compliance, or
managerial review of the customer parties' accounts or transactions
therein or of the associated persons assigned to the customer parties'
accounts for the period at issue.\69\
---------------------------------------------------------------------------

    \68\ See note 3 supra.
    \69\ Response Letter.
---------------------------------------------------------------------------

6. List 1, Item 14
    As initially proposed, this item would have required production of
portions of internal audit reports for the branch in which the
customers maintained accounts that ``focused on'' associated persons or
the accounts or transactions at issue.\70\ FINRA has amended this item
to clarify its intended scope by replacing ``focused on'' with
``concern.'' \71\
---------------------------------------------------------------------------

    \70\ See note 3 supra.
    \71\ Response Letter. Cf. Estell comments (relating to the term
``focused on'').
---------------------------------------------------------------------------

7. List 1, Item 15
    As initially proposed, this item would have required production of
records of disciplinary action taken against a firm's associated
persons by any regulator or employer for all sales practice violations
or conduct similar to the conduct alleged in the Statement of
Claim.\72\ FINRA has amended this proposed item to clarify its intended
scope by including the same parenthetical reference to ``state, federal
or self-regulatory organization'' that FINRA uses in other items in the
Discovery Guide that refer to regulators.\73\
---------------------------------------------------------------------------

    \72\ See note 3 supra.
    \73\ Response Letter.
---------------------------------------------------------------------------

8. List 2, Item 1
    As initially proposed, this item (relating to customer tax
documents) would have stated that customers may redact information
relating to medical and dental expenses and the names of charities on
Schedule A of their tax return unless the information is related to the
allegations in the Statement of Claim.\74\ The proposed statement was
followed by language indicating that income tax returns must be
identical to those that were filed with the Internal Revenue
Service.\75\ To add clarity to the proposed item, FINRA has amended it
by moving the sentence indicating that tax returns must be identical so
that it appears immediately above the statement permitting redaction of
the returns.\76\
---------------------------------------------------------------------------

    \74\ See note 3 supra.
    \75\ Id.
    \76\ Response Letter.
---------------------------------------------------------------------------

9. List 2, Item 4
    This item concerns the customers' accounts at firms that are not
parties to the matter. For clarity, FINRA has amended the proposed item
by distinguishing between non-party firms and party firms.\77\
---------------------------------------------------------------------------

    \77\ Id.
---------------------------------------------------------------------------

10. List 2, Item 8
    This item relates to telephone records. In the initial proposed
rule change, FINRA stated that it was not proposing any substantive
changes to the Discovery Guide's application to telephone records.\78\
In response to comments regarding that statement, FINRA offered a
clarification.\79\ FINRA states that, under the current Discovery
Guide, customers are required to produce certain documents relating to
telephone records only if they are alleging unauthorized trading.\80\
In contrast, proposed item 8 would require customers to produce the
specified documents in every case, which is more than a ministerial
change.\81\
---------------------------------------------------------------------------

    \78\ See note 3 supra.
    \79\ Response Letter. In its comment, PIABA questioned whether
there was an error in the rule text of List 2, Item 8(b) because it
did not limit production to claims alleging unauthorized trading.
    \80\ Response Letter.
    \81\ Id.
---------------------------------------------------------------------------

11. List 2, Item 17
    As initially proposed, this item would have required production of
documents showing the customers' complete educational and employment
background or, in the alternative, a description of the customers'
educational and employment background if not set forth in resumes
produced under item 16.\82\ FINRA has amended this proposed item by
revising it to require production of any existing description of the
customer parties' educational and employment background if not set
forth in resumes produced under item 16.
---------------------------------------------------------------------------

    \82\ See note 3 supra.
---------------------------------------------------------------------------

12. List 2, Item 19
    This item concerns insurance products that provide a death benefit.
As initially proposed, it would have

required customers to produce all insurance information received from
an insurance sales agent or securities broker relating to such
insurance.\83\ FINRA has amended the proposed item to clarify its
intended scope by deleting the reference to ``insurance'' before
``information.'' \84\
---------------------------------------------------------------------------

    \83\ See note 3 supra.
    \84\ Response Letter.
---------------------------------------------------------------------------

III. Commission's Findings

    After careful review of the proposed rule change, the comment
letters and the FINRA Response Letter, the Commission finds that the
proposed rule change, as modified by Amendment No. 1, is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities association.\85\ In
particular, the Commission finds that the proposed rule change is
consistent with Section 15A(b)(6) of the Act,\86\ which requires, among
other things, that FINRA rules be designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable
principles of trade, and, in general, to protect investors and the
public interest.
---------------------------------------------------------------------------

    \85\ In approving this proposal, the Commission has considered
the proposed rule's impact on efficiency, competition, and capital
formation. See 15 U.S.C. 78c(f).
    \86\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    The Commission believes that the revisions to the Discovery Guide
will help reduce the number and limit the scope of disputes involving
document production and other matters, thereby improving the
arbitration process for the benefit of the public investors, broker-
dealer firms, and associated persons who use the process. The revisions
to the Discovery Guide are the result of over six years of consultation
by FINRA with its constituents. The Commission also expects that
further improvement of the process should be possible through the
Discovery Task Force's consideration of discovery issues as they
arise.\87\
---------------------------------------------------------------------------

    \87\ Cf. Response Letter (describing plans for further
consideration of issues by the Discovery Task Force).
---------------------------------------------------------------------------

IV. Accelerated Approval

    The Commission finds goods cause, pursuant to Section 19(b)(2) of
the Exchange Act,\88\ for approving the proposed rule change, as
modified by Amendment No. 1 thereto, prior to the 30th day after
publication of notice of the filing of Amendment No. 1 in the Federal
Register. The proposed rule change was informed by FINRA's
consideration of, and the incorporation of many suggestions made in,
extensive comments on a 2008 proposal to update the Discovery Guide,
and Amendment No. 1's modifications to the proposed rule change add
clarity to the Discovery Guide and provide additional guidance to
parties and arbitrators.
---------------------------------------------------------------------------

    \88\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

    Accordingly, the Commission finds that good cause exists to approve
the proposal, as modified by Amendment No. 1, on an accelerated basis.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change, as modified by Amendment No. 1, is consistent with the Act.
Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to<EMAIL_ADDRESS>Please include
File Number SR-FINRA-2010-035 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.

All submissions should refer to File Number SR-FINRA-2010-035. This
file number should be included on the subject line if e-mail is used.
To help the Commission process and review your comments more
efficiently, please use only one method. The Commission will post all
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 Web site
viewing and printing in the Commission's Public Reference Room, 100 F
Street, NE., Washington, DC 20549, on official business days between
the hours of 10 a.m. and 3 p.m. Copies of such filing also will be
available for inspection and copying at the principal office of FINRA.
All comments received will be posted without change; the Commission
does not edit personal identifying information from submissions. You
should submit only information that you wish to make available
publicly. All submissions should refer to File Number SR-FINRA-2010-035
and should be submitted on or before April 27, 2011.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\89\ that the proposed rule change (SR-FINRA-2010-035), as modified
by Amendment No. 1, be, and hereby is, approved on an accelerated
basis.
---------------------------------------------------------------------------

    \89\ 15 U.S.C. 78s(b)(2).
    \90\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\90\
Cathy H. Ahn,
Deputy Secretary.
[FR Doc. 2011-8200 Filed 4-5-11; 8:45 am]
BILLING CODE 8011-01-P