

[Federal Register: August 8, 2006 (Volume 71, Number 152)]
[Notices]               
[Page 45086-45089]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr08au06-95]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54255; File No. SR-NYSE-2005-03]

 
Self-Regulatory Organizations; New York Stock Exchange LLC; 
Notice of Filing of Proposed Rule Change and Amendments Nos. 1 and 2 To 
Amend Exchange Rule 325 (Capital Requirements for Member 
Organizations), Rule 326 (Growth Capital Requirement, Business 
Reduction Capital Requirement, Unsecured Loans and Advances), and Rule 
431 (Margin Requirement)

July 31, 2006.
    Pursuant to Section 19(b)(1) \1\ of the Securities Exchange Act of 
1934 (the ``Exchange Act''),\2\ and Rule 19b-4 thereunder,\3\ notice is 
hereby given that on January 5, 2005, the New York Stock Exchange LLC 
(``NYSE'' or the ``Exchange'') filed with the Securities and Exchange 
Commission (``SEC'' or the ``Commission'') the proposed rule change as 
described in Items I, II, and III below, which Items have been prepared 
by the Exchange.\4\ The NYSE filed Amendment No. 1 to the proposed rule 
change on February 13, 2006.\5\ The NYSE filed Amendment No. 2 to the 
proposed rule change on March 17, 2006.\6\ The Commission is publishing 
this notice to solicit comments on the proposed rule change, as 
amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 15 U.S.C. 78a et seq.
    \3\ 17 CFR 240.19b-4.
    \4\ Pursuant to discussions with the Commission staff, the 
Exchange clarified the application of proposed amendments to NYSE 
Rules 325, 326 and 431 to reflect the Exchange's March 7, 2006 
merger with Archipelago Holdings, Inc. (``Archipelago''), 
adjustments to capital levels in Rule 326 and other general 
editorial changes. Telephone conversations between William Jannace, 
Director, Exchange, William Wollman, Vice President, Exchange and E. 
David Hwa, Special Counsel, Division of Market Regulation, 
Commission, on May 11, 2006, June 8, 2006, July 19, 2006 and email 
dated July 19, 2006.
    \5\ In Amendment No. 1, the Exchange clarified the application 
of proposed amendments to NYSE Rule 431(e)(9) solely to OTC 
derivatives transactions and expanded upon elements of the written 
risk analysis provided by the proposed rule for member organizations 
utilizing the alternative method of computing net capital.
    \6\ In Amendment No. 2, the Exchange clarified the application 
of proposed amendments to NYSE Rule 326 to make explicit the ability 
of the Exchange to restrict the growth or business of a member 
organization, respectively, when its tentative net capital declines 
below the early warning notification amount required by the Exchange 
Act Rule 15c3-1(a)(7)(ii).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange is proposing to amend Rule 325, Rule 326, and Rule 431 
to reflect recent SEC rule amendments under the Exchange Act, including 
amendments to Exchange Act Rule 15c3-1 that established an alternative 
method of computing net capital for broker-dealers.

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

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
Sections A, B, and C below, of the most significant aspects of such 
statements.

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

1. Purpose

Background

    Exchange Act Rule 15c3-1 (the ``net capital rule'') contains basic 
financial responsibility standards for broker-dealers. The rule is 
intended to protect customers and other market participants from 
broker-dealer failures, and to enable those firms that fall below the 
minimum net capital requirements to liquidate in an orderly fashion 
without the need for a formal proceeding or financial assistance from 
the Securities Investor Protection Corporation. To help insure that 
broker-dealers maintain sufficient liquid assets to satisfy promptly 
the claims of customers and cover potential market and credit risks, 
the net capital rule requires broker-dealers to maintain different 
minimum levels of capital based upon the nature of their business and 
whether they handle customer funds or securities.
    On August 20, 2004, the SEC adopted rule amendments under the 
Exchange Act, including amendments to Exchange Act Rule 15c3-1, that 
establish a voluntary, alternative method of computing net capital for 
certain large broker-dealers that are part of consolidated supervised 
groups referred to as consolidated supervised entities (``CSEs''). 
Under the SEC amendments, a broker-dealer may use this

[[Page 45087]]

``alternative/CSE'' method only if its ultimate holding company agrees 
to compute group-wide allowable capital and allowances for market, 
credit, and operational risk in accordance with the standards adopted 
by the Basel Committee on Banking Supervision, and consents to group-
wide SEC supervision. The alternative method of computing net capital 
permits a broker-dealer to use models, such as ``value-at-risk'' 
(``VAR'') models and scenario analysis,\7\ that are already part of its 
internal risk management control system to calculate the market risk 
and derivatives-related credit risk components of its net capital 
requirement. The deduction for market risk calculated using internal 
models replaces the traditional ``haircut'' approach to calculating net 
capital.\8\
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    \7\ Value-at risk models assess market risk based on the 
probability distribution for a portfolio's market value. Scenario 
analysis is a method of assessing market risk by testing various 
possible scenarios.
    \8\ The ``haircut'' approach to computing net capital involves 
reducing the value of firms'' proprietary securities by pre-
determined percentages to allow for potential reductions in market 
value.
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    When the Membership allow their net capital to decline below 
certain levels, they risk non-compliance with the net capital and 
financial responsibility requirements of Exchange Act Rule 15c3-1. NYSE 
Rules 325 and 326 are designed to alert the Exchange before such 
problems occur, and to enable the Exchange to prevent Membership non-
compliance by restricting the business activities of any member 
organization whose net capital falls below certain defined levels.

Proposed Amendment to NYSE Rule 325

    NYSE Rule 325, the Exchange's primary net capital rule, requires 
the Membership to comply with Exchange Act Rule 15c3-1 and imposes 
additional prophylactic requirements to ensure such compliance. Rule 
325(b) requires a member organization to notify the Exchange if its net 
capital falls below certain percentages. The proposed amendment adds 
Rule 325(b)(3), which would require a member organization to provide 
concurrently to the Exchange a copy of any report or notification made 
to the SEC pursuant to Exchange Act Rule 17a-11 \9\ or Commodities 
Exchange Act (``CEA'') \10\ Regulation 1.12.\11\
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    \9\ 17 CFR 240.17a-11.
    \10\ 7 U.S.C. 1 et seq.
    \11\ 17 CFR 1.12.
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    This new requirement is necessary to help ensure that the Exchange 
continues to receive timely notification of potential violations of 
Exchange Act Rule 15c3-1, including the rule's new CSE provisions. For 
example, as noted above, Exchange Act Rule 15c3-1, in conjunction with 
Exchange Act Rule 17a-11, now requires a broker-dealer that elects to 
use the alternative method of computing net capital to report to the 
SEC whenever its tentative net capital declines below $5 billion. 
Proposed Rule 325(b)(3) would require a member organization to provide 
the Exchange with copies of every such report.
    Language in Rule 325(b) regarding notification to the Exchange 
relating to CEA minimum capital requirements for members or member 
organizations acting as futures commission merchants was rendered 
obsolete by amendments to CEA Regulation 1.17 \12\ on September 30, 
2004 \13\ and, therefore, has been removed from the amended Rule 
325(b). The proposed new provisions of Rule 325(b)(3), however, would 
require a member organization to provide the Exchange with copies of 
any reports or notifications it provides to the Commodity Futures 
Trading Commission (``CFTC'') under CEA Regulation 1.12. Therefore, 
because CEA Regulation 1.12 requires notification by any futures 
commission merchant that experiences a decline in net capital below the 
CEA's early warning levels, the Exchange will continue to receive 
notification if a member organization acting as futures commission 
merchant is in danger of violating CEA minimum capital requirements.
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    \12\ 17 CFR 1.17.
    \13\ The CEA amendments eliminated capital requirement 
calculations based on the concept of ``segregated funds.''
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    The Exchange's merger with Archipelago rendered the Exchange's 
constitution obsolete so paragraphs (5) and (6) of Rule 325(e) and all 
references to the constitution were removed.
    Other grammatical changes have been made throughout Rule 325 for 
purposes of clarity and stylistic consistency.

Proposed Amendment to NYSE Rule 326

    NYSE Rule 326, which enables the Exchange to restrict a member 
organization's business activities if its net capital falls below 
certain defined levels, uses a two-step approach to preventing 
Membership non-compliance with Exchange Act Rule 15c3-1. First, Rule 
326(a) allows the Exchange to prohibit a member organization from 
expanding its business if its net capital falls below specified levels. 
Second, if a member organization's net capital falls below lower, 
specified levels, Rule 326(b) allows the Exchange to compel it to 
reduce its existing business. To enable the Exchange to regulate its 
Membership proactively (that is, to act if a member or member 
organization is in danger of violating Exchange Act Rule 15c3-1, rather 
than waiting until Exchange Act Rule 15c3-1 has been violated), the 
levels specified in NYSE Rule 326 are higher than those contained in 
Exchange Act Rule 15c3-1.
    The proposed amendments would add Rule 326(a)(4) to provide minimum 
tentative net capital \14\ and net capital levels for the Exchange to 
use when prohibiting, under Rule 326(a), the expansion of business by a 
member organization using the alternative method computing net capital 
under the CSE rules. The levels proposed in Rule 326(a)(1)(d) (50 
percent of the tentative net capital level that triggers SEC 
notification or the net capital level is less than $1.25 billion) will 
not unduly restrict a member organization's business, but will allow 
the Exchange, after evaluating a member organization's financial 
condition, to use the disincentive of restricted business expansion to 
encourage a member organization whose net capital has fallen to levels 
that risk violation of Exchange Act Rule 15c3-1 to take necessary 
corrective action.
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    \14\ The term ``tentative net capital,'' as it pertains to the 
new regulations regarding broker-dealers using the ``alternative/
CSE'' method, is defined in Exchange Act Rule 15c3-1(c)(15), part of 
the SEC's new CSE regulations.
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    Language in Rule 326(a) regarding limiting a member organization's 
expansion of business due to CEA minimum capital requirements for a 
member organization acting as futures commission merchant was rendered 
obsolete by the aforementioned amendments to CEA Regulation 1.17, and, 
therefore, has been removed from the amended Rule 326(a).
    The proposed amendment would add Rule 326(b)(1)(d) to provide 
minimum tentative net capital and net capital levels for the Exchange 
to use in requiring a member organization that uses the alternative 
method of computing net capital to reduce its business pursuant to Rule 
326(b). The levels proposed in Rule 326(b)(1)(d) (40 percent of the 
tentative net capital level that triggers SEC notification or net 
capital less than $1 billion) would not unduly restrict a member 
organization's business, but would allow the Exchange, after evaluating 
a member organization's financial condition, to use the disincentive of 
mandatory business reduction to encourage necessary corrective action 
by a member organization whose net capital has fallen to levels that 
risk violation of Exchange Act Rule 15c3-1.

[[Page 45088]]

    Language in Rule 326(b) regarding the reduction of a member 
organization's business due to CEA minimum capital requirements for a 
member organization acting as futures commission merchant was rendered 
obsolete by the aforementioned amendments to CEA Regulation 1.17, and, 
therefore, has been removed from the amended Rule 326(b). The proposed 
new provisions of Rule 326(b)(1)(e), however, would require a member 
organization to reduce its business if its net capital falls below 110 
percent of the minimum capital requirements of CEA Regulation 1.17 (the 
same level that triggers notification to the CFTC under CEA Regulation 
1.12). Therefore, the Exchange will retain the ability to compel a 
member organization to reduce its business if its net capital falls to 
levels that may violate CEA minimum capital requirements.
    Other grammatical changes have been made throughout Rule 326 for 
purposes of accuracy, clarity, and stylistic consistency.

Proposed Amendment to NYSE Rule 431

    Section 7(a) \15\ of the Exchange Act empowers the Board of 
Governors of the Federal Reserve System to prescribe the rules and 
regulations regarding the credit that may be extended by broker-dealers 
on securities (Regulation T \16\). NYSE Rule 431 prescribes specific 
margin requirements that must be maintained in all of a member 
organization's customer accounts, based on the type of securities 
products held in such accounts.
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    \15\ 15 U.S.C. 78g(a).
    \16\ 12 CFR 220 et seq.
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    Exchange Act Rule 15c3-1e(c),\17\ one of the recent SEC amendments 
related to the alternative method of computing net capital for CSE 
broker-dealers, prescribes deductions to net capital for credit risk on 
transactions in certain derivative instruments for broker-dealers using 
the alternative method (for example, VAR models), provided the broker-
dealers have in place comprehensive internal risk management procedures 
that address market, credit, liquidity, legal, and operational risk at 
the firm.
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    \17\ 17 CFR 240.15c3-1e(c).
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    The proposed amendment to Rule 431 would add Rule 431(e)(9). This 
new paragraph would exempt a member organization using the alternative 
method of computing net capital from Rule 431 for certain exposures 
arising from transactions in over-the-counter (``OTC'') derivative 
instruments \18\ for which the member organization may compute a 
deduction to net capital for credit risk using the methods contained in 
Rule 15c3-1e(c).
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    \18\ These instruments are described in Exchange Act Rule 15c3-
1e(c)(vi)(E), 17 CFR 240.15c3-1e(c)(vi)(E).
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    A member organization that applies Rule 431(e)(9) must maintain a 
written risk analysis methodology for assessing the amount of credit 
that may be extended with respect to OTC derivatives transactions and 
the methodology must include at least those procedures and guidelines 
enumerated in paragraph (e)(9). The procedures and guidelines relate to 
reviewing customer account documentation and financial information; 
establishing credit limits for customers; monitoring the member 
organization's credit risk exposure to its customers; management 
reporting on credit extension exposure; managing the impact of credit 
extension on the member organization's overall risk exposure; the 
appropriate management response to violations of credit extension 
limits; stress testing customer accounts individually and in the 
aggregate; and determining whether to collect margin from a particular 
customer. The member organization must establish a method for period 
review of these procedures by an independent unit of the organization, 
such as internal audit or risk management. Management also must review 
periodically the member organization's credit extension activities for 
consistency with the guidelines.
2. Statutory Basis
    The proposed amendments to NYSE Rules 325, 326, and 431 are 
consistent with the requirements of Section 6(b)(5) \19\ of the 
Exchange Act, which requires that the rules of the Exchange be designed 
to promote just and equitable principles of trade, to remove 
impediments to and perfect the mechanism of a free and open market and 
a national market system, and, in general, to protect investors and the 
public interest in that they incorporate into the Exchange's rules 
recent SEC amendments to Exchange Act Rule 15c3-1 regarding the 
alternative method of computing net capital for broker-dealers that are 
part of a CSE.
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    \19\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange believes that the proposal does not impose any burden 
on competition that is not necessary or appropriate in furtherance of 
the purposes of the Exchange Act.

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

    Written comments were neither solicited nor received.

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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) As the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the Exchange consents, the Commission will:
    A. By order approve such proposed rule change, or
    B. institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Exchange 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 e-mail to rule-comments@sec.gov. Please include File 

Number SR-NYSE-2005-03 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-NYSE-2005-03. 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

[[Page 45089]]

proposed rule change between the Commission and any person, other than 
those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the NYSE. 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-NYSE-2005-03 and should be submitted on or before August 
29, 2006.
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    \20\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\20\
Nancy M. Morris,
Secretary.
[FR Doc. E6-12841 Filed 8-7-06; 8:45 am]

BILLING CODE 8010-01-P
