
[Federal Register Volume 74, Number 120 (Wednesday, June 24, 2009)]
[Notices]
[Pages 30186-30188]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E9-14797]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-60126; File No. SR-CBOE-2008-55]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Granting Approval to a Proposed Rule Change, as 
Modified by Amendment No. 1, Relating to Margin Requirements

June 17, 2009.

I. Introduction

    On June 2, 2008, pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ 
the Chicago Board Options Exchange, Incorporated (the ``Exchange'' or 
``CBOE'') filed with the Securities and Exchange Commission (the 
``Commission'') a proposed rule change to modify its margin 
requirements to facilitate, under certain circumstances, the ability of 
account holders to use vested and currently exercisable compensatory 
employee stock options (``Vested Employee Options'') issued by publicly 
traded companies as collateral for writing call options that have the 
same underlying security as the Vested Employee Options. On May 3, 
2009, CBOE filed Amendment No. 1. The proposed rule change was 
published for comment in the Federal Register on May 13, 2009.\3\ The 
Commission received one comment letter on the proposed rule change.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 59876 (May 6, 2009), 
74 FR 22613 (May 13, 2009) (``Notice'').
    \4\ See letter from Kandy Rathinasamy, dated May 15, 2009 
(``Rathinasamy Letter'').
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II. Description

    The Exchange proposes to amend its margin requirements to 
facilitate, under certain circumstances, the ability of account holders 
to use Vested Employee Options issued by publicly traded companies 
(``Issuers'') as collateral for writing call options that have the same 
underlying security as the Vested Employee Options. Specifically, the 
proposal would allow account holders to sell, as a hedge, listed equity 
call options on the same underlying security as the account holder's 
Vested Employee Options without the requirement of margin (the 
``Transactions''). The proposal would permit account holders to engage 
in the Transactions using their Vested Employee Options as collateral. 
Currently, such Transactions would be deemed ``naked'' for purposes of 
margin rules and subject to a deposit of cash margin, effectively 
making the strategies cost prohibitive and impractical. The Exchange 
believes that enabling employees who hold Vested Employee Options to 
generate income and liquidity on their otherwise illiquid asset through 
the listed options markets will benefit investors by providing greater 
transparency and liquidity.
    Under Section 220.12(f)(1) of Regulation T,\5\ the Exchange, as a 
registered national securities exchange, is permitted to recognize the 
type of transactions described below as eligible for margin treatment 
subject to the approval of the Commission.
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    \5\ Section 220.12(f)(1) of Regulation T (12 CFR 220), 
Supplement: Margin Requirements, grants authority to registered 
national securities exchanges to promulgate rules relating to call 
and put margin requirements.
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    The proposal would permit account holders to sell listed call 
options on the same security that underlies their Vested Employee 
Options without the requirement of margin. Given the uncertificated 
nature of employee stock options, in order to secure the account

[[Page 30187]]

holder's obligations under the Transactions, the proposal would 
require:
    1. The account holder to (A) pledge the Vested Employee Options to 
the broker-dealer and (B) provide the broker-dealer with an irrevocable 
power-of-attorney authorizing the broker-dealer to exercise the Vested 
Employee Options on the account holder's behalf if the listed call 
options are assigned or if the broker-dealer determines it is 
necessary. The irrevocable power-of-attorney may also be used in the 
event the account holder wishes to close the listed option position 
prior to its expiration and instructs the broker-dealer to exercise 
that number of Vested Employee Options necessary to cover the cost of 
the closing purchase (the account holder will also have the option of 
depositing additional cash in the account holder's account to cover the 
cost of the closing purchase).
    2. In the event the Vested Employee Options are exercised between 
the date of the Transaction in the listed call options (the 
``Commencement Date'') and the date the Transaction is closed (the 
``Closing Date''), the shares issued upon exercise will be pledged to 
the broker-dealer (thereby replacing the Vested Employee Options that 
had been pledged prior to exercise). For example, during the time a 
Transaction is pending, the account holder may resign from the account 
holder's employment with the Issuer and may be required to exercise the 
Vested Employee Options within a certain timeframe following the 
account holder's departure. In such a scenario, the account holder 
would ask the broker dealer to exercise the Vested Employee Options and 
the stock issued pursuant to the exercise would be pledged to the 
broker-dealer.
    3. The Issuer will promptly deliver the stock upon payment or 
receipt of the exercise notice from the broker-dealer.\6\ The Issuer 
will also agree prior to the Commencement Date to waive any forfeiture 
conditions that otherwise might apply to the Vested Employee Options 
(e.g., upon a termination of the account holder's employment with the 
Issuer) as well as any transfer restrictions that would preclude pledge 
of the Vested Employee Options to the broker-dealer. In addition, the 
Issuer will represent that the Vested Employee Options are covered by 
an effective registration statement on Form S-8. If the registration 
statement becomes ineffective the Issuer will notify the broker-dealer 
immediately.
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    \6\ The Exchange will proscribe a set delivery period, which is 
expected to be no later than three business days following 
assignment of the listed options.
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    4. Because it is essential that the account holder, broker-dealer 
and Issuer cooperate and are each fully informed, agree to and 
acknowledge their own and each other's responsibilities, all 
Transactions will be governed by an agreement (the ``Agreement'') 
entered into by the account holder, broker-dealer and Issuer prior to 
the Commencement Date of the first transaction. The Agreement would 
generally set forth each party's obligations, representations and 
acknowledgements and the terms and conditions governing the 
Transactions and must be in a form acceptable to the Exchange.\7\
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    \7\ In this regard, the Exchange currently intends to recognize 
the Master Vested Stock Option Monetization Agreement, created by 
iOptions Group, LLC, as one acceptable agreement.
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    5. Such other terms and conditions prescribed by the Exchange in 
accordance with such form, formats and procedures as may be established 
by the Exchange from time to time would also apply. In this regard, 
upon approval of the proposed rule change and for a period of one year, 
the Exchange will require that, prior to the Commencement Date, a legal 
opinion with respect to the account holder's and Issuer's legal right 
to enter into the Transactions under the terms of the Issuer's employee 
stock option plan and related documents (the ``Legal Opinion'') be 
obtained in a form acceptable to the Exchange. During the one-year time 
period, the Exchange may determine that such Legal Opinion is no longer 
necessary and will revise its established forms, formats and procedures 
accordingly.

III. Discussion and Commission's Findings

    After careful review of the proposed rule change, the comment 
letter and CBOE's response, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
association.\8\
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    \8\ 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).
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    In particular, the Commission finds that the proposed rule change 
is consistent with Section 6(b)(5),\9\ in that the proposed rule change 
is designed to prevent fraudulent and manipulative acts and practices, 
promote just and equitable principles of trade, remove impediments to 
and perfect the mechanisms of a free and open market and a national 
market system, and, in general, to protect investors and the public 
interest. The proposed rule change will offer market participants new 
trading opportunities and will enhance the Exchange's competitive 
position.
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    \9\ 15 U.S.C. 78f(b)(5).
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    The Commission received one comment letter, in support of the 
proposal, stating that the proposed rule change is ``a great idea, 
allowing employees to monetize the time value of their options.''\10\
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    \10\ See Rathinasamy Letter, supra note 4.
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    The Commission believes that the proposed rule change to amend the 
Exchange's margin rule should be allowed. However, the Commission does 
have significant concerns with the amount of control each broker-dealer 
has over the Vested Employee Options. One purpose of the margin rules 
is to protect broker-dealers in the event of market turmoil. The 
broker-dealer must have enough control over the cash or securities it 
is holding as margin on behalf of investors to be able to act 
unilaterally to protect itself. With Vested Employee Options, the 
broker-dealer cannot act unilaterally to use the margin deposited by 
the customer (i.e., the Vested Employee Options); instead, the broker-
dealer must rely on another person (i.e., the issuer) to promptly 
deliver the required shares. For example, if an issuer notifies the 
broker-dealer that there is an ineffective registration statement, it 
could prevent the broker-dealer from exercising the options and 
receiving publicly tradable shares, a prospect that could cause 
financial harm to the broker-dealer.
    The Commission raised these concerns in the Notice by noting in a 
footnote that absent relief from the Commission, broker-dealers would 
need to take a capital charge for any unsecured margin debt and by 
asking questions about how the broker-dealer's legal authority to 
exercise the Vested Employee Options could be enhanced and how to limit 
the liquidity and operational risks arising from the Transactions. The 
Commission received no comments on this footnote or these questions. 
Thus, for purposes of determining whether an account is unsecured or 
partly secured pursuant to the net capital rule,\11\ including an 
account containing a Transaction, a broker-dealer may not include the 
value of a Vested Employee Option.
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    \11\ 17 CFR 240.15c3-1.

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[[Page 30188]]

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\12\ that the proposed rule change (SR-CBOE-2008-55), as modified 
by Amendment No. 1, be, and hereby is, approved.
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    \12\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-14797 Filed 6-23-09; 8:45 am]
BILLING CODE 8010-01-P


