[Federal Register Volume 61, Number 134 (Thursday, July 11, 1996)]
[Notices]
[Pages 36599-36601]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-17634]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37395; File No. SR-OCC-96-01]
Self-Regulatory Organizations; The Options Clearing Corporation;
Order Approving a Proposed Rule Change Relating to Choice of Law
Provisions in Connection With Amendments to Articles 8 and 9 of the
Uniform Commercial Code
July 2, 1996.
On January 16, 1996, The Options Clearing Corporation (``OCC'')
filed with the Securities and Exchange Commission (``Commission'') a
proposed rule change (File No. SR-OCC-96-01) pursuant to Section
19(b)(1) of the Securities Exchange Act of 1934 (``Act'').\1\ Notice of
the proposal was published in the Federal Register on March 25,
1996.\2\ No comment letters were received. For the reasons discussed
below, the Commission is approving the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1) (1988).
\2\ Securities Exchange Act Release No. 36983 (March 18, 1996),
61 FR 12124.
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I. Description of the Proposal
In 1994, The American Law Institute and the National Conference of
Commissioners on Uniform State Laws promulgated amendments to Articles
8 and 9 of the UCC (``1994 amendments''). To a significant degree, the
1994 amendments were adopted in response to the views of the Commission
and others that the shortcomings in the provisions of the 1977 version
of Articles 8 and 9 of the UCC contributed to the liquidity problems
associated with the October 1987 stock market decline. The 1994
amendments were intended to reduce legal uncertainty and to facilitate
the transfer of ownership of and creation of security interests in
securities as well as other financial assets and investment property,
including futures and futures options, through a set of rules designed
to apply to the modern securities and futures holding systems.
Illinois recently adopted the 1994 amendments. Accordingly, the
rule change amends OCC's by-laws, rules, and interpretations to take
advantage of the benefits associated with the application of the 1994
amendments to govern most options transactions involving OCC.
Previously, OCC's by-laws and rules contained choice of law provisions
that selected Delaware as the governing law.\3\ OCC originally adopted
the Delaware choice of law provisions to reinforce the provisions of
the 1977 version of the UCC under which OCC options were deemed
uncertificated securities. Under the conflict of laws rules in the 1977
version of the UCC, the law of the jurisdiction of incorporation of the
issuer of uncertificated securities governs the perfection of security
interests therein.
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\3\ Although the 1994 amendments have been adopted in Illinois,
they have not been adopted in many other jurisdictions, including
Delaware, the state of OCC's incorporation.
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Under the 1994 amendments, OCC will function as a ``securities
intermediary'' rather than an issuer of uncertificated securities.
Under the new choice of law provisions in the 1994 amendments, the
applicable law will be the law of the securities intermediary's
jurisdiction, which may be selected by agreement between the securities
intermediary and the entitlement holder (i.e., OCC and its clearing
members). In absence of a contrary agreement, OCC believes that
Illinois law will apply because under the choice of law rules found in
the 1994 amendments, Illinois would be deemed the securities
intermediary's jurisdiction.
As discussed above, OCC's present choice of law rules were adopted
solely to reinforce the choice of law provisions of the 1977 version of
the UCC. However, in light of Illinois' adoption of
[[Page 36600]]
the 1994 amendments, the rule change will replace those provisions with
Illinois choice of law provisions and makes certain other changes
intended to link the terminology of OCC's by-laws and rules with the
terminology of the 1994 amendments.
Notwithstanding the adoption of the Illinois choice of law
provisions, situations can arise in which the 1977 version of the UCC
will be applicable. This could occur if UCC issues develop in a
jurisdiction that has not yet adopted the 1994 amendments and if a
tribunal in that jurisdiction applies its own choice of law rules. The
choice of law provisions in the 1977 version of the UCC are mandatory
and cannot be altered by agreement. Therefore, OCC's new choice of law
rules would likely be unenforceable and therefore Delaware law would be
controlling. Because this possibility exists, OCC will retain the
provisions in its by-laws and rules that were deemed necessary or
desirable to manage instances when Delaware law is applied to options
transactions.\4\
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\4\ OCC's by-laws and rules previously contained interpretations
to alert clearing members and others that Delaware law will not
always govern notwithstanding the choice of law provisions. These
interpretations have been adapted to reflect the choice of law
change from Delaware law to Illinois law in OCC's by-laws. The
effect of this change will be to alert clearing members and others
that now Illinois law, instead of Delaware law, may not always
govern despite the choice of law provisions contained in OCC's by-
laws.
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To accommodate Illinois' adoption of the 1994 amendments, OCC has
made the following specific changes in its by-laws and rules. The terms
``lien'' and ``pledge'' are now defined in Article I, Section 1 of
OCC's by-laws to make it clear that these terms refer to a security
interest within the meaning of the 1994 amendments.\5\ Section 1-
201(37) of the UCC defines ``security interest'' broadly but without
reference to such common law concepts as lien and pledge, which are
subsumed within the amended definition of security interest.
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\5\ Even though the likelihood of misinterpretation on this
point may be remote, the addition of these definitions is prudent
because the terms lien and pledge no longer appear in the provisions
of UCC Articles 8 and 9 under the 1994 amendments that are
applicable to OCC.
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The definition of ``rules'' set forth in Article 1, Section 1 now
makes it clear that for purposes of Articles 8 and 9 the term ``rules
of a clearing agency'' as applied to OCC will mean anything deemed to
be a rule of a clearing agency under the Act. This is because Section
8-111 of the 1994 amendments in effect provides that a rule adopted by
a clearing corporation supersedes contrary provisions of the UCC.
The basic choice of law provision applicable to option holders and
writers with respect to cleared securities set forth in Article VI,
Section 9(c)(1) of OCC's by-laws now contains statements indicating how
revised Articles 8 and 9 will apply to OCC and its clearing members
with regard to ownership of and security interests in cleared
securities. These statements are not intended to alter the substantive
operation of Articles 8 and 9 but are intended merely to provide a
guide to proper interpretation of Articles 8 and 9. However, because
UCC Section 8-111 permits OCC to supersede provisions of the UCC with
its own rules, Section 9(c)(1) now deems all cleared securities to be
financial assets without regard to whether a particular cleared
security constitutes a similar obligation to an option. Determination
of whether a cleared security is a similar obligation to an option is
required under the definition of financial asset set forth in Section
8-102 of the 1994 amendments. Subparagraph 2 of Section 9(c), which
essentially is the prior OCC choice of law provision, will remain in
place to cover situations where the 1977 version of the UCC is
applicable.
OCC Rule 610(g), which involves the use of depository receipts and
electronic confirmations in connection with specific or bulk deposits
made to OCC in lieu margin payments, no longer requires that in certain
circumstances a depository must acknowledge that securities transfers
or pledges were effected through book-entry.\6\ This requirement arose
because in order to effect a securities pledge and the corresponding
perfection of a security interest therein or to deposit securities in
favor of OCC, the 1977 version of Article 8 required that the pledgor
or depositor ``transfer'' the security to the pledgee (i.e., OCC). In
order to effect this transfer, Section 8-313 of the 1977 version of the
UCC required an acknowledgement by the securities depository if the
securities were delivered by book-entry. Under the 1994 amendments, a
transfer pursuant to Section 8-313 is no longer required to effect a
securities deposit or pledge.\7\ Under Sections 8-106 and 9-115 of the
1994 amendments, a securities deposit or pledge with the corresponding
perfection of a security interest therein is effected once the
transferee or pledgee (i.e., OCC) obtains control over the securities.
Therefore, depository acknowledgement no longer is required in
connection with securities deposits or pledges in favor of OCC
involving book-entry delivery of securities.
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\6\ OCC originally proposed to amend Rule 610(g) in a prior
proposed rule filing (File No. SR-OCC-95-17). Subsequently, OCC
proposed that Rule 610(g) be amended in the proposed rule change
associated with this order. Because approval of SR-OCC-95-17 is
still pending with the Commission, the amendments to Rule 610(g) are
approved pursuant to this order, and OCC will amend SR-OCC-95-17 to
reflect that the changes made to this rule have been approved by
this order.
\7\ In fact, the entire concept of a transfer requirement in
connection with a securities pledge or deposit previously embodied
in Section 8-313 of the 1977 version of the UCC has been removed
from the 1994 amendments.
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Finally, OCC Rule 614(m) concerning OCC's obligations to pledgees
under OCC's pledge program is revised to make clear that certain
provisions of this rule which relate to the 1977 version of Articles 8
and 9 will apply only if the 1977 version of the UCC is otherwise
applicable.
II. Discussion
Section 17A(b)(3)(F) of the Act \8\ requires that the rules of a
clearing agency be designed to assure the safeguarding of securities
and funds which are in the custody or control of the clearing agency or
for which it is responsible. The Commission believes the proposed rule
change is consistent with OCC's obligations under the Act because it
should help to reduce the legal uncertainty associated with the
creation of ownership and security interests in options and other
securities under Articles 8 and 9 of the UCC. Furthermore, the rule
change should help to ensure that OCC's by-laws, rules, and
interpretations reflect the concepts embodied in the 1994 amendments.
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\8\ 15 U.S.C. 78q-1(b)(3)(F) (1988).
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The evolution of modern securities and futures processing and
holding systems have in some respects made obsolete previous versions
of the UCC.\9\ In certain instances, application of prior versions of
the UCC in the options context has led to some industry confusion and
in at least one instance required OCC to file a proposed rule change to
assure the proper legal interpretation of certain conflicts of laws
issues arising in options transactions.\10\ The provisions of the
[[Page 36601]]
1994 amendments provide a solution to many of these problems.
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\9\ U.C.C. Article 8 (1994 Revision) prefatory note (1995).
\10\ Under the pre-1997 UCC, OCC believed that options could be
deemed general intangibles which would require the law of the
jurisdiction of the debtor's location to govern the creation and
perfection of security interests. Under the 1977 amendments to the
UCC, options were deemed uncertificated securities in which case the
law of the jurisdiction of the issuer's organization would govern.
In an attempt to correct the renvoi issue caused by the omission of
transitional provisions in the 1977 amendments to the UCC, OCC
revised its rules and bylaws to designate Delaware law (OCC's state
of incorporation), including its conflict of laws rules, to apply to
the creation and perfection of security interests in connection with
options transactions to the full extent possible. Securities
Exchange Act Release No. 20521 (December 30, 1983), 49 FR 968 [File
No. SR-OCC-83-20] (ordering approving proposed rule change).
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Specifically, the rule change should expedite the eligibility
process for OCC clearing members seeking to participate in cross-
margining by expediting the creation and perfection of security
interests associated with such cross-margining.\11\ Although the
Commission notes that the 1994 amendments may not apply to options
transactions in all circumstances because certain states have yet to
adopt these provisions, in situations where the 1994 amendments do
apply, the 1994 amendments should provide a safer and more appropriate
framework, given the special characteristics of options, for the
transferring, pledging, and holding of such securities and for such
securities deposited at OCC for margin and clearing fund purposes.
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\11\ Currently, there is a two to three week delay before OCC
members that also are members of the Chicago Mercantile Exchange
(``CME'') or the Kansas City Board of Trade (``KCBOT'') (``joint
members'') are eligible to participate in the cross-margining
arrangements OCC has with CME and KCBOT. Prior to participation in
these cross-margining arrangements, OCC requires that security
interests be created and perfected in securities held by the joint
member prior to such member's eligibility as a cross-margining
participant. Under the 1977 version of the UCC, one way to perfect a
security interest in securities requires the filing of the
appropriate financing statements. Filing of the appropriate
financing statements and confirmation thereof typically can take
from two to three weeks. However, under the 1994 amendments, OCC
believes that financing statements no longer will be necessary for
perfection purposes. As a result, joint members can become cross-
margining participants in a matter of days instead of weeks.
Telephone conversation between Michael G. Vitek, Staff Counsel, OCC,
and Mark Steffensen, Attorney, Division of Market Regulation,
Commission (February 12, 1996).
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III. Conclusion
On the basis of the foregoing, the Commission finds that the
proposal is consistent with the requirements of the Act and in
particular with the requirements of section 17A of the Act and the
rules and regulations thereunder.
It is therefore ordered, pursuant to section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-OCC-96-01) be, and hereby
is, approved.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\12\
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\12\ 17 CFR 200.30-3(a)(12) (1995).
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Jonathan G. Katz,
Secretary.
[FR Doc. 96-17634 Filed 7-10-96; 8:45 am]
BILLING CODE 8010-01-M
