Legal & Compliance
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The Securities and Exchange Commission recently approved amendments to Appendix E to Article III, Section 33, of the NASD Rules of Fair Practice. These amendments will require members to develop and maintain written procedures for the approval, review, and supervision of customer accounts engaged in uncovered short option transactions. The revised rules also require members to distribute to customers a risk disclosure document concerning uncovered option writing. Members must be in compliance with these rule changes no later than March 1, 1990.
BACKGROUND AND SUMMARY
The amendments to Appendix E of the NASD Rules of Fair Practice conform to rule changes also made by the American Stock Exchange, the Chicago Board Options Exchange, the Midwest Stock Exchange, the new York Stock Exchange, the Pacific Stock Exchange, and the Philadelphia Stock Exchange (the "exchanges"). The NASD and the exchanges (the "SROs") have prepared the attached notice containing guidelines for compliance with the new rules for uncovered short option accounts.
The rule changes were promulgated by the SROs in consultation with industry representatives. The NASD supports these rule changes as a means of assuring that member firms that have public customers engaged in uncovered short option transactions focus increased attention on the suitability of such transactions for their customers and monitor activity in customer accounts on an ongoing basis.
In this regard, amendments to Section 16 of Appendix E will require firms to develop, implement, and maintain specific written procedures for the conduct of accounts engaged in short uncovered options transactions. Such procedures must include account approval, Senior Registered Options Principal (SROP) and/or Compliance Registered Options Principal (CROP) approval of exceptions to standards established by the member, minimum net equity requirements for such accounts, and delivery of a special disclosure statement to customers intended to increase awareness of the risks entailed in uncovered short option transactions.
Section 20 of Appendix E also has been amended. It will require that members develop and implement specific written procedures about supervision of customer accounts, maintaining un-covered short option positions, including specific standards for frequent supervisory review of such accounts.
Questions concerning this notice can be directed to P. William Hotchkiss, Director, Surveillance, at (202) 728-8235.
AMENDMENTS TO APPENDIX E TO ARTICLE III, SECTION 33 OF THE NASD RULES OF FAIR PRACTICE.
(Note: New language is underlined.)
(y) Uncovered — The term "uncovered" in respect of a short position in an option contract means the short position is not covered. For purposes of Section 16 (Opening of Accounts), Section 20 (Supervision of Accounts) and Section 11 (delivery of Current Disclosure Document(s)), the term "writing uncovered short option positions" shall include combinations and any other transactions which involve uncovered writing.
Opening of Accounts
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(e) Uncovered Short Option Contracts — Each member transacting business with the public in writing uncovered short option contracts shall develop, implement and maintain specific written procedures governing the conduct of such business which shall include, at least, the following:
1. Specific criteria and standards to be used in evaluating the suitability of a customer for writing uncovered short option transactions;
2. Specific procedures for approval of accounts engaged in writing uncovered short option contracts, including written approval of such accounts by a Registered Options Principal;
3. Designation of the Senior Registered Options Principal and/or Compliance Registered Options Principal as the person responsible for approved customer accounts that do not meet the specific criteria and standards for writing uncovered short option transactions and for maintaining written records of the reasons for every account so approved;
4. Establishment of specific minimum net equity requirements for initial approval and maintenance of customer accounts writing uncovered short option transactions; and
5. Requirements that customers approved for writing uncovered short option transactions be provided with a special statement for uncovered option writers approved by the Association that describes the risks inherent in writing uncovered short option transactions, at or prior to the initial writing of an uncovered short option transaction.
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Supervision of Accounts
(a) Duty to Supervise: Senior Registered Options Principal. Every member shall develop and implement a written program providing for the diligent supervision of all of its customer accounts, and all orders in such accounts, to the extent such accounts and orders relate to options contracts, by a general partner (in the case of a partnership) or officer (in the case of a corporation) of the member who is a Registered Options Principal and who has been specifically identified to the Corporation as the member's Senior Registered Options Principal. A Senior Registered Options Principal, in meeting his responsibilities for supervision of customer accounts and orders, may delegate to qualified employees (including other Registered Options Principals) responsibility and authority of supervision and control of each branch office handling transactions in option contracts, provided that the Senior Registered Options Principal shall have overall authority and responsibility for establishing appropriate procedures of supervision and control over such employees. Every such member shall also develop and implement specific written procedures concerning the manner of supervision of customer accounts maintaining uncovered short option positions and specifically providing for frequent supervisory review of such accounts.