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Default Rules and Procedures

Introduction

Chapter XI of OCC's Rules, published on this website, authorize OCC to expeditiously and flexibly deal with clearing member defaults. A general overview of the procedures embodied in these rules is provided below, but this overview is subject to the specific terms of the rules themselves. The term "rules" collectively refers to both OCC By-Laws and Rules and terms (capitalized or not) have the meaning given to them in the rules unless otherwise defined.

Suspension of a Clearing Member

Notice by Clearing Member. Any clearing member that is unable to meet its obligations, is insolvent or is the subject of a bankruptcy petition or a receivership proceeding or equivalent filing or proceeding is required to immediately provide telephone notice of such event followed promptly by confirming written notice. In addition, any Non-US clearing member that has been expelled or suspended by its regulatory agency or by an exchange of which it is a member must provide immediate notice of such event. See generally Rules 1101 and 1102(b).

Events of Default Which May Result in a Clearing Member Suspension. A clearing member may be summarily suspended by the OCC Board of Directors or the Chairman in the event the clearing member experiences an event of default. A detailed listing of such default events is found in Rule 1102(a), but generally they include: the suspension or expulsion of the clearing member from another self-regulatory or other regulatory organization; the clearing member's failure to make timely delivery of any cash, securities or property to OCC as provided in the rules; the clearing member's failure (or that of its permitted designated agent) to make timely delivery of funds or securities to another clearing member or the correspondent clearing corporation (i.e., NSCC) as provided for in the rules; and a determination made by the OCC Board or Chairman that the clearing member is in financial or operational difficulty that suspension is necessary for the protection of OCC, other clearing members or the public on notice to one or more designated regulatory authorities. In addition and as provided for in Rule 707, a clearing member maintaining a cross-margining account with OCC and a Participating CCO may be summarily suspended if it (or its affiliated clearing member, as applicable) is in default of any payment or other obligation owed in respect of such cross-margining account. See generally Rule 1102(a) and Rule 707.

Notice by OCC of Suspension. OCC will advise the suspended clearing member, other clearing members, and appropriate regulatory authorities (plus applicable self-regulatory organizations) when it has suspended a clearing member. OCC's notice to clearing members will ordinarily provide, in general terms, a description of the treatment of pending transactions, open positions, stock loan (borrow) positions, exercised and matured contracts and other items. Notice of a clearing member suspension may be posted on public and other websites maintained by OCC, which may be the sole means by which OCC provides certain third parties with notice of a suspension. See generally Rule 1103.

Suspended Clearing Member's Right to Appeal Suspension. A suspended clearing member may request a written statement of the grounds for suspension and has the right to appeal its suspension as provided for in Rule 1110. In the event a clearing member appeals its suspension, the procedures specified in Rule 1110 (which require written notice of appeal within a specified timeframe) must be followed. Upon receipt of such written notice, OCC will process and record the appeal as provided for in Rule 1110, including convening an appointed review panel and providing the suspended clearing member with the opportunity to be heard within the time periods specified in the referenced rule. Written notice of the review panel's decision will be provided and is reviewable by the OCC Board in accordance with the rule. However, under OCC's rules, the filing of any appeal neither impairs the validity of the effect of the suspension decision nor invalidates any action taken by OCC prior to such reversal. See generally Rule 1110.

Post-Suspension

Margin and Clearing Fund Deposits of a Suspended Clearing Member. Excluding deposits in lieu of margin (i.e., specific or escrow deposits) or letters of credit maintained in respect of accounts a suspended clearing member held at OCC, OCC may convert margin deposits of such clearing member to cash (including through a private auction), effect borrowing or other transactions using such deposits in order to obtain funds, or defer the conversion of such assets to cash. OCC may convert the clearing fund deposits of the suspended clearing member to cash or effect borrowing or other transactions using such deposit in order to obtain funds. To the extent such deposits are converted to cash, such cash is to be deposited into, as applicable, a Liquidating Settlement Account or Segregated Liquidating Settlement Account. Deposits to and disbursement from one or more liquidating settlement account shall be effected as provided in the rules. Any proceeds/funds remaining after application of relevant rule provisions (including provisions providing for reimbursement of expenses associate with liquidating or closing out positions held by the suspended clearing member) will be remitted to the clearing member's representative in bankruptcy. Note OCC may use proceeds remaining in any firm lien account to satisfy obligations arising out of any other account type (including segregated futures) or otherwise owed to OCC. Moreover, nothing in the rules is intended to preclude OCC from effecting transfers of positions and/or assets maintained in respect of a suspended clearing member's segregated funds account as provided in the rules. Any margin deposits in respect of one or more cross-margining accounts maintained by the suspended clearing member will be treated as provided in Rule 707 and the applicable cross-margining agreement between OCC and a participating CCO. See generally Rule 1104, Rule 707 and Section 5 of Article VIII of the by-laws.

Pending Transactions. Subject to the by-laws and rules, OCC has no obligation to accept matched trades effected by a suspended clearing member after the time the clearing member was suspended. (If a suspended clearing member's matched trades are rejected, such transactions are closed out in accordance with relevant provisions of the rules of applicable self-regulatory organizations.) Premiums on closing sales transactions and variation payments for specified futures contracts in respect of particular account types are treated as provided in Rule 1105 (i.e., deposited into an applicable liquidating settlement account). See generally Rule 1105, Rule 707, Rule 2210, Rule 2211, Rule 2210A and Rule 2211A.

Open Positions. Generally speaking, OCC will close out open positions of the suspended clearing member in the most orderly manner practicable, which may include a private auction. Open long positions, short positions and covered short options positions and open long and short positions in futures may be closed-out as provided in Rule 1106, including close-out by offset (netting) and by other permitted transactions or means. Open positions in stock loan (borrow) transactions may be closed out as provided in the Stock Loan/Hedge Program and Market Loan Program rules. However, OCC may defer effecting such close-out transactions (including liquidating margin and other deposits of the suspended clearing member) as well as may elect to implement protective (hedging) transactions in respect of positions or deposits of the suspended clearing member, subject to the reporting requirements, as applicable, in the rules. In addition and subject to applicable rule, law and/or regulation, OCC may effect certain position and/or asset transfers to other non-suspended clearing members. The close-out of cross-margining accounts maintained with a Participating CCO will be effected in accordance with the terms of the applicable rules and cross-margining agreement, which generally require coordinated action between OCC and the Participating CCO. See generally Rule 1106, Rule 707, Rule 2210, Rule 2211, Rule 2210A and 2211A.

Exercised or Matured Contracts. The disposition of exercised or matured contracts will occur as provided for in Rule 1107 and other applicable rules, including as provided for in any applicable options exercise (assignment) settlement agreement between OCC and the correspondent clearing corporation. See generally Rule 1107 and Rule 901.

Use of Private Auction. OCC reserves the right to utilize a private auction to liquidate all or any part of a suspended Clearing Member's account. Auction participation will be open to pre-approved Clearing Members and certain non-Clearing Members selected by OCC. Auctions will be conducted in a "sealed bid" manner and OCC will have full discretion to select or reject the best bid based upon the totality of circumstances. See generally Interpretation and Policy .02 following Rule 1104.

For auctions that include OTC options products, please refer to the following procedures:

Clearing Fund

In the event the margin which OCC holds from a defaulting clearing member is insufficient to satisfy the costs incurred in closing out the accounts of such defaulting clearing member, OCC may access the clearing fund deposits of the defaulting clearing member. (Clearing fund deposits of a clearing member must be in highly liquid assets (cash or US or Canadian Government securities). Upon suspension, OCC would convert the suspended clearing member's clearing fund deposit to cash, as necessary or appropriate.

In the event the clearing fund deposit of the defaulting clearing member is insufficient to satisfy the obligations to OCC, OCC may charge on a pro rata basis in accordance with the rules, the clearing fund deposits of all other clearing members. See generally Article VIII of the by-laws.

Conclusion

The foregoing summary has been provided for informational purposes only and is qualified in its entirety by reference to OCC's rules as well as applicable law (including insolvency law) and regulation. Subject to such rules, laws and regulations, OCC maintains broad discretionary authority in determining how to effect the liquidation (which may include transfers of positions and/or collateral or portfolio auction processes) of a suspended clearing member consistent with what is necessary - in OCC's view - for the protection of OCC, other clearing members and the general public.