April 11, 2003
Mr. Paul R. Greenwood
Dear Mr. Greenwood:
This responds to your letter of November 19, 2002, which was received in March 2003, concerning the possible status of your firm as an "exempted borrower," based on its trading activity. A firm that meets one of the three safe harbors in the definition of "exempted borrower" in section 220.2 of Regulation T or section 221.2 of Regulation U may borrow without regard to the requirements of the Board's Regulations T, U, and X (12 C.F.R. Parts 220, 221, and 224).
The following representations are contained in your letter. Your firm is a broker-dealer that is registered with the Securities and Exchange Commission and a member of the New York Stock Exchange. The firm engages in both index arbitrage and spread trading. The firm's index arbitrage trading involves taking a long position in an equity index and a short position in the related equity index future. The firm's spread trading involves taking a long position in an equity index future and a short position in the same equity index future, but with a different expiration than the long futures position. The counterparties for transactions in futures for both of these trading strategies are typically floor members of the Chicago Mercantile Exchange that are not brokers or dealers or persons associated with brokers or dealers.
Your firm believes it qualifies as an exempted borrower under the second safe harbor contained in the definition of "exempted borrower" in section 220.2 of Regulation T. This safe harbor covers registered brokers and dealers who earn "at least $10 million in gross revenues on an annual basis from transactions with persons other than brokers, dealers, and persons associated with a broker or dealer." You seek Board staff's concurrence with your view.
Board staff believes that revenue derived from the spread trading described
in your letter would count as eligible revenue for purposes of meeting
the safe harbor described in the previous paragraph, provided that these
transactions are, in fact, with "persons other than brokers, dealers,
and persons associated with a broker or dealer," as those terms
are defined in section 3(a) of the Securities Exchange Act of 1934 (15
U.S.C. § 78c(a)). It is therefore possible for a lender to make a
good faith determination that your firm is an exempted borrower based
on its spread trading, if the revenue derived therefrom satisfies the
threshold amount in the safe harbor.
Board staff is unable to conclude that revenue from the index arbitrage trading described in your letter could qualify as revenue that would make it eligible to claim exempted borrower status. This is because one leg of each arbitrage is a securities transaction, which by definition must be effected with a broker or dealer.
This is a staff opinion only, as the matter has not been presented to
the Board for its consideration. It is limited to the facts presented;
different facts could compel a different conclusion.
(Signed) Scott Holz