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No-Action Letter from SEC OK'd 'Mirror' OTC Calls

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WASHINGTON (–The Securities and Exchange Commission’s division of investment management has provided a “no-action letter” to Credit Suisse First Boston LLC, allowing CSFB to use certain “global consent forms” to provide statutorily required written disclosures to investment advisory clients regarding certain derivatives transactions.

A global consent form would economize, removing the need to obtain transaction-by-transaction consents for the program in question–a client would consent in advance to the CSFB’s, or its derivative affiliate’s, actions as principals for as much as a year at a time (or shorter periods as agreed upon).

The need for a no-action letter arose because section 206(3) of the Investment Advisers Act makes it unlawful for any adviser, acting as a principal for its own account, to sell any security to, or buy any security from, a client without disclosure and consent in writing–a rule designed to address the potential for self-dealing when the same firm is both counterparty and adviser to the same client.

The CSFB wants to employ a global consent system for a volatility management program for high-net-worth individuals, in which a participating client must have a net worth of at least US$20 million excluding assets committed to the program. The program uses covered call options, either to provide yield enhancement of a client’s underlying stock positions, or to enable the client to exit an underlying stock position at a specified price target.

Part of the program involves what CSFB calls “Mirror” over-the-counter calls. The idea is that if CSFB receives a bid from a third party to buy a covered call option from its derivatives affiliate, and it believes the terms of the bid meet its client’s needs within the program, it will (1) sell an OTC call for the client’s account to its own derivatives affiliate on the same terms, and (2) instruct the affiliate to simultaneously sell an offsetting OTC call to the third party that mirrors those of the contract it is purchases from its client. The upshot is that the affiliate purchases from the client both an option and, upon its exercise, the underlying stock–the affiliate acting as principal and the parent corporation acting as advisor.

As the no-action letter, issued Aug. 31, relates, “You [CSFB and its affiliate] claim that by structuring transactions in this manner, the client would have a single account, a single standardized OTC options agreement and a single collateral agreement” with the affiliate. Such a structure, including a global consent system in lieu of transactional consents, will “save clients substantial time, cost and paperwork, and would protect the confidentiality of client information.”

The Division of Investment Management recommended that, given the facts as stated, it won’t recommend enforcement action under section 206(3), and it cited the following points as especially pertinent to that conclusion:

  • The global consent will apprise the client of the capacities in which CSFB and its affiliate will be acting, the potential conflict of interest, the nature and maximum amount of compensation to be charged by the affiliate on each OTC call;
  • Mirror OTC calls will completely offset the affiliate’s transactions so as to prevent the affiliate from profiting from the premium or strike price of any call, and the affiliate will exercise a call only upon the exercise of the mirror call by the third-party dealer;
  • The variables for each covered call option transactions (strike price, premium, expiration date, quantity of stocks covered, time of transaction, amount of proposed fee) will be shown on the confirmation statement that will be sent to the client as promptly as possible;
  • Each client can cancel participation in the program upon 30 days’ notice and may withdraw his or her global consent to any further proposed principal transactions at any time; and
  • An advisory client must commit a minimum of $10 million of underlying stock to be managed under the program.

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Contact Bob Keane with questions or comments at [email protected].


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