Securities Transactions - Settlement Rules

Settling Equity Options
On the CBOE, where equity options are traded, settlement rules are different.

If your client decides to exercise his right to buy or sell the underlying shares of stock, he must direct you to submit an exercise notice to the OCC.

  • To ensure that an option is exercised on a particular day other than the expiration date, the holder must notify his brokerage firm before its exercise cut-off time, which is 4:30 p.m. CT on the business day before expiration.

  • Once the OCC receives your client's exercise notice, it assigns it to a clearing member firm with a customer who has written an uncovered option with the same terms. The member firm makes these assignments either randomly or on a FIFO basis.

If an option writer is short an option that expires in-the-money, she can count on getting an assignment on that contract. Once assignment has been received, she has no choice but to deliver on it.

Settling Federal Government Securities: The FICC
Federal government securities are settled through the Fixed Income Clearing Corporation (FICC), which compares and nets trades of U.S. Treasury securities, agency debt securities and mortgage-backed securities.

  • FICC uses real-time trade matching: trade details are compared and matched as soon as the information is submitted.

    • Successfully compared trades result in binding and enforceable obligations for settlement.

    • Unmatched trades may be revised to achieve a trade match.

  • Once Treasury securities' net positions are determined, FICC interposes itself between the original trading parties and becomes the legal counter-party for settlement purposes; much like the OCC does in the options market.

  • For those agencies issuing mortgage-backed securities, the FICC engages in multilateral position netting and does not stand in the middle of transactions.

  • In either case, final settlement is done through the Federal Reserve's Fedwire Securities Service and the participants' banks.

Settling Munis
Typically, a municipal bond issue's notice of sale states the bonds themselves will be available as of a delivery date that is typically a month after the sale, to allow time for printing and shipping.

Like equities, munis can be settled RW, WI or for cash. They can also be settled with delayed delivery or other mutually agreed upon terms.

DK Procedures
Sometimes trades do not match up. When a purchase has no corresponding sale, or vice versa, the broker-dealer receives a "Don't Know" (DK) report. A DK indicates the firms do not agree on the terms and conditions of a transaction. These discrepancies can occur due to inaccuracies regarding account numbers, ticker symbols, quantity of shares or price per share.

The rule governing DKs states that the price at which an order is executed is binding. It does not matter if there was an erroneous report. Each SRO has its own rules governing arbitration in the case of a DK.

Record Keeping
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