[Federal Register Volume 59, Number 186 (Tuesday, September 27, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-23792]


[[Page Unknown]]

[Federal Register: September 27, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34692; File No. SR-NYSE-94-15]

 

Self-Regulatory Organizations; Order Approving a Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment No. 1 to the Proposed Rule Change by the New York Stock 
Exchange, Inc., Relating to Restructuring Companies Portfolio Market 
Index Target-Term Securities (``MITTS'')

September 20, 1994.

I. Introduction

    On April 12, 1994, the New York Stock Exchange, Inc. (``NYSE'' or 
``Exchange''), pursuant to Section 19(b)(1) of the Securities Exchange 
Act of 1934 (``Act'')\1\ and Rule 19b-4 thereunder,\2\ filed with the 
Securities and Exchange Commission (``SEC'' or ``Commission'') a 
proposed rule change to list and trade Market Index Target-Term 
Securities (``MITTS''),\3\ the return on which is based upon a 
portfolio of securities of companies that have restructured or are in 
the process of restructuring (``Restructuring Companies 
Portfolio'').\4\ Notice of the proposal appeared in the Federal 
Register on April 28, 1994.\5\ No comment letters were received on the 
proposed rule change. On August 9, 1994, the NYSE filed Amendment No. 1 
to the proposed rule change.\6\ This order approves the proposal, as 
amended.
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    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1992).
    \3\``MITTS'' and ``Market Index Target-Term Securities'' are 
service marks of Merrill Lynch & Co., Inc. (``Merrill Lynch'').
    \4\The Restructuring Companies Portfolio is a static portfolio 
consisting of 17 equity securities listed as common shares in the 
United States. The components of the portfolio represent companies 
which are generally perceived to have recently experienced declines 
in earnings as compared to historical levels and/or other adverse 
developments which have required some form of restructuring by such 
companies.
    \5\See Securities Exchange Act Release No. 33934 (April 20, 
1994), 59 FR 22040 (April 28, 1994).
    \6\Amendment No. 1 to the proposed rule change provides that the 
value of the Restructuring Companies Portfolio will be calculated 
continuously and disseminated to the Options Price Reporting 
Authority (``OPRA'') no less frequently than once every minute 
throughout the trading day. See Letter from James Buck, Senior Vice 
President and Secretary, NYSE, to Sharon Lawson, Assistant Director, 
Office of Market Supervision, Division of Market Regulation, 
Commission, dated August 9, 1994 (``Amendment No. 1'').
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II. Description of the Proposal

    Under Section 703.19 of the Exchange's Listed Company Manual 
(``Manual''), the NYSE may approve for listing securities which can not 
be readily categorized under the listing criteria for common and 
preferred stocks, bonds, debentures, and warrants.\7\ The NYSE is now 
proposing under Section 703.19 of the Manual to list for trading MITTS 
based on the Restructuring Companies Portfolio (``Restructuring 
Companies Portfolio MITTS'').\8\
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    \7\See Securities Exchange Act Release Nos. 29229 (May 23, 
1991), 56 FR 24852 (May 31, 1991); and 28217 (July 18, 1990), 55 FR 
30056 (July 24, 1990) (``Hybrid Approval Orders'').
    \8\The Commission recently approved the listing and trading on 
the Exchange of MITTS based upon (1) A global portfolio of 
securities representing telecommunications companies, and (2) a 
portfolio of European companies. See Securities Exchange Act Release 
Nos. 32840 (September 2, 1993), 58 FR 47485 (September 9, 1993); and 
33368 (December 22, 1993), 58 FR 68975 (December 29, 1993) (``MITTS 
Approval Orders'').
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    As with the other MITTS products, the Restructuring Companies 
Portfolio MITTS will conform to the listing guidelines under Section 
703.19 of the Manual, which provide that: (1) Issues must have a 
minimum public distribution of one million securities; (2) a minimum of 
400 shareholders; (3) a minimum duration of one year; (4) a market 
value of at least $4 million; and (5) otherwise comply with the NYSE's 
initial listing criteria.\9\ In addition, the Exchange will monitor the 
Restructuring Companies Portfolio MITTS to verify compliance with the 
Exchange's continued listing criteria.\10\ MITTS are non-callable 
senior hybrid debt securities of Merrill Lynch that provide for a 
single payment at maturity, and will bear no periodic payments of 
interest. Restructuring Companies Portfolio MITTS will entitle the 
owner at maturity to receive an amount based upon the percentage change 
between the ``Original Portfolio Value'' and the ``Ending Average 
Portfolio Value,'' subject to a minimum repayment amount. The 
``Original Portfolio Value'' is the value of the Restructuring 
Companies Portfolio on the date on which the issuer prices the 
Restructuring Companies Portfolio MITTS issue for the initial offering 
to the public. The ``Ending Average Portfolio Value'' is the average of 
the values of the Restructuring Companies Portfolio at the end of the 
five calendar quarters preceding the expiration of the Restructuring 
Companies Portfolio MITTS on December 31, 1999.\11\ The Ending Average 
Portfolio Value will be used in calculating the amount owners will 
receive upon maturity.\12\
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    \9\The hybrid listing standards in Section 703.19 of the Manual 
are intended to accommodate listed companies in good standing, their 
subsidiaries and affiliates, and non-listed equities which meet the 
Exchange's original listing standards. Domestic issuers must also 
meet the earnings and net tangible assets criteria set forth in 
Sections 102.01 and 102.02 of the Manual. Specifically the minimum 
original listing criteria requires that issuers have: (1) 2,000 
holders holding 100 shares or more or have 2,200 holders with an 
average monthly trading volume of 100,000 shares; (2) a public float 
of $1.1 million shares; (3) an aggregate public market value of $18 
million or total net tangible assets of $18 million; and (4) 
earnings before taxes of $2.5 million in the latest fiscal year and 
earnings before taxes of $2 million in each of the preceding two 
fiscal years, or earnings before taxes of $6.5 million in the 
aggregate for the last three fiscal years with a $4.5 million 
minimum in the most recent fiscal year (all three years are required 
to be profitable).
    \10\The continued listing criteria for capital or common stock 
requires that: (1) The number of holders of 100 shares or more is 
equal to or greater than 1,200; (2) the number of publicly-held 
shares is equal to or greater than 600,000; (3) the aggregate market 
value of publicly-held shares is equal to or greater than $5 
million; (4) the aggregate market value of shares outstanding 
(excluding treasury stock) is equal to or greater than $8 million 
and average net income after taxes for the past three years is equal 
to or greater than $600,000; and (5) net tangible assets available 
to common stock are equal to or greater than $8 million and average 
net income after taxes for the past three years is equal to or 
greater than $600,000. In addition, the continued listing standards 
for bonds require that outstanding publicly-held bonds have an 
aggregate market value or principal amount equal to or greater than 
$1 million. See Section 802 of the Manual.
    \11\Specifically, the Ending Average Portfolio Value will equal 
the average of the quarterly values of the Restructuring Companies 
Portfolio beginning in the calendar quarter ending December 31, 
1998. The quarterly value for each of the first four of the final 
five calendar quarters shall be the Restructuring Companies 
Portfolio value on the last scheduled Exchange trading day on which 
there is no market disruption event. The quarterly value for the 
final calendar quarter shall be the Restructuring Companies 
Portfolio Value on the seventh scheduled Exchange trading day 
preceding maturity of the Restructuring Companies MITTS unless there 
is a market disruption event in which case the sixth trading day 
preceding maturity shall be used.
    \12\The Restructuring Companies Portfolio MITTS will entitle a 
holder at maturity to receive for each $10 principal amount of MITTS 
an amount equal to the Ending Average Portfolio Value of the 
Restructuring Companies Portfolio divided by 10, but in any event no 
less than $9 per each $10 principal amount of Restructuring 
Companies Portfolio MITTS.
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    If the market value of the portfolio has declined, the owner will 
receive not less than a specified percentage of the principal amount of 
the security. (For instance, if the market value of the portfolio used 
to calculate the amount payable at maturity has declined more than 10%, 
the owners of the Restructuring Companies Portfolio MITTS will receive 
90% of the principal amount of the securities.) The payment at maturity 
is based on changes in the value of the portfolio, but does not reflect 
the payment of dividends on the securities that comprise the portfolio. 
Restructuring Companies Portfolio MITTS are cash-settled in that they 
do not give the holder any right to receive a portfolio security or any 
other ownership right or interest in the portfolio securities, although 
the return on the investment is based on the aggregate portfolio value 
of the Restructuring Companies Portfolio securities.
    According to the NYSE, Restructuring Companies Portfolio MITTS will 
allow investors to combine the protection of a portion of the principal 
amount of the MITTS with a potential additional payment based upon the 
performance of a portfolio of securities representing 17 highly 
capitalized companies that either have restructured or are in the 
process of restructuring. Restructuring Companies Portfolio MITTS will 
mature on December 31, 1999.
    The Restructuring Companies Portfolio consists of securities of 17 
companies that have significantly different levels of market 
capitalization, ranging from a high of approximately $30. 2 billion 
(IBM) to a low of approximately $328 million (Arkis, Inc.).\13\ Sixteen 
of the securities in the Restructuring Companies Portfolio are traded 
on the NYSE and one is a National Market security traded through 
Nasdaq. The average daily trading volume for the components of the 
Restructuring Companies Portfolio for the period from November 5, 1992, 
through March 7, 1994, ranged from a high of approximately 3.7 million 
shares (Eastman Kodak), to a low of approximately 93,008 shares (The 
Columbia Gas System, Inc.).
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    \13\These values are as of March 7, 1994.
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    At the outset, each of the securities in the Restructuring 
Companies Portfolio will have equal representation. Specifically, each 
security included in the portfolio will be assigned a multiplier on the 
date of issuance so that the security represents an equal percentage of 
the value of the entire portfolio on the date of issuance. The 
multiplier indicates the number of shares (or fraction of one share) of 
a security, given its market price on an exchange or through NASDAQ, to 
be included in the calculation of the portfolio. Accordingly, each of 
the 17 companies included in the Restructuring Companies Portfolio will 
represent approximately 5.88 percent of the total portfolio at the time 
of issuance.
    The multiplier for each security in the Restructuring Companies 
Portfolio will generally remain unchanged except for limited 
adjustments that may be necessary as a result of stock splits or stock 
dividends.\14\ There will be no adjustments to the multipliers to 
reflect cash dividends paid with respect to a portfolio security. In 
addition, no adjustments of any multiplier of a portfolio security will 
be made unless such adjustment would require a change of at least 1% in 
the multiplier then in effect.
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    \14\Merrill Lynch will adjust the multiplier of any portfolio 
security if the security is subject to a stock split or reverse 
split to equal the product of the number of shares issued with 
respect to one share of the portfolio security and the prior 
multiplier. In the case of a stock dividend, the multiplier will be 
adjusted so that the new multiplier will equal the former multiplier 
plus the product of the number of shares of such portfolio security 
issued with respect to one share of the portfolio security and the 
prior multiplier.
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    If the issuer of a security included in the Restructuring Companies 
Portfolio no longer exists, whether for reason of a merger, acquisition 
or similar type of corporate control transaction, then Merrill Lynch 
will assign to that security a value equal to the security's final 
value for the purposes of calculating portfolio values. For example, if 
a company included in the portfolio is acquired by another company, 
Merrill Lynch shall thereafter assign a value to the shares of the 
acquired company's securities equal to the value per share at which 
time the acquisition takes place.
    If the issuer of a portfolio security is in the process of 
liquidation or subject to a bankruptcy proceeding, insolvency, or other 
similar adjudication, such security will continue to be included in the 
Restructuring Companies Portfolio so long as a market price on an 
exchange or through NASDAQ for such security is available. If such a 
market price is no longer available for a portfolio security, 
including, but not limited to, liquidation, bankruptcy, insolvency, or 
any other similar proceeding, then the value of the portfolio security 
will be assigned a value of zero in connection with calculating the 
daily portfolio value and the closing portfolio value of the 
Restructuring Companies Portfolio, for so long as no such market price 
exists for that security.\15\
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    \15\Merrill Lynch will not attempt to find a replacement stock 
or to compensate for the extinction of a security due to bankruptcy 
or a similar event.
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    The value of the Restructuring Companies Portfolio will be 
calculated by an independent third party and will be disseminated 
through OPRA at least once each minute throughout the trading day.\16\ 
The portfolio value will equal the sum of the products of the most 
recently available market prices and the applicable multipliers for the 
portfolio securities.
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    \16\See Amendment No. 1, supra note 6.
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    Like other issues of MITTS listed on the NYSE, Restructuring 
Companies Portfolio MITTS may not be redeemed prior to maturity and are 
not callable by the issuer. Holders of Restructuring Companies 
Portfolio MITTS will be able to cash-out of their investment by selling 
the security on the NYSE. The Exchange anticipates that the trading 
value of the security in this secondary trading market will depend in 
large part on the value of the securities comprising the Restructuring 
Companies Portfolio and also on such other factors as the level of 
interest rates, the volatility of the value of the Restructuring 
Companies Portfolio, the time remaining to maturity, dividend rates, 
and the creditworthiness of the issuer, Merrill Lynch.\17\
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    \17\Merrill Lynch will deposit registered securities 
representing Restructuring Companies Portfolio MITTS with its 
depository, the Depository Trust Company (``DTC''), so as to permit 
book-entry settlement of transactions by participants in DTC.
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    Because Restructuring Companies Portfolio MITTS are linked to a 
portfolio of equity securities, the NYSE's existing equity floor 
trading rules will apply to the trading of Restructuring Companies 
Portfolio MITTS. First, pursuant to NYSE Rule 405, the Exchange will 
impose a duty of due diligence on its members and member firms to learn 
the essential facts relating to every customer prior to trading 
Restructuring Companies Portfolio MITTS.\18\ Second, consistent with 
NYSE Rule 405, the Exchange will further require that a member or 
member firm specifically approve a customer's account for trading 
Restructuring Companies Portfolio MITTS prior to, or promptly after, 
the completion of the transaction. Third, Restructuring Companies 
Portfolio MITTS will be subject to the equity margin rules of the 
Exchange. Fourth, in accordance with the NYSE's Hybrid Approval Orders, 
the Exchange will, prior to trading Restructuring Companies Portfolio 
MITTS, distribute a circular to the membership providing guidance with 
regard to member firm compliance responsibilities (including 
suitability recommendations) when handling transactions in 
Restructuring Companies Portfolio MITTS and highlighting the special 
risks and characteristics of the Restructuring Companies Portfolio 
MITTS.\19\
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    \18\NYSE Rule 405 requires that every member, member firm or 
member corporation use due diligence to learn the essential facts 
relative to every customer and to every order or account accepted.
    \19\See Hybrid Approval Orders, supra note 7.
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III. Commission Findings and Conclusions

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, the requirements of Section 6(b)(5). Specifically, the 
Commission believes that providing for exchange-trading of 
Restructuring Companies Portfolio MITTS will offer a new and innovative 
means of participating in the market for securities of companies that 
have either recently restructured or are in the process of 
restructuring. In particular, the Commission believes that 
Restructuring Companies Portfolio MITTS will permit investors to gain 
equity exposure in such companies, while at the same time, limiting the 
downside risk of the original investment. For the reasons discussed in 
the MITTS Approval Orders, the Commission finds that the listing and 
trading of Restructuring Companies Portfolio MITTS is consistent with 
the Act.\20\
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    \20\See Mitts Approval Orders, supra note 8.
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    As with other MITTS products, Restructuring Companies Portfolio 
MITTS are not leveraged instruments, however, their price will still be 
derived and based upon the underlying linked security. Accordingly, the 
level of risk involved in the purchase or sale of a Restructuring 
Companies Portfolio MITTS is similar to the risk involved in the 
purchase or sale of traditional common stock. Nonetheless, because the 
final rate of return of a MITTS is derivatively priced, based on the 
price performance of a portfolio of securities, the Commission has 
several specific concerns regarding the trading of this type of 
product.
    The Commission notes that the Exchange's rules and procedures that 
address the special concerns attendant to the trading of hybrid 
securities will be applicable to Restructuring Companies Portfolio 
MITTS. In particular, by imposing the hybrid listing standards, 
suitability, disclosure, and compliance requirements noted above, the 
Commission believes the Exchange has addressed adequately the potential 
problems that could arise from the hybrid nature of Restructuring 
Companies Portfolio MITTS. Moreover, the Exchange will distribute a 
circular to its membership calling attention to the specific risks 
associated with Restructuring Companies Portfolio MITTS.
    The Commission realizes that Restructuring Companies Portfolio 
MITTS are dependent upon the individual credit of the issuer, Merrill 
Lynch. To some extent this credit risk is minimized by the Exchange's 
continued listing standards which require issuers to maintain an 
aggregate market value of $5 million for its publicly-held shares.\21\ 
In addition, the Exchange's hybrid listing standards further require 
that Restructuring Companies Portfolio MITTS have at least $4 million 
in market value. In any event, financial information regarding Merrill 
Lynch, in addition to the information on the issuers of the underlying 
securities comprising the Restructuring Companies Portfolio, will be 
publicly available.\22\
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    \21\See supra note 10.
    \22\The companies that comprise the Restructuring Companies 
Portfolio are reporting companies under the Act.
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    The Commission also has a systemic concern, however, that a broker-
dealer, such as Merrill Lynch, or a subsidiary providing a hedge for 
the issuer will incur position exposure. As discussed in the MITTS 
Approval Orders, the Commission believes this concern is minimal given 
the size of Restructuring Companies Portfolio MITTS issuance in 
relation to the net worth of Merrill Lynch.\23\
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    \23\See MITTS Approval Orders, supra note 8.
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    The Commission also believes that the listing and trading of 
Restructuring Companies Portfolio MITTS should not unduly impact the 
market for the underlying securities comprising the Restructuring 
Companies Portfolio. First, as discussed above, the underlying 
securities comprising the portfolio are well-capitalized, highly liquid 
stocks. Second, because all of the components of the Restructuring 
Companies Portfolio will initially be equally weighted, no single stock 
or group of stocks dominates the Restructuring Companies Portfolio. 
Finally, the issuers of the underlying securities comprising the 
Restructuring Companies Portfolio, are subject to reporting 
requirements under the Act, and all of the portfolio securities are 
either listed or traded on, or traded through the facilities of, U.S. 
securities markets.\24\ Additionally, the NYSE's surveillance 
procedures will serve to deter as well as detect any potential 
manipulation.
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    \24\The Commission notes that 16 of the component securities are 
traded on the NYSE and one is a National Market security traded 
through Nasdaq.
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    Finally, the Commission notes that the value of the Restructuring 
Companies Portfolio will be disseminated at least once every minute 
throughout the trading day. The Commission believes that this result is 
appropriate because, unlike previously approved MITTS products which 
contain foreign components, the Restructuring Companies Portfolio is 
comprised solely of securities traded in the U.S. for which real-time 
price information is available. The Commission believes that providing 
access to the value of the Restructuring Companies Portfolio at least 
once every minute throughout the trading day is extremely important and 
will provide benefits to investors in the product.\25\
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    \25\In this regard, the Commission believes that it is useful 
and beneficial for all investors and market participants to have 
access to the value of the Restructuring Companies Portfolio as 
frequently as possible and encourages the NYSE and Merrill Lynch to 
further explore the possibilities in this area, i.e., calculating 
and disseminating the value of the portfolio at least once every 15 
seconds as is done with other derivative products.
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    The Commission finds good cause for approving Amendment No. 1 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice thereof in the Federal Register. As discussed 
above, the Commission believes that investors and market participants 
will benefit from having the value of the Restructuring Companies 
Portfolio calculated and disseminated as frequently as possible 
throughout the trading day. The Commission believes that Amendment No. 
1 provides this benefit without unduly burdening either the Exchange or 
the issuer of the Restructuring Companies Portfolio MITTS. 
Additionally, the Commission notes that Amendment No. 1 provides for 
significantly greater access by investors and market participants to 
current values of the Restructuring Companies Portfolio than did the 
original proposal which was noticed for the full 21-day comment period 
without any comments being received by the Commission. Accordingly, the 
Commission believes it is consistent with Section 6(b)(5) of the Act to 
approve Amendment No. 1 to the proposed rule change on an accelerated 
basis.
    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 1 to the proposed rule change. 
Persons making written submissions should file six copies thereof with 
the Secretary, Securities and Exchange Commission, 450 Fifth Street 
NW., Washington, DC 20549. Copies of the submission, all subsequent 
amendments, all written statements with respect to the proposed rule 
change that are filed with the Commission, and all written 
communications relating to the proposed rule change between the 
Commission and any person, other than those that may be withheld from 
the public in accordance with the provisions of 5 U.S.C. 552, will be 
available for inspection and copying in the Commission's Public 
Reference Section, 450 Fifth Street NW., Washington, DC. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the NYSE. All submissions should refer to File No. 
SR-NYSE-94-15 and should be submitted by October 18, 1994.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\26\ that the proposed rule change (File No. SR-NYSE-94-15), as 
amended, is approved.

    \26\15 U.S.C. 78s(b)(2) (1988).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\27\
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    \27\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-23792 Filed 9-26-94; 8:45 am]
BILLING CODE 8010-01-M