[Federal Register Volume 61, Number 76 (Thursday, April 18, 1996)]
[Notices]
[Pages 16944-16948]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-9511]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-37106; File No. SR-NASD-96-02]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Temporary Accelerated Approval of Proposed Rule Change by 
National Association of Securities Dealers, Inc. Relating to Changes in 
the Structure of the NASD Board of Governors

April 11, 1996.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on January 
16, 1996, the National Association of Securities Dealers, Inc. 
(``NASD'' or ``Association'') filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission'') \1\ the proposed rule change as 
described in Items I, II, and III below, which Items have been prepared 
by the NASD. The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons. For the 
reasons discussed below, the Commission is granting accelerated 
approval of the proposed rule change for a period of ninety (90) days.
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    \1\ The NASD subsequently made three amendments to its filing. 
On January 24, 1996, the NASD submitted the final report of the vote 
with respect to Notice to Members 95-101. On April 10, 1996, the 
NASD submitted Amendment No. 2 which superseded the original rule 
filing and eliminated those parts of the original rule filing that 
proposed to eliminate Article V to the By-Laws and amend Section 7 
to Article VII of the By-Laws to establish a new procedure for 
nomination of the members of the Board of Governors. These 
amendments are not being proposed at this time. On April 11, 1996, 
the NASD submitted its third and fourth amendment to this filing 
which superseded all previous amendments and the original filing. 
The NASD at this time is proposing to amend Sections 4 and 6 of 
Article VII of its By-laws on a temporary 90 day basis. See letter 
from T. Grant Callery, NASD, to Mark Barracca, SEC (April 11, 1996).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Following is the full text of a proposed rule change to amend the 
NASD's By-Laws to reconfigure the NASD's Board of Governors. Below is 
the text of the proposed rule change.\2\ Proposed new language is 
italicized; proposed deletions are in brackets.
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    \2\ Article and section designations of the provisions covered 
by this rule change will be modified to conform to a new rule 
numbering system for the NASD Manual anticipated to be effective no 
later than May 1, 1996. See Exchange Act Release No. 36698 (January 
11, 1996), 61 FR 1419 (January 19, 1996).
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BY-LAWS
ARTICLE VII
BOARD OF GOVERNORS
Composition and Qualifications of the Board
    Sec. 4. [(a)] The management and administration of the affairs of 
the Corporation shall be vested in a Board of Governors composed of 
[from twenty-five to twenty-nine Governors as determined from time to 
time by the Board. The Board shall consist of: (1) At least thirteen 
but not more than fifteen Governors to be elected by the members of the 
various districts in accordance with the provisions of subsection (b) 
hereof; (2) at least eleven but not more than thirteen Governors to be 
elected by the Board in accordance with the provisions of subsection 
(c) hereof; (3) the President of the Corporation to be selected by the 
Board in accordance with the provisions of Article X, Section 2 of the 
By-Laws. The Board, in exercising its power to determine its size and 
composition under this subsection (a), shall be required to select its 
members in a manner such that when all vacancies, if any, are filled, 
the number of Governors elected by the members of the various districts 
in accordance with subsection (b) hereof shall exceed the number of 
Governors (including the President) not so elected.
    (b) The several districts shall be represented on the Board. Each 
district shall elect at least one Governor. The Board shall determine 
from time to time which districts, if any, shall elect more than one 
Governor, so as to provide fair representation of the Corporation's 
members and of its various districts on the Board. The determination of 
which districts shall elect more than one Governor need not be 
submitted to the membership for approval and shall become effective at 
such time as the Board may prescribe. The Board shall, from time to 
time, consider the fairness of the representation of members and of the 
various districts on the Board. Whenever the Board finds any unfairness 
in such representation to exist, it shall make appropriate changes in 
the number of boundaries of the

[[Page 16945]]

districts or the number of Governors elected by each district to 
provide fair representation of members and districts.] five or more 
members, the number thereof to be determined from time to time by 
resolution of the Board of Governors, and shall include at all times: 
(1) the Chief Executive Officer; (2) one or more Non-Industry Governors 
representative of issuers and investors and not associated with a 
member of the Corporation; (3) one or more Industry Governors; and (4) 
a majority of Non-Industry Governors, unless (A) there shall be a 
vacancy in the position of a Non-Industry Governor, in which case such 
vacancy shall be filled by a person satisfying the criteria for a Non-
Industry Governor in accordance with the provisions of Section 6 of 
this Article or (B) a Governor elected as a Non-Industry Governor 
becomes an Industry Governor and his remaining term of office is six 
months or less. If a Governor elected as a Non-Industry Governor 
becomes an Industry Governor and his remaining term of office is more 
than six months, or a Governor elected as an Industry Governor becomes 
a Non-Industry Governor and his remaining term of office is more than 
six months, he shall be automatically removed from office unless the 
Board determines otherwise.
    [(c) The Board shall elect (1) at least three Governors 
representative of investors, none of whom are associated with a member 
or any broker or dealer; (2) at least three Governors representative of 
issuers, at least one of whom is not associated with a member or any 
broker or dealer; (3) at least three Governors chosen from members; (4) 
at least one Governor representative of the principal underwriters of 
investment company shares or affiliated members; and (5) at least one 
Governor representative of insurance companies or insurance company 
affiliated members.]
Term of Office of Governors
    Sec. 5. No change.
[Succession to Office]

Filling of Vacancies

    Sec. 6.(a) [The office of a retiring Governor elected under 
subsection (b) of Section 4 of this Article shall be filled by the 
election of a Governor from the same district as that of the retiring 
Governor. The office of a retiring Governor elected under subsection 
(c) of Section 4 of this Article shall be filled by election by the 
Board as provided in subsection (c) of Section 4 of this Article.] Any 
vacancy in the office of a Governor, whether occurring by reason of 
death, disability, disqualification, removal, or resignation, other 
than a vacancy occurring by reason of an increase in the size of the 
Board, shall be filled by majority vote of the remaining Governors then 
in office and any person elected to fill such vacancy shall satisfy the 
qualifications and criteria for the governorship being filled as 
provided in Section 4 of this Article.
    (b) [Notwithstanding subsection (a) of this Section 6, the Board 
shall prescribe the succession of office in cases affected by a change 
in the number of Governors constituting the Board, the composition of 
the Board, the number or boundaries of districts, or the number of 
Governors elected by a district.] Any vacancy in the office of a 
Governor occurring by reason of an increase in the size of the Board 
shall be filled by majority vote of the Board and any person elected to 
fill such vacancy shall satisfy the criteria for such newly created 
governorship as shall be established by resolution of the Board, 
provided that the filing of any such vacancy shall not be inconsistent 
with any other provision of these By-Laws.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the NASD included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item V below. The NASD has prepared summaries, set forth in Sections 
(A), (B), and (C) below, of the most significant aspects of such 
statements.

 (A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

(a) Background
    In 1995, the NASD Board of Governors (``Board'') appointed The 
Select Committee on Structure and Governance (the ``Select Committee'') 
to examine the corporate structure, governance, and functions of the 
NASD and to recommend changes and improvements to enable the NASD to 
meet its regulatory and business obligations. The Select Committee 
reported to the Board of Governors at the September 1995 meeting and 
recommended, among other things, the establishment of two distinct 
subsidiaries; one to perform the regulatory functions of the NASD and 
the other to run The Nasdaq Stock Market.SM The Select Committee 
recommended that each subsidiary have an independent Board of Directors 
and that the NASD remain as parent corporation overseeing the 
operations of both subsidiaries.
    The NASD is proposing to amend Article VII of the NASD By-Laws in 
order to begin the restructuring necessary to implement the principles 
articulated in the report of the Select Committee. The Board of 
Governors of the NASD has adopted the Select Committee proposal that 
the NASD create a new subsidiary responsible for regulation and the 
provision of member and constituent services, with the NASD retaining 
responsibility for general oversight of the effectiveness of the self-
regulatory and business operations of the NASD and its major 
subsidiaries; The Nasdaq Stock Market, Inc. and NASD Regulation, 
Inc.\3\ (``NASDR''), and final policy making authority for the 
Association as a whole.\4\ The Board also adopted Select Committee 
proposals to implement policies that will: ensure a balance of non-
industry and industry representation on Boards of Directors of The 
Nasdaq Stock Market and NASDR; and reduce the size and structure the 
Board of Governors of the NASD to have a majority of non-industry 
members.
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    \3\ A new subsidiary has been incorporated as ``NASD Regulation, 
Inc.'' to carry out the NASD's obligations to regulate the broker/
dealer industry.
    \4\ The Nasdaq Stock Market, Inc. is a wholly-owned subsidiary 
of the NASD.
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    In summary, the NASD is proposing to reorganize its Board of 
Governors as a majority non-industry board comprising the CEO and 
``Industry'' and ``Non-Industry'' Governors, and reduces the minimum 
size of the Board from 25 to 5. The term ``Industry Governor'' means a 
persons associated with an NASD member. The term ``Non-Industry 
Governor'' means a person representing investors and issuers pursuant 
to criteria that will be adopted by the NASD Board of Governors. The 
implementation plan adopted by the NASD Board at its November 1995 
meeting specified that beginning in the second quarter of 1996 the NASD 
Board of Governors will be comprised of nine persons: the CEO, three 
Industry, and five Non-Industry Governors.
    Simultaneously with the submission of this rule change, the NASD is 
also submitting a temporary rule change in SR-NASD-96-16 to propose a 
Plan of Allocation and Delegation of Functions By NASD to Subsidiaries 
that sets forth the purpose, functions, governance, procedures, and 
responsibilities of the

[[Page 16946]]

NASD, the NASDR and Nasdaq following the reorganization of the NASD.\5\
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    \5\ See, Securities Exchange Act Release No. 37107 (April 11, 
1996).
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Description of Proposed Amendments

Article VII of the By-Laws

Section 4--Composition of the Board

    The NASD is proposing to delete rule language relating to the 
method by which representatives of the NASD's District Offices are 
elected to the Board of Governors and to add new rule language that 
would require that the Board of Governors be composed of at least five 
members, with the exact number to be determined from time-to-time by 
the Board of Governors. The proposed new provision would require that 
the NASD Board of Governors include the Chief Executive Officer; one or 
more Non-Industry Governors, representative of issuers and investors 
and not associated with a member of the NASD; one or more Industry 
Governors; and a majority of Non-Industry Governors. ``Industry 
Governor'' means a person associated with an NASD member. The term 
``Non-Industry Governor'' means a person that satisfies criteria that 
will be adopted from time-to-time by the NASD Board of Governors.\6\ An 
exception to the latter requirement is provided for situations where 
there is a vacancy in the position of a Non-Industry Governor or a 
person elected as a Non-Industry Governor becomes an Industry Governor 
at a time when the person's remaining term of office is no more than 
six months. The proposed new provision also provides that if a Non-
Industry Governor becomes an Industry Governor at a time when the 
person's remaining term of office is more than six months, the person 
will be removed from office unless the Board of Governors determines 
otherwise.
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    \6\ Non-Industry Governors will be ``representative of issuers 
and investors and not associated with a member of the Corporation.''
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    The NASD is also proposing to delete Subsection (c) to Section 4 
which currently sets forth the requirements for the composition of the 
Board of Governors, which the NASD is herein proposing be included in 
the amendments.

Section 6--Succession to Office

    The NASD is proposing to delete the current language of Subsection 
(a) which provides that, in case of an in-term vacancy, a Governor 
elected from a District will be replaced by a successor from that 
District, as District representatives will not serve on the Board of 
Governors of the NASD. Instead, District representatives will serve on 
the Board of the NASD's regulatory subsidiary, NASDR. The NASD is 
proposing to retitle this section ``Filling of Vacancies.'' The 
proposed new rule language under Subsection (a) would require that all 
vacancies on the NASD's Board of Governors that occur during a term of 
office of a sitting Governor will be filled by a majority vote of the 
remaining Governors. The provision further clarifies that any person so 
elected shall be required to fulfill the criteria set forth in new 
Section 4.
    The NASD is also proposing to delete the current language of 
Subsection (b) which authorizes the Board to prescribe the succession 
of offices where there is a change in the number of Governors 
comprising the Board, the number of boundaries of Districts, or the 
number of Governors elected by each District. New rule language is 
proposed that would provide that any vacancy in the office of Governor 
that occurs by reason of an increase in the size of the Board shall be 
filled by a majority vote of the Board and that any person so elected 
is required to fulfill the criteria set forth in new Section 4.
    (b) The NASD believes that the proposed rule change is consistent 
with the provisions of Sections 15A(b) (2), (4), and (6) of the Act.\7\ 
in that the restructured organization will: (1) enhance the NASD's 
ability to carry out its regulatory obligations under the Act and 
enforce compliance by its members and persons associated with its 
members with the Act, the rules and regulations thereunder, the rules 
of the Municipal Securities Rulemaking Board, and the rules of the 
NASD; (2) provide for the fair representation of members, issuers and 
investors on the Board of Governors and in the administration of the 
NASD's affairs; and (3) enhance the NASD's ability to protect investors 
and the public interest in furtherance of the purposes of the Act.
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    \7\ 15 U.S.C. Sec. 78o-3.
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(B) Self-Regulatory Organization's Statement on Burden on Competition

    The NASD does not believe that the proposed rule change will result 
in any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received from Members, Participants, or Others

    Written comments were not solicited with respect to the proposed 
rule change published for member vote in Notice to Members 95-101 
(December 11, 1995) \8\ (attached as Exhibit 2 to the rule filing) or 
the publication of an explanation of planned changes to the NASD's 
disciplinary and enforcement procedures published for information in 
Notice to Members 95-102 (December 11, 1995) (attached as Exhibit 3 to 
the rule filing). Nonetheless, three comments were received with 
respect to the proposed rule change published in Notice to Members 95-
101 and the concepts included in Notice to Members 95-102 that are 
attached as Exhibit 4 hereto. Two comments were opposed to the proposed 
rule change and one comment was in favor, with a request for 
modification of the rule change.
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    \8\ Notice to Members 95-101 also proposed to eliminate Article 
V to the By-Laws and amend Section 7 to Article VII of the By-Laws 
to establish a new procedure for nomination of the members of the 
Board of Governors. These amendments are not being proposed at this 
time. See also note 1, supra.
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    One Commentor (No. 2) indicated that the member had voted ``yes'' 
with respect to the proposed rule change, but recommended that the 
industry would be more effectively served by a structure that provides 
for minority non-industry public representation on the Boards of the 
NASD and the two operating subsidiaries. This Commentor also asked that 
it receive information related to the budget for the reorganization and 
the NASD's plan for funding the changes.
    Another Commentor (No. 3) stated that the NASD was being turned 
over to the SEC.
    One Commentor (No. 1) was opposed to the proposed rule change and 
stated in a cover letter that the NASD was relinquishing self-
regulation and peer review of disciplinary matters. The Commentor 
stated that these are principles basic to why the NASD was formed and 
why it has stayed in existence. In a separate letter, attached as an 
exhibit to the cover letter, the Commentor states that there was 
extensive consideration given to the formation of the NASD and that 
there is no evidence that the organization was to be anything else but 
self-regulatory. This Commentor states, ``* * * we are taking the 
`self' out of regulatory and making it an `outside' regulatory 
organization * * *.'' The Commentor objects to the inclusion on the 
Board of the NASD of people with no knowledge of the securities 
business and the elimination of District representation on the Board. 
The Commentor does not believe that the peer review system for 
disciplinary matters should be eliminated. The Commentor also argues 
that in light of the dramatic changes

[[Page 16947]]

being proposed, there should be time and opportunity for public comment 
and objects that there was less than a month over a holiday period to 
complete the ballot associated with Notice to Members 95-101.
    This Commentor urges that the proposed changes set forth in the two 
notices will result in inefficiency and ineffectiveness. It is argued 
that greater industry participation is needed on all levels and that 
there should be greater shared responsibility with the SEC.
    The Commentor states that the proposed changes are not adequately 
supported by the report of the Select Committee, pointing out that the 
200 interviews did not include industry persons in an industry with 
over 500,000 individual registered persons and over 5,400 member firms 
and that the report of the Select Committee states that the ``NASD has 
done its job exceedingly well.'' The Commentor argues that the 
significant changes proposed by the NASD should be accompanied by 
greater industry consensus and states the Commentor's belief that the 
proposal is intended only to ``appease'' the public perception.
    In response to the foregoing comments, the NASD believes that the 
NASD Select Committee on Structure and Governance did the most thorough 
analysis of this organization in the history of the NASD. The Select 
Committee concluded that the NASD has discharged its responsibilities 
``professionally and reasonably'' but not ``with perfection or without 
difficulty * * *''. In particular, the Select Committee determined that 
the NASD's governance structure had failed to keep pace with the 
significant growth and continuing evolution of the Nasdaq market, and 
the concomitant expansion of the NASD's regulatory responsibilities. 
The Select Committee concluded that the structure of the NASD would 
benefit from increasing public representation on the NASD's governing 
bodies. The Select Committee found, in this regard, that public 
governors on the NASD's Board constitute 21% of the Board in comparison 
to 50% public membership on the Boards of other self-regulatory 
organizations. The Select Committee pointed out that majority public 
representation was necessary to ensure adequate representation of the 
public interest as the NASD carries out its quasi-governmental 
functions; to maintain and enhance Nasdaq's competitive position; and 
to preserve public confidence in the NASD's oversight of the broker/
dealer profession.
    With respect to the Commentors' concerns regarding the potential 
elimination of self-regulation, the Select Committee stated that they 
believed that such greater public participation on the Boards of the 
NASD and its subsidiaries would not detract from self-regulation. The 
Select Committee believed that public confidence in the self-regulatory 
process would be enhanced by giving non-members a more significant role 
in the decision-making process and that the self-regulatory concept is 
not sacrificed by increasing public representation on the NASD's 
governing Boards. Finally, the Select Committee pointed that NASD 
members would still be fairly represented in the Association's affairs 
and have ample opportunity to bring their expertise and viewpoint to 
bear.\9\
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    \9\ See, Report of the NASD Select Committee on Structure and 
Governance to the NASD Board of Governors (``Report''), at C-12, C-
13, C-21.
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    With respect to the NASD's disciplinary process, which was focused 
on by Commentor No. 3, the Select Committee indicated that the core of 
the NASD's disciplinary process was sound, but emphasized that the 
disciplinary process had become more contentious, complex and 
consequential than the existing system was designed to accommodate. The 
Select Committee pointed out that the issues that the NASD addresses 
today increasingly turn on questions of law rather than industry 
standards and practice. Further, the NASD is now more likely to impose 
more severe penalties when infractions are found. These changes in the 
disciplinary environment lead to the greater likelihood that 
respondents in NASD disciplinary actions will more often retain counsel 
and NASD hearings have increasingly resembled a courtroom, rather than 
the traditional business forum for which the existing procedures were 
designed. As a result, the Select Committee recommended that the NASD 
adopt procedures and rules that would enhance the fairness and orderly 
conduct of the more complex and contentious disciplinary proceedings 
that now are prevalent.\10\
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    \10\ Report, at C-17, C-21, C-22.
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    The NASD believes that the proposed rule change to amend the NASD 
By-Laws will begin the restructuring necessary to implement the 
principles set forth in the report of the Select Committee and that 
such changes will benefit the membership by enhancing public confidence 
in the NASD's regulation of the securities industry.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    The NASD has requested that the Commission find good cause pursuant 
to Section 19(b)(2) for approving the proposed rule change prior to the 
30th day after publication in the Federal Register.

IV. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to the NASD and, in particular, the requirements 
of Section 15A and the rules and regulations thereunder. The Commission 
believes that the proposed rule change will allow the NASD to be able 
to carry out the purposes of the Act and to comply with, and enforce 
compliance by its members and associated persons, with the provisions 
of the Act, the rules and regulations thereunder, and the rules of the 
NASD. Furthermore, the amendments are designed (subject to further 
changes consistent with the NASD's Plan of Allocation and Delegation of 
Functions by NASD to Subsidiaries to be submitted to the NASD 
membership) to assure a fair representation of the NASD's members, in 
the selection of its directors and administration of its affairs as 
well as comply with the public and non-industry participant 
requirements of the Act. It is envisioned that these temporary rules 
and subsequent changes that may be implemented from time-to-time will 
enable the NASD to better comply with the requirements of Section 
15A(b)(6) in particular and the Act in general.
    The Commission finds good cause for temporarily approving the 
proposed rule change prior to the 30th day after the date of 
publication of notice of filing thereof in that the proposed rule 
change is intended to enhance the NASD's ability to carry out its 
regulatory obligations under the Act by restructuring the NASD's Board 
of Governors in conformance with the recommendations of The Select 
Committee on Structure and Governance in order to enable the NASD to 
meet its regulatory and business obligations. The proposed changes to 
the structure of the Board would also be in conformance the Plan of 
Allocation and Delegation of Functions By NASD to Subsidiaries, 
submitted in a separate rule filing to the SEC, that set forth the 
purpose, functions, governance, procedures, and responsibilities of the 
NASD, the

[[Page 16948]]

NASDR and Nasdaq following the reorganization of the NASD. Because the 
NASD's Board of Governors has been reorganized to be consistent with 
the proposed rule change and is to hold its first meeting on April 11, 
1996, accelerating approval of the proposed rule change on a temporary 
basis will benefit members and the public interest by permitting the 
NASD Board of Governors to conduct business at its first meeting.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. 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 Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to the file number in the caption 
above and should be submitted by May 9, 1996.
    It is Therefore Ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change be, and hereby is, approved and effective 
through July 10, 1996.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority. \11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-9511 Filed 4-17-96; 8:45 am]
BILLING CODE 8010-01-M