[Federal Register Volume 62, Number 188 (Monday, September 29, 1997)]
[Notices]
[Pages 50966-50970]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-25688]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39115; File No. SR-CBOE-96-75]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval of
Amendment Nos. 1, 2, and 3 to the Proposed Rule Change by the Chicago
Board Options Exchange, Incorporated Relating to the Listing and
Trading of Packaged Butterfly Spreads
September 22, 1997.
I. Introduction
On December 16, 1996, the Chicago Board Options Exchange, Inc.
(``CBOE''
[[Page 50967]]
or ``Exchange'') filed a proposed rule change with the Securities and
Exchange Commission (``SEC'' or ``Commission''), pursuant to Section
19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ and Rule
19b-4 thereunder,\2\ to list for trading Packaged Butterfly Spreads
based upon the S&P 100 and the S&P 500 Indexes.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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Notice of the proposal was published for comment and appeared in
the Federal Register on February 4, 1997.\3\ The Exchange filed with
the Commission Amendment Nos. 1,\4\ 2,\5\ and 3 \6\ to the proposal on
March 18, May 2, and June 5, 1997, respectively.
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\3\ See Securities Exchange Act Release No. 38213 (January 28,
1997), 62 FR 5265 (February 4, 1997).
\4\ In Amendment No. 1, the Exchange provided a new definition
for ``butterfly spread interval'' and several revisions to the
margin rules, as described more fully herein. See Letter from Tim
Thompson, Senior Attorney, CBOE, to John Ayanian, Special Counsel,
Office of Market Supervision (``OMS''), Division of Market
Regulation (``Market Regulation''), Commission, dated March 18, 1997
(``Amendment No. 1'').
\5\ In Amendment No. 2, the Exchange amended its margin rules as
they apply to spread positions where the long index option contract
is a Packaged Butterfly Spread. Amendment No. 2, also verified that
CBOE will list and add series for Packaged Butterfly Spreads in
accordance with Rule 24.9, Interpretation and Policy .01(c).
Finally, in Amendment No. 2, the Exchange indicated that position
limits for Packaged Butterfly Spreads based on the S&P 500 and 100
will be the same as existing position limits for the respective
index options and will be aggregated with other option contracts on
the same index. See Letter from William M. Speth, Sr. Research
Analyst, Product Development, Research Department, CBOE, to Howard
L. Kramer, Senior Associate Director, OMS, Market Regulation,
Commission, dated May 2, 1997 (``Amendment No. 2'').
\6\ In Amendment No. 3, the Exchange made several technical,
non-substantive changes to the proposal. In addition, the Exchange
made changes to the margin rules. In particular, the Exchange
amended its margin rules (and modified Amendment No. 2), to indicate
that margin treatment for spread positions set forth in Rule
24.11(c)(1)(B) do not apply for spread positions where one or both
positions comprising the spread are Packaged Butterfly Spreads. As
proposed in new Rule 24.11(c)(1)(D), if a spread position involves a
Packaged Butterfly Spread, as either the long options position or
the short options position, the minimum margin required on such a
position will be the full purchase price on the long position plus
the margin required in Rule 24.11(b) for the short position. The
Exchange also clarified its policy for changing butterfly spread
intervals, as described more fully herein. See Letter from Eileen
Smith, Director, Product Development, Research Department, CBOE, to
John Ayanian, Special Counsel, OMS, Market Regulation, Commission,
dated June 4, 1997 (``Amendment No. 3'').
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No comment letters were received on the proposed rule change. This
order orders the Exchange's proposal, as amended.
II. Description of the Proposal
The Exchange proposes to list for trading Packaged Butterfly
Spreads based upon the S&P 100 index and the S&P 500 index. A Packaged
Butterfly Spread is a packaged European-style option that replicates
the behavior and payout of a butterfly spread \7\ composed of standard
index option contracts. The Exchange proposes that the Packaged
Butterfly Spreads on the S&P 100 and 500 indexes will have a multiplier
of 100. Because Packaged Butterfly Spreads composed of puts are
identical to those composed of calls the Exchange will not list both
puts and calls; there will be only one call option listed for each
strike price and butterfly interval.
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\7\ A butterfly spread is a combination of four option positions
of the same type (put or call) and the same expiration on thee same
underlying interest using three different strike prices. For
example, using only calls, a butterfly spread would consist of
buying one call at the lowest strike price, selling two calls at the
middle strike price and buying one call at the highest strike price.
A butterfly spread with a butterfly spread interval of 30 might
consist of one long December (expiration month) 670 (strike price)
call option, two short December 700 call options, and one long
December 730 call option.
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The Exchange believes Packaged Butterfly Spreads on the Indexes
will provide advantages to the investing public that are not provided
for by standard index options. First, the Exchange believes Packaged
Butterfly spreads offer investors a relatively low risk security which
results because Packaged Butterfly Spreads, by their nature, have a
maximum gain and loss that can be realized regardless of the movement
in the index level. Packaged Butterfly Spreads allow investors to
profit from trendless markets with limited risk. Second, the
``packaging'' of a strategy of four option positions into one option
product reduces transaction-related expenses because the investor will
only have to enter into one transaction. Third, in the case of Packaged
Butterfly Spreads overlying the S&P 100, the investor will have the
opportunity to invest in an option product that has European-style
exercise.\8\ Standard S&P 100 options (``OEX'') have American-style
exercise.\9\ The Exchange expects Packaged Butterfly Spreads to be
supported enthusiastically by market-makers because butterfly spread
trading is a familiar strategy to professional traders and the Packaged
Butterfly Spreads can be easily incorporated into the overall risk
profile of the market-maker's trading strategy in standard index
options.
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\8\ Only European-style Packaged Butterfly Spreads will be
available to investors. A European-style option is one that may be
exercised only during a limited period of time prior to expiration.
\9\ An American-style option is one that may be exercised at any
time prior to expiration.
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The Exchange proposes to amend Rule 24.1 to describe the new
product \10\ as well as the term ``butterfly spread interval''.\11\
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\10\ See Amendment No. 3, supra note 6.
\11\ Specifically, the ``butterfly spread interval'' means a
value specified by the Exchange which, when added to the exercise
price and subtracted from the exercise price defines a range of
index values over which the option has an exercise settlement amount
greater than $0. See Amendment No. 1, supra note 4.
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Position and Exercise Limits
The Exchange is proposing position limits for Packaged Butterfly
Spreads overlying the S&P 100 of 25,000 contracts. The Exchange is
proposing position limits for Packaged Butterfly Spreads overlying the
S&P 500 of 100,000 contracts. For position limit purposes, Packaged
Butterfly Spreads will be aggregated with option contracts on the same
index. These position limits are consistent with the position limits
that have been established for standard index options on the S&P 100
and 500 indexes, respectively. The exercise limits for Packaged
Butterfly Spreads will be equal to the position limits set forth above
in accordance with the terms of CBOE Rule 24.5.
Margin
With respect to margin, risk exposure is limited in Packaged
Butterfly Spreads, and therefore, the maximum margin requirements
should not exceed the maximum exposure amount which, for each Packaged
Butterfly Spread option contract equals the butterfly spread interval
times the index multiplier. The proposed amendments state that the
maximum margin required for a Packaged Butterfly Spread option contract
carried in a short position shall not exceed this maximum exposure
amount. In addition, margin requirements for spread positions set forth
in Rule 24.11(c)(1)(B) does not apply for spread positions where one or
both positions comprising the spread are Packaged Butterfly Spreads. If
a spread position involves a Packaged Butterfly Spread, as either the
long position or the short position, the minimum margin required on
such a position will be the full purchase price on the long position
plus the margin required in Rule 24.11(b) for the short position.\12\
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\12\ See Rule 24.11(c)(a)(D) and Amendment No. 3, supra note 6.
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Listing of Series. The Exchange expects to list contracts having
butterfly spread intervals of ranging from 10 to 50 points. The
Exchange does not intend to simultaneously open series with more than
one butterfly spread interval. However, the CBOE may introduce a
[[Page 50968]]
new series with a new butterfly spread interval with a new ticker
symbol resulting in a brief period (1 or 2 months) of open series with
two butterfly spread intervals. Initially, the Exchange intends to list
an at-the-money and various strikes around the at-the-money in the
first two near-term months in accordance with Rule 24.9, Interpretation
and Policy .01(c).\13\ New strikes will be added when the underlying
trades through the highest or lowest strike available.
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\13\ See Amendment No. 2, supra note 5.
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Settlement
The expiration date for Packaged Butterfly Spreads will be the
Saturday immediately following the third Friday of the expiration
month. Exercise will result in the delivery of cash on the business day
following expiration. The exercise settlement amount is equal to the
greater of: (1) Butterfly spread interval minus the difference between
the index settlement value and the midpoint of the butterfly multiplied
by the multiplier ($100), and (2) $0. Packaged Butterfly Spreads will
have a European-style of exercise.
Miscellaneous
CBOE will use the same surveillance methods it currently employs
with respect to their broad-based index options.
CBOE has also been informed that the Options Price Reporting
Authority recently added another outgoing high speed line from OPRA
processor and thus, has the capacity to support the new series
associated with the listing of Packaged Butterfly Spreads.\14\
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\14\ See Memorandum from Joe Corrigan, OPRA, to Eileen Smith,
CBOE, dated November 21, 1996.
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III. Commission Finding 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) of the Act.\15\
Moreover, the Exchange's proposal to list and trade Package Butterfly
Spreads on the S&P 100 and S&P 500 indexes strikes a reasonable balance
between the Commission's mandates under Section 6(b)(5) to remove
impediments to and perfect the mechanism of a free and open market and
a national market system while protecting investors and the public
interest.\16\ Specifically, the Commission finds that the Packaged
Butterfly Spreads are an innovative financial product that will provide
investors with additional choices and flexibility in their use of
derivatives.\17\ In addition, Packaged Butterfly Spreads offer both
holders and writers of options a means to participate in the options
markets at a predetermined maximum gain or loss. Under the terms of
Packaged Butterfly Spreads, the option writer's (holder's) maximum loss
(gain) is established at the time of the investment by the option's
butterfly spread interval. Accordingly, Packaged Butterfly Spreads
permit investors to participate in the options market at a known cost.
In addition, the Commission believes that Packaged Butterfly Spreads,
which replicate the combination of four separate option positions on
the same underlying interest and expiration, likely will benefit
investors by providing them with a more efficient and cost effective
method of executing spread transactions.
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\15\ 15 U.S.C. 78f(b)(5).
\16\ In approving this rule, the Commission notes that it has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
\17\ Pursuant to Section 6(b)(5) of the Act, the Commission must
predicate approval of any new option proposal upon a finding that
the introduction of such new derivative instrument that served no
hedging or other economic function, because any benefits that might
be derived by market participants likely would be outweighed by the
potential for manipulation, diminished public confidence in the
integrity of the markets, and other valid regulatory concerns. In
this regard, the trading of Packaged Butterfly Spreads on the S&P
500 and 100 will provide investors with another hedging vehicle that
should reflect the overall movement of the U.S.-listed stock market.
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The Commission also finds that the specific rules proposed by the
CBOE to accommodate Packaged Butterfly Spreads are consistent with the
Act.\18\ Specifically, the Commission believes that it is reasonable
for the Exchange to set a butterfly spread interval range from 10 to 50
points. In response to the Commission's concerns about investor
confusion by having series of Packaged Butterfly Spreads simultaneously
open with different butterfly spread intervals, the Exchange does not
intend to simultaneously open series with more than one butterfly
spread interval. However, the CBOE may introduce a new series with a
new butterfly spread interval with a new ticker symbol resulting in a
brief period (1 or 2 months) of open series with two butterfly spread
intervals.\19\ The Commission notes that the Exchange may submit a
``noncontroversial filing'' pursuant to Section 19(b)(3)(A) of the Act
and Rule 19b-4(e)(6) thereunder if it decided to change the present
butterfly spread range (currently 10 to 50 points) and the proposal
does not raise any other regulatory issues.
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\18\ The Commission notes that CBOE Rule 24.1, as amended,
defines Packaged Butterfly Spreads. Because the current Exchange
proposed definition is limited to Packaged Butterfly Spreads on the
S&P 500 and 100 Indexes, the Exchange is required to submit a rule
filing pursuant to Section 19(b) of the Act in order to list
Packaged Butterfly Spreads on another stock index or individual
security.
\19\ The Exchange represents that it would not allow margin
offset, pursuant to Rule 24.11(c), between spread with different
spreads intervals. See Amendment No. 3, supra note 6.
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The Commission also notes that Packaged Butterfly Spreads on the
S&P 500 and S&P 100 indexes will be subject to the same position and
exercise limit requirements that currently apply to S&P 500 and S&P 100
index options, respectively. In particular, Packaged Butterfly Spreads
on the S&P 500 will be aggregated with all other S&P 500 index options,
subject to a 100,000 contract limit under Rule 24.4(b). Packaged
Butterfly Spreads on the S&P 100 index will be aggregated with all
other S&P 100 index options, subject to a 25,000 contract limit under
Rule 24.4(b).
The Commission believes that the proposed margin treatment for
Packaged Butterfly Spreads in cash and margin accounts is consistent
wit the Act. Specifically, the Commission believes that, similar to
short capped options positions,\20\ it is reasonable to permit short
Packaged Butterfly Spreads positions in a cash account so long as the
maximum exposure (the butterfly spreads interval) is deposited. This
position is the equivalent of a completely covered position, because
the maximum risk of loss is already on deposit. In addition, the
Commission believes that the proposed margin requirements for Packaged
Butterfly Spreads in margin accounts is reasonable because they are
virtually identical to the margin requirements for traditional short
stock index options positions held in margin accounts, except that a
limit equal to the maximum exposure to the option writer is placed on
the margin requirement. It is reasonable to limit the margin in this
way because the margin would cover 100% of the writer's exposure,
thereby requiring no additional margin calls.
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\20\ See Securities Exchange Act Release No. 29865 (October 28,
1991), 56 FR 56255 (November 1, 1991).
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The Commission also believes it is reasonable to require for any
spread position involving a Packaged Butterfly Spread a minimum margin
deposit equal to the full purchase price on the long position plus the
margin required in Rule 24.11(b) for the short position.\21\
Accordingly, the Commission believes it is reasonable under such
circumstances to prohibit application of margin
[[Page 50969]]
requirements for spread positions involving a Packaged Butterfly Spread
because the required margin deposit would not always cover 100% of the
writer's exposure. For example, a spread involving a long 670 S&P 500
index call option and a short 650 Packaged Butterfly Spread on the S&P
500, with a butterfly spread interval of 50, the margin deposit
requirement under the margin rule for spread transactions would be the
lesser of (1) The difference in aggregate exercises prices
((670-650) x 100=$2,000) and (2) the butterfly spread interval times
the multiplier (i.e., 50 x 100=$5,000). The margin deposit requirement
under the spread rule, if allowed, would be $2,000. The writer's
maximum exposure (when the current index level is 650), however, is
$3,000.\22\ For this spread position, the margin requirement under
proposed CBOE Rule 24.11(c)(1)(D) will be the full purchase price of
the long position (premium x $100) plus the butterfly spread interval
times the index multiplier (50 x $100) of the short position.
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\21\ See supra note 12.
\22\ The writer's maximum exposure of this spread position is
determined as follows:
short loss-long gain=maximum exposure
$5,000-(670-650) x 100
$5,000-(20) x 100
$500-$2,000=($3,000)
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In summary, the Commission believes that the Packaged Butterfly
Spreads on the S&P 500 and S&P 100 Indexes will provide investors with
additional choices and flexibility in their use of derivatives and
offer both holders and writers of options a means to participate in the
options markets at a predetermined maximum gain or loss. Further, the
Commission notes that in order to promote investor protection and to
ensure adequate disclosure in connection with Packaged Butterfly
Spreads, the rules pertaining to standardized options and the
requirements of Exchange Act Rule 9b-1 will apply to trading in
Packaged Butterfly Spreads. The Commission believes it is important to
provide investors with information regarding the rights and
characteristics of Packaged Butterfly Spreads. In this regard, Packaged
Butterfly Spread investors will receive a special supplement to the
Options Clearing Corporation's (``OCC'') Options Disclosure Document
(``ODD Supplement'') explaining in detail the risks and characteristics
of Packaged Spreads.\23\
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\23\ In reviewing any disclosure materials submitted, the
Commission intends to assure that the materials specifically
describe the risks and characteristics associated with trading
Packaged Spreads. Trading trading of Packaged Butterfly Spreads is
Packaged Spreads. The trading of Packaged Butterfly Spreads is
expressly contingent upon the Commission's approval of such an ODD
supplement.
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The Commission finds good cause for approving Amendment Nos. 1, 2,
and 3 prior to the thirtieth day after the date of publication of
notice of filing thereof in the Federal Register. Specifically,
Amendment No. 1 to CBOE's proposal set forth a new definition for
``butterfly spread interval'' and several technical revisions to the
margin rules, as described above.
Amendment No. 2 to CBOE's proposal: (1) Verifies that CBOE will
list and add series for Packaged Butterfly Spreads in accordance with
Rule 24.9, Interpretation and Policy .01(c); and (2) sets position
limits for Packaged Butterfly Spreads based on the S&P 500 and 100 to
equal existing position limits for the respective index options.\24\
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\24\ As described above, Packaged Butterfly Spreads on the S&P
500 and 100 indexes will be aggregated with other options on the
same index.
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The first change described above is clarifying in nature and will
prevent undue proliferation of options series on Packaged Butterfly
Spreads. The Commission believes the Exchange's proposed reduction in
position limits from those originally proposed presents no new
regulatory issues and can be approved on an accelerated basis. Further,
the originally proposed higher position limits were subject to the full
21-day comment period without any comments being received by the
Commission.
Amentment No. 3 to CBOE's proposal also makes several technical
non-substantive changes. In addition, the Exchange amended the
definition of Packaged Butterfly Spread to further clarify that the
product is intended to replicate the behavior of the combination of
four separate options, as described above. Finally, Amendment No. 3
provides that margin requirements for spread positions set forth in
Rule 24.11(c)(1)(B) do not apply for spread positions where one or both
positions comprising the spread are Packaged Butterfly Spreads. \25\
The Commission believes that the proposed changes to the margin
requirements present no new regulatory issues and further strengthens
the Exchange's proposal by ensuring that adequate margin will be
deposited by those with positions involving Packaged Butterfly Spreads.
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\25\ Accordingly, this proposed amendment eliminates the
provision in Amendment No. 2 which would have allowed spread
positions involving long Packaged Butterfly Spread positions to
receive margin treatment under the spread rule. See Amendment No. 3,
supra note 6.
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The Commission believes that the changes proposed in Amendment Nos.
1, 2, and 3, unless otherwise stated above, merely clarify in the rule
text what was originally proposed by the Exchange and will help to
ensure that investors understand the specifications and trading
characteristics of the Packaged Butterfly Spread contracts. In
addition, the Commission notes that the original proposal was published
for the full 21-day comment period without any comments being received
by the Commission. Moreover, the Commission believes that the foregoing
amendments raise no new regulatory issues.
Accordingly, the Commission finds good cause, consistent with
Sections 6(b)(5) and 19(b)(2) of the Act, to approve Amendment Nos. 1,
2, and 3 to the proposed rule change, on an accelerated basis.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment Nos. 1, 2, and 3 to the proposed rule
change. Persons making written submissions should file six copies
thereof with the Secretary, Securities and Exchange Commission, 450
Fifth Street, N.W., Washington, D.C. 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. Sec. 552, will
be available for inspection and copying at the Commission's Public
Reference Section, 450 Fifth Street, N.W., Washington, D.C. 20549.
Copies of such filing will also be available for inspection and copying
at the principal office of the CBOE. All submissions should refer to
SR-CBOE-96-75 and should be submitted by October 20, 1997.
V. Conclusion
Based upon the aforementioned factors, the Commission finds that
the proposed changes relating to the listing and trading of Packaged
Butterfly Spreads on the S&P 500 and 100 are consistent with the
requirements of Section 6(b)(5) and the rules and regulations
thereunder. The initiation of Packaged Butterfly Spread trading,
however, is conditioned upon the issuance of an order approving an ODD
Supplement, pursuant to Rule 9b-1 of the Act.
[[Page 50970]]
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\26\ that the proposed rule change (File No. SR-CBOE-96-75), is
amended, is approved.
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\26\ 15 U.S.C. 78s(b)(2).
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).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-25688 Filed 9-26-97; 8:45 am]
BILLING CODE 8010-01-M