[Federal Register Volume 63, Number 18 (Wednesday, January 28, 1998)]
[Notices]
[Pages 4333-4336]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-1975]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39550; File No. SR-NASD-96-51]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Approving Proposed Rule Change and Notice of 
Filing and Order Granting Accelerated Approval to Amendment Nos. 2, 3, 
and 4 to the Proposed Rule Change Relating to NASD Rule 11890 Regarding 
Clearly Erroneous Transactions

January 14, 1998.
    On December 17, 1996, the National Association of Securities 
Dealers, Inc. (``NASD'' or ``Association'') filed with the Securities 
and Exchange Commission (``SEC'' or ``Commission'') a proposed rule 
change pursuant to Section 19(b)(1) of the Securities Exchange Act of 
1934 (``Exchange Act'') \1\ and Rule 19b-4 thereunder.\2\ On January 
17, 1997, the NASD filed Amendment No. 1 to the proposed rule 
change.\3\ Notice of the proposed rule change and Amendment No. 1 
thereto, including the substance of the proposal, were published for 
comment in the Federal Register.\4\ No comments were received. On March 
11, 1997, August 13, 1997, and January 5, 1998, the NASD, through its 
wholly owned subsidiary, The Nasdaq Stock Market, Inc. (``Nasdaq''), 
submitted to the Commission Amendment Nos. 2,\5\ 3,\6\ and 4 \7\ 
respectively, to the proposed rule change. The Commission is hereby 
approving the proposed rule change, including Amendment 1 to the 
proposal. In addition, the Commission is publishing this notice to 
solicit

[[Page 4334]]

comments from interested persons on Amendment Nos. 2, 3, and 4 to the 
proposed rule change and is approving those amendments on an 
accelerated basis.
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    \1\ 15 U.S.C. Sec. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Robert E. Aber, Vice President and General 
Counsel, Nasdaq, to Katherine A. England, Assistant Director, 
Division of Market Regulation, SEC, dated January 17, 1997 
(``Amendment No. 1''). Amendment No. 1 corrected typographical 
errors in the text of the proposed rule change.
    \4\ Securities Exchange Act Release No. 38196 (Jan. 22, 1997) 62 
FR 4368 (Jan. 29, 1997) (``Notice'').
    \5\ See Letter from Robert E. Aber, Vice President and General 
Counsel, Nasdaq, to Ivette Lopez, Assistant Director, Division of 
Market Regulation, SEC, dated March 11, 1997 (``Amendment No. 2''). 
In Amendment No. 2, the NASD: (1) Provides the names of Nasdaq 
officers who have authority to declare transactions clearly 
erroneous (see footnote 12, below); (2) replaces the term 
``Association'' with ``Nasdaq'' in section (b)(4) of NASD Rule 
11890; (3) clarifies that the Market Operations Review Committee's 
(``MORC's'') decision constitutes the final action of the NASD; (4) 
clarifies that the officers with the authority to declare on their 
own motion transactions clearly erroneous because of a system 
malfunction are the same persons who are authorized to take action 
when a member makes a complaint; (5) clarifies the length of time 
for Nasdaq to act on an allegedly clearly erroneous transaction; and 
(6) explains that as soon as Nasdaq obtains a written appeal from a 
party, Nasdaq would notify the other party to the transaction.
    \6\ See Letter from Robert E. Aber, Vice President and General 
Counsel, Nasdaq, to Ivette Lopez, Assistant Director, Division of 
Market Regulation, SEC, dated August 13, 1997 (``Amendment No. 3''). 
In Amendment No. 3, Nasdaq adds to NASD Rule 11890(d)(1) a provision 
that if Nasdaq notifies the parties of action taken pursuant to 
paragraph (c) of that rule after 4:00 p.m., either party has until 
9:30 a.m. the next trading day to appeal.
    \7\ See Letter from Robert E. Aber, Vice President and General 
Counsel, Nasdaq, to Katherine A. England, Assistant Director, 
Division of Market Regulation, SEC, dated January 5, 1998 
(``Amendment No. 4''). In Amendment No. 4 Nasdaq corrected a 
drafting error to proposed NASD Rule 11890(d)(1) to clarify that an 
``appeal to the Committee [i.e., the MORC] shall not operate as a 
stay of the determination made pursuant to paragraphs (a)(2) or 
(c)'' of proposed NASD Rule 11890.
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I. Description of Rule Changes

A. Background

    In April 1990, the SEC approved an NASD proposal to add Section 70 
to the Uniform Practice Code (now NASD Rule 11890) to permit the NASD 
to declare clearly erroneous transactions null and void if they arise 
out of the use or operation of any automated quotation, execution, or 
communication system owned or operated by the NASD. Previously, the 
NASD had no authority to cancel a transaction, even if one or more 
terms of the transaction clearly was in error. As described in Nasdaq's 
filing, one of the catalysts for adopting Rule 11890 was a member's 
complaint concerning a transaction executed over SelectNet. The 
transaction was ten points away from the inside quotation, which the 
member argued was clearly an error, but the contra party refused to 
cancel the transaction. NASD Rule 11890 gives Nasdaq the ability to 
resolve disputes involving obvious errors in an expeditious manner, 
akin to an exchange floor governor ruling.\8\
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    \8\ See, e.g., New York Stock Exchange Rule 75.
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B. Current Procedures

    NASD Rule 11890 governs the review and resolution of clearly 
erroneous transaction complaints. Currently, the rule permits the NASD 
to declare any transaction arising out of the use or operation of any 
automated quotation, execution, or communication system owned or 
operated by the NASD or any subsidiary thereof, null and void when 
there is an obvious error in any term, such as price, number of shares 
or other unit of trading, or identification of the security. The rule 
also sets forth procedures for declaring a transaction null and void.
    Under NASD Rule 11890(b)(1), a member or person associated with a 
member seeking to have a transaction declared null and void must notify 
an officer of the NASD designated by the President of the transaction 
during Nasdaq's operating hours on the same business day the 
transaction occurs, and provide such official with all facts and 
information necessary for a determination. The rule requires the 
complainant to confirm in writing any information communicated orally. 
Each member and/or person associated with a member involved in the 
transaction must provide the NASD with any information requested to 
resolve the matter on a timely basis.
    Under NASD Rule 11890(b)(2), the designated officer must then 
review the information submitted and determine whether the transaction 
is clearly erroneous and detrimental to the maintenance of a fair and 
orderly market and the protection of investors and the public interest. 
The official may decline to act on a disputed transaction if he or she 
believes that action is unnecessary or inappropriate. Under NASD Rule 
11890(b)(3), if either party wishes to appeal the staff determination, 
it may seek review by the Market Operations Review Committee 
(``MORC'').
    While the current procedures have served as a vehicle to cancel 
erroneous transactions, experience has shown that NASD Rule 11890 can 
be improved to enhance the fairness and expediency with which clearly 
erroneous transaction complaints are resolved. Experience with the Rule 
also has revealed shortcomings in the scope of Nasdaq's authority to 
take action with respect to clearly erroneous transactions. In 
particular, there have been instances in the past where it would have 
been appropriate for NASDAQ to declare a series of transactions clearly 
erroneous even through the parties to the transactions were unaware of 
any error and therefore were not in a position to bring the error to 
Nasdaq's attention. The proposed changes to NASD Rule 11890 are 
intended to eliminate these shortcomings and to provide Nasdaq with 
additional capabilities to resolve clearly erroneous transactions.

C. Proposed Amendments

    The proposed amendments provide greater specificity and flexibility 
regarding declarations of clearly erroneous transactions. As explained 
in more detail below, the proposed amendments would:
    (1) Provide Nasdaq officials the authority to effciently and 
expeditiously nullify or modify the price and size of clearly erroneous 
transactions (currently, Nasdaq officials may only nullify, affirm, or 
decline to act with respect to an allegedly clearly erroneous 
transaction) (NASD Rule 11890(a)(2));
    (2) Shorten the time period in which parties may submit clearly 
erroneous transaction complaints from any time the same day to within 
30 minutes of the disputed transaction (NASD Rule 11890(b)(1));
    (3) Clarify the procedures by which the parties to an allegedly 
clearly erroneous transaction may submit written information concerning 
the transaction (NASD Rule 11890(b)(2)-(4));
    (4) Provide Nasdaq officials the requisite authority to cancel or 
modify clearly erroneous transactions on their own motion during system 
disruptions or malfunctions in the use or operation of any automated 
quotation, execution, or communication system owned or operated by 
Nasdaq and approved by the Commission (NASD Rule 11890(c));
    (5) Prohibit a member from withdrawing a clearly erroneous 
transaction complaint unless the other party to the transaction agrees 
to withdraw the matter (NASD Rule 11890(b)(5));
    (6) Shorten the time period to appeal a clearly erroneous 
transaction determination from four ``market'' hours to 30 minutes 
(NASD Rule 11890(d)(1)); and
    (7) Clarify that an appeal of a clearly erroneous transaction 
determination does not operate as a stay of the determination (NASD 
Rule 11890(d)(1)).
    Under the proposed rule change, a complainant seeking to have a 
transaction reviewed must submit a written complaint to Nasdaq Market 
Operations: (1) By 10:30 a.m., Eastern Time, for transactions occurring 
prior to 10:00 a.m.; or (2) within 30 minutes of the transaction for 
transactions occurring on or after 10:00 a.m.\9\ Once a complaint is 
received, the complainant has up to 30 minutes, or such longer period 
as specified by Nasdaq staff, to submit any supporting written 
information concerning the complaint necessary for a determination. 
\10\ The counterparty to the transaction would be verbally notified of 
the complaint by Nasdaq staff and would have up to 30 minutes, or such 
longer period as specified by Nasdaq staff, to submit any supporting 
written information concerning the complaint necessary for a 
determination. Either party to a disputed transaction may request the 
written information provided by the other party. Once a party to a 
disputed transaction communicates that it does not intend to submit any 
further information concerning a complaint, the party may not 
thereafter provide additional information unless requested to do so by 
Nasdaq staff.\11\ If both parties to a disputed transaction indicate 
that they have no further information to provide concerning the 
complaint before their respective 30-minute periods have elapsed, the 
matter would

[[Page 4335]]

be immediately presented by a Nasdaq officer for a determination.
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    \9\ Proposed NASD Rule 11890(b)(1).
    \10\ Proposed NASD Rule 11890(b)(2).
    \11\ Proposed NASD Rule 11890(b)(3).
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    Under the proposed rule change, the President of Nasdaq would 
designate officers of Nasdaq who would have the authority to review any 
transaction arising out of the use or operation of any automated 
quotation, execution, or communication system owned or operated by 
Nasdaq and approved by the Commission.\12\ A Nasdaq officer would 
review the transactions with a view toward maintaining a fair and 
orderly market and protecting investors and the public interest. Based 
upon this review, the officer would (1) Decline to act on a disputed 
transaction if the officer believes the transaction under dispute is 
not clearly erroneous, or (2) declare the transaction null and void or 
modify one or more terms of the transaction if the officer determines 
that the transaction is clearly erroneous.
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    \12\ Proposed NASD Rule 11890(a)(2). According to the NASD, 
officers of Nasdaq are designated by the President of Nasdaq based 
on the breadth and depth of their experience regarding Nasdaq's 
rules and market procedures. Alfred Berkeley, Nasdaq's President, 
has designated, in addition to himself, the following senior 
officers of Nasdaq as having the authority to act under Rule 
11890(a)(2) and 11890(c): John T. Wall, Executive Vice President; 
John Hickey, Executive Vice President; Glen Shipway, Senior Vice 
President; Sherman W. Broka, Senior Vice President; Mark DeNat, Vice 
President; Donald Bosic, Vice President; Beth Weimer, Vice 
President; William Wlcek, Vice President; Richard Gonzales, Vice 
President; Richard Bayha, Vice President; and Robert E. Aber, Vice 
President and General Counsel. According to the NASD, these officers 
are the only officers that are authorized to declare a transaction 
clearly erroneous. A list of these designated officers would be 
maintained by Nasdaq Market Operations and the NASD's Corporate 
Secretary. See Amendment No. 2.
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    With respect to the modification of transactions, the Nasdaq 
officer may adjust any of the terms of a disputed transaction (e.g., 
price, number of shares or other unit of trading, or identification of 
the security) to achieve an equitable rectification of the error that 
would place the parties to the transaction in the same position or as 
close as possible to the same position as they would have been in had 
the error not occurred. After making a determination with respect to a 
particular transaction or group of transactions, Nasdaq would promptly 
provide oral notification of that determination to the parties and 
thereafter issue a written confirmation of the determination.\13\ Under 
the proposal, once a party has applied to Nasdaq for review, the 
transaction would be reviewed and a determination rendered, unless both 
parties to the transaction agree to withdraw the application for review 
prior to a decision being rendered.\14\
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    \13\ The NASD has represented to the Commission that Nasdaq 
officers will render a decision based upon the record as soon as 
possible under the circumstances. According to the NASD, currently, 
in almost all cases, the officer makes a decision on the same day 
the transaction occurred. The NASD indicated that a matter is not 
handled on the transaction date only where the complaint was filed 
late in the day (i.e., after 5:00 p.m.) and the necessary 
information cannot be obtained the same day. The NASD explained 
that, generally, a decision is made within an hour of the final 
submission from a party except where a particular transaction 
involves complexities that require the staff to take additional time 
to verify facts provided by the parties. See Amendment No. 2.
    \14\ Proposed NASD Rule 11890(b)(5).
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    The proposed rule change also would provide Nasdaq with the 
authority and procedures to review transactions executed during system 
disruptions or malfunctions in the use or operation of any automated 
quotation, execution or communication system owned or operated by 
Nasdaq and approved by the Commission.\15\ In such an event, Nasdaq, 
acting through an officer designated by the President of Nasdaq, may, 
on its own motion, declare the transactions null and void or modify the 
terms of the transactions.\16\ The proposed rule provides that in the 
absence of extraordinary circumstances, a Nasdaq officer must take 
action within 30 minutes of detection of the clearly erroneous 
transactions, but by no later than 6:00 p.m., Eastern Time, on the next 
trading day following the date of the transactions at issue. When 
Nasdaq takes action under these circumstances, the member firms 
involved in the transactions would be notified as soon as practicable 
and have a right to appeal such action.
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    \15\ Proposed NASD Rule 11890(c).
    \16\ The officials who have the authority to review transactions 
on their own motion would be the same officials who have the 
authority to review transactions submitted by a member's complaint. 
See Amendment No. 2 and note 12, above.
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    Finally, the NASD proposal changes the process by which a Nasdaq 
officer's determination is appealed. Under the proposal, a member or 
person associated with a member may appeal a determination to the MORC, 
provided that such an appeal is made in writing within 30 minutes after 
the member or person associated with a member receives verbal 
notification of such determination.\17\ An exception exists for 
circumstances where Nasdaq notifies the parties of action taken 
pursuant to paragraph (c) (i.e., in cases of system disruptions or 
malfunctions) after 4:00 p.m. Under these circumstances, either party 
has until 9:30 a.m. the next trading day to appeal after the member or 
person associated with a member receives verbal notification of such 
determination. Once a written appeal has been received, the 
counterparty to the transaction would be notified of the appeal \18\ 
and both parties would be permitted to submit any additional supporting 
written information until the time the appeal is considered by the 
MORC. Either party to a disputed transaction may request the written 
information provided by the other party during the appeal process. An 
appeal to the MORC would not operate as a stay of the determination. 
Once a party has appealed a determination to the MORC, the 
determination would be reviewed and a decision rendered. Upon 
consideration of the record and after such hearings as it may in its 
discretion order, the MORC would affirm, modify, reverse, or remand the 
determination of the designated Nasdaq officer. Under the proposal, any 
adverse determination by a Nasdaq officer or any adverse decision by 
the MORC would be rendered without prejudice as to the rights of the 
parties to the transaction to submit their dispute to arbitration.\19\
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    \17\ Proposed NASD Rule 11890(d).
    \18\ As soon as Nasdaq obtains a written appeal from a party, 
Nasdaq would notify the other party to the transaction of the 
appeal. See Amendment No. 2, and note 5, above.
    \19\ See Proposed NASD Rule 11890(d)(2). In Amendment No. 4, 
Nasdaq clarified the ability of parties to seek arbitration: With 
respect to the ability of a party to submit a dispute to arbitration 
without prejudice notwithstanding an adverse decision by a Nasdaq 
officer or the Committee [i.e., the MORC], as set forth in paragraph 
(d)(2) [of proposed NASD Rule 11890], it should be made clear that 
this rule does not prevent such party from seeking arbitration 
either before any such decision is rendered, or in the absence of a 
determination altogether.
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II. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 2, 3, and 4. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, N.W., 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 at the Commission's Public Reference Section, 450 Fifth Street, 
N.W., Washington, DC 20549. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to File No. SR-NASD-96-51 and should 
be submitted by February 18, 1998.

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III. Discussion

    The Commission finds the proposed rule change, by helping to ensure 
that clearly erroneous transactions are quickly corrected or nullified 
and properly reported to the public, is consistent with the Exchange 
Act and in particular with Sections 15A(b)(6) and 11A(a)(1)(C) of the 
Exchange Act. Among other things, Section 15A(b)(6) requires that the 
rules of a national securities association be designed to remove 
impediments to and perfect the mechanism of a free and open market and 
a national market system and in general to protect investors and the 
public interest. Section 15A(b)(6) also provides that the rules of the 
association not be designed to permit unfair discrimination between 
customers, issuers, brokers, or dealers. Section 11A(a)(1)(C) provides 
that, among other things, it is in the public interest to assure the 
availability to brokers, dealers, and investors of information with 
respect to quotations for and transactions in securities.
    In the proposed rule change, the NASD provides greater specificity 
in the procedures for resolving clearly erroneous transactions and 
greater flexibility to Nasdaq officials to remedy such errors 
expeditiously. The Commission believes that the amendments to the 
NASD's procedures to review these transactions should benefit market 
participants by promoting fair and efficient resolution of disputes 
involving clearly erroneous transactions. In addition, the proposed 
rule change--in particular the provision for appeal to the MORC--
addresses concerns raised by the Commission in its August 8, 1996, 
Report Pursuant to Section 21(a) of the Securities Exchange Act of 1934 
Regarding the NASD and The Nasdaq Stock Market regarding the fairness 
of the clearly erroneous review process. The NASD believes, and the 
Commission agrees, that with these amendments the process for resolving 
clearly erroneous transaction complaints would become fairer and more 
efficient. In this regard, the proposal is consistent with Exchange Act 
Section 15A(b)(6) because it helps to ensure that NASD Rule 11890 does 
not permit unfair discrimination between customers, issuers, brokers, 
or dealers.
    Further, it is important for the proper functioning of the 
securities markets that investors be able to rely on reported 
transactions as accurately reflecting the current state of the market 
and actual executions. When clearly erroneous transactions are publicly 
reported, it is important that, whenever possible,\20\ Nasdaq correct 
these clear errors and correct the inaccurate information that was 
disseminated in the market about these transactions as quickly as 
possible.
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    \20\ Regarding the transparency of voided or modified clearly 
erroneous transactions, Nasdaq represented to the Division of Market 
Regulation that whenever possible within the constraints of Nasdaq's 
systems, Nasdaq will endeavor to ensure that the tape and historical 
record will be corrected as soon as possible. Given that allegedly 
clearly erroneous trades will now be brought to Nasdaq's attention 
within 30 minutes rather than within four hours as was previously 
the case, it will be significantly less likely that transactions 
voided or modified as clearly erroneous will not be corrected on the 
tape or historical record. Nasdaq also represented that in 1997, 
when the time period was still four hours, clearly erroneous 
transactions that were modified or voided were almost always 
corrected on the tape or historical record. Conversation between 
Andrew S. Margolin, Office of the General Counsel, Nasdaq, and 
Jeffrey R. Schwartz, Special Counsel, Division of Market Regulation, 
SEC, January 8, 1998.
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    For the foregoing reasons, the Commission finds that the proposed 
rule change is consistent with the requirements of the Exchange Act and 
the rules and regulations thereunder applicable to national securities 
association and, in particular, the requirements of Sections 15A(b)(6) 
and 11A(a)(1)(c) and the rules and regulations thereunder.\21\
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    \21\ In approving this rule, the Commission has considered the 
proposed rule's impact on efficiency, competition, and capital 
formation. The proposed rule change likely will enhance the 
efficiency and fairness of the process by which clearly erroneous 
transactions are modified or nullified. The proposal also should 
increase the accuracy of transaction reports disseminated to the 
public. The net effect of approving the proposed rule change will be 
positive. 15 U.S.C. Sec. 78c(f).
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    Finally, the Commission finds good cause for approving Amendment 
No. 2, 3, and 4 to the proposed rule change prior to the thirtieth day 
after the date of publication of notice of filing thereof. The 
Exchange's proposal was published in theFederal Register for the full 
statutory period.\22\ Amendment Nos. 2, 3, and 4 are technical 
amendments that clarify the operation of the rule to enhance market 
participants' comprehension and compliance with these procedures. The 
Amendments do not diminish the rights of any prospective party with 
respect to resolving clearly erroneous transactions. Consequently, the 
Commission finds that there is good cause, consistent with the Exchange 
Act, to accelerate approval of Amendment Nos. 2, 3, and 4.
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    \22\ See Securities Exchange Act Release No. 38196, supra note 
4.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Exchange Act,\23\ that the proposed rule change (SR-NASD-96-51) is 
approved.

    \23\ 15 U.S.C. Sec. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\24\
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    \24\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-1975 Filed 1-27-98; 8:45 am]
BILLING CODE 8010-01-M