[Federal Register Volume 65, Number 28 (Thursday, February 10, 2000)]
[Proposed Rules]
[Pages 6569-6573]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-2917]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1

RIN 3038-AB51


Minimum Financial Requirements for Futures Commission Merchants 
and Introducing Brokers; Amendments to the Restrictions on the 
Withdrawal of Equity Capital from a Futures Commission Merchant and to 
the Percentage Deduction (i.e., Haircut) Applied to the Value of Equity 
Securities Collateralizing Secured Demand Notes Included in Adjusted 
Net Capital by a Futures Commission Merchant or Introducing Broker

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rules.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or 
``CFTC'') is proposing to amend several provisions of its Regulation 
1.17, which governs the minimum financial requirements imposed upon 
futures commission merchants (``FCMs'') and introducing brokers 
(``IBs''). The proposal would: ease the restrictions

[[Page 6570]]

imposed upon the withdrawal of equity capital from an FCM; increase the 
percentage deduction (i.e., ``haircut'') applied to the value of equity 
securities pledged as collateral for secured demand notes that are 
included in the adjusted net capital of an FCM or IB; and delete a 
reference to a section of the Securities and Exchange Commission's 
(``SEC'') capital rule that has been repealed.
    The Commission believes that the current restriction on the 
withdrawal of equity capital that is based on a percentage of the 
amount of funds an FCM is required to segregate or set aside for 
customers may be unnecessary in light of other early warning capital 
standards and the degree of surveillance carried out by SROs over their 
member FCMs. The proposed amendment increasing the haircut applied to 
equity securities pledged as collateral for secured demand notes would 
provide greater conformity between the Commission's capital rules and 
the capital rules of the SEC.

DATES: Comments must be received on or before March 13, 2000.

ADDRESSES: Comments should be mailed to Jean A. Webb, Secretary, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street, N.W., Washington, D.C. 20581. In addition, comments may be sent 
by facsimile to (202) 418-5521, or by electronic mail to 
[email protected]. Reference should be made to ``Minimum Financial 
Requirements for Futures Commission Merchants and Introducing Brokers--
Equity Capital.''

FOR FURTHER INFORMATION CONTACT: Henry J. Matecki, Financial Audit and 
Review Branch, Commodity Futures Trading Commission, 300 S. Riverside 
Plaza, Room 1600-N, Chicago, IL 60606; telephone (312) 886-3217; 
electronic mail [email protected]: or Gary C. Miller, Associate Chief 
Accountant, Division of Trading and Markets, Commodity Futures Trading 
Commission, Three Lafayette Centre, 1155 21st Street, N.W., Washington, 
D.C. 20581; telephone (202) 418-5461; electronic mail [email protected].

SUPPLEMENTARY INFORMATION:

I. Restrictions on the Withdrawal of Equity Capital From a Futures 
Commission Merchant

A. Background

    Commission Regulation 1.17(e) \1\ prohibits the withdrawal of 
equity capital from an FCM \2\ to redeem or to repurchase shares of 
stock of the FCM, to pay dividends, or to make an unsecured advance or 
loan to a stockholder, partner, sole proprietor or employee of the FCM 
if, after giving effect to the withdrawal and to certain other 
specified withdrawals and payments, the FCM's adjusted net capital 
would be less than the greatest of:
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    \1\ Commission rules cited herein can be found at 17 CFR Ch. I 
(1999).
    \2\ The prohibition against withdrawal of equity capital set 
forth in Regulation 1.17(e) applies to both FCMs and IBs. The 
restriction requires consideration of both the minimum dollar amount 
of net capital required for both types of registrants ($250,000 for 
FCMs and $30,000 for IBs) and, just for FCMs, the amount of funds 
required to be segregated and set aside for FCMs' customers. For 
purposes of this proposal, only the restriction on FCMs need be 
addressed since the change relates only to the percentage applied to 
the amount of funds required to be segregated and set aside for 
customers.
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    (1) $300,000 (120 percent of the $250,000 minimum adjusted net 
capital requirement);
    (2) Seven percent of the customer funds required to be segregated 
or set aside pursuant to the Commodity Exchange Act (``Act'') and 
Commission regulations, \3\ (hereinafter collectively referred to as 
the ``customer segregated and secured amount'');
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    \3\ Before applying the percentage capital factor, the amount 
required to be segregated or set aside is reduced by the market 
value of commodity options purchased by customers on or subject to 
the rules of a contract market or a foreign board of trade for which 
the full premiums have been paid: provided, however, that the option 
premium deduction for each customer is limited to the amount of 
customer funds and the foreign futures and foreign options secured 
amounts in such customer's account(s).
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    (3) 120 percent of the amount of adjusted net capital required by a 
registered futures association of which the FCM is a member; or
    (4) For an FCM that is also a securities broker or dealer 
registered with the Securities and Exchange Commission (``SEC''), the 
amount of net capital specified in SEC Rule 15c3-1(e) (17 CFR 240.15c3-
1(e)).
    The Joint Audit Committee (``JAC'') has petitioned the Commission 
to amend the restriction in (2) above to permit the withdrawal of 
equity capital from an FCM provided that, after giving effect to the 
withdrawal, the FCM's adjusted net capital is in excess of six percent 
of the customer segregated and secured amount. \4\ The JAC's petition 
did not address the other withdrawal restrictions listed above.
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    \4\ The JAC is comprised of representatives of the audit and 
compliance departments of the self-regulatory organizations 
(``SROs'') and National Futures Association. The JAC coordinates the 
industry's audit and ongoing surveillance activities to promote a 
uniform framework of self-regulation.
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    In its petition, the JAC stated that prohibiting capital 
withdrawals that result in an FCM having adjusted net capital that is 
less than seven percent of the customer segregated and secured amount 
is an unnecessary regulatory burden. In support of its position, the 
JAC claimed that other provisions of the Commission's regulations also 
impose effective restraints on the excessive withdrawal of capital from 
an FCM by an equity holder. Specifically, the JAC noted that: (1) FCMs 
are required to maintain minimum adjusted net capital of at least four 
percent of the customer segregated and secured amount funds 
requirements in order to operate and to handle customer positions and 
funds; (2) the Commission's ``early warning'' notice and financial 
reporting requirements provide the Commission and the FCMs' designated 
self-regulatory organizations (``DSRO'') with the ability to monitor 
the financial condition and operations, including capital withdrawals, 
of an FCM that fails to maintain adjusted net capital at a level that 
exceeds six percent of the customer segregated and secured amount; and 
(3) the Commission's debt-equity ratio requirement imposes an effective 
restraint on the excessive withdrawal of equity capital.
    Furthermore, the JAC stated that the changes it requested would 
provide greater harmony between the Commission's capital rules and the 
capital rules of the SEC. In this regard, the JAC noted that the SEC's 
capital rules permit withdrawals of capital from a broker or dealer 
provided that, after giving effect to the withdrawal, the broker's or 
dealer's net capital equals or exceeds the SEC's early warning level. 
Each of the reasons set forth by the JAC is discussed below.

B. Proposed Rule Amendments

    After careful consideration of the JAC's petition and the issues 
that the petition presents, the Commission is proposing to amend 
Regulation 1.17(e) to permit equity capital withdrawals provided that, 
after giving effect to the withdrawals, the FCM's adjusted net capital 
is in excess of six percent of the customer segregated and secured 
amount. The Commission is not proposing to amend any of the other 
capital withdrawal restrictions set forth in the regulation.
    An FCM is required to maintain minimum adjusted net capital of the 
greatest of: (A) $250,000; (B) four percent of the customer segregated 
and secured amount; (C) the amount of adjusted net capital required by 
a registered futures association of which it is a member; or (D) for 
securities brokers and dealers, the amount of net capital required by 
SEC Rule 15c3-1(a) (17 CFR

[[Page 6571]]

240.15c3-1(a)). FCMs that are members of commodity exchanges must 
comply with the net capital requirements of those exchanges, which are 
required to be at least as stringent as the Commission's. \5\ 
Generally, FCMs that handle customer accounts are required to maintain 
adjusted net capital in excess of four percent of the customer 
segregated and secured amount.
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    \5\ See Regulations 1.17(a)(2)(i) and 1.52.
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    An FCM that is not in compliance with the minimum net capital 
requirement must transfer all customer accounts and immediately cease 
doing business as an FCM. \6\ Therefore, each FCM must ensure that a 
capital withdrawal does not cause the FCM's adjusted net capital to 
fall below four percent of the customer segregated and secured amount.
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    \6\ See Regulation 1.17(a)(4).
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    In addition, the Commission's ``early warning'' notice and 
financial reporting requirements deter excessive equity withdrawals. 
Commission Regulation 1.12(b)(2) requires an FCM to notify its DSRO and 
the Commission in writing if its adjusted net capital does not equal or 
exceed six percent of the customer segregated and secured amount. These 
early warning notices must be filed within five business days of the 
FCM's adjusted net capital falling below the early warning level. 
Moreover, Commission Regulation 1.12(g)(2) requires an FCM to give the 
Commission written notice at least two business days prior to a planned 
withdrawal of equity capital if the withdrawal would reduce excess net 
capital by 30 percent or more from that most recently reported in a 
financial report filed with the Commission.
    An FCM that hits the early warning trigger is also required to file 
a financial report on Form 1-FR-FCM with the Commission and its DSRO as 
of the close of the month during which its adjusted net capital does 
not exceed the early warning level and for each month thereafter until 
three successive months have elapsed during which its adjusted net 
capital is at all times equal to or in excess of the early warning 
level. \7\ This early warning notice is intended to bring to the 
Commission's and DSRO's attention firms that should be subjected to 
closer monitoring because of their minimal regulatory capital.
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    \7\ See Regulation 1.12(b)(4).
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    Furthermore, the Commission's ``debt-equity ratio'' requirement 
also limits the amount of capital that may be withdrawn from an FCM. 
Commission Regulation 1.17(d) prohibits the withdrawal of capital from 
an FCM if, after giving effect to the withdrawal, the FCM's equity 
capital would be less than 30 percent of its debt-equity total. \8\
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    \8\ Equity capital is defined by Regulation 1.17(d)(1) to 
include certain loans subject to qualifying satisfactory 
subordination agreements and the following:
    (1) In the case of a corporation, the sum of its par or stated 
value of capital stock, paid in capital in excess of par, retained 
earnings, unrealized profit and loss, and other capital accounts;
    (2) In the case of a partnership, the sum of its capital 
accounts of partners (inclusive of such partners' commodity interest 
and securities accounts subject to the provisions of Rule 1.17(e) 
concerning restrictions on withdrawals of equity capital), and 
unrealized profit and loss; and
    (3) In the case of a sole proprietorship, the sum of its capital 
accounts and unrealized profit and loss.
    ``Debt-equity total'' is defined by Regulation 1.17(d)(2) and 
encompasses equity capital as defined above plus loans subject to 
satisfactory subordination agreements that do not qualify as equity 
capital under Regulation 1.17(d)(1).
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    Finally, setting the capital withdrawal limit at the Commission's 
early warning level is supported by the capital withdrawal rules 
adopted by the SEC for securities brokers or dealers that compute their 
minimum net capital requirement in accordance with the SEC's 
``alternative'' method. \9\ SEC Rule 15c3-1(e)(2)(vi) (17 CFR 240.15c3-
1(e)(2)(vi)) prohibits a capital withdrawal from a broker or dealer 
that computes its minimum net capital requirement under the alternative 
method if, after giving effect to the withdrawal, the broker's or 
dealer's minimum net capital would be less than five percent of the 
aggregate debit items as determined by the Reserve Formula. The SEC's 
early warning requirement for such brokers and dealers is also set at 
five percent of aggregate debit items. \10\
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    \9\ SEC Rule 15c3-1(a)(1)(ii) (17 CFR 240.15c3-1(a)(1)(ii)) 
requires a securities broker or dealer computing its minimum net 
capital requirement under the alternative method to maintain minimum 
net capital of not less than the greater of $250,000 or 2 percent of 
aggregate debit items computed in accordance with the Formula for 
Determination of Reserve Requirement for Brokers and Dealers 
(Exhibit A to Rule 15c3-3).
    \10\ 17 CFR 240.17a-11(c)(2).
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II. Equity Securities Pledged as Collateral for Secured Demand 
Notes

A. Background

    Commission Regulation 1.17(h) sets forth the minimum requirements 
for satisfactory subordination agreements. An FCM or IB may enhance its 
regulatory capital by borrowing cash pursuant to subordinated loan 
agreements or by accepting secured demand notes. A secured demand note 
must be collateralized by cash or readily marketable securities. \11\ 
The securities collateralizing a secured demand note are subject to 
percentage deductions (i.e., haircuts) to provide protection against a 
potential decrease in the market values of the securities. Commission 
regulations, however, do not specify the specific haircuts to be 
applied. Instead, the Commission's regulations provide that an FCM or 
IB must apply the haircuts that are set forth in SEC Rule 15c3-
1(c)(2)(vi) (17 CFR 240. 15c3-1(c)(2)(vi)), which are the haircuts that 
a broker or dealer must apply to securities that it includes in its 
capital computation.
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    \11\ The value of the collateral, after applicable haircuts, 
must exceed the full outstanding face amount of the secured demand 
note.
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    When the Commission adopted its current capital rules in September 
1978, the haircut for an equity security under SEC Rule 15c3-
1(c)(2)(vi) was 30 percent. Therefore, an FCM or IB was required to 
apply a 30 percent haircut to an equity security collateralizing a 
secured demand note. \12\
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    \12\ 43 FR 39956 (September 8, 1978).
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    In December 1992, the SEC amended its capital rules. As part of 
these amendments, the SEC amended Rule 15c3-1(c)(2)(vi) by reducing the 
haircut on equity securities from 30 percent to 15 percent. \13\ Since 
the Commission's capital rules incorporated the haircuts in SEC Rule 
15c3-1(c)(2)(vi), the Commission's capital rules were effectively 
amended and the haircut applied to equity securities collateralizing a 
secured demand note was reduced from 30 percent to 15 percent. In the 
December 1992 amendments, however, the SEC also explicitly retained the 
30 percent haircut on equity securities collateralizing secured demand 
notes included in adjusted net capital by brokers or dealers. Thus, an 
unintended difference developed between the Commission's capital rules 
and the capital rules of the SEC. The difference stems from the 
Commission incorporating the SEC's regulation imposing haircuts on 
securities that a broker or dealer includes in its capital computation 
(Rule 15c3-1(c)(2)(vi)) as opposed to the regulation imposing haircuts 
on securities that a broker or dealer receives as collateral for a 
secured demand note that was contributed as capital (Rule 15c3-1d) (17 
CFR 240.15c3-1(d)).
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    \13\ 57 FR 56984 (December 2, 1992).
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B. Proposed Rule Amendment

    The Commission attempts to maintain, to the extent practicable, 
uniformity between its capital rules and those of the SEC. Uniform 
capital rules more readily permit dually-registered FCMs (i.e., FCMs 
that are also SEC-registered securities brokers or dealers) that comply 
with the Commission's

[[Page 6572]]

capital rules to comply with the SEC's capital rules. As set forth 
above, the Commission's capital rules were originally consistent with 
the SEC's capital rules with respect to the haircuts to be applied to 
equity securities collateralizing secured demand notes and the current 
difference is unintended. Accordingly, in order to provide greater 
uniformity between the Commission and SEC capital rules, the Commission 
proposes increasing to 30 percent from 15 percent the haircut on the 
market value of equity securities pledged as collateral for a secured 
demand note.

III. Technical Amendment

    Commission Regulation 1.17(c)(5)(v) requires an FCM or IB, in 
computing its adjusted net capital, to apply haircuts to securities 
positions carried in the FCM's or IB's proprietary accounts and to 
securities purchased with customer funds that are required to be 
segregated or set aside in separate accounts. The regulation directs 
the FCM or IB to apply the specific haircut percentages that are set 
forth in SEC Rule 15c3-1(c)(2)(vi) for equity securities and Rule 15c3-
1(c)(2)(vii) (17 CFR 240.15c3-1(c)(2)(vii)) for non-marketable 
securities, or Rule 15c3-1(f) (17 CFR 240. 15c3-1(f)) for dually 
registered securities brokers or dealers and FCMs that compute their 
minimum net capital requirements in accordance with the SEC's 
``alternative, or aggregate debit items,'' method.
    In December 1992, the SEC amended its capital rules by, among other 
things, revising the securities haircuts that a broker or dealer 
subject to the alternative capital method had to apply to securities 
positions in the broker's or dealer's proprietary accounts. 
Specifically, the amendments made the haircuts consistent regardless of 
the method that a broker or dealer used in computing its minimum net 
capital. The SEC effected the revisions by consolidating the haircuts 
in Rule 15c3-1(f) into Rules 15c3-1(c)(2)(vi) and 15c3-1(c)(2)(vii) and 
repealing15c3-1(f). Accordingly, the Commission proposes deleting the 
reference to Rule 15c3-1(f) in its Rule 1.17(c)(5)(v).

IV. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601-611, 
requires that agencies, in proposing rules, consider the impact of 
those rules on small businesses. The proposed rule amendments discussed 
herein would affect FCMs and IBs. The Commission has previously 
determined that, based upon the fiduciary nature of FCM/customer 
relationships, as well as the requirement that FCMs meet minimum 
financial requirements, FCMs should be excluded from the definition of 
small entity.\14\
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    \14\ 47 FR 18618, 18619-18620 (April 30, 1982).
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    With respect to IBs, the Commission stated that it is appropriate 
to evaluate within the context of a particular rule whether some or all 
IBs should be considered to be small entities and, if so, to analyze 
the economic impact on such entities at that time.\15\ The proposed 
technical amendment to Regulation 1.17(c)(5)(v) and the proposed 
amendment to Regulation 1.17(e) easing the restriction on the 
withdrawal of equity capital from an FCM do not impose additional 
requirements on an IB. The proposed amendment to Regulation 
1.17(h)(1)(iii) increasing the haircut on equity securities submitted 
as collateral for a secured demand note may impact an IB's financial 
operations. The proposal, however, conforms the Commission's rules to 
those of the SEC and restores the haircut to its previous level prior 
to the SEC amendment of its capital rules in December 1992. Thus, on 
behalf of the Commission, the Chairman certifies that the proposed rule 
amendments will not have a significant economic impact on a substantial 
number of small entities. The Commission, however, invites comments 
from registered FCMs or IBs who believe that the proposed amendments 
would have a significant impact on their operations.
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    \15\ 48 FR 35248, 35275-78 (August 3, 1983).
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B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (PRA), 44 U.S.C. 3501 et seq. 
(Supp. I 1995), requires federal agencies (including the Commission) to 
review rules and rule amendments to evaluate the information collection 
burden that they impose on the public. The Commission believes that 
paragraphs (c)(5)(v), (e)(1)(ii), and (h)(1)(iii) of Rule 1.17, as 
proposed, do not impose an information collection burden on the public.

List of Subjects in 17 CFR Part 1

    Brokers, Commodity futures.
    In consideration of the foregoing and pursuant to the authority 
contained in the Commodity Exchange Act and, in particular, Sections 
4f, 4g and 8a(5) thereof, 7 U.S.C. 6d, 6g and 12a(5), the Commission 
hereby proposes to amend Chapter I of Title 17 of the Code of Federal 
Regulations as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

    1. The authority citation for Part 1 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f, 
6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 
12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24.

    2. Section 1.17 is amended by revising paragraphs (c)(5)(v), 
(e)(1)(ii), and (h)(1)(iii) to read as follows:


Sec. 1.17  Minimum financial requirements for futures commission 
merchants and introducing brokers.

* * * * *
    (c) * * *
    (5) * * *
    (v) In the case of securities and obligations used by the applicant 
or registrant in computing net capital, and in the case of a futures 
commission merchant with securities in segregation pursuant to Section 
4d(2) of the Act and these regulations which were not deposited by 
customers, the percentages specified in Rule 240.15c3-1(c)(2)(vi) of 
the Securities and Exchange Commission (17 CFR 240.15c3-1(c)(2)(vi)) 
(``securities haircuts'') and 100 percent of the value of 
``nonmarketable securities'' as specified in Rule 240.15c3-1(c)(2)(vii) 
of the Securities and Exchange Commission (17 CFR 240.15c3-
1(c)(2)(vii));
* * * * *
    (e) * * *
    (1) * * *
    (ii) For a futures commission merchant or applicant therefor, 6 
percent of the following amount: The customer funds required to be 
segregated pursuant to the Act and the regulations in this part and the 
foreign futures or foreign options secured amount, less the market 
value of commodity options purchased by customers on or subject to the 
rules of a contract market or a foreign board of trade for which the 
full premiums have been paid: Provided, however, That the deduction for 
each customer shall be limited to the amount of customer funds in such 
customer's account(s) and foreign futures and foreign options secured 
amounts;
* * * * *
    (h) * * *
    (1) * * *
    (iii) The term ``collateral value'' of any securities pledged to 
secure a secured demand note means the market value of such securities 
after giving effect to the percentage deductions specified in Rule 
240.15c3-1d(a)(2)(iii) of the Securities

[[Page 6573]]

and Exchange Commission (17 CFR 240.15c3-1d(a)(2)(iii)).
* * * * *

    Issued in Washington D.C. on February 3, 2000 by the Commission.
Catherine D. Dixon,
Assistant Secretary of the Commission.
[FR Doc. 00-2917 Filed 2-9-00; 8:45 am]
BILLING CODE 6351-01-P