[Federal Register Volume 65, Number 128 (Monday, July 3, 2000)]
[Notices]
[Pages 41116-41119]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-16745]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42983; File No. SR-NASD-00-27]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Approving Proposed Rule Change Amending the Nasdaq 
By-Laws and Restated Certificate of Incorporation

June 26, 2000.

I. Introduction

    On May 11, 2000, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association''), through its wholly owned subsidiary 
The Nasdaq Stock Market, Inc. (``Nasdaq'') filed 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\ a proposed rule change amending the Nasdaq By-laws 
and Restated Certificate of Incorporation. The proposed rule change was 
published for comment in the Federal Register on May 23, 2000.\3\ The 
Commission received no comments on the proposal. This order approves 
the proposal.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 42790 (May 16, 2000), 65 
FR 33384.
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II. Description of Proposal

    The purpose of the proposed rule change was to amend Nasdaq's By-
Laws and Restated Certificate of Incorporation (``Certificate'') in 
accordance with the Restructuring Plan (the ``Restructuring'') approved 
by NASD members on April 14, 2000. The Restructuring involves 
broadening the ownership in Nasdaq (which is currently 100 percent 
owned by the NASD) through a two-phase private placement of common 
stock and warrants to NASD members, Nasdaq issuers, institutional 
investors and strategic partners. Nasdaq's By-laws and Certificate must 
be amended in order to reflect the changes to Nasdaq's ownership 
structure. Therefore, the proposed rule change included the amendments 
necessary to implement Phase I of the Restructuring.
    Eventually, Nasdaq will submit an Application For, and Amendments 
to Application For, Registration as a National Securities Exchange or 
Exemption from Registration Pursuant to Section 5 of the Exchange Act 
to obtain exchange registration. Prior to its registration as a 
national securities exchange, however, Nasdaq will continue to operate 
under the Plan of Allocation and Delegation of Functions by the NASD to 
its Subsidiaries (the ``Delegation Plan''), as approved by the 
Commission. After exchange registration, Nasdaq will no longer be 
governed pursuant to the Delegation Plan.
    This Order does not address provisions of the existing Nasdaq By-
laws Certificate and that remain unchanged, and it limits the 
discussion to the most significant changes to the corporate documents.

Summary of Significant Amendments

1. Authorized Capital Stock
    To carry out the recapitalization of Nasdaq, the total number of 
shares that Nasdaq is authorized to issue has been increased to 
330,000,000, consisting of 30,000,000 shares of preferred stock, par 
value $.01 per share, and 300,000,000 shares of common stock, par value 
$0.01 per share. In addition, the Nasdaq Board of Directors (``the 
Board'') is now entitled to issue preferred stock in one or more 
series, and to fix the powers, preferences, rights, qualifications, 
limitations, and restrictions of this preferred stock (including, for 
example, dividend rights, conversion rights, voting rights, terms of 
redemption, liquidation preferences, etc). The issuance of preferred 
stock could have the effect of decreasing the market price of the 
common stock and could adversely affect the voting and other rights of 
the holders of common stock.
2. Scaled Voting Provision
    The Certificate provides that holders of common stock are entitled 
to one vote per share on all appropriate matters, except that any 
person, other than the NASD or any other person approved by the Board 
prior to the time such person owns more than 5% of the then outstanding 
shares of common stock will be unable to exercise voting rights in 
respect of any shares owned in excess of 5%.\4\ Exemptions from this 
scaled voting provision can be granted by the Board. The Certificate, 
however, provides that in no event shall an exemption from the scaled 
voting provision be granted to (1) a registered broker or dealer, or an 
affiliate \5\ thereof, or (2) an individual or entity subject to 
statutory disqualification under Section 3(a)(39) of the Act. The Board 
may approve an exemption from the scaled voting provision if the Board 
determines that granting the exemption would (1) not reasonably be 
expected to diminish the quality of, or public confidence in, the 
Nasdaq Stock Market or other operations of Nasdaq, on the ability to 
prevent fraudulent and manipulative acts and practices and on investors 
and the public, and (2) promote just and equitable principles of trade, 
foster cooperation and coordination with persons engaged in regulating, 
clearing, settling, processing information with respect to, and 
facilitating transactions in securities or assist in the removal of 
impediments to or perfection of the mechanisms for a free and open 
market and a national market system.
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    \4\ This restriction on voting shares owned in excess of 5% is 
referred to as the ``scaled voting provision.''
    \5\ The Certificate provides that an affiliate ``shall not be 
deemed to include an entity that either owns ten percent or less of 
the equity of a broker or dealer, or the broker or dealer accounts 
for one percent or less of the gross revenues received by the 
consolidated entity.'' For purposes of this order, references to a 
broker or dealer will include affiliates, as defined in the By-laws 
or Certificate.
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3. Board of Directors
    The Certificate provides for a ``classified'' or ``staggered'' 
Board; that is, the Board will be divided into three classes, with one 
class to be elected each year to serve a three-year term. The By-laws 
also create a Chief Executive Officer (``CEO''), who shall have general 
supervision over the business and affairs of Nasdaq. The By-laws 
preserve the existing Industry, Non-Industry and Public classifications 
for Board Directors, and provide that the newly created CEO and 
President are deemed ``neutral'' directors for classification purposes.
    The Certificate provides that the exact number of directors is to 
be determined by the Board from time to time. The By-laws require that 
the number of Non-Industry Directors, including at least one Public 
Director and at least one issuer representative, must equal or exceed 
the number of Industry Directors, plus the President and CEO (if they 
are elected Directors), unless the Board consists of 10 or more 
Directors. If the Board consists of 10 or more Directors, then at least 
two Directors shall be issuer representatives. The By-laws provide that 
at least two Industry Directors and two Non-Industry Directors shall be 
drawn from candidates proposed to the National Nominating Committee by 
a majority of the non-NASD stockholders of Nasdaq.\6\

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The By-laws also authorize the Nasdaq Board, rather than the NASD 
Board, to fill vacancies on the Nasdaq Board.
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    \6\ As previously noted, Nasdaq currently operates under the 
Delegation Plan which authorizes NASD to elect the Board. Vacancies 
on the Board are filled by candidates put forward by the NASD's 
National Nominating Committee (``NNC''). The Board is currently 
authorized to consist of 10 members. Prior to Exchange registration, 
it is contemplated that the Board will be increased from 10 voting 
members to 14. These four new members of the Board will not be 
current members of the NASD Board of Directors, nor will they be 
able to serve concurrently on the NASD Board of Directors. Two of 
the four new directors will be Industry Directors and the other two 
will be Non-Industry or Public Directors. Before exchange 
registration, or until such time that Nasdaq does not otherwise 
operate under the Delegation Plan, the Board is expected to consist 
of 14 members, the majority of whom shall be Public or Non-Industry 
Directors.
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    Under the Delegation Plan, all stockholders have the right to 
recommend one or more candidates for consideration by the NNC for 
nomination to the Board by providing written notice to the Corporate 
Secretary, containing specified information relating to the candidate 
(the candidate's name, industry classification, etc.).\7\
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    \7\ If Nasdaq as a national securities exchange, then the 
procedures for nomination to the Board may differ.
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4. Removal of Directors and Committee Members
    Directors previously could be removed with or without cause. The 
By-laws and Certificate now provide that Directors may only be removed 
for cause by an affirmative vote of a supermajority of outstanding 
shares entitled to vote. Removal of committee members still requires a 
majority vote of the Board and notice to the committee member, but the 
provision that committee members may only be removed for refusal, 
failure, neglect, or inability to discharge the committee member's 
duties is eliminated.
5. Annual and Special Meetings of Stockholders, and Stockholder Action
    Because there will be multiple owners of Nasdaq, the By-laws now 
provide detailed procedures for the calling and conduct of annual and 
special meetings of shareholders. The Certificate provides that 
stockholders are not entitled to act by written consent in lieu of a 
meeting.
6. Notice Requirements for Stockholder Proposals and Stockholder 
Nominated Directors
    The By-laws allow stockholders to bring business before an annual 
and special meeting of stockholders, and to nominate candidates for 
election as directors at an annual meeting of stockholders, provided 
they comply with the procedures outlined in the By-laws.
7. Amendments to the By-Laws
    The By-laws and Certificate state that By-law amendments may be 
made by a supermajority vote of the shareholders or by the Board. In 
addition, the Certificate requires a supermajority vote of the 
outstanding shares of common stock to amend, repeal or adopt certain 
provisions of the Certificate including, but not limited to, 
limitations on voting rights of certain persons, the classified Board, 
removal of Directors, and prohibitions on stockholder action by written 
consent.
8. Certificate, Article Eleventh--``Constituency Provision'' Relating 
to Certain Corporate Transactions
    A new provision, Article Eleventh of the Certificate, sets forth 
factors that the Board must consider when evaluating the merits of 
certain major corporate transactions such as tender or exchange offers, 
mergers, liquidations, any action relating to the voting cap, or other 
issues, due to the unique nature of Nasdaq and its operations and 
status as a self-regulatory organization.\8\ Article Eleventh requires 
that the Board shall to the fullest extent permitted by applicable law, 
take into account the following factors when evaluating a major 
corporate transaction: (1) The potential impact on the integrity, 
continuity and stability of The Nasdaq Stock Market and the other 
operations of Nasdaq, on the ability to prevent fraudulent and 
manipulative acts and practices and on investors and the public, and 
(2) whether such a transaction would promote just and equitable 
principles of trade, foster cooperation and coordination with persons 
engaged in regulating, clearing, settling, processing information with 
respect to, and facilitating transactions in securities, or assist in 
the removal of impediments to, or perfection of the mechanisms for, a 
free and open market and a national market system.
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    \8\ The Commission notes that, by it terms, Article Eleventh is 
not operative until the Commission approves nasdaq's registration as 
a national securities exchange.
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9. Other Changes to Conform the By-Laws and Certificate to Nasdaq's New 
Corporate Form
    Other changes to the By-laws and Certificate are made to reflect 
Nasdaq's new ownership structure and to institute procedures necessary 
for Nasdaq to operate as a corporation. For example, references to 
``shareholder'' have been changed to ``shareholders,'' to reflect the 
fact that the NASD no longer owns 100% of Nasdaq and that ownership of 
Nasdaq will now be broadened to a number of entities and individuals. 
Similarly, provisions have been added relating to waiver of notice of a 
meeting by a Director, definitions of new terms (e.g., ``beneficial 
owner'' and ``subsidiary''), and a provision defining the necessary 
quorum to approve interested party transactions.

III. 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 a national securities association. The 
proposed rule change also fulfills the division of responsibilities as 
set forth in the Delegation Plan approved by the Commission. Pursuant 
to the Delegation Plan, NASD has retained the authority ``[t]o exercise 
overall responsibility for ensuring that the Association's statutory 
and self-regulatory obligations are fulfilled.'' \9\ However, NASD has 
delegated to Nasdaq the responsibility to operate The Nasdaq Stock 
Market, including the responsibility to ``develop and adopt rules, 
interpretations, policies, and procedures and provide exemptions to 
maintain and enhance the integrity, fairness, efficiency, and 
competitiveness of The Nasdaq Stock Market and other markets operated 
by The Nasdaq Stock Market.\10\ Thus, the Commission looks to NASD as 
the self-regulatory organization with statutory responsibility to 
implement and enforce the requirements of the Act, but Nasdaq, as a 
market owned and controlled by NASD, is required to operate The Nasdaq 
Stock Market and to provide rules, interpretations, policies, and 
procedures to carry out the purposes of the Act.\11\ In the Discussion 
section below, the Commission applies this ``chain'' of regulatory 
responsibilities in its analysis and findings in support of this 
approval order.\12\
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    \9\ Section I(B)(1) of the Delegation Plan.
    \10\ Section III(A)(1)(e) of the Delegation Plan.
    \11\ NASD, however, is ultimately responsible for ensuring that 
the Nasdaq's actions fulfill the statutory and self-regulatory 
obligations as set forth in the Act.
    \12\ The Commission also notes that the amendments to the By-
laws and Certificate begin the process of implementing the corporate 
governance changes that will be necessary if Nasdaq registers as a 
national securities exchange.
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    In light of the above, the Commission believes that the proposed 
rule change is consistent with the requirements of Section 15A(b)(2), 
(4) and (6) \13\ of the Act. Section 15A(b)(2) \14\ requires that the 
association be so organized and have the capacity to be able to carry 
out the purpose of the title and to comply, and to enforce compliance 
by its members and persons associated with its members, with the 
provisions of the

[[Page 41118]]

Act.\15\ Section 15A(b)(4) \16\ requires that the rules of an 
association assure a fair representation of its members in the 
selection of its directors and administration of its affairs and 
provide that one or more directors shall be representative of issuers 
and investors and not be associated with a member of the association, 
broker, or dealer.\17\ Section 15A(b)(6) \18\ requires, among other 
things, that the association's rules must be designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to remove impediments to and perfect the 
mechanism of a free and open market and national market system, and, in 
general, to protect investors and the public interest.\19\
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    \13\ 15 U.S.C. 78o-3(b)(2), (4) and (6).
    \14\ 15 U.S.C. 78o-3(b)(2).
    \15\ Again, through the operation of the Delegation Plan, NASD 
must be responsible for, and Nasdaq must implement, rules, policies 
and procedures that are consistent with the Act.
    \16\ 15 U.S.C. 78o-3(b)(4).
    \17\ See supra note 15.
    \18\ 15 U.S.C. 78o-3(b)(6).
    \19\ See supra note 15.
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A. Amendments Incident to the Restructuring and Recapitalization of 
Nasdaq

    The Commission finds that the amendments to Nasdaq's By-laws and 
Certificate authorizing certain corporate actions and implementing 
procedures that are necessary to allow Nasdaq to function as a for-
profit corporation are consistent with Section 15A(b)(2) \20\ of the 
Act. The Commission believes that the amendments relating to the 
following subject matters, as described in more detail above, are 
needed to reflect the recapitalization and restructuring of Nasdaq: the 
issuance of capital stock (both common and preferred shares); the 
procedures for calling and conducting annual meetings and special 
meetings of stockholders; the nomination and election procedures for 
the Board of Directors; the quorum calculations for interested party 
transactions; the defined terms; and the procedures for amendments to 
the By-laws and Certificate. These changes satisfy the requirements set 
forth in Section 15A(b)(2) that NASD be so organized and have the 
capacity to carry out the purposes of the Act.
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    \20\ 15 US.C. 78o-3(b)(2).
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B. Structure and Governance of Nasdaq's Board

    Section 15A(b)(4) \21\ of the Act requires fair representation of 
an association's members in the selection of its directors and 
administration of its affairs, and provides that one or more directors 
shall be representative of issuers and investors and not be associated 
with a member of the association, broker, or dealer. The NASD, through 
the Delegation Plan, has the responsibility for ensuring that the 
Nasdaq Board fulfills the fair representation and public participation 
requirements.\22\ The Commission finds that the proposed structure and 
composition of the Board fulfills the provisions of Section 15A(b)(4).
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    \21\ 15 U.S.C. 78o-3(b)(4).
    \22\ The Delegation Plan also provides that the NASD will 
appoint Nasdaq's Board. Section I(B)(3) of the Delegation Plan.
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    The fair representation requirement of Section 15A(b)(4) helps to 
ensure that no particular constituency is subject to the unfair, 
unfettered actions of another constituency, and helps to ensure that 
the NASD, including its Nasdaq subsidiary, is administered in a way 
that is equitable to NASD members.
    In addition, to ensure that the public interest is adequately 
represented in an association's decision-making process, Section 
15A(b)(4) states that an association must provide that one or more of 
its directors be representatives of issuers and investors. The 
Commission believes that public directors provide a unique, unbiased 
perspective that should enhance the ability of a board to address 
issues in a non-discriminatory fashion.
    The Commission finds that the proposed composition of the Board 
meets the fair representation and public participation criteria as set 
forth in Section 15A(b)(4) of the Act. The By-laws provide that the 
number of Non-Industry Directors on the Board, including at least one 
Public Director and at least one issuer representative, shall equal or 
exceed the number of Industry Directors, plus the President and CEO (if 
they are elected Directors), unless the Board consists of 10 or more 
Directors. If the Board consists of 10 or more Directors, at least two 
Directors shall be issuer representatives. The Certificate also 
requires public participation on the Board. This structure ensures that 
all interests, Industry and Non-Industry, will be adequately 
represented on the Board. Further, the requirement that the number of 
Non-Industry Directors equal or exceed the number of Industry 
Directors, and the requirement of Public Directors helps to ensure that 
decisions by the Board are not unfairly discriminatory between 
customers, issuers, brokers, or dealers, and that the protection of 
investors and the public interest is considered. Therefore, the 
Commission believes that the Board structure is consistent with the 
fair representation and public participation requirements of Section 
15A(b)(4) of the Act.

C. Scaled Voting, Exemptions From Scaled Voting, and Other Limitations 
on the Control of Nasdaq

    The Commission is concerned that the NASD's self-regulatory 
obligations may be challenged if a substantial portion of Nasdaq is 
owned or controlled by a broker or dealer that also trades on Nasdaq. 
In such a situation, it may be difficult for NASD to carry out its 
self-regulatory responsibilities if it is required to take action 
against that broker or dealer. These concerns will be heightened if 
NASD goes through with its plans to register Nasdaq as a national 
securities exchange, and sell off additional shares of Nasdaq to 
investors.
    The scaled voting provision is one way of limiting the ability of 
any entity, particularly a registered broker or dealer, from 
controlling Nasdaq. However, permitting the Board to lift the voting 
cap in some cases is necessary to allow Nasdaq flexibility should 
Nasdaq seek to enter into a business combination in which it would want 
to use shares of common stock in the transaction. The Certificate 
therefore provides that the Board may generally lift the voting cap, 
but that it cannot be lifted for a broker or dealer (or an affiliate of 
a broker or dealer) \23\ or any other individual or entity subject to 
statutory disqualification as defined in Section 3(a)(39) of the Act. 
The Board is also required to consider certain factors before lifting 
the voting cap for any other individual or entity.
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    \23\ See supra note 5.
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    The Commission believes that the proposed rule change relating to 
scaled voting, exemptions from scaled voting, and other limitations 
affecting the control of Nasdaq fulfill the obligations under Section 
15A(b)(2) and (6). The Certificate provides for an absolute bar on a 
broker, dealer, or statutorily disqualified person, from voting shares 
owned in excess of 5%. Section 15A(b)(6) requires that rules be in 
place that prevent fraudulent and manipulative acts and practices, 
promote just and equitable principles of trade, facilitate transactions 
in securities, and remove impediments to and perfect the mechanism of a 
free and open market and a national market system. The limitation on 
voting shares owned in excess of 5% satisfies this requirement because 
it helps to avoid a situation where the integrity of Nasdaq might be 
compromised if the NASD had to choose between taking action against a 
broker or dealer that owned, and could vote, a Nasdaq share in excess 
of 5%,

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and fulfilling its self-regulatory responsibilities.
    The Commission also finds that the current requirement that the 
Board consider factors relating to the qualifications of any 
shareholder (other than a broker or dealer or statutorily disqualified 
person) before lifting the voting cap also helps to address the 
Commission's concern that Nasdaq not be controlled or substantially 
influenced by an entity that may promote acts or practices that would 
be inimical to the purposes of the Act.
    Two other provisions also act as a deterrent to a shareholder's 
ability to effect a rapid change in control of Nasdaq. The classified 
Board structure ensures that it will take at least two shareholder 
meetings, instead of one, for majority control of the board to shift. 
As discussed previously, the Certificate also provides that Directors 
may only be removed for cause and by a supermajority vote of the 
shareholders. These provisions, together with the scaled voting 
provision, help to ensure that control of Nasdaq will be attained only 
in a measured manner and consistent with the requirements set forth in 
the Act.
    Finally, the Commission notes that as currently stated, a person or 
entity could own a substantial portion of Nasdaq and yet be limited in 
its actual control of Nasdaq by virtue of the scaled voting provisions, 
the classified Board structure, and the limitations on the removal of 
Directors in the By-laws and Certificate. While these provisions help 
ameliorate the Commission's concern about the control of Nasdaq, 
concerns about the ability of an entity--in particularly a broker, 
dealer or affiliate--to own up to 100 percent of Nasdaq remain. Thus, 
further action to address the ownership of a substantial portion of 
Nasdaq by a broker, dealer or affiliate may be warranted if Nasdaq 
registers as a national securities exchange.

D. Certificate, Article Eleventh (``Constituency Provision'')

    By its own terms Article Eleventh applies when Nasdaq achieves 
``status as a self-regulatory organization,'' and it therefore will 
become operative only if the Commission approves Nasdaq's anticipated 
application to register as a national securities exchange. The 
Commission notes preliminarily, however, that Article Eleventh balances 
the need to ensure that Nasdaq fulfill the self-regulatory obligations 
incumbent upon it if it registers as a national securities exchange 
without unduly hampering Nasdaq's ability to consummate major corporate 
transactions. Therefore, the Commission finds that new Article Eleventh 
of the Certificate is consistent with Section 15A(b)(6) of the Act and 
outlines a legitimate and useful set of criteria that should be 
considered by the Board if it considers major corporate transactions 
after exchange registration.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\24\ that the proposed rule change (SR-NASD-00-27) is approved.
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    \24\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\25\
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    \25\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-16745 Filed 6-30-00; 8:45 am]
BILLING CODE 8010-01-M