[Federal Register Volume 65, Number 164 (Wednesday, August 23, 2000)]
[Notices]
[Pages 51377-51380]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-21430]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43157; File No. SR-NASD-99-67]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment No. 2 to the Proposed Rule Change by NASD Regulation, Inc. 
Relating to its Membership Rules

August 15, 2000.
    On November 2, 1999, the National Association of Securities 
Dealers, Inc. (``NASD'' or ``Association''), through its wholly owned 
subsidiary NASD Regulation, Inc. (``NASD Regulation''), submitted to 
the Securities and Exchange Commission (``SEC'' or ``Commission'') 
pursuant to section 19(b)(1) \1\ of the Securities Exchange Act of 1934 
(``Act'') and rule 19b-4 \2\ thereunder, a proposed rule change 
amending NASD Rule 1010 Series, which contains the provisions relating 
to the admission to membership. On May 1, 2000, NASD Regulation 
submitted Amendment No. 1 to the proposed rule change.\3\ The proposed 
rule change, as amended by Amendment No. 1, was published for comment 
in the Federal Register on June 12, 2000.\4\ The Commission received no 
comments on the proposal. On August 11, 2000, NASD Regulation submitted 
Amendment No. 2 to the proposed rule change.\5\ This order approves the 
proposal.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Alden S. Adkins, Senior Vice President and 
General Counsel, NASD Regulation, to Katherine England, Assistant 
Director, Division of Market Regulation, SEC, dated April 28, 2000 
(``Amendment No. 1'').
    \4\ Securities Exchange Act Release No. 42885 (June 1, 2000), 65 
FR 36860.
    \5\ See letter from Alden S. Adkins, General Counsel and Senior 
Vice President, NASD Regulation, to Katherine England, Assistant 
Director, Division of Market Regulation, SEC, dated August 9, 2000 
(``Amendment No. 2''). In Amendment No. 2, NASD Regulation corrected 
a typographical error and deleted proposed Rule 1018 in its 
entirety.
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II. Description of the Proposal

    NASD Regulation proposes to amend its Rule 1010 Series, which 
governs admission to NASD membership.

A. Proposed Rule 1010--Definitions

    In addition to clarifying and conforming changes to certain current 
definitions, NASD Regulation has proposed the following new 
definitions.
1. ``Material Change in Business Operations''
    NASD Regulation has proposed to define of the phrase ``material 
change in business operations'' in proposed Rule 1011(i). As proposed, 
a ``material change in business operations'' shall include, but not be 
limited to, removing or modifying a membership agreement restriction; 
market making, underwriting, or acting as a dealer for the first time; 
or adding business activities that require a higher minimum net 
capital. This proposed definition is significant because it will 
require a member to apply to its district office for approval of a 
material change in business operations pursuant to proposed Rule 1017.
    In conjunction with the proposed definition, NASD Regulation has 
proposed Interpretative Material 1011-1 (IM-1011-1) to create a safe 
harbor for certain business expansions that will not be presumed to be 
material, and therefore will not require a member to submit an 
application for approval of the proposed expansion pursuant to proposed 
Rule 1017. The safe harbor would not be available to members that have 
a disciplinary history, which is proposed to be defined as a finding of 
a violation by the member or a principal of the member in the past five 
years by the SEC, a self-regulatory organization, or a foreign 
regulatory authority of one or more of the following provisions (or 
comparable foreign provisions) or rules or regulations thereunder: 
Sections 15(b)(4)(E) \6\ and 15(c) \7\ of the Act (failure to 
supervise; fraud and manipulation); section 17(a) \8\ of the Securities 
Act of 1933 (fraudulent interstate transactions); Exchange Act Rule 
10b-5 \9\ (fraud and manipulation); Exchange Act Rules 15g-1 through 
15g-9 \10\ (penny stock rules); NASD Rules 2110 (just and equitable 
principles of trade), 2120 (fraud and manipulation), 2310 
(suitability), 2330 (protection of customer securities and funds), 2440 
(fair prices and commissions), 3010 (failure to supervise), 3310 
(manipulative and deceptive quotations), 3330 (payments to influence 
market prices); and MSRB Rules G-19 (suitability), G-30 (prices and 
commissions), and G-37 (b) and (c) (political contributions).
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    \6\ 15 U.S.C. 78o(b)(4)(E).
    \7\ 15 U.S.C. 78o(c).
    \8\ 15 U.S.C. 78q(a).
    \9\ 17 CFR 240.10b-5.
    \10\ 17 CFR 240.15g-1 through 15g-9.
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    Further, because NASD Regulation cannot predict and draft an 
exhaustive definition of all changes that may in fact be material, if a 
change in a member's business falls outside of the definition, or the 
safe harbor (e.g., because the change exceeds the safe harbor limits or 
because the member has a disciplinary history), members may contact 
their NASD district office to inquire as to whether the district would 
deem the change to be material. A member is not required, however, to 
contact the district office if the member believes that a change would 
not be considered material. If the staff later determines that a change 
is indeed material, then the member could potentially be subject to 
disciplinary action for failure to file an application under proposed 
Rule 1017.
2. ``Principal Place of Business''
    NASD Regulation has proposed to define the phrase ``principal place 
of business'' for purposes of clarifying where an Applicant's \11\ 
application will be processed, in proposed Rule 1011(l). As proposed, 
an Applicant's principal place of business shall be the location where 
the officers, partners, or managers direct and control the activities 
of the Applicant, unless NASD Regulation staff designates a different 
location, which may be where the largest number of associated persons 
are located or

[[Page 51378]]

where the books and records of the member are kept.
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    \11\ The term Applicant is defined as a person that applies for 
membership in the Association under Rule 1013 or a member that files 
an application for approval of a change in ownership, control, or 
business operations under Rule 1017. See Rule 1011(a).
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3. ``Sales Practice Event''
    NASD Regulation has proposed to change the phrase ``sales practice 
violations'' to ``sales practice event'' and to amend the current 
definition in proposed rule 1011(m). As amended, the phrase sales 
practice event will include not only proven violations, but also 
unproven allegations.\12\ The proposed definition will include any 
customer complaint, arbitration, or civil litigation that has been or 
is required to be reported to the Central Registration Depository 
(``CRD'') or otherwise required to be reported to the Association 
(e.g., NASD Rule 3070).
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    \12\ NASD Regulation noted that it was not proposing any change 
to the definition of ``sales practice violation'' as that phrase is 
used on the Form U-4.
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B. Proposed Rule 1012--Filing by Applicant or Service by the 
Association

    NASD Regulation has proposed to amend the service and filing 
requirements to permit additional methods of delivery and to 
standardize how deadlines will be calculated. Specifically, the term 
``commercial courier'' has been replaced with the term ``overnight 
courier'' to clarify that Applicants and NASD Regulation may use the 
overnight delivery service offered by the United States Post Office, as 
well as any entity that regularly provides overnight delivery services, 
such as Federal Express or DHL. The use of the term overnight courier, 
however, does not imply that only actual overnight delivery may be used 
under the rule. Overnight delivery should be used if it is available, 
but if it is not available for a particular location, and Applicant or 
staff of the Department of Member Regulation of NASD Regulation 
(``Department'') may use the most rapid delivery option available from 
the overnight courier to comply with the rule.
    NASD Regulation has proposed to standardize the use of the terms 
``file'' and ``serve'' to clarify their definitions. Specifically, the 
term ``file'' will refer to submissions by an Applicant, while the term 
``serve'' will refer to delivery of requests, decisions, and the like 
by the Association.
    Proposed Rule 1012(b) contains the lapse of application provisions, 
which NASD Regulation has proposed to consolidate from current Rules 
1013(b), 1017(c), and 1018(d). The lapse provisions permit the 
Department staff to discontinue processing an application if an 
Applicant does not provide requested documents or information in a 
timely manner. In addition to consolidating the lapse provisions, NASD 
Regulation also has proposed to permit the Department staff and the 
Applicant to agree on a submission date for the membership agreement, 
rather than requiring all agreements to be submitted within 25 days. 
Finally, NASD Regulation has proposed to clarify that fees are not 
refunded for applications that are lapsed.

C. Proposed Rule 1013--New Member Application and Interview

    NASD Regulation has proposed to amend the procedures for filing a 
new member application so that the entire application will be filed in 
one location--the district office in the district where an Applicant 
intends to have its principal place of business.\13\ Once filed, the 
Department staff will review the entire application to determine if it 
is substantially complete and if so, the Department staff will forward 
the appropriate documents to the CRD.
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    \13\ See proposed Rule 1011(1).
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    In addition, NASD Regulation has proposed a new rule, proposed Rule 
1013(a)(4), setting forth procedures for applications that are not 
substantially complete at the time of submission. As proposed, if an 
application is so deficient upon submission that the Department staff 
cannot begin processing (e.g., it is missing major components of the 
application, such as written supervisory procedures or a business 
plan), the Department staff may reject the application. The Department 
staff must reject the application within 30 days of the submission of 
the application and must provide reasons for the rejection in writing. 
If an application is rejected, NASD Regulation will assess a $350 
processing fee, which shall be deducted from the application fee.
    To eliminate duplicative submissions, NASD Regulation has proposed 
to eliminate the requirement for Applicants to submit information that 
has already been submitted to CRD in proposed Rule 1013(a)(2)(L). 
Further, an Applicant will continue to submit only its initial Forms BD 
and U-4 in paper form along with the rest of the application. 
Thereafter, upon approval of an Applicant's Web CRD entitlement request 
form, pursuant to proposed Rule 1013(a)(3), an Applicant will be 
required to make all subsequent form filings and amendments 
electronically via Web CRD.\14\ In addition, the initial Member Contact 
Questionnaire and user access request form also will be submitted in 
paper form, which thereafter may be updated electronically.
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    \14\ See Securities Exchange Act Release No. 41594 (July 2, 
1999), 64 FR 37586 (July 12, 1999) (regarding SEC requirements for 
submitting BD and amendments thereto). In addition, NASD Regulation 
has proposed conforming changes to Rule 1140.
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    As part of its application, an Applicant will be required to 
provide a description of the communications and operational systems 
that it will employ to ensure business continuity, including 
information about its systems' capacity, contingency plans, disaster 
recovery plans, and the like, pursuant to proposed Rule 
1013(a)(2)(F)(xii). In addition, an Applicant will be required to 
provide NASD Regulation with its disclosures that will be provided to 
customers who use its systems as well as supervisory or customer 
protection measures that may apply to customer use of or access to its 
systems. Pursuant to proposed Rule 1014(a)(6), an Applicant's 
communications and operational systems must be adequate and provide 
reasonably for business continuity before an application for membership 
may be granted. NASD Regulation will not be required to investigate the 
adequacy of an Applicant's systems, rather the Applicant will be 
required to certify that its systems, plans, and procedures are 
adequate for the Applicant's business. The Applicant may either self-
certify or may rely on a third party (e.g., a vendor of such a system) 
to provide the certification.
    NASD Regulation has clarified that the Applicant and the Department 
staff may agree to hold the membership interview that is required 
pursuant to Rule 1013(b)(4) at the Applicant's place of business. 
Finally, NASD Regulation has proposed to amend Rule 1013(b)(5) to 
require an Applicant to provide updated financial information at the 
time of its membership interview.

D. Proposed Rule 1014--Department Decision \15\
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    \15\ The Commission notes that the Federal Register notice 
contained an incorrect subsection reference. Subsection (a)(4) 
should read as follows: ``The Applicant has established all 
contractual or other arrangements and business relationships with 
banks, clearing corporations, service bureaus, or others necessary 
to: (A) Initiate the operations described in the Applicant's 
business plan, considering the nature and scope of operations and 
the number of personnel; and (B) comply with federal securities 
laws, the rules and regulations thereunder, and the Rules of the 
Association,'' In addition, subsection (5) should have its further 
subsections labeled as (A) and (B).
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    Proposed Rule 1014 sets forth the standards for admission to 
membership. In addition to the proposed new business continuity 
standard, as

[[Page 51379]]

discussed above, NASD Regulation has proposed that an Applicant's 
supervisory procedures specifically include procedures to ensure that 
the firm obtains proper registrations for its associated persons.
    Proposed Rule 1014(d), which concerns the submission of membership 
agreements, has been amended so that the requirement that any member 
with a membership agreement obtain approval from NASD Regulation of any 
change in its business that would be outside of the terms of agreement 
has been deleted.\16\ In addition, upon approval of this proposed rule 
change, NASD Regulation will permit members that are eligible for the 
safe harbor, IM-1011-01, to use it even if their membership agreement 
includes a general requirement to obtain approval from NASD Regulation 
of any change in business outside the terms of the agreement.
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    \16\ NASD Regulation noted that many members have been admitted 
without executing a membership agreement because NASD Regulation 
only began requiring all members to execute membership agreements in 
1997. See Securities Exchange Act Release No. 38908 (August 7, 
1997), 62 FR 43385 (August 13, 1997). Therefore, according to NASD 
Regulation, members with a membership agreement may be at a 
disadvantage when seeking to change their business compared to 
members that have been admitted without a membership agreement.
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E. Proposed Rule 1015--Review by National Adjudicatory Council

    NASD Regulation has proposed to delete the provision whereby the 
National Adjudicatory Council (``NAC'') or a Review Subcommittee may 
call for the review of a decision on a membership application made by 
the Department staff, even if the Applicant does not appeal the 
decision. In addition, new paragraph (h) regarding dismissing appeals 
that have been abandoned by an Applicant has been proposed. Pursuant to 
proposed Rule 1015(h), if an Applicant fails to specify the grounds for 
its request for review, appear at a hearing, or file information or 
briefs as directed, the NAC or Review Subcommittee may dismiss the 
request for review as abandoned.

F. Proposed Rule 1017--Application for Approval of Change in Ownership, 
Control, or Business Operations

    Proposed Rule 1017 will contain provisions regarding applications 
for removal or modification of a business restriction, as well as, 
provisions regarding applications for approval of changes in ownership, 
control, or operations.
    Pursuant to proposed Rule 1011(i), a material change in business 
operations includes the removal or modification of a business 
restriction. In addition, all material changes in business operations 
will trigger the requirement for a review under proposed Rule 1017. 
NASD Regulation noted that a restriction contained in a membership 
agreement is specifically labeled as such and is accompanied by a 
decision issued by NASD Regulation setting forth the rationale for the 
restriction. A restriction is distinct from other limitations that may 
be set forth in a member's business plan and may be recited in the 
``Business Activities'' section of the membership agreement. These 
limitations are not considered ``restrictions'' under the rules because 
NASD Regulation does not impose them. Therefore, a member may expand 
beyond those limitations to the extent permitted in the safe harbor set 
forth in IM-1011-1 without having to apply to NASD Regulation for 
approval.
    In contrast, NASD Regulation may impose specific restrictions in a 
membership agreement. If a member wishes to modify such restrictions, 
it must seek NASD Regulation approval pursuant to proposed Rule 1017, 
and thus will not be able to utilize the safe harbor found in IM-1011-
1.
    In addition, NASD Regulation has proposed to discontinue its review 
of certain changes, such as mergers and acquisitions by members that 
are reviewed by the New York Stock Exchange (``NYSE''). Proposed Rule 
1017 also sets forth the type of information to be included in an 
application and the content of the Department staff's decision 
regarding an application. Further, proposed Rule 1017 clarifies when an 
application should be filed and what changes can be effected prior to 
obtaining NASD Regulation's approval.
    Proposed Rule 1017(k) clarifies the procedures to be followed in 
the event that a change in ownership application lapses or is denied. 
In such instances, an Applicant has a fixed period of time to submit a 
new application; \17\ unwind the transaction, or file a Form BDW. The 
Department may shorten the 60-day period for the protection of 
investors or lengthen it upon good cause shown by the Applicant. During 
the 60-day period, the Department may continue to place interim 
restrictions on the member.
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    \17\ A lapsed Applicant may propose the same owners; a denied 
Applicant must propose new owners.
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III. Discussion

    Upon careful review, 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.\18\ Specifically, the Commission finds that the proposed 
ruel change is consistent with Section 15A(b)(6),\19\ which requires, 
among other things, that the rules of an association be designed to 
prevent fraudulent and manipulative acts and practices, to promote just 
and equitable principles of trade, and in general, to protect investors 
and the public interest.
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    \18\ In approving this proposal, the Commission has considered 
its impact on efficiency, competition, and capital formation. 15 
U.S.C. 78c(f).
    \19\ 15 U.S.C. 78o-3(b)(6).
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    The Commission believes that the changes proposed by NASD 
Regulation relating to the admission of members to be consistent with 
the Act because they clarify the process by which persons may apply for 
membership and the process by which current members may change the 
terms of their membership. For example, NASD Regulation has proposed to 
specifically define the phrase material change in business operations 
to enable members to determine when changes to their business structure 
require the prior approval of NASD Regulation, pursuant to proposed 
Rule 1017. As defined, a material change in business operations 
includes removing or modifying a membership agreement restriction; 
market marking, underwriting or acting as a dealer for the first time; 
or adding business activities that require a higher minimum net 
capital. Each of these examples of material changes in business 
operations has significant investor protection considerations. For 
example, in granting membership, NASD Regulation may determine to limit 
the activities of a member, which is set forth as a restriction in the 
membership agreement. These restrictions are based upon findings made 
by NASD Regulation that it believes are necessary for the member to 
engage in business consistent with the Act. Thus, the Commission 
believes that it is reasonable for NASD Regulation to review any change 
to the restriction.
    Further, engaging in market making, underwriting, or acting as a 
dealer involves many complex regulatory issues, including ensuring that 
the public interest is protected. Moreover, activities that would lead 
to an increase in a member's net capital requirements would also raise 
investor protection concerns. The Commission believes that it is in the 
public interest for NASD Regulation to review these changes in its 
members' business structure. NASD Regulation has regulatory

[[Page 51380]]

responsibilities over its members and it must ensure that its members' 
businesses operate in a manner that is consistent with the requirements 
of the Act. Further, the Commission believes that NASD Regulation 
should review its members with respect to these issues to prevent 
members from expanding beyond their capabilities to the detriment of 
the markets and investors.
    In conjunction with the new definition of material change in 
business operations, NASD Regulation has also proposed a safe harbor 
for certain types of changes in business operations. Specifically, a 
member can increase the number of associated persons involved in sales 
or increase the number of offices it operates or increase the number of 
markets made by the member without having to submit an application 
pursuant to proposed Rule 1017 so long as the increases fall within the 
specified limits. The Commission believes that the safe harbor should 
increase NASD Regulation's, as well as its members', operational 
efficiency without sacrificing regulatory interests.
    NASD Regulation has also proposed changes to Rule 1017 regarding 
applications for approval of changes in ownership, control or business 
operations. In its proposal, NASD Regulation clarified the difference 
between a restriction, which is subject to NASD Regulations' review and 
approval, and a limitation, which may be set forth in the Business 
Activities section of a membership agreement and thus not required to 
be reviewed by NASD Regulation if the safe harbor applies. The 
Commission finds that this clarifies NASD Regulation's oversight 
responsibilities with respect to restrictions and limitations and 
should enhance the ability of its members to operate efficiently within 
the requirements of NASD Regulation's rules. Further, this 
clarification should assist members in determining whether they are 
eligible to utilize the safe harbor for their planned business changes.
    In addition, proposed Rule 1017 makes the application process for 
changes in a member's structure more efficient by discontinuing NASD 
Regulation's review of certain changes that are already reviewed by the 
NYSE. This change eliminates duplicative oversight. The Commission 
believes that the NYSE, as part of its self-regulatory 
responsibilities, should be able to sufficiently review such 
transactions to ensure that they comply with the requirements of the 
Act.
    In proposed rule 1014, NASD Regulation proposed to require as a 
condition for membership that an Applicant provide supervisory 
procedures that include procedures that ensure that proper 
registrations are obtained by the firm. This new requirement should 
ensure that associated persons are adequately trained and supervised, 
which should enhance investor protections.
    In addition, NASD Regulation has proposed as a condition of 
admission that firms certify that their systems, plans, and procedures 
are adequate for the firm's business. Thus, as part of its application, 
an Applicant will be required to provide a description of its 
communications and operational systems that will be employed to ensure 
business continuity, including information about systems' capacity, 
contingency plans and disaster recovery plans. NASD Regulation will use 
this information to determine, pursuant to proposed Rule 1014(a)(6), 
whether an Applicant's communications and operational systems are 
adequate and provide reasonably for business continuity such that the 
applicant has met the standard for admission to membership. The 
Commission finds that this new requirement is consistent with the Act 
and furthers just and equitable principles of trade and should enhance 
protections for investors. Today, technology is a driving force in the 
markets. As never before, many firms utilize and rely on technology to 
perform many roles, such as accepting and routing of customer orders 
for execution. Thus, it is more important than ever that the technology 
used by firms be able to operate and have sufficient capacity to carry 
out its stated functions. Today, a technology failure can have 
significant consequences both for the customer and the firm. Thus, the 
Commission believes that it is imperative that NASD Regulation seek to 
ensure that its members have the systems capabilities to operate in a 
fashion that is consistent with the requirements of the Act.
    Finally, in proposed Rule 1014(d), NASD Regulation has proposed to 
delete the requirement that members with membership agreements obtain 
NASD Regulation's approval of any change outside of the membership 
agreement. The Commission believes that this provision may have given 
an unfair advantage to those members that do not have a membership 
agreement.\20\ The Commission believes that the proposed definition of 
material change in business operations along with the safe harbor 
should provide members with the ability to expand their business 
without raising investor protection concerns. Further, these provisions 
provide NASD Regulation with sufficient tools to oversee its members' 
business operations.
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    \20\ See supra note 16.
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    In conclusion, the Commission finds that the proposal is consistent 
with the requirements of the Act. The proposal, in general, clarifies 
and organizes the rules in a manner that should be beneficial to 
members and potential members. Further, the proposed changes should 
enhance the ability of NASD Regulation to implement its regulatory 
objectives in a fair and efficient manner.
    The Commission finds good cause for approving Amendment No. 2 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice in the Federal Register. In Amendment No. 2, the 
NASD Regulation deleted proposed Rule 1018. Therefore, this portion of 
the proposed rule change is no longer subject to Commission review. In 
addition, NASD Regulation corrected a typographical error. Therefore, 
because Amendment No. 2 does not raise any regulatory concerns, the 
Commission finds good cause for accelerating approval of Amendment No. 
2 to the proposed rule change.

IV. Conclusion

    It Is Therefore Ordered, pursuant to section 19(b)(2) \21\ of the 
Act, that the proposed rule change (SR-NASD-99-67) is hereby approved.
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    \21\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\22\
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    \22\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-21430 Filed 8-22-00; 8:45 am]
BILLING CODE 8010-01-M