[Federal Register Volume 65, Number 185 (Friday, September 22, 2000)]
[Notices]
[Pages 57413-57416]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-24389]



[[Page 57413]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43291; File No. SR-NASD-00-34]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. Relating 
to the Authority of the Director of Arbitration to Remove Arbitrators 
for Cause

September 14, 2000.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on June 13, 2000, the National Association of Securities Dealers, Inc. 
(``NASD'' or ``Association''), through its wholly owned subsidiary NASD 
Dispute Resolution, Inc. (``NASD Dispute Resolution''), filed with the 
Securities and Exchange Commission (``Commission'' or ``SEC'') the 
proposed rule change as described in Items I, II, and III below, which 
Items have been prepared by NASD Dispute Resolution. On July 28, 2000, 
NASD Dispute Resolution submitted Amendment No. 1 to the proposed rule 
change.\3\ The Commission is publishing this notice of the rule change, 
as amended, to solicit comments on the proposed rule change from 
interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Jean I. Feeney, Special Advisor to the 
President, NASD Dispute Resolution, to Katherine A. England, 
Assistant Director, Division of Market Regulation (``Division''), 
Commission, dated July 27, 2000. In Amendment No. 1, NASD Regulation 
clarifies certain portions of the description of the proposed rule 
change and makes technical amendments to the text of the proposed 
rule language.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    NASD Dispute Resolution proposes to amend NASD Rules 10308 and 
10312 to provide authority for the Director of Arbitration 
(``Director'') to remove arbitrators for cause after hearings have 
begun. Below is the text of the proposed rule change. Proposed new 
language is italicized; proposed deletions are in brackets.

10000. CODE OF ARBITRATION PROCEDURE

* * * * *
10308. Selection of Arbitrators
    (a)-(c) Unchanged.
    (d) Disqualification and Removal of Arbitrator Due to Conflict of 
Interest or Bias.
    (1) Disqualification by Director
    After the appointment of an arbitrator and prior to the 
commencement of the earlier of (A) the first pre-hearing conference or 
(B) the first hearing, if the Director or a party objects to the 
continued service of the arbitrator, the Director shall determine if 
the arbitrator should be disqualified. If the Director sends a notice 
to the parties that the arbitrator shall be disqualified, the 
arbitrator will be disqualified unless the parties unanimously agree 
otherwise in writing and notify the Director not later than 15 days 
after the Director sent the notice.
    (2) [Authority of Director to Disqualify Ceases] Removal by 
Director
    After the commencement of the earlier of (A) the first pre-hearing 
conference or (B) the first hearing, the Director['s authority to] may 
remove an arbitrator from an arbitration panel [ceases] based on 
information that is required to be disclosed pursuant to Rule 10312 and 
that was not previously disclosed.
    (3) Unchanged.
    (e) Unchanged.
* * * * *
10312. Disclosures Required of Arbitrators and Director's Authority to 
Disqualify
    (a) Each arbitrator shall be required to disclose to the Director 
of Arbitration any circumstances which might preclude such arbitrator 
form rendering an objective and impartial determination. Each 
arbitrator shall disclose:
    (1) Any direct or indirect financial or personal interest in the 
outcome of the arbitration;
    (2) Any existing or past financial, business, professional, family, 
[or] social, or other relationships or circumstances that are likely to 
affect impartiality or might reasonably create an appearance of 
partiality or bias. Persons requested to serve as arbitrators should 
disclose any such relationships or circumstances that they [personally] 
have with any party or its counsel, or with any individual whom they 
have been told will be a witness. They should also disclose any such 
relationship or circumstances involving members of their families or 
their current employers, partners, or business associates.
    (b) Persons who are requested to accept appointment as arbitrators 
should make a reasonable effort to inform themselves of any interest, 
[or] relationships or circumstances described in paragraph (a) above.
    (c) The obligation to disclose interests, relationships, or 
circumstances that might preclude an arbitrator form rendering an 
objective and impartial determination described in paragraph (a) is a 
continuing duty that requires a person who accepts appointment as an 
arbitrator to disclose, at any stage of the arbitration, any such 
interests, relationships, or circumstances that arise, or are recalled 
or discovered.
    (d) Removal by Director
    [Prior to the commencement of the earlier of (1) the first pre-
hearing conference or (2) the first hearing, the]
    (1) The Director may remove an arbitrator based on information that 
is required to be disclosed pursuant to this Rule.
    (2) After the commencement of the earlier of (A) the first pre-
hearing conference or (B) the first hearing, the Director may remove an 
arbitrator based only on information not known to the parties when the 
arbitrator was selected. The Director's authority under this 
subparagraph (2) may be exercised only by the Director or the President 
of NASD Dispute Resolution.
    (e) [Prior to the commencement of the earlier of (1) the first pre-
hearing conference or (2) the first hearing, t]The Director shall 
inform the parties to an arbitration proceeding of any information 
disclosed to the Director under this Rule unless either the arbitrator 
who disclosed the information withdraws voluntarily as soon as the 
arbitrator learns of any interest, [or] relationship, or circumstances 
described in paragraph (a) that might preclude the arbitrator from 
rendering an objective and impartial determination in the proceeding, 
or the Director removes the arbitrator.
    [(f) After the commencement of the earlier of (1) the first pre-
hearing conference or (2) the first hearing, the Director's authority 
to remove an arbitrator from an arbitration panel ceases. During this 
period, the Director shall inform the parties of any information 
disclosed by an arbitrator under this Rule.]
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NASD Dispute Resolution included 
statements concerning the purpose of and basis for the proposed rule 
change and discussed any comments it received on the proposed rule 
change. The text of these statements may be examined at the places 
specified in Item IV below. NASD Dispute Resolution has prepared 
summaries, set forth in Sections A, B,

[[Page 57414]]

and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Code of Arbitration Procedure (``Code'') presently providezs 
that the authority of the Director of Arbitration to remove an 
arbitrator for cause ceases after the earlier of the first pre-hearing 
conference or the first hearing. The proposed rule change would amend 
the Code to eliminate this restriction, and to allow the Director to 
remove an arbitrator for sufficient cause shown at any juncture, where 
there is a challenge based on information not known to the parties at 
the time of the arbitrator's appointment.
2. Background and Discussion
    In order to protect the integrity of the process and to ensure the 
impartiality of arbitrators, Rule 10312(a) requires that arbitrators 
make full disclosure of certain enumerated interests, relationships, 
and circumstances, as well as ``any circumstances which might preclude 
such arbitrator from rendering an objective and impartial 
determination.'' Prior to implementation of the Neutral List Selection 
System (``list selection'') in November 1998, the Code required the 
Director to inform the parties of information disclosed by the 
arbitrator at least 15 days before the first hearing. Parties were 
allowed one peremptory challenge and unlimited challenges for cause 
under Rule 10311.\4\
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    \4\ The standard for circumstances that would be considered 
``for cause'' would be the same as the general disclosure standard 
contained in Rule 10312: ``any circumstances which might preclude 
such arbitrator from rendering an objective and impartial 
determination.''
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    Under the list selection method, Rule 10311 no longer applies. 
Rather, Rule 10308(b)(6) requires the Director to send the parties the 
employment history and other background information about the 
arbitrators on their lists. The parties may request additional 
information. Then, as provided in Rule 10308(c), they may strike 
arbitrators from the list for any reason, and rank those who remain. 
The Director (or his staff)\5\ consolidates the parties' lists in 
ranking order and, if the number of arbitrators available to serve from 
the consolidated list is not sufficient to fill a panel, the Director 
uses NLSS to extend the list and appoints one or more additional 
arbitrators to complete the panel. Parties receive information about 
any arbitrators appointed by extending the list, and have the right to 
object as provided in Rule 10308(d)(1), which is similar to the former 
challenge for cause procedure under Rule 10311.
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    \5\ Rule 10103 provides that the duties and functions of the 
director may be delegated, as appropriate.
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    Rule 10308(c)(4)(A) provides that the Director appoints arbitrators 
``subject to availability and disqualification.'' ``Availability'' 
refers to the arbitrator's ability to serve on the case in the desired 
location during the relevant time period. ``Disqualification'' could 
occur either when a disqualifying fact is revealed to the Director 
after the parties have completed the striking and ranking process, or 
when the Director consults with a ranked candidate just prior to 
appointment and the candidate, upon hearing more case-specific 
information, reveals information that the Director's staff determines 
is a basis for disqualification. In the latter case, the Director would 
either drop the arbitrator or disclose the information to the parties.
    Under Rule 10312(c), an arbitrator's disclosure obligation 
continues throughout the arbitration. If a disqualifying fact comes to 
light after a panel has been appointed, Rules 10308(d) and 10312(d) 
permit the Director to remove an arbitrator based on such information 
before the earlier of the first pre-hearing conference or the first 
hearing.\6\ Once one of these events occurs, Rules 10308(d)(2) and 
10312(f) specifically state that the Director's authority to remove an 
arbitrator ceases.
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    \6\ Rule 10308(d) states that either the Director or a party may 
object to the continued service of the arbitrator, whereas Rule 
10312(d) does not indicate that a specific objection is required.
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    Nevertheless, Rule 10312(f) requires the Director to inform the 
parties of any potentially disqualifying information disclosed after 
the first pre-hearing or hearing session. At that point, however, a 
party can no longer use a challenge for cause to remove the arbitrator. 
Rather, the parties can only attempt to resolve the matter themselves, 
which can be difficult in the adversarial setting of an ongoing 
arbitration. The parties may agree that the arbitrator be removed, in 
which case the arbitration may continue with the two remaining 
arbitrators or a replacement may be appointed under Rule 10313. If all 
the parties do not agree, a party objecting to the continued service of 
the arbitrator may make a formal request for the arbitrator to recuse 
himself or herself; however, the arbitrator may decline the request. 
The Director may suggest that the arbitrator withdraw voluntarily, but 
may not remove the arbitrator.
    In summary, when a for-cause objection is raised after the first 
pre-hearing or hearing session, the arbitrator can only be removed 
where (1) he or she agrees to step down, or (2) all the parties agree 
that the arbitrator should be removed. Failing that, an aggrieved 
party's only recourse is to seek judicial intervention, which increases 
the party's legal expenses, and which could reduce confidence in the 
fairness and efficiency of the arbitration process.\7\
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    \7\ In Commonwealth Coatings Corp. v. Continental Casualty Co., 
393 U.S. 145, 151 (footnote omitted) (1968), which vacated an award 
because of an arbitrator's failure to disclose a business 
relationship with one of the parties, Justices White and Marshall 
noted in their concurring opinion:
    The arbitration process functions best when an amicable and 
trusting atmosphere is preserved and there is voluntary compliance 
with the decree, without need for judicial enforcement. This end is 
best served by establishing an atmosphere of frankness at the 
outset, through disclosure by the arbitrator of any financial 
transactions which he has had or is negotiating with either of the 
parties. In many cases the arbitrator might believe the business 
relationship to be so insubstantial that to make a point of 
revealing it would suggest he is indeed easily swayed, and perhaps a 
partisan of that party. But if the law requires the disclosure, no 
such imputation can arise. And it is far better that the 
relationship be disclosed at the outset, when the parties are free 
to reject the arbitrator or accept him with knowledge of the 
relationship and continuing faith in his objectivity, than to have 
the relationship come to light after the arbitration, when a 
suspicious or disgruntled party can seize on it as a pretext for 
invalidating the award. The judiciary should minimize its role in 
arbitration as judge of the arbitrator's impartiality. That role is 
best consigned to the parties, who are the architects of their own 
arbitration process, and are far better informed of the prevailing 
ethical standards and reputations within their business.
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    NASD Dispute Resolution believes that an alternative dispute 
resolution forum should be able to resolve all issues relating to an 
arbitration without forcing the parties to go to court. As presently 
written, the Code does not permit the Director to remove an arbitrator 
for cause after the first pre-hearing or hearing session has commenced, 
no matter how egregious the circumstances. Accordingly, NASD Dispute 
Resolution proposes that the Code be amended to permit the Director to 
remove an arbitrator for cause at any time, if there is a challenge to 
the arbitrator based on information not known to the parties when the 
arbitrator was appointed. In addition, NASD Dispute Resolution proposes 
certain minor language changes to clarify that both relationships and 
circumstances must be disclosed if they fit within the criteria of Rule 
10312, and that the Rule is not limited to personal relationships and 
circumstances of the arbitrator, as described in more detail below.
    NASD Dispute Resolution believes there are four major reasons for 
the proposed rule change:

[[Page 57415]]

    The present rule is no longer necessary. The present rule language 
reflects a long-standing policy of the NASD and all other SROs that 
administer securities arbitration, that the Director may not remove an 
arbitrator after the hearings have commenced. In addition, the 
Securities Industry Conference on Arbitration (SICA) adopted an 
amendment to the Uniform Code of Arbitration at its meeting on March 
14, 2000, which is analogous to this proposed rule change.\8\ That 
policy was designed, in part, to eliminate any perception that member 
firms could influence the composition of the panel after hearings have 
commenced. The proposed amendment reflects the greater acceptance that 
arbitration now enjoys. In addition, the corporate separation of the 
market and regulation functions, and the spin-off of the NASD 
Regulation Office of Dispute Resolution as a separate company \9\ 
increase the independence of the Director and diminish the need for the 
present rule.
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    \8\ Section 11 of the Uniform Code of Arbitration, Disclosures 
Required by Arbitrations, was revised to read as follows:
    (e) Once the hearings have commenced, the Director may remove an 
arbitrator based only on information required to be disclosed under 
subsection (a), not known to the parties when the arbitrator was 
selected. The Director's authority under this subsection (e) may not 
be delegated.
    \9\ See Exchange Act Release No. 41971 (Sept. 30, 1999) (File 
No. SR-NASD-99-21), 64 FR 55793 (Oct. 14, 1999), which approved 
creation of a new dispute resolution subsidiary, NASD Dispute 
Resolution, Inc. That subsidiary began operations on July 9, 2000.
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    The present rule is inconsistent with the concept of administered 
arbitration. NASD Dispute Resolution offers an ``administered'' 
arbitration system, in that the parties submit their dispute to NASD 
Dispute Resolution for complete administration of the dispute, from 
filing a claim to issuance of an award. One of the key benefits of 
administered arbitration is the ability to have all ancillary issues 
relating to the arbitration--such as removal of arbitrators for cause--
resolved without recourse to the courts. Moreover, the present rule is 
inconsistent with the approaches of other major dispute resolution 
forums, such as the American Arbitration Association (``AAA'') \10\ and 
JAMS,\11\ whose rules permit the administering organization to remove 
an arbitrator for cause at any time in the arbitration process.
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    \10\ The Commercial Dispute Resolution Procedures of the AAA 
(January 1, 1999), provides as follows:
    R-19. Disclosure and Challenge Procedure
    (a) Any person appointed as a neutral arbitrator shall disclose 
to the AAA any circumstance likely to affect impartiality or 
independence, including any bias or any financial or personal 
interest in the result of the arbitration or any past or present 
relationship with the parties or their representatives. Upon receipt 
of such information from the arbitrator or another source, the AAA 
shall communicate the information to the parties and, if it deems it 
appropriate to do so, to the arbitrator and others.
    (b) Upon objection of a party to the continued service of a 
neutral arbitrator, the AAA shall determine whether the arbitrator 
should be disqualified and shall inform the parties of its decision, 
which shall be conclusive.
    \11\ The Procedures for Securities Arbitrations Administered by 
JAMS Under the Securities Industry Conference on Arbitration Non-SRO 
Pilot Program (Website visited June 1, 2000) http://www.jamsadr.com/arbitrationrules/securitiesarab.htm#13. Disclosure, provide:
    Section 13. Disclosure and Challenge Procedure
    Any person appointed as an arbitrator must disclose to JAMS any 
circumstance likely to affect impartiality, including any bias or 
any financial or personal interest in the result of the arbitration 
or any past or present relationship with the parties or their 
representatives. Upon receipt of such information from the 
arbitrator or other source, JAMS will communicate the information to 
the parties and, if it deems it appropriate to do so, to the 
arbitrator and others. Upon objection of a party to the continued 
service of an arbitrator, JAMS will determine whether the arbitrator 
should be disqualified and will inform the parties of its decision, 
which will be conclusive.
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    The present rule invites delay and administrative disruption. The 
present rule invites delays in the process, while parties wrestle with 
the issue of for-cause challenges to sitting arbitrators, and perhaps 
seek judicial intervention. In the NASD Dispute Resolution forum, there 
have been situations in which viable for-cause challenges were raised 
after the Director's authority to remove arbitrators ceased. Under 
current rules, the Director would be unable to rule on the merits of 
such challenges, despite clear substantive grounds supporting removal, 
and the prevailing party would be subject to the risk of having the 
award vacated on grounds of evident partiality. \12\
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    \12\ Under the Federal Arbitration Act, courts may vacate 
arbitration awards for, among other reasons, ``evident partiality or 
corruption in the arbitrators.'' 9 U.S.C. Sec. 10(a)(2). See e.g., 
Wages v. Smith Barney Harris Upham & Co., 937 P.2d 715 (Ariz. Ct. 
App. 1997), in which the court vacated an award to investors of 
$950,000 plus costs and fees, where the chair of an arbitration 
panel declined to rescue himself after it was learned that he had 
represented claimants in a similar matter against a predecessor of 
the respondent firm; the court found that the arbitrator's later 
harsh rulings against respondent showed evident partiality. See also 
Schmitz v. Zilveti et al., 20 F.3d 1043, 1049 (9th Cir. 1994) (``A 
finding of evident partiality in one arbitrator generally requires 
vacatur of the arbitration award.'').
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    The arbitrator should not be the only source of information. Rule 
10312 of the Code can be interpreted to limit the Director's authority 
to challenges based on information disclosed by the arbitrator under 
that rule. This could prevent the Director from entertaining a 
challenge based on information, obtained from some other source, that 
should have been disclosed by the arbitrator. Consistent with the rules 
of other dispute resolution forums, NASD Dispute Resolution proposes to 
amend the Code to permit the Director to entertain for-cause challenges 
based on sources in addition to the arbitrator. Therefore, the proposed 
changes would allow the Director to remove an arbitrator based on 
information that is required to be disclosed pursuant to Rule 10312 and 
that was not previously disclosed.
    Some users of the arbitration forum may be concerned about giving 
more power to NASD Dispute Resolution staff to remove arbitrators who 
were selected by the parties. To address that concern, the proposed 
rule change provides that the only persons who can remove arbitrators 
under the proposed amendments will be the Director and the President 
(following the spin-off), to whom he reports. This authority cannot be 
delegated. In addition, as discussed above, removal can only be based 
on information that was required to be disclosed pursuant to Rule 10312 
and that was not known to the parties at the time the arbitrator was 
appointed.
b. Description of Proposed Amendments
    NASD Dispute Resolution proposes to amend Rule 10308, the list 
selection rule, to provide that the authority of the Director to 
disqualify or remove arbitrator does not end when the first pre-hearing 
or hearing session begins. Rather, proposed Rule 10308(b)(2) provides 
that, after that first session, the Director may remove an arbitrator 
from an arbitration panel based on information that is required to be 
disclosed pursuant to Rule 10312 and that was not previously disclosed.
    NASD Dispute Resolution proposes to amend Rule 10312, the 
arbitrator disclosure rule, in several places. NASD Dispute Resolution 
proposes to amend Rule 10312(a)(2) to include any existing or past 
financial, business, professional, family, social, or other 
relationships or circumstances that are likely to affect impartiality 
or might reasonably create an appearance of partiality or bias. NASD 
Dispute Resolution proposes to delete the word ``personally'' from Rule 
10312(a)(2), as it might be read too narrowly, and to add the phrase 
``or circumstances'' to paragraphs (b) and (e) of Rule 10312. This will 
clarify that the arbitrator is required to disclose any relationships 
or circumstances that might fit under Rule 10312. \13\
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    \13\ The deletion of the word ``personally'' was also made to 
the Uniform Code of Arbitration at SICA's March 14, 2000 meeting. 
See supra note 8. The word ``addition'' was removed from this 
sentence and replaced with the word ``deletion.'' Telephone 
conversation between Jean I. Feeney, Special Advisor to the 
President, NASD Dispute Resolution, and Joseph Corcoran, Attorney, 
Division, Commission, on September 14, 2000.

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[[Page 57416]]

    NASD Dispute Resolution also proposes to amend Rule 10312 to 
provide, as in Rule 10308, that the Director's authority to remove 
arbitrators does not cease with the first pre-hearing or hearing 
session. There are two restrictions on the exercise of this authority, 
however, once such sessions have begun. Proposed Rule 10312(d)(2) 
provides that, after the earlier of the first pre-hearing conference or 
the first hearing, the Director may remove an arbitrator based only on 
information not known to the parties when the arbitrator was selected. 
This provision is intended to prevent parties from raising challenges 
late in the process which could have been raised at the outset. Rule 
10312(d)(2) also will provide that the Director's authority under this 
subparagraph may only be exercised by the Director or by the President 
of NASD Dispute Resolution. \14\
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    \14\ Id.
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    Finally, NASD Dispute Resolution proposes to amend Rule 10312(e) 
consistently with the above changes, to delete language limiting the 
time within which the Director may remove arbitrators for cause; and 
Rule 10312(f) is deleted as no longer necessary in light of the 
proceeding changes.
2. Statutory Basis
    NASD Dispute Resolution believes that the proposed rule change is 
consistent with the provisions of section 15A(b)(6) of the Act,\15\ 
which 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, and, in general, to 
protect investors and the public interest. The NASD believes that the 
proposed rule change will protect the public interest by providing a 
procedure to remove an arbitrator for sufficient cause shown at any 
time in an arbitration, where the challenge is based on information not 
known to the parties at the time of the arbitrator's appointment.
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    \15\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD Dispute Resolution does not believe that the proposed rule 
change will result in any burden on competition that it not necessary 
or appropriate in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
is consistent with the Act. Persons making written submissions should 
file six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. 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 in the Commission's 
Public Reference Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the NASA. All 
submissions should refer to File No. SR-NASD-00-34 and should be 
submitted by October 13, 2000.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-24389 Filed 9-21-00; 8:45 am]
BILLING CODE 8010-01-M