[Federal Register Volume 67, Number 29 (Tuesday, February 12, 2002)]
[Notices]
[Pages 6562-6565]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-3298]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45361; File No. SR-MSRB-2002-01]


Self-Regulatory Organizations; Municipal Securities Rulemaking 
Board; Notice of Filing of Proposed Rule Change Relating to Rule G-17, 
on Disclosure of Material Facts

January 30, 2002.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby 
given that on January 25, 2002 the Municipal Securities Rulemaking 
Board (``MSRB'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by the MSRB. The 
Commission is publishing this notice 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.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

Interpretive Notice Regarding Rule G-17, on Disclosure of Material 
Facts

    Rule G-17, the MSRB's fair dealing rule, encompasses two general 
principles. First, the rule imposes a duty on dealers \3\ not to engage 
in deceptive, dishonest, or unfair practices. This first prong of rule 
G-17 is essentially an antifraud prohibition.
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    \3\ The term ``dealer'' is used in this interpretive notice as 
shorthand for ``broker,'' ``dealer'' or ``municipal securities 
dealer,'' as those terms are defined in the Exchange Act. The use of 
the term in this interpretive notice does not imply that the entity 
is necessarily taking a principal position in a municipal security.
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    Second, the rule imposes a duty to deal fairly. Statements in the 
MSRB's filing for approval of rule G-17 and the Commission's order 
approving the rule note that rule G-17 was implemented to establish a 
minimum standard of fair conduct by dealers in municipal securities. In 
addition to the basic antifraud prohibitions in the rule, the duty to 
``deal fairly'' is intended to ``refer to the customs and practices of 
the municipal securities markets, which may, in many instances differ 
from the corporate securities markets.'' \4\ As part of a dealer's 
obligation to deal fairly, the MSRB has interpreted the rule to create 
affirmative disclosure obligations for dealers. The MSRB has stated 
that dealer's affirmative disclosure obligations require that a dealer 
disclose, at or before the sale of municipal securities to a customer, 
all material facts concerning the transaction, including a complete 
description of the security.\5\ These obligations apply even when a 
dealer is acting as an order taker and effecting non-recommended 
secondary market transactions.
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    \4\ See Exchange Act Release No. 13987 (Sept. 22, 1977).
    \5\ See e.g., Rule G-17 Interpretation--Educational Notice on 
Bonds Subject to ``Detachable'' Call Features, May 13, 1993, MSRB 
Rule Book (July 2001) at 129-130. The Commission described material 
facts as those ``facts which a prudent investor should know in order 
to evaluate the offering before reaching an investment decision.'' 
Municipal Securities Disclosure, Exchange Act Release No. 26100 
(Sept. 22, 1988) (the ``1988 SEC Release'') 53 FR 37778 at note 76, 
quoting In re Walston & Co. Inc., and Harrington, Exchange Act 
Release No. 8165 (Sept. 22, 1967) 43 SEC 508, 1967 SEC LEXIS 553. 
Furthermore, the United States Supreme Court has stated that a fact 
is material if there is a substantial likelihood that its disclosure 
would have been considered significant by a reasonable investor. TSC 
Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976).
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    Rule G-17 was adopted many years prior to the adoption of the 
Exchange Act's Rule 15c2-12. The development of the NRMSIR system,\6\ 
the MSRB's Municipal Securities Information Library 
(MSIL) system \7\ and

[[Page 6563]]

Transaction Reporting System (``TRS''),\8\ rating agencies and 
indicative data sources in the post-Rule 15c2-12 era have created much 
more readily available information sources. Recently, the market has 
made progress and market professionals (including institutional 
investors) can, and do, go to these industry sources to find securities 
descriptive information, official statements, rating agency ratings and 
reports, and ongoing disclosure information. These developments suggest 
a need for further explanation of what ``disclosure of all material 
facts'' means in today's market.
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    \6\ For purposes of this notice, the ``NRMSIR system'' refers to 
the disclosure dissemination system adopted by the Commission in 
Rule 15c2-12. Under Rule 15c2-12, as adopted in 1989, participating 
underwriters provide a copy of the final official statement to a 
NRMSIR to reduce their obligation to provide a final official 
statement to customers. In the 1994 amendments to Rule 15c2-12, the 
Commission determined to require that annual financial information 
and audited financial statements submitted in accordance with issuer 
undertakings must be delivered to each NRMSIR and to the State 
Information Depository (``SID'') in the issuer's state, if such 
depository has been established. The requirement to have annual 
financial information and audited financial statements delivered to 
all NRMSIRs and the appropriate SID was included in Rule 15c2-12 to 
ensure that all NRMSIRs receive disclosure information directly. 
Under the 1994 amendments, notices of material events, as well as 
notices of a failure by an issuer or other obligated person to 
provide annual financial information, must be delivered to each 
NRMSIR or the MSRB, and the appropriate SID.
    \7\ The MSIL system collects and makes available to 
the marketplace official statements and advance refunding documents 
submitted under MSRB rule G-36, as well as certain secondary market 
material event disclosures provided by issuers under Rule 15c2-12. 
Municipal Securities Information Library and 
MSIL are registered trademarks of the MSRB.
    \8\ The MSRB's TRS collects and makes available to the 
marketplace information regarding inter-dealer and dealer-customer 
transactions in municipal securities.
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    Rule G-17 requires that dealers disclose to a customer at the time 
of trade all material facts about a transaction known by the dealer. In 
addition, a dealer is required to disclose material facts about a 
security when such facts are reasonably accessible to the market. Thus, 
a dealer would be responsible for disclosing to a customer any material 
fact concerning a municipal securities transaction made publicly 
available through sources such as the NRMSIR system, the MSIL 
system, TRS, rating agency reports and other sources of information 
relating to the municipal securities transaction generally used by 
dealers that effect transactions in the type of municipal securities at 
issue (collectively, ``established industry sources'').\9\
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    \9\ Dealers operating electronic trading platforms have inquired 
whether providing electronic access to material information is 
consistent with the obligation to disclose information under Rule G-
17. The MSRB believes that the provision of electronic access to 
material information to customers who elect to transact in municipal 
securities on an electronic platform is generally consistent with a 
dealer's obligation to disclose such information, but that whether 
such access is effective disclosure ultimately depends upon the 
particular facts and circumstances present.
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    The customs and practices of the industry suggest that the sources 
of information generally used by a dealer that effects transactions in 
municipal securities may vary with the type of municipal security. For 
example, a dealer might have to draw on fewer industry sources to 
disclose all material facts about an insured ``triple-A'' rated general 
obligation bond than for a non-rated conduit issue. In addition, to the 
extent that a security is more complex, for example, because of complex 
structure or where credit quality is changing rapidly, a dealer might 
need to take into account a broader range of information sources prior 
to executing a transaction.
    With respect to primary offerings of municipal securities, the 
Commission has noted, ``By participating in an offering, an underwriter 
makes an implied recommendation about the securities.'' The Commission 
stated, ``This recommendation itself implies that the underwriter has a 
reasonable basis for belief in the truthfulness and completeness of the 
key representations made in any disclosure documents used in the 
offerings.'' \10\ Similarly, if a dealer recommends a secondary market 
municipal securities transaction, rule G-19 requires a dealer to ``have 
reasonable grounds for the recommendation in light of information 
available from the issuer or otherwise.'' \11\ If this ``reasonable 
basis'' suitability cannot be obtained from the established industry 
sources, then further review may be necessary before making a 
recommendation. To the extent that such review elicits material 
information that would not have become known through a review of 
established industry sources, dealers recommending transactions would 
be obligated to disclose such information in addition to information 
available from established industry sources.
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    \10\ 1988 SEC Release at text following note 70. The Commission 
also stated that an underwriter must review the issuer's disclosure 
documents for possible inaccuracies and omissions. In the case of a 
negotiated offering, the Commission expects the underwriter to make 
an inquiry into the key representations included in the disclosure 
materials. In the case of a competitive offering, the Commission 
acknowledges that the underwriter may have more limited 
opportunities to undertake such a review and investigation but 
nonetheless is obligated to take appropriate actions under the 
particular facts and circumstances of such offering.
    \11\ See e.g., Rule G-19 Interpretation'Notice Concerning the 
Application of Suitability Requirements to Investment Seminars and 
Customer Inquiries Made in Response to a Dealer's Advertisement, May 
7, 1985 MSRB Rule Book (July 2001) at 134; In re F.J. Kaufman and 
Company of Virginia, 50 S.E.C. 164, 168, 1989 SEC LEXIS 2376, *10 
(1989) (discussing ``reasonable basis'' suitability).
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II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the MSRB 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. The MSRB has prepared summaries, set forth in Sections 
A, B, 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

    In May 2000, the MSRB-hosted a roundtable discussion about the use 
of electronic trading systems in the municipal securities market. 
Industry discussion at the roundtable, as well as subsequent comments, 
made it apparent that the municipal securities market, like the equity 
market, is in the process of developing alternative models of trading 
relationships between dealers and customers.
    Based on the comments from the industry as well as the MSRB's 
review of market developments, the MSRB concluded that in order for 
innovation to occur, the industry needed interpretive guidance on the 
application of certain rules to these new trading methodologies. 
Alternative trading systems present the most graphic example of 
changing dealer/customer relationships and consequent need for 
regulatory change, but the changing relationships are not necessarily 
limited to electronic trading venues.
    The MSRB proposed the original sophisticated market professional 
(``SMP'') concept in guidance that was published for comment in 
September 2000 (``2000 Notice'') to illustrate how different fair 
practice rules would operate when dealers were transacting with 
sufficiently sophisticated market professionals. When the 2000 Notice 
was released for comment, several institutional investors raised 
concerns about the appropriateness of the guidance in light of the 
municipal securities disclosure regime. For example, investors asserted 
that the duty of a dealer to disclose all material information under 
rule G-17 is necessary because it cannot be presumed that an investor, 
however sophisticated, has access to all information that has been 
gathered by or is available to a dealer. Investors also noted that, 
like retail investors, institutional investors struggle to get the 
necessary disclosures in the municipal securities market and that a 
dealer, by virtue of its relationship with the issuer, may possess 
information that is material but unavailable to the investor on a 
timely basis.
    The MSRB believes that these concerns are valid, but that they 
overstate the scope of a dealer's rule G-17 obligations. In order to 
attempt to alleviate investors' concerns about the SMMP concept's 
application to rule G-17, the new rule G-17 interpretive notice 
includes an expanded explanation of what rule G-17's

[[Page 6564]]

obligation to ``disclose all material facts'' means in today's market.
    Investors' comment letters suggest that they have interpreted rule 
G-17's affirmative disclosure obligations too broadly by implying that 
a dealer always has an obligation to ``acquire'' all material 
information about a municipal security before effecting a customer 
transaction. Rule G-17 requires that dealers disclose to a customer at 
the time of trade all material facts about a transaction known by the 
dealer. In addition, a dealer is required to disclose material facts 
about a security when such facts are reasonably accessible to the 
market. Thus, a dealer would be responsible for disclosing to a 
customer any material fact concerning a municipal security transaction 
made publicly available through sources such as the NRMSIR system, the 
MSIL system, TRS, rating agency reports and other sources of 
information relating to the municipal securities transaction generally 
used by dealers that effect transactions in the type of municipal 
securities at issue (collectively, ``established industry sources''). 
In other words, if a material fact is known by the dealer or available 
from an established industry source and the dealer did not disclose 
such fact to its customer, then the dealer could be found to have 
violated rule G-17.\12\
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    \12\ Concurrently with this filing, the MSRB is filing with the 
Commission an interpretive notice regarding dealers' obligations 
when effecting transactions for sophisticated municipal market 
professionals (``SMMPs''). See infra note 13 and Filing No. SR-MSRB-
2002-02. Once the SMMP notice is approved, dealers who effect non-
recommended secondary market transactions for SMMP customers will 
not be obligated to affirmatively disclose the information available 
from established industry sources to their SMMP customers. However, 
as in the case of an inter-dealer transaction, in a transaction with 
an SMMP, a dealer's intentional withholding of a material fact about 
a security, where the information is not accessible through 
established industry sources, may constitute an unfair practice 
violative of rule G-17. In addition, a dealer may not knowingly 
misdescribe securities to the customer. A dealer's duty not to 
mislead its customers is absolute and is not dependent upon the 
nature of the customer.
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    The MSRB believes the proposed rule change is consistent with 
section 15B(b)(2)(C) of the Exchange Act, which provides that the 
MSRB's rules shall:

 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 in municipal securities, and, in general, to protect 
investors and the public interest.

    The MSRB believes that the proposed rule change is consistent with 
this standard in that it will clarify that a dealer's general 
obligations to provide disclosure about a municipal security is viewed 
within the context of reasonably available information about the 
municipal security and the dealer's actual knowledge of the municipal 
security.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Board does not believe that the proposed rule change will 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Exchange Act, since it would apply 
equally to all brokers, dealers and municipal securities dealers.

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

    On July 6, 2001, the MSRB published a Notice and Draft Interpretive 
Guidance concerning two related topics (``2001 Notice'').\13\ The first 
notice concerns rule G-17 and the disclosure of material facts. The 
second concerns sophisticated municipal market professionals. The MSRB 
invited public comments on all aspects of the 2001 Notice.\14\ In 
response to the 2001 Notice, the MSRB received eight comment 
letters.\15\ Four of those comment letters addressed the Rule G-17 
Notice.\16\ The comment letters ask for some modification to the rule 
G-17 interpretation, but in general seemed to ``welcome and concur with 
the MSRB's statements regarding a dealer's obligations to ``disclose 
all material facts'' in the context of today's evolving trading 
environment.'' \17\ After reviewing the comment letters, the MSRB 
approved the revised rule G-17 interpretive notice, with certain 
modifications and additions, for filing with the Commission.
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    \13\ ``Notice and Draft Interpretive Guidance on Rule G-17--
Disclosure of Material Facts and Interpretive Guidance Concerning 
Sophisticated Municipal Market Professionals,'' MSRB Reports, Vol. 
21, No. 2 (July 2001) at 3, attached to the filing application as 
Exhibit 2.
    \14\ The 2001 Notice was a revision to guidance that was 
published in September 2000 (``the 2000 Notice''). The 2000 Notice, 
which related only to the SMP guidance, received 17 comment letters 
that were considered prior to publishing the 2001 Notice. 
Concurrently with this rule G-17 filing the MSRB is filing its SMMP 
guidance with the Commission for approval. A discussion of the 2000 
Notice and the comment letters received in response thereto is 
included in the MSRB's SMMP filing, which has been filed as File No. 
SR-MSRB-2002-02.
    \15\ Letter from Linda L. Rittenhouse, Staff, Association for 
Investment Management and Research Advocacy, to Carolyn Walsh, dated 
October 19, 2001 (``AIMR''); letter from David C. Witcomb, Jr., Vice 
President, Compliance Department, Charles Schwab & Co., Inc., to 
Carolyn Walsh, dated October 11, 2001 (``Schwab''); letter from 
Michael J. Marx, Vice Chairman, First Southwest Company, to Carolyn 
Walsh, dated October 12, 2001 (``First Southwest''); letter from Amy 
B.R. Lancellotta, Senior Counsel, Investment Company Institute, to 
Carolyn Walsh, dated October 19, 2001 (``ICI''); letter from Alan 
Polsky, Chairman, National Federation of Municipal Analysts, to 
Carolyn Walsh, dated November 13, 2001 (``NFMA''); letter from Roger 
G. Hayes, Chair, The Bond Market Association Municipal Securities 
Division E--Commerce Task Force, to Carolyn Walsh, dated October 10, 
20001 (``TBMA''); letter from Thomas S. Vales, Chief Executive 
Officer, TheMuniCenter, to Carolyn Walsh, dated October 1, 2001 
(``MuniCenter''); and letter from David Levy, Sr. Associate General 
Counsel, First Vice President, UBS Paine Webber Inc., to Carolyn 
Walsh, dated October 19, 2001 (``UBSPW'').
    \16\ See First Southwest, MuniCenter, TBMA, and UBSPW, supra 
note 15.
    \17\ UBSPW, supra note 15.
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Established Industry Sources
    Comments Received. All four of the comment letters received suggest 
that the MSRB should not identify specific repositories of information 
as ``established industry sources.'' \18\ TBMA states that `` 
`established industry sources' change frequently--especially now, as 
issuer websites and other technological advances are making new 
information sources available to our industry on a daily basis.''
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    \18\ First Southwest, MuniCenter, TBMA, and UBSPW, supra note 
15.
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    MSRB Response. By using the term ``established industry sources,'' 
the MSRB intended to alert dealers to the sources of material 
information that are considered reasonably accessible to dealers 
engaging in municipal securities transactions. The definition 
identifies the basic sources for material information concerning 
municipal securities and recognizes that for some securities there may 
be other sources of information relating to the municipal securities 
transaction that are generally used by dealers that effect transactions 
in the type of security at issue.
    While the MSRB is hopeful that technological advances will develop 
new sources of municipal securities information, the MSRB believes that 
the sources listed as established industry sources remain the 
predominant public sources of municipal securities information. 
Moreover, the definition of ``established industry sources'' was 
deliberately drafted to include additional sources that may be 
developed for certain securities. Likewise, if any of the listed 
sources of information become less relevant to the market in the 
future, the MSRB can make specific note of it at that time.
Raising the Standard of Care
    Comments Received. MuniCenter's letter suggests that the MSRB is 
``raising the standard of care'' for dealers and states that they doubt 
``that broker-

[[Page 6565]]

dealers operating in the traditional marketplace, effecting a municipal 
transaction that does not involve making a recommendation, have 
interpreted fair dealing rules to require that they discover and 
disclose information from specified sources.'' \19\
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    \19\ MuniCenter, supra note 15.
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    MSRB Response. The rule G-17 interpretive notice does not raise the 
standard of care required by dealers in non-recommended transactions 
with customers. The existing interpretive statement on rule G-17 can be 
construed, on its face, to obligate dealers to disclose all material 
information about a municipal security transaction, without regard to 
how accessible the information is to the dealer. The proposed rule 
change makes clear that the obligation of the dealer to disclose all 
material information is limited to such information that is reasonably 
accessible.
    The MSRB recognizes that at times dealers may have difficulty 
ensuring that they have taken into account all material information 
available from established industry sources when disclosing material 
information to customers. The MSRB has been working with the industry 
to improve dealers' ability to access all material information 
concerning municipal securities transactions so that dealers can better 
meet their regulatory responsibilities. However, given that the 
disclosure system is currently not as accessible to most customers as 
it is to dealers, the MSRB continues to believe that dealers must be 
responsible for disclosing information available from established 
industry sources to customers.\20\
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    \20\ The MSRB's proposed SMMP interpretive notice acknowledges 
that certain customers (i.e., SMMPs) have access to established 
industry sources and would allow dealers to effect non-recommended 
secondary market transactions with SMMPs without making the 
affirmative disclosures required under rule G-17. See File No. S-
MSRB-2002-02.
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Providing Electronic Access
    Comments Received. MuniCenter is concerned that an obligation to 
disclose is ``susceptible to an interpretation that the broker-dealer 
must actually deliver or otherwise communicate all material facts 
derived from established industry sources.'' \21\ MuniCenter states 
that it believes that providing electronic access to information is 
consistent with the obligation to disclose information and would like 
confirmation of that view by the MSRB.
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    \21\ MuniCenter, supra note 15.
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    MSRB Response. The MSRB does not believe it would be appropriate 
for it to issue a blanket statement to the effect that providing 
electronic access to information always fulfills a dealer's obligation 
to disclose this information to a customer. Nevertheless, the MSRB 
believes that under appropriate facts and circumstances (e.g., the 
dealer is not shifting the cost of acquiring the information to the 
customer, the link is prominent and functioning and the link provides 
information that is comprehensible to the customer) providing 
electronic access to information is consistent with the dealer's 
disclosure obligation. Therefore, the MSRB has added a statement to the 
rule G-17 interpretive notice to the effect that the MSRB believes that 
the provision of electronic information to customers who elect to 
transact in municipal securities on an electronic platform is generally 
consistent with a dealer's obligation to disclose information, but 
whether such access constitutes effective disclosure ultimately depends 
upon the particular facts and circumstances present.

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 
change is consistent with the Exchange 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 submissions, 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 the 
filing will also be available for inspection and copying at the MSRB's 
principal offices. All submissions should refer to File No. SR-MSRB-
2002-01 and should be submitted by March 5, 2002.

    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. 02-3298 Filed 2-11-02; 8:45 am]
BILLING CODE 8010-01-P