[Federal Register Volume 67, Number 72 (Monday, April 15, 2002)]
[Notices]
[Pages 18285-18289]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-9061]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45712; File No. SR-PCX-2001-13]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by the Pacific Exchange, Inc. 
Relating to Its Auto-Ex System

April 9, 2002.
    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 January 30, 2002, the Pacific Exchange, Inc. (``PCX'' or 
``Exchange'') 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 the 
Exchange. PCX submitted Amendment No. 1 to the proposed rule change on 
April 9, 2002.\3\ The Commission is publishing this notice to solicit 
comments on the proposed rule change, as amended, from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the Exchange proposed the following: (1) 
To add rule text and a purpose statement discussion specifying the 
circumstances necessary for declaring away markets unreliable and 
the procedures to be followed in making such declarations; (2) to 
delete language from the rule text and purpose statement that 
defines unusual market conditions as including ``other situations 
that create unusual trading conditions;'' (3) amend the definition 
of large influx of orders to include an extraordinarily large 
options order on the PCX in place of the prior language that 
referred to an extraordinarily large order on an options exchange; 
and (4) to delete language from the rule text and purpose statement 
that describes the underlying quote feed as unreliable when there is 
no response to orders to buy or sell the underlying stock, or when 
Market Makers are unable to manually update their quotes. See letter 
from Cindy Sink, Senior Attorney, Regulatory Policy, PCX, to Deborah 
L. Flynn, Assistant Director, Division of Market Regulation, 
Commission, dated April 8, 2002 (``Amendment No. 1'').
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Exchange proposes rule changes that describe circumstances and 
Exchange procedures for disengaging the Exchange's Automatic Execution 
System for Options (``Auto-Ex'') and increasing or decreasing Auto-Ex 
order size. The proposed changes include a procedure for documenting 
circumstances in which Auto-Ex is disengaged or the eligible order size 
is increased or decreased. The proposed rule changes also establish 
circumstances and procedures for declaring away markets unreliable. The

[[Page 18286]]

text of the proposed rule change follows. Proposed new language is 
italicized; proposed deletions are in brackets.
Rule 6.28
    (a)-(b)--No change.
    (c)(1)-(5)--No change.
    (6) Suspend the Automatic Execution System (``Auto-Ex'') pursuant 
to Rule 6.87(h)(3)(B). [for a period of time not to exceed five minutes 
if, because of an influx of orders or unusual market conditions or 
circumstances, the Floor Officials determine that such action is 
appropriate in maintaining a fair and orderly market. Whenever such 
action is taken, Floor Officials or senior Exchange Staff must 
immediately notify a Floor Governor. Thereafter, the suspension of 
Auto-Ex may be ended, or may be continued for more than five minutes, 
based on a determination of two Floor Officials and one Floor Governor 
(or a senior operations officer if no Floor Governor is available), 
with a 2/3 majority prevailing.]
    (7)--No change.
    (8) The Exchange may increase the permissible size of orders that 
may be automatically executed over the Auto-Ex system pursuant to Rule 
6.87(h)(3)(C). [to up to 50 contracts, to be effected on a case-by-case 
basis in a particular option issue, or for all option issues, when two 
floor officials and one Floor Governor deem such an increase to be 
appropriate. Pursuant to this Rule, the ability to execute order of up 
to 50 contracts will only occur during high volume or high volatility 
emergency situations. At all other times, the order size for Auto-Ex 
will remain to be the number of contracts permitted under Rule 6.87.]
    * * *
Rule 6.87
    (a)-(g)--No change.
    (h) Suspension and Unusual Use of Auto-Ex.
    (1) Floor-Wide POETS System Malfunction.--No change.
    (2) Non-Floor-Wide POETS System Malfunction. If POETS is inoperable 
and Market Makers are physically unable to update their quotations in 
an issue or issues at the same trading post or trading quad, two Floor 
Officials may declare a ``fast market'' and direct the OBO to turn off 
the Auto-Ex system in the affected issue or issues. Once the system 
malfunction has been corrected, two Floor Officials may re-start Auto-
ex. If a POETS malfunction occurs but the Exchange is able to process 
and disseminate quotes accurately, two Floor Officials may decrease the 
guaranteed Auto-Ex size in one or more option issues pursuant to the 
procedures set forth in subsection (h)(3)(B).
    (3) Other Unusual Conditions.
    (A) Unusual Market Conditions. The unusual market conditions that 
may permit increasing or decreasing the size of orders that may be 
automatically executed over the Auto-Ex or suspending Auto-Ex pursuant 
to subsections (B) and (C) are caused by news announcements (e.g. 
announcements relating to earnings speculation, economic news, reports 
of mergers or takeovers, disasters, etc.). Unusual market conditions 
that would permit unusual use of Auto-Ex under this Rule include:
    (i) High Volatility. High volatility occurs generally when a stock 
or the entire market is experiencing rapid and extreme price 
fluctuations usually accompanied by doublewide spreads.
    (ii) Large Influx of Orders. A large influx of orders occurs when 
volume is two or more times the average daily volume in an issue. It 
may also occur when an extraordinarily large options order is executed 
on the PCX and reported.
    (iii) Unreliable Quote Feed. The underlying quote feed is 
unreliable when the Exchange is unable to accurately collect, process 
and/or disseminate quotation data.
    (B) Suspension of Auto-Ex. If there are other unusual market 
conditions not involving a POETS System malfunction, two Floor 
Officials may suspend Auto-Ex [in accordance with Rule 6.82(b).] for a 
period of time not to exceed five minutes if, because of unusual market 
conditions or circumstances, the Floor Officials determine that such 
action is appropriate in maintaining a fair and orderly market. 
Whenever such action is taken, Floor Officials or senior Exchange Staff 
must immediately notify a Floor Governor. Thereafter, the suspension of 
Auto-Ex may be ended, or may be continued for more than five minutes, 
based on a determination of two Floor Officials and one Floor Governor 
(or a senior operations officer if no Floor Governor is available), 
with a 2/3 majority prevailing.
    (C) Unusual use of Auto Ex. Two Floor Officials may increase the 
size of orders that may be automatically executed over the Auto-Ex 
system up to 100 contracts or decrease the size of orders eligible for 
automatic execution in one or more option issues when they believe that 
unusual market conditions exist, provided that the decision is made for 
no more than one trading day. To the extent the conditions exist on the 
following trading day, two Floor Officials must review the situation 
again and make an independent decision of whether to increase or 
decrease the Auto-Ex eligible order size for that subsequent day. Any 
decisions made by two Floor Officials to increase or decrease the Auto-
Ex eligible order size for a particular option issue for two or more 
consecutive days will be reviewed by the Options Floor Trading 
Committee at its next regularly scheduled meeting. Whenever two Floor 
Officials decrease the size of orders eligible for automatic execution, 
the lowest number of contracts that may be established is five.
    (D) Any suspension or unusual use of Auto-Ex must be documented 
pursuant to Rule 6.87(n).
    (4) Declaring Away Markets Unreliable. When a Floor Official 
determines that quotes from one or more particular markets in one or 
more options series are not reliable, the Floor Official may direct the 
senior person in charge of the Exchange's control room to exclude the 
unreliable quotes from the Auto-Ex determination of the NBBO in the 
particular options series.
    (A) Determining Unreliability. A Floor Official may determine that 
quotes in one or more particular options classes in a market are not 
reliable only under the following circumstances:
    (i) A market's quotes in a particular options class are not firm 
based upon direct communication to the Exchange from the market or the 
dissemination through OPRA of a message indicating that disseminated 
quotes are not firm; or
    (ii) A market has directly communicated to the Exchange or 
otherwise confirmed that the market is experiencing systems or other 
problems affecting the reliability of its disseminated quotes.
    (B) Procedures to Follow. If one of the factors set forth in 
subsection (4)(A) occurs, then the following procedures must be 
followed.
    (i) First, an LMM contacts an Order Book Official (``OBO'') and 
requests that the away market be declared unreliable.
    (ii) Second, the OBO contacts the control room and requests [a 
declaration] that the control room confirm with the away market that it 
is unreliable pursuant to subsection (4)(A).
    (iii) Third, if the control room has confirmed that an away market 
is unreliable, then the OBO will contact a Floor Official and request a 
declaration that the away market is unreliable.
    (iv) Fourth, the Floor Official reviews and verifies the 
circumstances and determines whether away market should be declared 
unreliable. The OBO notifies the control room that the away market is 
unreliable and should be removed from the NBBO calculation.

[[Page 18287]]

    (v) Fifth, the Floor Surveillance Unit (``FSU'') contacts the away 
exchange, and notifies the away market that one or more of its quotes 
have been removed from the NBBO calculation.
    (vi) Sixth, the Floor Official will continue to monitor the away 
market that has been declared unreliable and notify the control room to 
return to firm mode when appropriate.
    (C) Documentation Required. The following documentation is required 
when an away market is declared unreliable.
    (i) The OBO must log the issues(s) and time of the LMM's request 
for a declaration that the away market was unreliable.
    (ii) The OBO must prepare an Unusual Activity Report (``UAR'') 
documenting the facts giving rise to the LMM's request, the date, time, 
and duration of the exclusion and the reasons for placing the away 
market back into the NBBO calculation.
    (iii) The Floor Official must sign the UAR.
    (iv) The control room will maintain a log of the time the away 
market was taken out of the NBBO calculation and the time that the away 
market was placed back into the NBBO calculation.
    (D) Duration of the Declaration. Any determination to exclude a 
market or any of its quotes from the Auto-Ex determination of the NBBO 
pursuant to subsections (4)(B)(i) or (ii) will expire at the end of the 
trading day, or at the time that the quotes are confirmed by the market 
to be reliable again, whichever occurs first. Exclusion of a market or 
its quotes from the Auto-Ex determination of the NBBO will be reported 
to Exchange member firms.(i)-(m)--No change.
    (n) Documentation of Auto-Ex Use. The Exchange will document any 
action taken to suspend Auto-Ex, increase or decrease the size of Auto-
Ex eligible orders or to operate Auto-Ex in a manner other than the 
usual manner with an Unusual Activity Report (UAR). The UAR will be 
signed by two Floor Officials and will state the system problem or 
market activity that led to the Floor Officials' ruling. The UAR 
information will be recorded in the Floor Surveillance log, which will 
document the option issues affected by the action, the time the action 
was taken, the Exchange officials who undertook the action, and the 
reasons why the action was taken.

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 Exchange 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 Exchange 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

1. Purpose
    The proposed rule changes describe circumstances and Exchange 
procedures for disengaging the Exchange's Auto-Ex and increasing or 
decreasing Auto-Ex order size. The proposed changes include a procedure 
for documenting circumstances in which Auto-Ex is disengaged or the 
eligible order size is increased or decreased. The proposed rule 
changes also establish circumstances and procedures for declaring away 
markets unreliable.

Background

    The Pacific Options Exchange Trading System (``POETS'') is the 
Exchange's automated trading system comprised of an options order 
routing system, an automatic execution system, an on-line limit order 
book system and an automatic market quote update system. Option orders 
may be sent to POETS via the Exchange's Member Firm Interface 
(``MFI''). Market and marketable limit orders that are sent through the 
MFI will be executed by Auto-Ex if they meet the order type and size 
requirements designated by the Exchange. Orders executed on Auto-Ex 
receive the PCX's disseminated market price or better. Auto-Ex may be 
set to provide automatic price improvement when the national best bid 
or offer (``NBBO'') is better than the PCX best bid or offer (``BBO'') 
by one trading increment. In addition, Auto-Ex may be set to execute 
inbound orders at the NBBO price regardless of whether it is only one 
trading increment better than the PCX BBO, i.e., orders may be executed 
at prices that may be multiple trading increments better than the then 
prevailing PCX BBO. Furthermore, Auto-Ex may be set to execute at 
improved prices regardless of whether the NBBO is locked or crossed. 
Auto-Ex prevents inbound orders from being executed at prices inferior 
to the NBBO. The PCX designates the eligible order size--which may be 
between 20 and 100 option contracts--on an issue-by-issue basis.

Summary

    Pursuant to a Commission order, the PCX is required to adopt rules 
that specify the circumstances under which the Auto-Ex system may be 
disengaged or operated in any manner other than the normal manner set 
forth in the Exchange's rules.\4\ The order also requires documentation 
of reasons for each decision to disengage Auto-Ex or to operate Auto-Ex 
in any manner other than the normal manner.
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    \4\ See Securities Exchange Act Release No. 43268 (September 11, 
2000) (Order Instituting Public Administrative Proceedings Pursuant 
to Section 19(h)(1) of the Securities Exchange Act of 1934, Making 
Findings and Imposing Remedial Sanctions, Section IV.h(i)(bb)).
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    The Exchange proposes to modify PCX's Automatic Execution System 
Rule (Rule 6.87) to include provisions regarding disengaging Auto-Ex 
and increasing or decreasing the Auto-Ex eligible order size. The 
proposed changes also include a procedure for documenting circumstances 
when Auto-Ex is disengaged or the eligible order size is increased or 
decreased. The proposed rules specify the unusual market conditions 
that will justify an increase or decrease of the established Auto-Ex 
size or a suspension of Auto-Ex. The proposed rules codify the 
procedures that must be followed in the event the eligible order sizes 
are increased or decreased or Auto-Ex is suspended. Additionally, the 
proposed rules require documentation in the event that Auto-Ex order 
sizes are increased or decreased or that Auto-Ex is suspended.\5\
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    \5\ PCX represents that the proposed rule concerning 
documentation of operation of Auto-Ex in a manner other than usual 
is similar to CBOE Rule 6.8, Interpretations and Policies .08.
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Unusual Market Conditions

    Proposed Rule 6.87(h)(3)(A) provides a definition of unusual market 
conditions that may permit suspending Auto-Ex or increasing or 
decreasing the size of orders that may be automatically executed over 
the Auto-Ex. Such unusual market conditions may be caused by news 
announcements (e.g., announcements relating to earnings speculation, 
economic news, reports of mergers or takeovers, disasters, etc.). 
Unusual market conditions that would permit unusual use of Auto-Ex 
under this Rule include the following:
    (a) High Volatility. High volatility occurs generally when a stock 
or the

[[Page 18288]]

entire market is experiencing rapid and extreme price fluctuations 
usually accompanied by doublewide spreads.
    (b) Large Influx of Orders. A large influx of orders occurs when 
volume is two or more times the average daily volume in an issue. It 
may also occur when an extraordinarily large options order is executed 
on the PCX and reported.
    (c) Unreliable Quote Feed. The underlying quote feed is unreliable 
when the Exchange is unable to accurately collect, process and/or 
disseminate quotation data.

Suspending Auto-Ex

    The Exchange's current Rules 6.87(h)(1) and (2) permit suspension 
of Auto-Ex in the event of Floor-Wide and Non-Floor Wide POETS System 
Malfunction. Current PCX Rule 6.87(h)(3) permits the suspension of 
Auto-Ex in other unusual situations not involving POETS malfunction. 
For consistency and clarity, the Exchange proposes to move current Rule 
6.28(c)(6) concerning suspension of Auto-Ex and place it in Rule 
6.87(h)(3)(B). The rule has been renumbered but the text is unchanged. 
It provides that if there are unusual market conditions not involving a 
POETS System malfunction, two Floor Officials may suspend Auto-Ex for a 
period of time not to exceed five minutes if, because of unusual market 
conditions or circumstances, the Floor Officials determine that such 
action is appropriate in maintaining a fair and orderly market. 
Whenever such action is taken, Floor Officials or senior Exchange Staff 
must immediately notify a Floor Governor. Thereafter, the suspension of 
Auto-Ex may be ended, or may be continued for more than five minutes, 
based on a determination of two Floor Officials and one Floor Governor 
(or a senior operations officer if no Floor Governor is available).

Increasing or Decreasing Auto-Ex Size

    For consistency and clarity, the Exchange proposes to move and 
revise current Rule 6.28(c)(8) (concerning the procedure for increasing 
the permissible size of orders that may be automatically executed over 
Auto-Ex up to 100 contracts) and place it in Rule 6.87(h)(3)(C). 
Proposed Rule 6.87(h)(3)(C) also addresses the procedure for decreasing 
the size of orders that may be automatically executed over Auto-Ex. The 
proposed procedure provides that two Floor Officials may: (1) Increase 
the size of orders that may be automatically executed over the Auto-Ex 
system up to 100 contracts; or (2) decrease the size of orders eligible 
for automatic execution. Such an increase or decrease may be approved 
by two Floor Officials in one or more option issues when they believe 
that unusual market conditions exist, provided that the decision is 
made for no more than one trading day. To the extent the conditions 
exist on the following trading day, two Floor Officials must review the 
situation again and make an independent decision of whether to increase 
or decrease the Auto-Ex eligible order size for that subsequent day. 
Any decisions made by two Floor Officials to increase or decrease the 
Auto-Ex eligible order size for a particular option issue for two or 
more consecutive days will be reviewed by the Options Floor Trading 
Committee at its next regularly scheduled meeting. Whenever two Floor 
Officials decrease the size of orders eligible for automatic execution, 
the lowest number of contracts that may be established is five.
    Additionally, the Exchange proposes to amend Rule 6.87(h)(2) to 
provide for decreasing the guaranteed Auto-Ex size in one or more 
option issues when a non floor-wide POETS malfunction occurs but the 
Exchange is able to process and disseminate quotes accurately. In such 
circumstances, two Floor Officials may decrease the guaranteed Auto-Ex 
size in one or more option issues pursuant to the procedures set forth 
in Rule 6.87(h)(3)(C).

Declaring Away Markets Unreliable

    A Floor Official may determine that quotes in one or more 
particular options classes in a market are not reliable only when: (1) 
A market's quotes in a particular options class are not firm based upon 
direct communication to the Exchange from the market or the 
dissemination through OPRA of a message indicating that disseminated 
quotes are not firm; or (2) a market has directly communicated to the 
Exchange or otherwise confirmed that the market is experiencing systems 
or other problems affecting the reliability of its disseminated quotes.
    If one or more of these factors occurs, then the following 
procedures must be followed. First, an LMM contacts an Order Book 
Official (``OBO'') and requests that the away market be declared 
unreliable. Second, the OBO contacts the control room and requests a 
declaration that the away market is unreliable. Third, if the control 
room has confirmed that an away market is unreliable, then the OBO will 
contact a Floor Official and request a declaration that the away market 
is unreliable. Fourth, the Floor Official reviews and verifies the 
circumstances and determines whether away market should be declared 
unreliable. The OBO notifies the control room that the away market is 
unreliable and should be removed from the NBBO calculation. Fifth, the 
Floor Surveillance Unit contacts the away exchange, and notifies the 
away market that one or more of its quotes have been removed from the 
NBBO calculation. Sixth, the Floor Official will continue to monitor 
the away market that has been declared unreliable and notify the 
control room to return to firm mode when appropriate.
    The following documentation is required when an away market is 
declared unreliable: (1) The OBO must log the issues(s) and time of the 
LMM's request for a declaration that the away market was unreliable; 
(2) the OBO must prepare an Unusual Activity Report (``UAR'') 
documenting the facts giving rise to the LMM's request, the date, time, 
and duration of the exclusion and the reasons for placing the away 
market back into the NBBO calculation; (3) the Floor Official must sign 
the UAR; and (4) the control room will maintain a log of the time the 
away market was taken out of the NBBO calculation and the time that the 
away market was placed back into the NBBO calculation.
    Any determination to exclude a market or any of its quotes from the 
Auto-Ex determination of the NBBO pursuant to the proposed rule will 
expire at the end of the trading day, or at the time that the quotes 
are confirmed by the market to be reliable again, whichever occurs 
first. Exclusion of a market or its quotes from the Auto-Ex 
determination of the NBBO will be reported to Exchange member firms.

Documentation

    Under the proposed rules, the Exchange will document any action 
taken to suspend Auto-Ex, increase or decrease the size of Auto-Ex 
eligible orders or to operate Auto-Ex in a manner other than the usual 
manner with an Unusual Activity Report (``UAR''). The UAR must be 
signed by two Floor Officials and must state the system problem or 
market activity that led to the Floor Officials' ruling. The UAR 
information will be recorded in the Floor Surveillance log, which will 
document the option issues affected by the action, the time the action 
was taken, the Exchange officials who undertook the action, and the 
reasons why the action was taken.
2. Statutory Basis
    The Exchange believes that the proposed rule changes, as amended, 
are

[[Page 18289]]

consistent with section 6(b) of the Act,\6\ in general, and further the 
objectives of Section 6(b)(5),\7\ in particular, because they are 
designed to promote just and equitable principles of trade, to enhance 
competition and to protect investors and the public interest.
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    \6\ 15 U.S.C. 78f(b).
    \7\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change, as 
amended, will impose any burden on competition that is 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 on the proposed rule change 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 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, as amended, 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 PCX. All submissions should refer to File No. 
SR-PCX-2001-13 and should be submitted by May 6, 2002.
    For the Commission, by the Division of Market Regulation, pursuant 
to delegated authority.\8\
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    \8\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-9061 Filed 4-12-02; 8:45 am]
BILLING CODE 8010-01-U