[Federal Register Volume 67, Number 75 (Thursday, April 18, 2002)]
[Notices]
[Pages 19288-19291]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-9480]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45744; File No. SR-CHX-2000-08]


Self-Regulatory Organizations; The Chicago Stock Exchange, Inc.; 
Order Granting Approval of Proposed Rule Change and Amendment No. 1, 
and Notice of Filing and Order Granting Accelerated Approval of 
Amendment No. 2 to the Proposed Rule Change, to Establish a Board 
Review Process for Decisions of the Exchange's Committee on Specialist 
Assignment and Evaluation Regarding Specialist Firm Consolidations

April 12, 2002.

I. Introduction

    On March 17, 2000, the Chicago Stock Exchange, Inc. (``CHX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC''), pursuant to section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change amending CHX Article XXX, Rule 1, 
Interpretation .01, to establish a review process for certain decisions 
of the Exchange's Committee on Specialist Assignment and Evaluation 
(``Committee''). On April 3, 2000, the Exchange amended the 
proposal.\3\ The proposed rule change, along with Amendment No. 1, was 
published for comment in the Federal Register on July 12, 2000.\4\ The 
Commission received two comment letters on the proposal.\5\ The CHX 
submitted a letter in response to these comments.\6\ On September 7, 
2001, the CHX again amended the proposal.\7\ This

[[Page 19289]]

order approves the proposed rule change as amended by Amendment Nos. 1 
and 2. The Commission has found good cause to approve Amendment No. 2 
on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See March 31, 2000 letter from Ellen J. Neely, Vice 
President and General Counsel, CHX, to Katherine A. England, 
Assistant Director, Division of Market Regulation (``Division''), 
SEC (``Amendment No. 1''). In Amendment No. 1, the CHX made minor, 
technical changes to the proposal.
    \4\ See Securities Exchange Act Release No. 43010 (July 5, 
2001), 65 FR 43066.
    \5\ See October 6, 2000 letter from Gerald M. Miller, Vanasco 
Genelly & Miller, on behalf of Chicago Securities Group Limited 
Partnership, to Jonathan G. Katz, Secretary, SEC (``Vanasco 
letter''); October 6, 2000 letter from Dempsey & Company LLC 
(representing five specialist units on the CHX) to Jonathan G. Katz, 
Secretary, SEC (``Dempsey letter'').
    \6\ See November 24, 2000 letter from Paul B. O'Kelly, Executive 
Vice President, Market Regulation and Legal, CHX, to Joseph P. 
Morra, Special Counsel, Division of Market Regulation 
(``Division''), SEC.
    \7\ See August 31, 2001 letter from Paul B. O'Kelly, Chief 
Operating Officer, CHX, to Joseph P. Morra, Special Counsel, 
Division, SEC (``Amendment No. 2''). In Amendment No. 2, the CHX (i) 
clarified that the proposed rule change was not submitted as a 
result of any pre-judgment about the consequences of concentration 
among specialist firms; rather, the proposed rule reflects the CHX's 
view that concentration of specialist firms may create broader risks 
to the Exchange; (ii) clarified that the Committee does not consider 
a member firm's activities in other market centers (other than 
trading in the issue to be assigned) when it assigns stocks, except 
to the extent such activity is relevant to the Committee's overall 
assessment of the firm's risk controls and procedures; (iii) 
clarified that information provided to the CHX staff, the Committee, 
and the Exchange's Board of Governors, will be kept confidential; 
(iv) clarified that specialists and affiliates of specialists cannot 
sit on the Committee or that Board panels that will review Committee 
decisions will not involve specialists or their affiliates; and (v) 
made minor changes to the proposed rule language to clarify the 
intent of the proposal, and to incorporate certain changes suggested 
by the commenters.
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II. Description of the Proposal

    The Exchange proposes to amend its rules to add ``consolidations'' 
to the list of circumstances that may lead to the need for assignment 
or reassignment of a security, and establish a review process for 
certain Committee decisions. Specifically, the Exchange proposes an 
amendment to CHX Article XXX, Rule 1, Interpretation .01.
    The Committee currently is charged with approving the assignment of 
stocks to specialist firms and their co-specialists, as well as 
evaluating the performance of such specialists and co-specialists. The 
Committee also reviews and must approve the transfers of assigned 
issues that typically occur in connection with the acquisitions of 
specialist firms by other specialist firms.
    The CHX reports it is experiencing significant consolidation of its 
specialist firms. The Exchange's Board of Governors (``Board'') 
believes that specialist firm consolidations and the concentration of 
business that can result from these consolidations can raise issues 
that are significant in the context of the Exchange's long-term 
business plan and operational forecasts. According to the CHX, these 
issues are beyond those typically addressed by the Committee in the 
ordinary stock allocation process. The CHX has determined that it is 
both appropriate and necessary for the Board to review Committee 
decisions that raise the broader issues referenced above. Accordingly, 
the CHX proposes a procedure for discretionary, and in certain cases, 
mandatory Board review and approval of stock assignment transfers in 
the case of specialist firm consolidations, and for discretionary 
authority to review and approve transfers of assigned stocks in 
circumstances where there is a change in control of a specialist firm.
    Under the proposal, the Committee will continue to review transfers 
of assigned stocks in connection with specialist firm consolidations or 
changes in control of specialist firms, subject to new review 
procedures. The proposal would add consolidations to the current list 
of events leading to assignment proceedings.\8\
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    \8\ There are currently seven circumstances under which the 
Committee may assign or reassign a security: (i) New listing or 
obtaining unlisted trading privilege; (ii) specialist request; (iii) 
corporation request; (iv) split-up and/or merger of specialist 
units; (v) fundamental change in specialist unit; (vi) 
unsatisfactory performance action; or (vii) disciplinary action.
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    The proposed rule sets forth certain factors the Committee must 
consider when the consolidation creates concentration. Concentration 
occurs when a consolidation creates or increases a specialist unit's 
financial interest in trades constituting 10% or more of the total CHX 
trade volume in the three preceding calendar months.\9\ Under the 
proposal, the full Board of Governors, excluding those Governors that 
are co-specialists or affiliates of specialists or co-specialists (a 
``Board Panel'') may on its own initiative review any Committee 
decision involving a change in control or consolidation of a specialist 
unit. The Board Panel must give any interested member an opportunity to 
present its views on the matter. Committee decisions will be final if 
any member of a Board Panel does not request that the Board Panel 
initiate a review within ten days of a Committee decision. However, a 
Board Panel must review all Committee decisions made with respect to 
consolidations that create concentration. Board Panel decisions, and 
the basis for those decisions, must be in writing and communicated to 
the specialist.
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    \9\ When a consolidation creates concentration, the Committee 
will consider (i) the effect of the consolidation on the specialist 
units' capital supporting specialist activities, experience and 
quality of management, experience and performance of co-specialists, 
risk controls and procedures, and operational efficiencies; and (ii) 
the effect of the consolidation on the CHX's ability to enhance its 
position as a market center by promoting competition among members, 
minimize risk to the financial integrity of the marketplace, and 
continue operating in the public interest by enhancing market 
quality and public awareness of the products and services offered 
through the CHX.
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III. Summary of Comments

    The Commission received two comments on the proposal,\10\ both of 
which objected to the Commission approving the proposed rule change. As 
discussed below, the CHX responded to these comments.\11\
    Unnecessary Burden On Competition. The commenters believe the 
proposal would impose significant burdens on the ability of specialists 
to compete with over-the-counter market makers.\12\ The commenters 
believe that consolidation of specialist firms on the CHX floor 
provides a broader range of stocks to the firm, and permits the 
aggregation of greater capital than would be possible by smaller firms, 
which helps them to compete with third market makers.\13\ By limiting 
the ability of specialist firms to consolidate, the commenters believe 
the proposal places an unnecessary burden on competition by limiting 
the ability of specialists to expand their businesses in order to 
effectively compete, and perhaps placing restrictions on the transfer 
of a business.\14\
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    \10\ See footnote 5, supra.
    \11\ See footnote 6, supra. As noted in footnote 6, and 
discussed in more detail herein, some of the changes proposed in 
Amendment No. 2 were made in response to the comments.
    \12\ Vanasco letter at 1; Dempsey letter at 1-2.
    \13\ Vanasco letter at 2.
    \14\ Vanasco letter at 2; Dempsey letter at 2.
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    Appealability. The commenters object to language in the proposal 
that would make decisions by the Committee or the Board ``final.'' \15\ 
The commenters believe that, when an exchange takes an action that 
restricts access to the exchange's market, the action must provide for 
due process, by way of an appeal to the SEC.\16\ The commenters asked 
that the CHX make clear that ``final'' judgments about the allocation 
of stocks are appealable to the Commission.\17\
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    \15\ Vanasco letter at 2-3; Dempsey letter at 3.
    \16\ Id.
    \17\ Vanasco letter at 3; Dempsey letter at 3.
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    Disclosure Of Confidential Information. The commenters expressed 
concern that specialists would be required to disclose detailed 
financial information to the Committee, and possibly to the Board. 
Because the disclosure of confidential financial information has the 
potential to harm specialist units, the commenters asked that the CHX 
delineate procedures to prevent further disclosure of confidential 
information or to eliminate potential competitors from serving on the 
Board.\18\ Further, the Dempsey letter stated that the proposal should 
be amended to limit the scope of information available for review to 
information related to the specified factors in the rule. This would 
address concerns, in the commenter's view, that the Committee could 
request

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confidential information outside the scope of review.
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    \18\ Vanasco letter at 3; Dempsey letter at 3-4.
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    Miscellaneous Ambiguities. The commenters asked that the CHX 
clarify the following ambiguities:
    (i) The current rules provide for two types of business changes 
that would require assignment proceedings--a split up and/or merger of 
a specialist unit, and a fundamental change of a specialist unit. While 
the current rules do not define ``fundamental change,'' they provide 
examples of actions that would or would not be considered a fundamental 
change. The proposal would add ``consolidation'' to the rule. The 
commenters note that, unlike a split up, merger, or fundamental change 
that result only from ownership changes, a consolidation could arise 
from contractual arrangements that do not result from ownership 
changes. The proposal does not explain why a change in or creation of a 
non-ownership financial interest should require Committee approval.\19\
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    \19\ Vanasco letter at 3; Dempsey letter at 4.
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    (ii) The filing is unclear as to whether any consolidation would 
require a posting, or whether a consolidation would require posting 
only when it would result in a specialist unit having a financial 
interest in trades constituting 10% or more of the CHX's total volume 
in the three preceding calendar months (``concentration'').\20\
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    \20\ Vanasco letter at 3-4; Dempsey letter at 5.
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    (iii) The current rule requires a posting only when there is an 
ownership change that results in a change of control. The proposed rule 
would require a posting when two specialists come under common control. 
Thus, the mere combination of control would be a triggering event. 
However, the commenter states the proposed rule would not require a 
posting when there is a change in control as long as the new 
controlling person did not control another specialist.\21\ The 
commenter believes this conflicts with the basic intent of the rule 
which is to allow for transfer of books.
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    \21\ Vanasco letter at 4.
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    (iv) The filing is unclear if the CHX intends to restrict the 
participation of affiliates of specialists (as opposed to co-
specialists) from the Board Panel.\22\ The CHX currently defines a co-
specialist as an individual trading stock on the floor of the CHX on 
behalf of a specialist firm. The commenter believes the CHX should 
restrict participation of the affiliates of specialists as well.
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    \22\ Dempsey letter at 5.
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    CHX's Response To Comments. The CHX offered the following in 
response to the comment letters: \23\
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    \23\ See footnote 6, supra. See also Amendment No. 2.
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    (i) Effect on Competition: While the commenters believe the 
proposed rule will hinder their ability to compete with over-the-
counter market makers, the CHX notes that Exchange members are subject 
to a number of rules that are not imposed upon their competitors in 
other markets, while their competitors are subject to other rules that 
are not imposed on Exchange specialists. The CHX believes it has an 
interest in assuring that the process of assigning stocks to specialist 
units is fair to all specialist firms, and that awards are made and 
transfer requests granted while taking into account the best interests 
of the CHX. In this context, the CHX believes consolidation can have a 
substantial positive or negative impact on the surviving firm or its 
ability to perform specialist functions. The CHX believes the proposed 
rule will assist in achieving what is best for the Exchange, and that 
the process is not unfairly discriminatory or burdensome on 
competition.\24\
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    \24\ Id.
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    (ii) Confidential Information. The CHX states that it regularly 
receives confidential information in connection with its SRO 
responsibilities and it does not believe this proposal is any different 
in terms of maintaining confidentiality. The CHX asserts that the 
Committee and the Board will not contain individuals that are 
affiliated with co-specialists or specialist firms. These restrictions 
should allay the commenters' concern that competitors acting in an 
official capacity might gain access to another specialist firm's 
proprietary information.\25\
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    \25\ Id. Amendment No. 2 amends the rule to make clear that 
affiliates of co-specialists, as well as specialists, cannot be on 
the reviewing Board Panel.
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    (iii) Appealability. While the proposed rule language states that 
the Board's decision is final, the CHX clarifies that the reference to 
finality in the proposal is to emphasize only that the Board Panel's 
decision is not subject to full Board review.\26\ The CHX notes that 
appealability of an action to the Commission would be governed by the 
Act and rules thereunder, not CHX's rules.
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    \26\ Id.
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    (iv) Miscellaneous Ambiguities. In response to the commenters' 
objection to the definition of ``consolidation'' in the proposed rule 
including arrangements that do not involve a change in ownership 
interests among the affected specialist firms, the CHX explains that 
the definition has been expanded to include such arrangements because 
of the possibility that specialist firms can transfer virtually all or 
part of their economic interests in assigned stocks to other specialist 
firms without changing the ownership interest in either specialist. The 
CHX believes the Committee should be able to reconsider the basis for 
an assignment if an applicant proposes to transfer some or all of its 
interest in or responsibility for an assigned stock to another 
specialist, even if the consolidation does not result in a change in 
ownership interests among the affected specialist firm.\27\
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    \27\ Id. at 3.
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    (v) The CHX agrees that proposed item 6 (``Consolidations creating 
Concentration'') under ``I. EVENTS LEADING TO ASSIGNMENT PROCEEDINGS'' 
should be changed to ``Consolidations'' to avoid confusion.\28\
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    \28\ See Amendment No. 2.
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    (vi) The CHX agrees to modify ``II. ASSIGNMENT PROCEDURES'' item 4 
(``Board Review'') to include affiliates of specialists as well as 
affiliates of co-specialists.\29\
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    \29\ Id.
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IV. Discussion and Commission Findings

    The Commission has reviewed carefully the CHX's proposed rule 
change, as amended, the comment letters, and the CHX's response to the 
comments, and finds, for the reasons set forth below, that the proposal 
is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange,\30\ and, in particular, with the requirements of Section 
6(b).\31\
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    \30\ In approving this rule, the Commission has considered its 
impact on efficiency, competition, and capital formation. 15 U.S.C. 
78c(f).
    \31\ 15 U.S.C. 78f(b).
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    The Commission does not believe that consolidations among 
specialist units are inherently harmful, and believes that in many 
situations they can, in fact, be beneficial, particularly for those 
units with limited capital. Nevertheless, the Commission recognizes 
that undue concentration can have negative effects on market quality 
by, among other things, hampering competition among specialists and 
reducing incentives for specialists to provide better markets.
    The Commission believes that the factors identified in the CHX 
policy for reviewing specialist combinations are reasonably designed to 
result in approval of proposed combinations that will not have an 
adverse impact on market quality or result in undue concentration. The 
Commission notes that the CHX's proposal would not

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permit the CHX to weigh against a particular firm its activities in 
other markets, unless the firm is already acting as a specialist in the 
same issue for which the combination would result in that firm acting 
as a specialist on the CHX, or to the extent it is relevant to overall 
firm risk controls and procedures.\32\ The CHX has amended its filing 
to reflect that the focus of the review is on improving the quality of 
markets and services at the Exchange. As noted above, the commenters 
have argued that the review procedures for a combination resulting in 
concentration are extraordinary, and such procedures impose an 
inappropriate burden on competition that does not exist on their third 
market competitors. However, the Commission finds that the CHX proposal 
does not impose an unnecessary burden on competition under section 
6(b)(8) of the Act \33\ because it establishes review procedures that 
are intended to prevent undue concentration that could potentially 
hinder market quality.
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    \32\ See Amendment No. 2.
    \33\ 15 U.S.C. 78f(b)(8).
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    Indeed, the CHX has stated that, while its filing reflects the 
Board's recognition of the risks from greater concentration, it has not 
made any prejudgments on whether the Exchange is benefited or harmed by 
consolidation among specialist units. Although the Commission 
recognizes that the new rules could result in prohibiting a combination 
from occurring, the Commission finds the factors for consideration in 
reviewing concentration effects, such as adequate capital, risk 
controls, and operational efficiencies, are related to legitimate 
market quality issues which the CHX should be permitted to weigh. 
Amendment No. 2 also has made clear that competition from other markets 
will not be considered a factor in a consolidation review. Accordingly, 
while the proposed rule language states that the Exchange can consider 
the effect of the consolidation on the Exchange's ability to enhance 
its position as a market center by promoting competition among members, 
this factor could not be used in an anticompetitive manner to deny a 
consolidation because of a specialist's presence in another market. 
Thus, a firm's decision to route customer orders to another market for 
different issues, or to make markets on another exchange in different 
issues, would be irrelevant to the CHX's review.
    In addition, as a result of concerns raised by the commenters, the 
CHX made several changes to the proposal. For example, the commentors 
raised concerns regarding the confidentiality of information provided 
to the Committee or Board Panel in connection with reviews. The CHX 
amended the proposal to clarify that information provided to CHX staff, 
the Committee, and the Board Panel will be kept confidential, and that 
members that are specialists or affiliates may not sit on the 
Committee. Similarly, Board Panels that review Committee decisions will 
not include specialists or their affiliates. Additionally, the CHX, in 
response to concerns raised by the commenters that a specialist's 
activities in other market centers might be used in an anticompetitive 
manner to prevent consolidation, clarified that the Committee will not 
consider a member firm's activities in other market centers when it 
assigns stocks except to the extent that such activity is relevant to 
the Committee's overall assessment of the firm's risk controls and 
procedures. The Commission notes that all Board Panel decisions, and 
the basis for those decisions, must be in writing, and must be 
communicated to the specialist. With regard to any remaining issues 
raised by the commenters, the Commission is satisfied that the CHX has 
adequately addressed those comments.
    In summary, the Commission believes the CHX proposal balances 
competing concerns of its market and allows it to consider the effect 
of a consolidation resulting in concentration on market quality. The 
Commission believes this is an appropriate goal and that the rules 
should not be used, or applied, in an anti-competitive manner.
    The Commission finds good cause for approving proposed Amendment 
No. 2 before the 30th day after the date of publication of notice of 
filing thereof in the Federal Register. Amendment No. 2 clarifies the 
CHX's position on a number of issues raised by the commenters. The 
Commission finds no legitimate reason to delay approval of proposed 
Amendment No. 2, given that Amendment No. 2 is responsive to the 
commenters' concerns. For these reasons, the Commission finds good 
cause for accelerating approval of proposed Amendment No. 2.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing Amendment No. 2, including whether 
Amendment No. 2 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 CHX. All submissions should refer to File No. 
SR-CHX-2000-08 and should be submitted by May 9, 2002.

VI. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\34\ that the proposed rule change (SR-CHX-2000-08), as amended by 
Amendment Nos. 1 and 2, is approved.
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    \34\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\35\
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    \35\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-9480 Filed 4-17-02; 8:45 am]
BILLING CODE 8010-01-P