[Federal Register Volume 67, Number 242 (Tuesday, December 17, 2002)]
[Notices]
[Pages 77297-77300]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-31652]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46975; File No. SR-CME-2002-02]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of a Proposed Rule Change by the Chicago Mercantile 
Exchange Relating to Listing Standards for Security Futures Products

December 9, 2002.
    Pursuant to Section 19(b)(7) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-7 under the Act,\2\ notice is hereby given 
that on October 28, 2002, Chicago Mercantile Exchange (``CME'' or ``the 
Exchange'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission'') the proposed rule change as described in Items I, 
II, and III below, which Items have been prepared by CME.
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    \1\ 15 U.S.C. 78s(b)(7).
    \2\ 17 CFR 240.19b-7.
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    On November 1, 2002, CME filed an amendment to the proposed rule 
change to clarify the proposed rules.\3\ On

[[Page 77298]]

November 6, 2002, CME filed an amendment to the proposed rule change to 
reflect technical changes to the proposed rules.\4\ On November 20, 
2002, CME filed an amendment to the proposed rule change to provide 
additional information for inclusion in this Notice, and to reflect 
further technical changes to the proposed rules.\5\
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    \3\ See letter from Richard J. McDonald, Managing Director, 
Product Development, CME, to Office of Market Supervision, Division 
of Market Regulation, Commission, dated October 31, 2002 
(``Amendment No. 1'').
    \4\ See letter from Richard J. McDonald, Managing Director, 
Product Development, CME, to Office of Market Supervision, Division 
of Market Regulation, Commission, dated November 5, 2002 
(``Amendment No. 2'').
    \5\ See letter from Richard J. McDonald, Managing Director, 
Product Development, CME, to Office of Market Supervision, Division 
of Market Regulation, Commission, dated November 19, 2002 
(``Amendment No. 3'').
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    The Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons. CME also has certified 
the proposed rule change with the Commodity Futures Trading Commission 
(``CFTC'') under Section 5c(c) of the Commodity Exchange Act \6\ on 
October 28, 2002.
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    \6\ 7 U.S.C. 7a-2(c).
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I. Self-Regulatory Organization's Description of the Proposed Rule 
Change

    CME proposes to adopt Security Futures Product Listing Standards 
(``CME Listing Standards'') for purposes of Section 6(h) of the Act.\7\ 
The CME Listing Standards are generally identical to the sample listing 
standards (the ``Sample Listing Standards'') published in Staff Legal 
Bulletin No. 15 (``SLB 15'') \8\ except that they:
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    \7\ 15 U.S.C. 78f(h).
    \8\ SEC Division of Market Regulation: Staff Legal Bulletin No. 
15: Listing Standards for Trading Security Futures Products 
(September 5, 2001).
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    [sbull] Reflect the modifications to the statutory listing 
standards requirements adopted by the Commission and the CFTC governing 
shares of American Depositary Receipts, exchange-traded funds, trust-
issued receipts and shares of registered closed-end management 
investment companies; \9\ and
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    \9\ See Joint Order Granting the Modification of Listing 
Standards Requirements (American Depository Receipts), Securities 
Exchange Act Release No. 44725 (August 20, 2001) and Joint Order 
Granting the Modification of Listing Standards Requirements 
(Exchange Traded Funds, Trust Issued Receipts and shares of Closed-
End Funds), Securities Exchange Act Release No. 46090 (June 19, 
2002), 67 FR 42760 (June 25, 2002).
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    [sbull] Establish an approximately equal dollar weighting 
methodology for physically settled futures based on narrow-based 
security indices (``NBIs'') which (1) requires the number of each 
component security to be rounded up or down to the nearest multiple of 
100 shares or receipts in the course of the initial index composition 
and any subsequent rebalancing, (2) contemplates mandatory annual 
rebalancing of such indices under specified circumstances, complemented 
by CME's ability to rebalance indices on an interim basis if it so 
elects; and (3) ensures that outstanding contracts will not be affected 
by any rebalancing.

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

    CME has prepared statements concerning the purpose of, and basis 
for, the proposed rule change, burdens on competition, and comments 
received from members, participants, and others. The text of these 
statements may be examined at the places specified in Item IV below. 
These statements are set forth in Sections A, B, and C below.

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

1. Purpose
    Section 6(h)(3) of the Act \10\ identifies requirements for listing 
standards applicable to security futures products. In particular, the 
Act requires that such listing standards: (1) Must be no less 
restrictive than comparable listing standards for options traded on a 
national securities exchange; and (2) must require that trading in 
security futures products not be readily susceptible to manipulation of 
the price of such products or of the underlying securities or options 
on such securities.
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    \10\ 15 U.S.C. 78f(h)(3)(I).
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    Listing Standards--The Sample Listing Standards found in SLB 15 
were modeled after listing standards employed by option exchanges and 
were intended to provide guidance as to how the requirements under the 
Act may be addressed but also provided that alternate standards could 
be consistent with the Act as well.
    Accordingly, the CME Listing Standards are generally modeled on the 
Sample Listing Standards (as modified by the Commissions' orders 
regarding American Depositary Receipts, exchange-traded funds, trust-
issued receipts and registered closed-end management investment 
companies \11\ and subject to additional modifications relating to 
physically settled futures based on NBIs described above. These 
additional modifications are (1) limited in application to physically 
settled contracts, and (2) designed to enhance the utility of NBI 
futures in connection with hedging, arbitrage and other investment 
applications.
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    \11\ See supra, n. 9.
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    CME contemplates the possibility that it may seek to list 
physically settled NBI futures per its belief that physical settlement 
might reduce basis risk and result in tighter bid/offer spreads, 
limiting the potential for market manipulation, under certain 
circumstances where the NBI is comprised of a very limited number of 
securities.
    CME believes that it is impracticable to make delivery of 
securities in lot sizes smaller than the customary transactional unit 
of 100 shares or receipts. Thus, rounding is required with respect to 
the initial composition and subsequent rebalancing of physically 
settled futures based on NBIs. If the composition of NBIs were subject 
to frequent or retroactive changes as a result of index rebalancings, 
NBI futures would lose their potential as particularly effective tools 
in the implementation of hedging, arbitrage and other investment 
applications.
    The Sample Listing Standards contemplate at least quarterly 
rebalancings of equal dollar-weighted indices. The CME Listing 
Standards modify this requirement by providing that an approximately 
equal dollar-weighted NBI underlying a physically settled security 
futures product is to be rebalanced annually, but only if the aggregate 
value of the security position with the highest value is two or more 
times greater than the aggregate value of the security position with 
the lowest value in the index for a specified time period. CME believes 
that this procedure effectively balances the potential adverse 
consequences of frequent composition adjustments with concerns 
regarding the degree to which an NBI represents the subject industry 
sector.
    CME may rebalance NBIs on an interim basis if warranted as a result 
of extraordinary changes in the relative values of the component 
securities. To the extent investors with open positions must rely upon 
the continuity of the futures contract, CME Listing Standards clarify 
that outstanding contracts are unaffected by rebalancings. Precedent 
for these provisions may be found in the rules of the American Stock 
Exchange (``Amex'') for portfolio depositary receipts \12\ and index 
fund shares \13\

[[Page 77299]]

which provide for a ``modified equal-dollar weighting'' and do not 
appear to provide for rebalancing. Rebalancing is likewise not required 
in the context of trust-issued receipts traded on Amex.\14\
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    \12\ See Amex Rule 1000, in particular Commentary .03 thereto.
    \13\ See Amex Rule 1000A, in particular Commentary .02 thereto.
    \14\ See Amex Rule 1202, in particular Commentary .01 thereto.
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    The contents of the CME Listing Standards, including the 
approximately equal dollar-weighting methodology described above, will 
be publicly available and fully disclosed.
    Section 6(h)(3) Requirements--Section 6(h)(3) of the Act \15\ 
contains detailed requirements for listing standards and conditions for 
trading applicable to security futures products. Set forth below is a 
summary of each such requirement or condition, followed by a brief 
explanation of how CME will comply with it, whether by particular 
provisions in the CME Listing Standards or otherwise.
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    \15\ 15 U.S.C. 78f(h)(3).
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    Clause (A) of Section 6(h)(3) \16\ requires that any security 
underlying a security future be registered pursuant to Section 12 of 
the Act.\17\ This requirement is addressed by CME Rules 70001.2, 
70003.2.b. and 70004.2.a.
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    \16\ 15 U.S.C. 78f(h)(3)(A).
    \17\ 15 U.S.C. 78l.
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    Clause (B) of Section 6(h)(3) \18\ requires that a market on which 
a physically settled security futures product is traded have 
arrangements in place with a registered clearing agency for the payment 
and delivery of the securities underlying the security futures product. 
CME has reached an agreement with a registered clearing agency to 
facilitate the payment and delivery of securities underlying security 
futures products. This agreement will be fully operational prior to any 
possible delivery event associated with such security futures products.
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    \18\ 15 U.S.C. 78f(h)(3)(B).
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    Clause (C) of Section 6(h)(3) \19\ provides that listing standards 
for security futures products must be no less restrictive than 
comparable listing standards for options traded on a national 
securities exchange or national securities association registered 
pursuant to Section 15A(a) of the Act.\20\ For the reasons discussed 
above, notwithstanding specified differences between the Sample Listing 
Standards and the CME Listing Standards, CME believes that the latter 
are no less restrictive than comparable listing standards for exchange-
traded options.
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    \19\ 15 U.S.C. 78f(h)(3)(C).
    \20\ 15 U.S.C. 78o-3f(a).
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    Clause (D) of Section 6(h)(3) \21\ requires that each security 
future be based on common stock or such other equity securities as the 
Commission and the Commodity Futures Trading Commission jointly 
determine appropriate. This requirement is addressed by Rules 70001.1, 
70003.2.c. and 70004.2.b.
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    \21\ 15 U.S.C. 78f(h)(3)(D).
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    Clause (E) of Section 6(h)(3) \22\ requires that each security 
futures product be cleared by a clearing agency that has in place 
provisions for linked and coordinated clearing with other clearing 
agencies that clear security futures products, which permits the 
security futures product to be purchased on one market and offset on 
another market that trades such product. CME intends to clear security 
futures products traded through Exchange facilities through the CME 
Clearing House Division. The Clearing House Division will have in place 
all provisions for linked and coordinated clearing as mandated by law 
and statute as of the effective date of such laws and statutes.
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    \22\ 15 U.S.C. 78f(h)(3)(E).
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    Clause (F) of Section 6(h)(3) \23\ requires that only a broker or 
dealer subject to suitability rules comparable to those of a national 
securities association registered pursuant to Section 15A(a) of the Act 
\24\ effect transactions in a security futures product.
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    \23\ 15 U.S.C. 78f(h)(3)(F).
    \24\ 15 U.S.C. 78o-(a).
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    CME clearing members, and their correspondents, are bound by the 
applicable sales practice rules of the National Futures Association 
(``NFA''), which is a national securities association. As such, the 
sales practice rules of the NFA are, perforce, comparable to those of a 
national securities association registered pursuant to Section 15A(a) 
of the Act.\25\ The application of NFA sales practice rules is extended 
beyond the CME clearing membership to the extent that NFA By-Law 1101 
provides that ``[n]o member may carry an account, accept an order or 
handle a transaction in commodity futures contracts for or on behalf of 
any non-Member of NFA.''
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    \25\ 15 U.S.C. 78o-(a).
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    Clause (G) of Section 6(h)(3) \26\ requires that each security 
futures product be subject to the prohibition against dual trading in 
Section 4j of the Commodity Exchange Act \27\ and the rules and 
regulations thereunder or the provisions of Section 11(a) of the Act 
\28\ and the rules and regulations thereunder. Exchange Rule 123 
requires Exchange members to comply with all applicable ``provisions of 
the Commodity Exchange Act and regulations duly issued pursuant thereto 
by the CFTC.''
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    \26\ 15 U.S.C. 78f(h)(3)(G).
    \27\ 7 U.S.C. 6j.
    \28\ 15 U.S.C. 78k.
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    Note that the prohibition of dual trading in security futures 
products per CFTC Regulation Sec.  41.27 \29\ adopted pursuant to 
Section 4j(a) of the Commodity Exchange Act \30\ applies to a contract 
market operating an electronic trading system if such market provides 
participants with a time or place advantage or the ability to override 
a predetermined matching algorithm. CME anticipates that trading of 
security futures products on CME will be fully electronic. Further, the 
Exchange will not provide participants with a time or place advantage 
or the ability to override a predetermined matching algorithm in the 
context of security futures products.
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    \29\ 17 CFR 41.27.
    \30\ 7 U.S.C. 4j(a).
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    Clause (H) of Section 6(h)(3) \31\ provides that trading in a 
security futures product must not be readily susceptible to 
manipulation of the price of such security futures product, nor to 
causing or being used in the manipulation of the price of any 
underlying security, option on such security, or option on a group or 
index including such securities.
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    \31\ 15 U.S.C. 78f(h)(3)(H).
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    CME Listing Standards are designed to ensure that CME products and 
the underlying securities will not be readily susceptible to price 
manipulation. Exchange Rule 432 defines activity ``to manipulate prices 
or to attempt to manipulate prices'' as a ``major offense,'' 
punishable, per Exchange Rule 430, by ``expulsion, suspension, and/or a 
fine of not more than $1,000,000 plus the monetary value of any benefit 
received as a result of the violative action.''
    Clause (I) of Section 6(h)(3) \32\ requires that procedures be in 
place for coordinated surveillance amongst the market on which a 
security futures product is traded, any market on which any security 
underlying the security futures product is traded, and other markets on 
which any related security is traded to detect manipulation and insider 
trading.
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    \32\ 15 U.S.C. 78f(h)(3)(I).
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    CME is an affiliate member of the Intermarket Surveillance Group 
(``ISG'') and is party to an affiliate agreement and an agreement to 
share market surveillance and regulatory information with the other ISG 
members. Further, CME is party to a supplemental agreement regarding 
security futures

[[Page 77300]]

with the other ISG members with respect to affiliate ISG 
membership.\33\
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    \33\ See Joint Notice of Final Rules, Release No. 34-45956 (May 
17, 2002), 67 FR 36740, 36750-51 (May 24, 2002).
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    Note that CME Rule 424 permits CME to enter into agreements for the 
exchange of information and other forms of mutual assistance with 
domestic or foreign self-regulatory organizations, associations, boards 
of trade and their respective regulators.
    Clause (J) of Section 6(h)(3) \34\ requires that a market on which 
a security futures product is traded have in place audit trails 
necessary or appropriate to facilitate the coordinated surveillance 
referred to in the preceding paragraph.
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    \34\ 15 U.S.C. 78f(h)(3)(J).
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    The audit trail capability provided by GLOBEX[reg], the Exchange's 
trade matching engine, includes specialized electronic surveillance 
programs to identify potentially abusive trades and trade patterns. 
GLOBEX creates and maintain an electronic transaction history database 
that contains information with respect to all transactions executed on 
the Exchange. The audit trail capability includes an electronic 
analysis capability, permitting the sorting and presentation of data 
included in the transaction history in order to reconstruct trading and 
to identify possible trading violations with respect to both customer 
and market abuses.
    Information recorded with respect to each order includes: Time 
entered, terms of the order, order type, instrument and contract month, 
price, quantity, account type, account designation, user code and 
clearing firm. This information is archived and maintained by the CME 
Market Regulation Department.
    For orders that cannot be immediately entered into CME's systems 
and, therefore, will not be recorded electronically at the time they 
are received, Exchange Rule 536 requires that the complete written 
records of each order must be prepared and retained. Each such record 
must be retained for at least five years.
    Clause (K) of Section 6(h)(3) \35\ requires that a market on which 
a security futures product is traded have in place procedures to 
coordinate trading halts between such market and any market on which 
any security underlying the security futures product is traded and 
other markets on which any related security is traded.
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    \35\ 15 U.S.C. 78f(h)(3)(K).
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    The Exchange proposes to amend its Rules 71001.E. and 71301.E. to 
clarify that trading in security futures shall be halted when a 
regulatory halt occurs in the underlying security or securities, as 
defined in CFTC Regulation 41.1(l). The Exchange intends to make such 
amendment by certification of such amendments with the CFTC per Section 
5c(c) of the Commodity Exchange Act and Regulation 41.24 thereunder, 
with a copy to the SEC.
    Clause (L) of Section 6(h)(3) \36\ requires that the margin 
requirements for a security futures product comply with the regulations 
prescribed pursuant to Section 7(c)(2)(B) of the Act.\37\ As set forth 
in Amendment No. 1 to a Form 19b-4 separately filed by CME with the 
Commission on October 3, 2002, CME believes that its proposed Rules 
regarding customer margin are consistent with the requirements of the 
Act.
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    \36\ 15 U.S.C. 78f(h)(3)(L).
    \37\ 15 U.S.C. 78g(c)(2)(B).
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    For the reasons described above, CME submits that the CME Listing 
Standards submitted herewith, satisfy the requirements set forth in 
Section 6(h)(3) of the Act.\38\
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    \38\ 15 U.S.C. 78f(h)(3).
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2. Statutory Basis
    The CME Listing Standards are authorized by, and consistent with, 
Section 6(b)(5) \39\ of the Act because they are designed to prevent 
fraudulent and manipulative acts and practices and to promote just and 
equitable principles of trade.
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    \39\ 15 U.S.C. 78f(g).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CME does not believe that the CME Listing Standards will have an 
impact on competition because (1) it may be anticipated that other 
self-regulatory organizations that will list security futures products 
will adopt substantially similar listing standards; and (2) any 
concerns about possible anti-competitive effects should be evaluated in 
light of the standards applicable to other financial instruments based 
on narrowly based security indices or baskets, which are consistent 
with the CME Listing Standards.

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

    Comments on the CME Listing Standards have not been solicited.

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

    The proposed rule change has become effective on October 28, 2002, 
except that the technical changes made in Amendment Nos. 2 and 3 have 
become effective on November 5 and 19, respectively. Within 60 days of 
the date of effectiveness of the proposed rule change, the Commission, 
after consultation with the CFTC, may summarily abrogate the proposed 
rule change and require that the proposed rule change be refiled in 
accordance with the provisions of Section 19(b)(1) of the Act.\40\
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    \40\ 15 U.S.C. 78s(b)(1).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change conflicts with the Act. Persons making written submissions 
should file nine copies of the submission with the Secretary, SEC, 450 
Fifth Street, NW., Washington, DC 20549-0609. Comments also may be 
submitted electronically to the following e-mail address: [email protected]. 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 these 
filings also will be available for inspection and copying at the 
principal office of CME. Electronically submitted comments will be 
posted on the Commission's Internet website (http://www.sec.gov). All 
submissions should refer to File No. SR-CME-2002-02 and should be 
submitted by January 7, 2003.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\41\
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    \41\ 17 CFR 200.30-3(a)(75).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-31652 Filed 12-16-02; 8:45 am]
BILLING CODE 8010-01-U